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8 March, 2017
The provisions of the Insolvency and Bankruptcy Code, 2016 (“Code”) relating to the insolvency of companies and LLPs were notified on 1 December 2016. In the past three months anecdotal evidence suggests that scores of applications have been filed at the National Company Law Tribunal (“NCLT”) throughout the country. Of these, 64 cases have been listed, out of which 11 cases have been admitted and 13 have been rejected.1
The others are in different stages of being heard.
The number of published orders is still relatively low to be able to discern a pattern of (a) grounds on which applications are admitted or rejected; (b) NCLT judges’ willingness to grant adjournments; or (c) the NCLT track record in meeting the statutorily recommended limit of 14 days for disposing off applications.
Some important judgments have, however, been delivered by the NCLTs in the last couple of months which are discussed below.
ICICI v Innoventive Industries Limited (NCLT, Mumbai; 16 January 2017)
The first major case under the Code was filed by ICICI Bank Limited (“ICICI”) against Innoventive Industries Limited (“Innoventive”) before the NCLT, Mumbai Bench, where an application filed by ICICI to initiate the corporate insolvency resolution process (“CIRP”) against Innoventive, under Section 7 of the Code, was allowed.
Innoventive filed a writ petition before the Bombay High Court inter alia on the following grounds:
- challenging the constitutional validity of Sections 4 to 32 of the Code;
- the distinction in the Code between an ‘operational creditor’ and a ‘financial creditor’ with respect to the debtor’s right to be provided a notice and be heard before admission of an application under the Code;
- challenging the vires of Rule 4(3) and 10(1) of the Insolvency and Bankruptcy (Application to Adjudicating Authority) Rules, 2016 (“Rules”) on the ground that the same are vague, incomplete and / or unworkable;
- the order passed by the NCLT admitting ICICI’s application under Section 7.
However, before the Bombay High Court had occasion to decide the above questions of law, Innoventive’s Writ Petition was disposed of on account of the fact that Innoventive had also challenged the NCLT order admitting ICICI’s application before the National Company Law Appellate Tribunal (“NCLAT”). The matter is due to be heard at the NCLAT on 7th March 2017.
The questions raised in the writ petition still remain relevant and contentious including the question of whether financial creditors must be mandated to provide a notice to the corporate debtor prior to initiating a CIRP. Had the Bombay High Court ruled on these issues conclusively, it would have most likely closed the doors for any fresh writ petitions challenging the constitutionality of the Code on similar grounds.
Nikhil Mehta & others v AMR Infrastructures Ltd. (NCLT, New Delhi; 23 January 2017)
The applicants filed an insolvency application as a financial creditor (presupposing that they had a financial debt due to them). The applicants had booked real estate units and were promised monthly ‘assured returns’ until possession was offered. They claimed that the debt of ‘assured returns’ was in the nature of a ‘financial debt’. This case is important because the NCLT discussed the meaning of ‘financial debt’ and ‘time value of money’ for the first time.
The NCLT observed that a key ingredient of financial debt is that it must be disbursed against consideration for the time value of money. The NCLT referred to a dictionary meaning of ‘time value’, being ‘the price associated with the length of time that an investor must wait until an investment matures or related income is earned’. The Tribunal also observed that the underlying financial transaction must be in the nature of debt and not equity. The Tribunal did concede that there are “complex financial instruments” in the market and that it would not be “a happy situation to decipher the true nature and meaning” of such transactions – a reference perhaps to debt instruments whose return is linked to parameters observed in equity transactions.
In this case however, the Tribunal concluded that the amount paid by the applicants was for purchase of property and not financial debt; and that the essential ingredient of consideration for ‘time value of money’ was absent (i.e., on the facts, counsel for the applicants could not convince the Tribunal that the ‘assured monthly return’ was consideration for the ‘time value of money’).
This case will discourage operational debt being disguised as financial debt to avail of the benefits for such classification. It is also a reminder that there is ground to be covered in ‘deciphering complex financial instruments’ which have both debt and equity elements – and understanding whether they constitute financial debt.
KKV Naga Prasad v Lanco Infratech Limited (NCLT, Hyderabad; 21 February 2017)
The applicant was an ex-employee of the corporate debtor. He claimed he was owed certain amounts in connection with his employment which was disputed by the company. The application was rejected by the NCLT on the ground that the applicant (a) did not show his bona fides to the Tribunal (b) the applicant was not able to satisfactorily prove that debt was indeed due and payable (without which no default can have taken place and in the absence of which no insolvency application may be filed). This case seems to be one where the Tribunal was significantly influenced by the bona fides of the applicant and facts of the case (for e.g., the applicant took no significant action for over three years and seemed to not have taken up the corporate debtor on their offer to discuss and settle the matter). However there are a few points worth noting.
One of the arguments of the corporate debtor was that the non-payment of debt or default occurred prior to the Code coming into effect and therefore such debts cannot be the subject matter of an insolvency application under the Code. This contention was not considered by the Tribunal.
Another argument of the corporate debtor was that they had raised a dispute in relation to the debt. This dispute was raised after delivery of the demand notice and so the applicant argued that this was irrelevant and only a suit or arbitral proceeding filed in relation to the dispute regarding the debt before delivery of the demand notice would give grounds for rejection of the insolvency application. The Tribunal did not seem to decide this point. It did clarify however that the “Tribunal cannot go into roving enquiry into the disputed claims of the parties”.
The corporate debtor made a number of arguments challenging the existence of the debt. On the facts, it seemed that the applicant had thin grounds and limited documents to prove the existence of the debt. As a result, the Tribunal concluded that it did not have available for its consideration adequate and convincing documents that proved that any debt was due in the first place. And if the applicant could not prove the existence of debt, there was no question of a default, and so the Tribunal rejected the insolvency application.
While it is expected that details of financial creditors’ debt will be recorded in an information utility and admittedly, operational creditors are also able to do so, it is unlikely many operational creditors will have the commercial leverage to ensure this is done. So, operational creditors have an evidential burden to prove that their debt exists. In this regard, guidance is provided in Form 5 set out in the Rules.
The Code was a landmark financial sector reform and the past few months demonstrate that market participants have shown great interest in availing of its provisions. However, there is still inadequate jurisprudence created by the NCLTs to demonstrate a clear direction in which implementation of the IBC is headed.
1 Matters have currently been filed in Mumbai, New Delhi, Kolkata, Hyderabad, Allahabad and Chandigarh.
For further information, please contact:
Zia Mody, Partner, AZB & Partners
zia.mody@azbpartners.com
