Context

• The Supreme Court in its recent judgment has held that Section 7(5) (a) of the Insolvency and Bankruptcy Code (IBC) confers discretionary power on the adjudicating authority, i.e. National Company Law Tribunal (NCLT) to admit an application of a financial creditor under the Code for initiation of corporate insolvency resolution process (CIRP).
• The Apex Court with its aforesaid finding thus differed from the long-settled view that the moment the Adjudicating Authority is satisfied that a default has occurred, the application must be admitted unless it is incomplete.

Observations in SC judgment

• Case ruling: The Supreme Court judgment in Vidarbha Industries Power Ltd. v. Axis Bank held that the NCLT cannot admit an insolvency application filed by a financial creditor merely because a financial debt exists and the corporate debtor has defaulted in its repayment.
• Additional grounds: Instead, the NCLT must consider any additional grounds that the corporate debtor may raise against such admission.
• Significance: This interpretation could fundamentally reshape a crucial innovation in the IBC framework.

Concerns

• NCLT hesitation: Even if the NCLT is satisfied that a financial debt exists and that the corporate debtor has defaulted, it may not admit the case for resolution if the corporate debtor resists admission on any other grounds.
• Misuse by debtors: Corporate debtors are likely to use this precedent to the fullest to resist admission into IBC.
• Larger implication: The likely outcome of the latest ruling would be more litigation and delay at the admission stage, enhancing the risks of value destruction in the underlying distressed business.
• Another failure: Unless the NCLT consciously constrains the use of its own discretion at the admission stage, the IBC may well end up like the repealed Sick Industrial Companies Act (SICA).
  • About SICA: SICA 1985 was a key piece of legislation that was enacted in India to detect unviable ("sick") or potentially sick companies and to help with their revival, if possible, or their closure, if not.
  • Significance: This measure was taken to release investment locked up in unviable companies for productive use elsewhere. However, SICA failure was an unintended consequence of this pro-revivalist judicial approach.
  • Tribunal: The SICA had established the Board for Industrial and Financial Reconstruction (BIFR) as a specialist tribunal to ensure speedy resolution of distressed industrial companies.
  • Failure: The BIFR became a haven where companies could seek shelter from their creditors for years, with managers siphoning off assets in the interim.
  • Findings: A study revealed that a series of judicial innovations with the stated intention to facilitate rescue of distressed companies resulted in improving the position of some stakeholders at the expense of others, particularly institutional creditors such as banks.

Determining insolvency

• Balance-Sheet Test: It is a legal exercise to establish whether the company is in an insolvent state. A court determines what value to attribute to the prospective and contingent liabilities of a company. This includes deferred payments or potential litigation decisions against a company, so that a precise arrangement can be made.
• Drawback: This test, however, is vulnerable to the quality of accounting standards. That’s why the Bankruptcy Law Reforms Committee did not favour this test in the Indian context.
• Twin-test: The Bankruptcy Law Reforms Committee recommended that a filing creditor must provide a record of the liability (debt), and evidence of default on payments by the corporate debtor.
• Importance: This twin-test was expected to minimise litigation at admission stage, enabling quicker resolution of distressed businesses.

About Corporate Insolvency Resolution Process (CIRP)

• It is a recovery mechanism for creditors. If a corporate becomes insolvent, a financial creditor, an operational creditor, or the corporate itself may initiate CIRP.
• The CIRP may include necessary steps to revive the company such as raising fresh funds for operation, looking for new buyer to sell the company as going concern.
• CIRP in a case under Insolvency and Bankruptcy Code, 2016 (IBC) should be completed within 180 days or within the extended period of 90 days and mandatorily be completed within 330 days including any extension, including time taken for litigation.

About Insolvency and Bankruptcy Code

• Legislation: In 2016, the Insolvency and Bankruptcy Code was passed to tackle the mounting bad debts and to favour the creditor e.g. banks in recovering debts and avoiding bad loans during the resolution process.
• Applicability: It is India's bankruptcy law that applies to all businesses, partnerships, and individuals (other than financial firms).
• Time frame: The Company is subject to a 180-day moratorium (which can be extended up to 270 days). The resolution time frame for startups and small businesses is 90 days, which can be extended by 45 days.
• Four-pillar institutional framework : IBC comprises of NCLT and NCLAT, the adjudicating authority; Insolvency and Bankruptcy Board of India (IBBI), the regulator of insolvency professionals and insolvency professional agencies; Insolvency professionals, the class of regulated persons responsible for the efficient execution of the processes specified under IBC; and Information utilities, the new industry to electronically store facts about lenders and terms of lending.

Conclusion

• In all fairness, the Supreme Court has been extremely pragmatic in its interpretation and application of the IBC. Even in the recent ruling, the court has rightly cautioned that the NCLT should not exercise its discretionary power in an arbitrary manner.
• Yet, this decision may have opened a Pandora’s box. Policymakers would be well-advised to take note before history starts repeating itself.
• Moreover, the law must clearly provide the grounds on which an insolvency application against a corporate debtor should be admitted. This could minimize litigation and the distressed business could be resolved faster. Evidently, objective legal criteria for admission are critical for an effective corporate insolvency law.