The Insolvency and Bankruptcy Code (IBC) is a significant piece of Indian law that aims to quickly address the problems associated with insolvency and bankruptcy. Despite the admirable efforts made to implement the IBC, there have been a few incidents that have caused problems and raised questions about how well it will function going forward. To address these issues, the government has proposed certain amendments to the IBC, which aim to provide a clearer and more effective framework for the resolution of insolvency of the Corporate Debtor. In this article, a comprehensive examination of the Vidarbha Industries Power Limited vs. Axis Bank Limited (Supreme Court) (‘Vidarbha Industries’) will be conducted, including an brief examination of the government’s proposed modifications aimed at its impact.
THE ESTABLISHED LAW
1. Section 7 of the Insolvency and Bankruptcy Code, 2016, addresses the initiation of the corporate insolvency resolution process by the financial creditor. The section provides a framework for the financial creditor to approach the National Company Law Tribunal (NCLT) to initiate insolvency proceedings against a defaulting corporate debtor, outlining the procedure for filing an application and providing the grounds on which the insolvency proceedings can be initiated.
2. Section 7(5)(a) of the IBC reads: “Where the Adjudicating Authority(NCLT) is satisfied that— a default has occurred and the application under sub-section (2) is complete, and there is no disciplinary proceedings pending against the proposed resolution professional, it may, by order, admit such application.”
3. Moreover, sec 7(5)(b) states that if a default has not occurred or the application under sub-section (2) is incomplete or any disciplinary proceeding is pending against the proposed resolution professional, it may, by order, reject such application.
4. Thus, it would appear from Section 7 of the Code that the Adjudicating Authority lacks discretion over whether to accept or reject the application of the Financial Creditors’.
5. According to earlier Supreme Court rulings, the NCLT must limit its examination to two things: (1) the existence of debt; and (2) a debt’s default in payment. The Supreme Court ruled in Innoventive Industries Limited v. ICICI Bank (“Innoventive Industries”) that the purpose of the Code is to guarantee that the insolvency resolution process starts as soon as a default occurs and also held that the moment the NCLT is satisfied that a default has occurred, the application must be admitted.
6. Further, in Swiss Ribbons Private Limited v. Union of India (“Swiss Ribbons”), the Supreme Court elaborated on the decision laid down in Innoventive Industries and held that the trigger under the Code is the failure to pay debts. It further asserted that the legislative policy in India has observed a shift from the concept of “inability to pay debts” to “determination of default”. This shift enables the financial creditor to initiate the insolvency resolution process the moment there is evidence of a default, as is highlighted in the Bankruptcy Law Reforms Committee (“BLRC”) Report as the committee was opposed to introducing a test of solvency under Section 7.
7. In its report dated November 4, 2015 , the BLRC noted that previous laws had convoluted the process by allowing authorities to delve into the merits of the dispute and the solvency of the debtor, leading to prolonged delays and uncertain results.
THE VIDARBHA CASE
- In summary, Vidarbha Industries Power Limited (VIPL) was engaged in the business of production of Electricity, tariffs whereof is regulated by the MERC (Maharashtra Electricity Regulatory Commission) and APTEL(Appellate Tribunal for Electricity)
- The company was anticipating a sum of 1,730 crores due to a favourable ruling by APTEL However, MERC challenged this decision, and a verdict was awaited from the Supreme Court but during the pendency of the above appeal by MERC, an application under section 7 of the Code was filled by its financial creditor, Axis Bank limited
- VIPL filed an application seeking stay on proceedings under section 7 of the Code as long as the appeal filed by MERC was pending
- However both NCLT and NCLAT(Appellate Authority) refused to put stay on the proceedings and thus this case landed before the Supreme Court
1B) Supreme Court’s Ruling
- The Supreme court ruled in favour of VIPL and noted that the NCLT may reject an application even after the existence of debt and/or admission of default, and the existence of a financial debt and default in payment thereof only gave the financial creditor the right to apply for initiation of CIRP. The Supreme Court further noted that the use of the word “may” instead of “shall” in Section 7(5)(a) of the Code expressly showed the legislature’s intent to make the provision discretionary and not mandatory. The Code granted the tribunal discretion to accept or deny a Section 7 petition submitted thereafter by a financial creditor.
- Instead of using a purpositive construction to construe “may ” as “must,” The Supreme Court adopted the literal interpretation of the expression ‘may’.
- The Supreme Court stated that NCLT might exercise its discretion after considering all pertinent facts and circumstances, including the corporate debtor’s general financial health and viability
- Contrary to the position taken in Innoventive Industries, where it was decided that AA must commence CIRP if the twin prerequisites of debt and default are established, the Supreme Court took a different stance.
- This judgement provided the AA broad discretionary jurisdiction. Despite the Supreme Court’s pronouncement, the extent of discretion that can be exercised by the NCLT remains unclear, except for the requirement that it must not be arbitrary.
- Several stakeholders in the sector fiercely opposed this decision. Many believe that the judgement undermines the purpose of the IBC, which was established to provide a time-bound resolution process for NPAs and led to the worry that this decision will lead to further delays and legal battles, ultimately hurting the bottom line of many companies and adding to the mounting NPA burden.
- Further, BLRC in its Final Report,which was published in November 2015, promoted starting the insolvency resolution procedure merely based on the presence of a default. This position was subsequently supported by the court in the Swiss Ribbons case, where it was stated that legislative policy had changed from emphasizing a debtor’s inability to pay debts to a determination of default, enabling financial creditors to establish the debtor’s obligation to pay and their failure to do so through tangible documentary evidence.
THE WAY FORWARD
- On September 22, 2022, the Hon’ble Supreme Court dismissed the review petition instituted by Axis Bank Ltd against its verdict delivered in Vidarbha Industries, thereby affirming the Apex Court’s holding that the Adjudicating Authority under the Code must exercise due care to ascertain the financial health and viability of the corporate debtor prior to admitting a petition under Section 7 of the Code.
- On January 18, 2023, the Ministry of Corporate Affairs (MCA), issued a notification inviting comments from the public on changes being considered to the Code wherein following changes are proposed to overturn the precedent set by Vidarbha Industries judgement and improve the admission stage.
- It is proposed to amend Section 7 of the code to make it explicit that the Adjudicating Authority must accept the application and launch the CIRP after it is satisfied that a default has occurred and that all procedural conditions have been met, making the legislative intent more clear.
- Additionally, it is suggested that more reliance be placed on the Information Utilities’ (IU) record submitted during the admission process. When applying under sections 7 and 9, the evidence stored with the IUs will be required to be produced before the AA. This can be relied on for quick default verification and swift initiation of the CIRP.
The Vidarbha judgment is held to be unfavourable by a majority because it leads to a personalised test for the admission and initiation of CIRP instead of a standardized test, as advocated by the intent of the legislation and the BLRC report. Moreover, the limits of such discretion remain widely obscure, creating further complications. The government, particularly the MCA, took prompt measures to try to address the procedural errors and ensure that CIRP under the Code maintains a transparent and impartial mechanism. It’s possible that the government’s suggested revisions will clear up the murkiness surrounding the admission of applications, but it would have been better if the judiciary had acknowledged the adverse precedent that the Vidarbha Industries case had set.
Authored by- Vishal Palav and Ishita Mehta