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Initiation Of Corporate Insolvency Resolution Process By Financial Creditors – Now A Discretionary Relief! – Insolvency/Bankruptcy



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I. INTRODUCTION

The Insolvency and Bankruptcy Code, 2016
(“Code“) was enacted at a time when
there was no singular law which dealt with insolvency and
bankruptcy in India. A perusal of the statement of objects and
preamble of the Code reveal that it was enacted to consolidate the
law of insolvency resolution of companies, partnerships etc in a
time bound manner, for maximisation of assets and for balancing of
interests of all stakeholders.

Since the inception of the Code, the Hon’ble Supreme Court
of India (“Supreme Court“) has in
several judgments interpreted various provisions of the Code.
Keeping with the legislative intent behind the enactment of the
Code, the Supreme Court has in several judgments upheld that the
objective of the Code has been timely resolution of the
Corporate Debtor who is in the red
.

In the case of Vidarbha Industries Power Limited v. Axis
Bank Limited
(2022 SCC Online SC 841)
(“case“), the Supreme Court was
presented with a set of facts which necessitated adjudication on
the discretionary powers of the Adjudicating Authority (as
defined as “National Company Law Tribunal” under Section
5(1) of the Code
) basis the statutory interpretation of
Section 7(5) (a) of the Code. Upon a detailed consideration of the
rules of statutory interpretation, a division bench of the
Hon’ble Supreme Court rejected the view of National Company Law
Tribunal, Mumbai (“NCLT Mumbai“) and
National Company Law Appellate Tribunal
(“NCLAT“) and vide order dated 14th July
2022 inter alia held that the Adjudicating Authority has the
discretion powers to admit or dismiss a petition under Section 7
even in the existence of debt and default. Pertinently, the Supreme
Court has also held that these discretionary powers cannot be
wielded arbitrarily, and the discretionary powers can be exercised
by the Adjudicating Authority only when the facts and circumstances
of the cases warrant this exercise.

The present news-alert discusses the observations made by the
Supreme Court in the said judgment and its implications.

II. Summary of the Order dated 14th July 2022
(“Judgment”)

A. Facts of the case:

  1. The Appellant/original Corporate Debtor, Vidarbha Industries
    Power Limited (“Corporate Debtor“), a
    power generating company, was awarded the contract for
    implementation of a group power project
    (“GPP“) by the Maharashtra Industrial
    Development Corporation. The GPP was later converted into an
    Independent Power Project.

  2. In 2016, the Corporate Debtor filed an application with the
    Maharashtra Electricity Regulatory Commission
    (“MERC“) for the purpose of truing up
    the aggregate revenue requirement and for determination of tariff
    in terms of MERC (Multi Year Tariff) Regulations, 2011, in view of,
    inter alia, the increase in fuel costs, consequential to
    the rise in the cost of procuring coal for the purpose of running
    the power plant. The same was disallowed by MERC. Thereafter, the
    Corporate Debtor appealed before the Appellate Tribunal for
    Electricity (“APTEL“), wherein the APTEL
    allowed the appeal (“APTEL Order“). A
    sum of Rs. 1730 Crores was due to the Corporate Debtor in terms of
    the APTEL Order. In the meanwhile, MERC filed a civil appeal before
    the Hon’ble Supreme Court challenging the APTEL Order
    (“MERC Appeal“) which is still
    pending.

  3. In view of the MERC Appeal, the Corporate Debtor was unable to
    implement the directions of APTEL due to which it suffered
    financial difficulties. According to the Corporate Debtor,
    implementation of the APTEL Order would have enabled it to clear
    all its outstanding liabilities.

  4. On or about 15th January 2020, Axis Bank Limited, a Financial
    Creditor of the Corporate Debtor, filed an application under
    Section 7(2) of the Code before the NCLT Mumbai for initiation of
    Corporate Insolvency Resolution Process
    (“CIRP“) against the Corporate Debtor.
    The Corporate Debtor preferred a stay proceeding before the NCLT
    Mumbai and the same was dismissed on 29th January 2021. While
    dismissing the application of the Corporate Debtor for the stay
    proceedings, the NCLT Mumbai was of the view that the dispute
    between the Corporate Debtor and MERC was extraneous to the matters
    involved in the present proceedings before the Adjudicating
    Authority and will have no bearing and impact on the issues
    involved under the Code. The CIRP would be initiated against the
    Corporate Debtor if two most important requirements are satisfied
    under the Code i.e., existence of a valid debt and default on the
    Corporate Debtor in making the repayments. If these two aspects are
    satisfied, the Company Petition under Section 7 of the Code shall
    be maintainable.

