On July 12, 2022, the Supreme Court of India (“Supreme Court”) passed a judgment in Vidarbha Industries Power Limited v. Axis Bank Limited[1] (“Vidarbha”), which considered the question whether Section 7(5)(a) of the Insolvency and Bankruptcy Code, 2016 (“Code”), is mandatory or discretionary in nature. Section 7(5)(a) of the Code states that the National Company Law Tribunal (“NCLT”) “may” admit an Application filed under Section 7 of the Code (“Application”), if (a) a default has occurred; (b) the Application is complete; and (c) there is no disciplinary proceeding pending against the proposed resolution professional. The Supreme Court held that Section 7(5)(a) of the Code allows the NCLT to reject an Application even if the financial creditor establishes ‘debt’ and ‘default’ on the part of the corporate debtor.
The Supreme Court held that the existence of debt and default merely gives the financial creditor a right to initiate the Corporate Insolvency Resolution Process (“CIRP”) and, if ‘reasons’ are provided and justified, the NCLT has the discretion to reject such Application. While the intent of providing such discretion was never to be unguided or arbitrary, a few examples of NCLT decisions would demonstrate that new defences are being considered while determining an Application filed by a financial creditor. Some of these decisions are analysed below.
The determination of financial viability:
In Bank of Maharashtra v. Newtech Promoters and Developers Private Limited[2], the financial creditor, Bank of Maharashtra’s Application was dismissed by the NCLT, New Delhi. Despite establishing ‘debt’ and ‘default’, the NCLT held that as the corporate debtor was working on an ongoing housing project, initiating CIRP would impair the interests of homebuyers. It was observed that despite the financial creditor fulfilling all the elements of Section 7 of the Code, the NCLT, considering the rights of third parties i.e., home buyers (who are in no manner involved in the proceedings), that will be impacted, proceeded to reject the Application.
In complete contrast to the above, a different bench of the NCLT, New Delhi, in Induslnd Bank Limited v. Hacienda Projects Private Limited[3], rejected the arguments of the corporate debtor (who was also a real estate developer) that, (i) the project undertaken by it was almost complete; (ii) it was a financially viable company; and (iii) initiation of CIRP would not be fruitful. The NCLT, New Delhi, in its reasoning, held that had the corporate debtor been financially healthy, it would not have defaulted in repayment. Moreover, completion of one project cannot be the sole criteria to decide the financial viability of a company. The NCLT, New Delhi, further noted that this is not an exceptional case where despite default, CIRP should not be initiated.
From the above decisions, it is apparent that the Vidarbha judgment has created some amount of ambiguity for the NCLT. It now appears that being a financially healthy corporate debtor is a criterion to reject the Application under Section 7 of the Code. What is interesting is that rights of third parties being impacted is an argument that can be taken by every corporate debtor since there will be vendors and unsecured creditors that will be impacted by CIRP initiation.
An example determining financial viability can be seen from the decision of the NCLT, Indore, in State Bank of India v. Krishidhan Seeds Pvt. Ltd[4], where the NCLT held that since:
(i) the corporate debtor had made payment of Rs. 2 crore to a different financial institution;
(ii) paid Rs. 6 crore to another entity towards part payment of debt;
(iii) generated a revenue of Rs. 175 crore in the previous financial year; and
(iv) thousands were employed by the corporate debtor.
It can exercise its discretion under Section 7 of the Code to keep the proceedings in abeyance for a period of six months. This stems from the Vidarbha judgment, which provides (Para 79) that “the Adjudicating Authority (NCLT) has been conferred the discretion to admit the Application of the Financial Creditor. If facts and circumstances so warrant, the Adjudicating Authority can keep the admission in abeyance or even reject the Application”.
However, this approach does not bode well with the objectives of the Code or the legislative intent behind bringing about the Code, which is to ensure the insolvency resolution of corporations, partnerships, and individuals in a “time-bound manner”.
