Background

The judiciary has played a vital role in the evolution and strengthening of India’s insolvency regime under the Insolvency and Bankruptcy Code, 2016 (“IBC”). Landmark rulings by the Supreme Court (“SC”), the National Company Law Appellate Tribunal (“NCLAT”) and the National Company Law Tribunals (“NCLTs”) have taken pragmatic views and consistently addressed critical gaps in the law. Seven years after IBC’s enactment, NPAs are at a 10-year low at 3.9%^[1], the corporate credit culture in the country has improved and a behavioural change has been observed in promoters^[2]

Despite being a relatively nascent regime, the last seven years have seen development of a strong IBC jurisprudence delineating key legal principles which now form its backbone.

Nevertheless, there have also been instances of inconsistent court decisions, and rulings which are arguably contrary to the clear legislative intent behind the IBC. However, the Ministry of Corporate Affairs (“MCA”) and the Insolvency and Bankruptcy Board of India (“IBBI”) have played an active role in promptly addressing ambiguity arising due to inconsistent rulings, through amendments to the law and accompanying regulations. In fact, in January, 2023, the MCA issued a consultation paper (“MCA Proposal”), seeking public comments on proposed amendments to the IBC, many of which are aimed at addressing issues arising out of conflicting rulings.

This article discusses key principles that have evolved through case laws and landmark judgments since the IBC’s inception. While some of these rulings established key bedrock IBC principles, some arguably diluted the objective of the law.

Landmark judgments and key principles under the IBC

• Trigger for CIRP: Is a payment default enough?

Initiation of CIRP by a financial creditor under the IBC only requires establishment of a payment default^[3] (of at least INR 10 million). In 2017, the SC underscored this principle in the first application made under the IBC in its order in Innoventive Industries^[4], where it held that the once a debt and default are established and the application is complete, the NCLT must admit the application. However, in Vidarbha Industries^[5] a division bench of the SC diluted this principle and held that the NCLT has the discretion to not admit a CIRP application filed by a financial creditor despite the existence of payment default. The SC relied on the usage of the term ‘may..admit’ under Section 7 of the IBC and held that the NCLT may also consider viability and overall financial health of the corporate debtor while considering the initiation application. This order moved from an objective trigger test (i.e., establishment of payment default) for admission to a subjective one, opening the doors to long-winded litigation at the admission stage itself.

Importantly, in M Suresh Kumar Reddy^[6], a division bench of the SC held that the decision in Vidarbha Industries was specific to the facts of that case and is not contrary to the ratio in Innoventive Industries. While the Vidarbha ruling has been confined to the facts of the case, technically, it is yet to be overruled. In fact, one of the proposed changes under the MCA’s Proposal, is to clarify that once a payment default is established, the NCLT must mandatorily admit the application.

• Introduction of Section 29A: the Synergies Dooray case

Section 29A of the IBC disqualifies persons such as an undischarged insolvent, wilful defaulters, entities holding NPAs for over a period of one-year, certain convicted offenders, among others from bidding (even if the company is one the person is a promoter of) in a CIRP. This provision was introduced in November, 2017 over concerns that recalcitrant promoters were using CIRP to get an undervalued back-door entry to their company through CIRP. This concern took centre stage in the Synergies Dooray^[7] case, where Synergy Casting Ltd. (“SCL”), a related party of the corporate debtor bid for it under CIRP. SCL also held a significant size of the debtor’s debt. Creditors who are related parties of the corporate debtor are not allowed to be members of the committee of creditors (“CoC”) (which is tasked with critical decisions including voting on the plan). However, SCL assigned its debt to a third-party who then became a member of the debtor’s CoC. By assigning its debt to a third-party who had voting rights in the CoC, SCL was able to get a back-door entry to the debtor. Soon after this order, Section 29A was introduced in the IBC. Importantly, while Section 29A does not expressly bar promoters from bidding in CIRPs, the restriction relating to entities holding NPAs for a specified period often has the effect of barring promoters of distressed companies, if they wait for an extended period (around 18 months) post default to get restructuring completed.