  5. The Corporate Debtor filed an appeal before the NCLAT
    challenging the order of the NCLT Mumbai which also came to be
    dismissed.

  6. Aggrieved by the decisions of the NCLT Mumbai and the NCLAT,
    the Corporate Debtor approached the Supreme Court.

B. Outcome

The key issue that arose for determination before the Supreme
Court was the interpretation Section 7(5)(a) of the Code and
whether the same could be construed to vest discretionary powers in
the Adjudicating Authority whilst considering admission of
petitions filed under Section 7 of the Code.


  1. The interpretation of Section 7(5)(a) of the
    Code

    The Supreme Court was of the view that the term
    “satisfied” used in Section 7(5) of the Code
    showcases that it is the discretion of the Adjudicating Authority
    to accept or reject the application. The NCLT Mumbai and the NCLAT
    proceeded with a view that an application filed under Section 7(5)
    of the Code must be mandatorily admitted if the Adjudicating
    Authority is satisfied that there exists a debt. The Supreme Court
    rejected this interpretation of the NCLT Mumbai and the NCLAT and
    examined the merits of the contention of the Corporate
    Debtor.

    In Swiss Ribbons v. Union of India, it
    was held that “the imperativeness of timely resolution of
    a Corporate Debtor, who was in the red, indicated that no other
    extraneous matter should come in the way of expeditiously deciding
    a petition under Section 7 or under Section 9 of the
    IBC”
    . Though the Supreme Court partially agreed with the
    above view, however, it also stated the viability and overall
    financial health of the Corporate Debtor are not extraneous
    matters. The Supreme Court observed that the Adjudicating Authority
    must examine the expedience of initiation of CIRP, considering all
    relevant facts and circumstances, including the overall financial
    health and viability of the Corporate Debtor. In the present case,
    the NCLT Mumbai must have applied its mind to relevant factors
    including the feasibility of initiation of CIRP, against an
    electricity generating company operated under statutory control,
    the impact of the MERC Appeal, pending in this Court, the APTEL
    Order and overall financial health and viability of the Corporate
    Debtor.



  2. Interpretation of Section 9(5)(i) and Section 7(5)(a)
    while interpreting the word “May” and
    “Shall”

    The court juxtaposed the two provisions by interpreting the usages
    of the words “may” and
    “shall”. The Supreme Court has held that the
    expression “may” used in Section 7(5)(a) of the Code
    shows that the provision is not mandatory in nature. Whereas the
    expression “shall” used in Section 9(5)(a) of
    the Code is a mandatory provision and therefore, an application of
    an Operational Creditor shall be mandatorily accepted if the
    conditions provided under the said Section are satisfied.

    Normally, the term “may” is indicative. In
    contrast, the term “shall” imply a necessary
    duty. The usage of the word “shall” imply that a
    provision is mandatory. However, additional elements such as the
    scope of the statute and the consequences of the construction may
    rebut the prima facie inference that the provision is
    mandatory. Thus, the legislature intended Section 9(5)(a) of the
    Code to be mandatory and Section 7(5)(a) of the Code to be
    discretionary. It is also pertinent to note that Section 7(5)(a) of
    the Code is applicable to the Financial Creditors and Section
    9(5)(a) is applicable to the Operational Creditors. Non-payment of
    admitted dues may have significantly more serious consequences for
    an Operational Creditor than for a Financial Creditor. The
    differentiation between both is a legislature-conscious
    choice.

    A similar view of the Supreme Court was laid down by the National
    Company Law Tribunal, Kolkata in the case of State Bank
    of India v. N. S. Engineering Projects Pvt. Ltd.
    An
    important question of law that was carved out in this case, was
    whether the Adjudicating Authority is bound to admit an application
    under Section 7 of the Code when it is alleged that there is
    contributory negligence arising out of non-disbursement of the
    amount sanctioned by the Financial Creditor leading to the alleged
    default by the Corporate Debtor. While interpreting the meaning of
    the word “may” used in Section 7(5)(a) of the
    Code, NCLT held that the “adjudicating authority
    “may” by an order admit application under Section 7(5)(a)
    of the IBC if it is satisfied that there exists a default. It
    cannot be extended to a situation where the Financial Creditor, by
    its own acts of omission and commission, contributes to the default
    on the part of the Corporate Debtor. The present proceedings
    initiated by the Financial Creditor seems to be for purposes other
    than insolvency resolution of the Corporate Debtor, and is,
    therefore, liable to be rejected.”