Relegating parties to alternate dispute resolution:
In Whitestock Holdings Ltd. v. Prajay Holdings Pvt. Ltd[5], NCLT, Hyderabad, observed that prior to the filing of the Application under Section 7 of the Code, the parties had already approached the NCLT under Sections 241-242 of the Companies Act, 2013 (oppression and mismanagement), where the NCLT had referred the parties to mediation to settle their disputes. Considering that these disputes were being considered by the mediator, the NCLT, in the Application filed under Section 7 of the Code also relegated the parties to appear before the mediator.
The NCLT held that if an Application under the Code is being allowed, then automatically an order of moratorium in terms of Section 14 of the Code shall come into operation. Consequently, the ongoing mediation will be stayed. Hence, the choice of both parties for settling their disputes through mediation would be in jeopardy.
The financial creditor, Whitestock Holdings Ltd., challenged the order before the NCLAT, Chennai.[6] The NCLAT set aside the NCLT order, stating that as there existed a debt and default, there was no reason for the NCLT to not decide on the admissibility of the Application. Further, it was observed that there existed no reason in the present case, which would merit the NCLT using its discretion as provided in the Vidarbha judgment. Thus, the matter was remanded to the NCLT, Hyderabad, for fresh consideration. On an appeal filed by the corporate debtor against the order of the NCLAT (Prajay Holdings Pvt Ltd. vs. White Stock Ltd[7]), the Supreme Court refused to interfere with the order of the NCLAT. The matter is currently pending before NCLT, Hyderabad.
What next?
On January 18, 2023, the Ministry of Corporate Affairs, Government of India, invited comments from the public on the proposed amendment to the Code (“Proposal”). The Proposal noted that the Vidarbha judgment has interpreted the term ‘may’ in Section 7(5)(a) of the Code to indicate that the NCLT has the discretion to admit or reject the Application despite the existence of a default. Further, the Proposal clarified that the NCLT is not required to delve into factors relating to the solvency and financial health of the corporate debtor.
The Government of India has proposed to amend Section 7 of the Code to clarify that the NCLT must admit an Application on being satisfied that there exists a ‘default’ as defined under Section 2 of the Code. It is evident that the intention of the Legislature was never to provide any discretion to the NCLT as held by the Supreme Court in the Vidarbha judgment.
Conclusion
Evidently, divergent views and interpretations have been taken by the NCLT and NCLAT post the Vidarbha judgment. Certain NCLTs have also required additional thresholds to be met before passing an order of admission. These additional requirements, such as financial solvency or impact on third-party rights, would drastically increase the time needed to assess each Application under the Code. It remains to be seen if the Supreme Court will reconsider this aspect of discretion of the NCLT in the case of Maganlal Daga HUF v. Jag Mohan Daga[8],where submissions were madethat the Vidarbha judgment runs contrary to the settled position of law in Innoventive Industries Ltd. v. ICICI Bank[9] and E S Krishnamurthy v. Bharath Hi-Tech Builders Pvt. Ltd[10]. In the very same case, the Solicitor General of India has submitted that the principles of the Vidarbha judgment dilute the very substratum of the Code. The alternate possibility is that the Code is amended (after considering all comments from the public) since the intention of the legislature is clear when it comes to admitting Applications that establish ‘debt’ and ‘default’
For further information, please contact:
Sharan Kukreja, Partner, Cyril Amarchand Mangaldas
sharan.kukreja@cyrilshroff.com
[1] (2022) 8 SCC 352 (Supreme Court, decided on July 12, 2022)
[2] MANU/NC/5110/2022 (NCLT, New Delhi, decided on October 14, 2022)
[3] MANU/NC/5231/2022 (NCLT, New Delhi, decided on November 11, 2022)
[4] MANU/NC/4700/2022 (NCLT, Indore, decided on August 25, 2022).
[5] MANU/NC/2778/2022 (NCLT, Hyderabad, decided on May 13, 2022).
[6] White Stock Limited v. Prajay Holdings Private Limited, MANU/NL/0677/2022 (NCLAT, Chennai decided on September 7, 2022).
[7] MANU/SCOR/118874/2022 (Supreme Court, decided on November 30, 2022).