• Group insolvency: the Videocon case

The IBC does not have a framework for group insolvency i.e., framework for cases where insolvency proceedings have been initiated against interdependent group companies, and where separate CIRPs for each group company may hinder the objective of value maximisation. Despite no existing group insolvency framework under the IBC, NCLT in Videocon Group^[8]ordered the consolidation of CIRPs of 13 group companies. It laid down a list of factors such as common control, inter-dependence, pooling of resources that may be considered to determine if substantive consolidation (i.e., merger of assets and liabilities) of CIRPs of group companies should be opted for. In another case in Uttam Galva^[9] and Uttam Value^[10], the NCLT adopted the procedural coordination approach (but not substantial) where procedural aspects of the CIRPs of the two group companies such as appointment of a common resolution professional for their CIRPs, date of NCLT hearings etc. were allowed to be coordinated.^[11]

• Immunity for past offences under Section 32A: the JSW-Bhushan Power case

JSW Steel’s resolution plan for Bhushan Power & Steel was approved by the NCLT in September, 2019. However, soon after, the Enforcement Directorate, attached the corporate debtor’s property in relation to alleged money laundering by its erstwhile promoters. JSW, as the successful resolution applicant approached the courts and sought immunity for offences committed by the erstwhile management of the corporate debtor. In what is widely believed to be a reaction to this case, Section 32A was introduced to the IBC. Put simply, Section 32A of the IBC protects bidders against liability associated with offences committed prior to initiation of CIRP and protects against attachment of the corporate debtor’s property for pre-CIRP offences.

• Cross-border insolvency: the Jet Airways case

India has not yet adopted the UNCITRAL Model Law on Cross-Border Insolvency. In 2019, Dutch insolvency proceedings were initiated against Jet Airways in the Netherlands. Simultaneously, a CIRP was initiated against the private airlines in India. Despite the absence of a legislative framework for cross-border insolvency in India, the NCLAT^[12] directed the Dutch administrator and the Indian resolution professional of Jet Airways to enter a cross-border insolvency protocol to cooperate and coordinate the two insolvency proceedings. This is yet another example of how court-driven solutions have filled important gaps in the law and strengthened the IBC regime.

• Validity of differential treatment of operational and financial creditors: the Swiss Ribbons case

In the landmark case of Swiss Ribbons, the SC considered whether the IBC’s differential treatment of operational creditors’ vis-à-vis financial creditors (i.e., lack of right of representation and voting in the CoC) was violative of Article 14 of the Constitution of India. The SC upheld the constitutional validity of the IBC provisions and held that there is an intelligible differentia between operational and financial creditors. It noted that financial creditors are typically involved in assessing the viability of the corporate debtor. Consequently, in times of financial distress, financial creditors engage in restructuring of the loan as well as reorganization of the corporate debtor’s business, which the operational creditors do not and cannot undertake.

• Supremacy of the commercial wisdom of the CoC: the K. Sashidhar case

In K. Sashidhar^[13], the SC held that the commercial wisdom of the CoC is supreme and that the NCLT and NCLAT are not endowed with the jurisdiction or authority to analyse or evaluate the commercial decisions of the CoC. In Essar Steel^[14], the NCLAT ordered the modification in distribution of amounts under the resolution plan to treat secured and operational creditors on par. In response to this widely criticised NCLAT ruling, Section 30 of the IBC was amended to specifically provide that the CoC may take it into account the priority and value of security interest of a secured creditor while voting on the manner of distribution under a resolution plan.^[15] Subsequently, the ruling of the SC in Essar Steel^[16] reaffirmed the primacy of the commercial wisdom of the CoC in the CoC in determining the feasibility and viability of a resolution plan.

• Treatment of ipso facto clauses under IBC: the Gujarat Urja case

Ipso facto clauses are provisions that allow termination of a contract upon the occurrence of a pre-defined event such as commencement of insolvency proceedings against the counterparty. Bankruptcy regimes in several jurisdiction such as the US and Singapore limit the enforceability of ipso facto clauses during bankruptcy proceedings. While section 14 of the IBC prohibits termination of (i) government licenses and permits and (ii) supply of essential goods or services to the corporate debtor during the moratorium, the IBC is silent on treatment of ipso facto clauses in other contracts. In Gujarat Urja,^[17] the SC ruled that NCLTs have the jurisdiction to stay the enforcement of ipso facto clauses if the termination is based solely on the grounds of insolvency and if the contract is critical to the survival of the corporate debtor. The order stayed the termination of power purchase agreement (“PPA”) of the corporate debtor by Gujarat Urja Vikas Nigam Limited (“GUVNL”) on the ground that GUVNL was the sole power purchaser of the company and termination of the PPA would result in its corporate death. Subsequent judgments have somewhat limited this ratio but the core principle remains.