    The objective of the Code is to maximize the value of the assets of
    the Corporate Debtor, promote entrepreneurship, and avail credit.
    It is not the objective of the Code to penalize solvent companies,
    temporarily defaulting in repayment of their financial debts, by
    the initiation of CIRP. Thus, legislation has given discretionary
    powers to the Adjudicating Authority under Section 7(5)(a) of the
    Code to admit an application of the Financial Creditor under
    Section 7 of the Code for initiation of CIRP.



  3. The need to interpret statutes.

    The Supreme Court was of the view that NCLT Mumbai and the NCLAT
    should have taken the literal interpretation of the statute. The
    most predominant and paramount principle of statutory
    interpretation is the rule of literal interpretation. Intentional
    interpretation can only be used when the plain words of a statute
    are ambiguous or if construed literally, the provision would
    nullify the object of the statute or otherwise result in an absurd
    result. The Supreme Court relied on the decision of
    Hiralal Rattanlal v. State of Uttar
    Pradesh
    wherein it was held that a statute must be
    interpreted by the rule of literal interpretation if the provision
    is unambiguous, and the legislative intent is clear. The other
    rules of construction of statutes are called into aid only when the
    legislative intent is not clear.

    Since there is no ambiguity in Section 7(5)(a) of the Code, it can
    be said that the legislature never intended to make Section 7(5)(a)
    of the Code a mandatory provision.

III. Conclusion

The rationale of the Supreme Court is based on the general
principles of interpretation of statutes. The Supreme Court has
interpreted the word “may” in Section 7(5) (a)
of the Code to uphold the discretionary powers vested in the
Adjudicating Authority whilst deciding petitions filed by Financial
Creditors under Section 7 of the Code. In doing so, the Hon’ble
Supreme Court has taken a liberal interpretation of the provisions
of the Code to hold that it is not the intention of the Code to
penalize solvent companies who have temporarily defaulted in
repayment of financial debts
. However, these discretionary
powers are in no manner unfettered. The Supreme Court has also
cautioned that the said discretionary powers must be exercised in a
particular manner based on the facts and circumstances of the case.
Whilst this move is a welcome relief for Corporate Debtors who have
for genuine grounds lapsed in payments, the possibility of misuse
to frustrate the object of the Code can certainly not be ruled
out.

The order passed by the Supreme Court, is landmark in so far as
it emphasises an element of discretion vested in the Adjudicating
Authority whilst considering petitions filed for default in
re-payment of financial debts under the Code. The order is in stark
contrast to the established hierarchy and preference enjoyed by
Financial Creditors in the implementation of the Code. Furthermore,
the order also serves as a stark departure of the practical
implementation of the Code and the summary nature of proceedings
before the Adjudicating Authority. Prior to the Judgment, it was
settled law that once the existence of debt and default is proved,
petitions under Sections 7 and 9 of the Code must be admitted by
the Adjudicating Authority. However, pursuant to the Judgment of
the Supreme Court, the Adjudicating Authority is obligated to
evaluate if the discretionary powers under Section 7(5) (a) ought
to be exercised basis the facts and circumstances of each case.

In the facts of the present case, the Corporate Debtor had
arguably made out a prima facie case that it was otherwise
a solvent company. In view thereof, as per the judgment, the NCLT
Mumbai and the NCLAT ought to have exercised discretion under
Section 7(5) (a) of the Code. Apart from laying down the broad
contours of the discretionary powers, the Judgement does not set
out any clear parameters for the exercise of such discretionary
powers. In view thereof, it remains to be seen how the Adjudicating
Authority will exercise its discretion specially in cases which are
not straightforward and in which proof of solvency and temporary
lapse in repayment cannot be easily ascertained.

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.

POPULAR ARTICLES ON: Insolvency/Bankruptcy/Re-structuring from India



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