• Introduction of Section 12A to allow withdrawal of CIRP: the Lokhandwala Kataria case

In 2017 in Lokhandwala Kataria ^[18], the SC exercised its inherent powers under Article 142 of the Constitution of India, to permit a settlement between the erstwhile management of the corporate debtor undergoing CIRP and its creditor and allow the withdrawal of the CIRP. Subsequently, Section 12A was introduced into the IBC in June, 2018 to provide for withdrawal of CIRP applications following a settlement with 90% of financial creditors.

• Priority of government dues backed by a statutory charge: the Rainbow Papers case

Dues owed to the government rank relatively low in priority^[19] in the liquidation waterfall set out in Section 53 of the IBC. Section 53 provides a separate and distinct treatment of dues owed to secured creditors who have relinquished their security to the liquidation estate (which is at level two of the waterfall) and dues payable to the government (which is at level five of the waterfall). However, in Rainbow Papers^[20], the SC held that in cases where a ‘charge’ is created (including deemed charges) over the assets of the corporate debtor in favour of the government under a statute, the government would be classified as a secured creditor and the government dues would rank at par with the debts owed to secured creditors. This is because a security interest could be created by an operation of law and governmental authorities are not excluded from the definition of secured creditors under IBC.

However, in PVVNL^[21], the SC confined the ruling in Rainbow Papers to the facts of that case. The order distinguished between (i) dues payable and required to be credited to the treasury (such as taxes or tariffs); and (ii) dues payable to statutory corporations and held that only the former would classify as ‘government dues’ (irrespective of whether they are backed by a statutory charge) and rank lower in priority to the class of creditors described in Clauses (a) to (d) of Section 53(1) of the IBC and the latter may be classified as operational creditors or financial creditors (whether secured or unsecured) depending on the nature of their transactions with the debtor.

• Liquidation as a going concern: akin to a CIRP?

Typically, liquidation involves a sale of assets, distribution of proceeds and dissolution of the corporate debtor. By way of an amendment dated July 25, 2019, to the IBBI Liquidation Process Regulations, 2016, the concept of sale of a company under a liquidation on a going concern basis was introduced (to effectively provide another chance to resolve the business than a sale of assets). NCLT rulings have held that ‘liquidation as a going concern’ is akin to a CIRP and provided reliefs usually granted in CIRP in these going concern sales as well. For example, in Sterling Biotech^[22], the NCLT approved the transfer of the corporate debtor through a ‘liquidation process as a going concern’ and permitted reliefs including extinguishment of the existing share capital and acquisition of the corporate debtor on a clean slate basis (akin to a CIRP). In SKP Steels^[23], the NCLT held that the sale of a corporate debtor through liquidation as a going concern is akin to a de-facto CIRP.

• Application of IBC principles outside of IBC proceedings: the IL&FS restructuring

In 2018, when Infrastructure Leasing and Financial Services Limited (“IL&FS”) defaulted on its debt repayments, no legal framework was in place for insolvency resolution of financial institutions. Even though IL&FS’ restructuring was outside the IBC framework, the NCLAT^[24] approved reliance on IBC principles such as moratorium in its restructuring process.

Conclusion

While this article focuses on key IBC principles that have evolved through case laws, other stakeholders such as the MCA, market professionals (lawyers, financial advisors, auditors etc.) and the IBBI have also actively contributed to the development of an efficient and well-regulated IBC ecosystem.

Pragmatic rulings, innovation by market players and prompt response by the regulator to address gaps in law has played an important role in development of an efficient insolvency regime.

However, IBC’s glowing track record has recently been affected by certain issues arising from contradictory rulings (such as the lack of clarity on treatment of statutory dues), and inordinate delays before NCLTs at the admission and resolution plan approval stage. Introduction of IBC amendments as proposed under the MCA Proposal will be key to strengthening the IBC regime and dealing with these issues.

The MCA Proposal addresses some critical issues such as: mandatory admission of a CIRP application filed by a financial creditor if payment default established (to reverse the Vidarbha order), increasing reliance on information utilities for establishment of ‘default’ to obviate lengthy admission proceedings, streamlining the prepack regime and expanding its applicability, introducing an equitable scheme of distribution of proceeds, providing clarity on treatment of claims backed by a ‘statutory charge’ (to address the issues arising from the Rainbow Papers order), among others.

Endnotes:

[1] The Reserve Bank of India, Financial Stability Report (June, 2023).

[2] Once a company is admitted into CIRP, the erstwhile board of directors is suspended and the management and control of the company is vested in a registered insolvency professional. Therefore, the erstwhile management lose control over their company once its admitted into CIRP. Moreover, Section 29A bars certain entities (such as wilful defaulters, certain convicted offenders and entities holding NPAs for more than a year, among others) from bidding in a CIRP. If the promoter is hit by any of these restrictions, then they run the risk of losing control over their company, once its admitted into  CIRP. This risk is believed to have led to behavioural change in the promoters. For example, according to data released by the IBBI, as on 31 May 2023, 25,565 applications for initiation of CIRP with an underlying default of around INR 8 trillion were resolved before the application was admitted i.e., as a result of the threat of IBC.

[3] Section 7, Insolvency and Bankruptcy Code, 2016.

[4] Innoventive Industries Ltd. v. ICICI Bank and Anr., (2018) 1 SCC 407.

[5] Vidarbha Industries Power Ltd. v. Axis Bank Ltd., (2022) 8 SCC 352.

[6] M. Suresh Kumar Reddy v. Canara Bank, (2023) 8 SCC 387.

[7] Synergies-Dooray Automative Ltd v. Edelweiss Asset Reconstruction Company Limited in C.A. No. 123 of 2017 in CP(IB) No. 01/HDB/2017

[8] State Bank of India and ors. v. Videocon Industries Limited, 2019 SCC OnLine NCLT 34792.

[9] State Bank of India v. Uttam Galva Steels Ltd., CP 2054/ I&BP/ NCLT/ MB/ 2018)..

[10] State Bank of India v. Uttam Value Steels Ltd., CP (IB) 1830/ MB/ 2017.

[11] State Bank of India v. Uttam Galva Metallics Limited, MA No. 1750 of 2019 in CP 2054 (MB) of 2018.

[12] Jet Airways (India) Limited v. State Bank of India, 2019 SCC OnLine NCLAT 1216

[13] K Sashidhar v. Indian Overseas Bank, (2019) 12 SCC 150.

[14] Standaard Chartered Bank v. Satish Kumar Gupta, 2019 SCC OnLine NCLAT 388.

[15] Committee of Creditors of Essar Steel India Limited v. Satish Kumar Gupta and Others, (2020) 8 SCC 531 (para 131).

[16] Committee of Creditors of Essar Steel India Limited v. Satish Kumar Gupta and Others, (2020) 8 SCC 531.

[17] Gujarat Urja Vikas Nigam Ltd. v. Amit Gupta, (2021) 7 SCC 209.

[18] Lokhandwala Kataria Construction Private Limited v. Nisus Finance and Investment Managers LLP, 2017 SCC OnLine SC 1715

[19] Government dues rank below the class of creditors described in Clauses (a) to (d) of Section 53(1) of the IBC, which are: (i) insolvency resolution process costs and liquidation costs; (ii) dues of secured creditors (if security is relinquished) and workmen dues (up to maximum of 2 years); (iii) employees’ dues (up to maximum of 1 year); (iv) dues of unsecured financial creditors.

[20] State Tax Officer v. Rainbow Papers Ltd., (2022) 13 SCR 808.

[21] Paschimanchal Vidyut Vitran Nigam Ltd. v. Raman Ispat Private Limited, 2023 SCC OnLine SC 842.

[22] Perfect Day Inc. v. Ms. Mamta Binani, Liquidator for Sterling Biotech Limited, 2022 SCC OnLine NCLT 283

[23] Soumitra Lahiri, Liquidator of SKP Steel Industries Private Limited, I.A.(I.B.)No. 1096/KB/2022 in C.P.(I.B.) No. 2171/KB/2019

[24] Union of India v. Infrastructure Leasing & Financial Services Ltd., NCLAT order dated March 12, 2020 [Company Appeal (AT) No. 346 of 2018]