The bankruptcy process in India before the enactment of the Insolvency and Bankruptcy Code, 2016 (code), was fragmented with the rights of creditors and debtors decided by different judicial forums with sometimes conflicting decisions resulting in lack of clarity regarding jurisdiction and appeals.
This led to a loss of economic value of assets of corporate debtors, loss of public money and even confidence in the bankruptcy resolution process. The code was enacted as a comprehensive legislation to preserve economic value, revive corporate debtors where possible and prevent value depletion by promoters continuing to manage corporate debtors that they had driven to the verge of bankruptcy.
Inevitably, the legislation faced several challenges not only in its implementation but even on its constitutional validity.
In Swiss Ribbons Pvt Ltd v Union of India & Ors, the Supreme Court laid to rest the question over the constitutional validity of the code. The attack on the validity of the code was manifold – the hostile and irrational discrimination between financial creditors and operational creditors; the procedure for appointment of members of the National Company Law Tribunal (NCLT) and the National Company Law Appellate Tribunal (NCLAT); the NCLT and the NCLAT functioning under the Ministry of Corporate Affairs instead of the Ministry of Law and Justice; the seat of the NCLAT being confined to the National Capital Territory of Delhi; and the arbitrary exclusion of “connected persons” from becoming resolution applicants.
The complaint that access to the appellate tribunal was not available as easily and quickly as when bankruptcy matters were decided by high courts was assuaged by the attorney general’s assurance that the NCLAT would have circuit benches. The Supreme Court directed that administrative support for the NCLT and NCLAT should be provided by the Ministry of Law and Justice.
The distinction in the rights of financial and operational creditors was based on “intelligible differentia” in keeping with the objectives of the code, the Supreme Court ruled. Financial creditors are usually banks and financial institutions who lend money to the companies and their claims are generally large and secured, unlike those of operational creditors, who supply goods or services.
Financial creditors evaluate financial viability when lending and have larger amounts outstanding to them. They are consequently willing to modify the terms of liability and accept the risk of postponing repayments to secure repayment, unlike operational creditors. Therefore, it is sound practice for the restructuring and reorganizing of loans and businesses to be undertaken only by financial creditors. Operational creditors have priority of payment over financial creditors in all eventualities – resolution or liquidation, so their interests are secured. Therefore, it is proper that financial creditors alone have a vote on the resolution plan despite operational creditors having a seat at the table.
Section 29A of the code prescribes disqualification criteria for resolution applicants. Subsection (c) barred persons who have an account with or manage a corporate debtor whose account was classified as non-performing as per Reserve Bank of India (RBI) guidelines and had remained so for more than a year. The restriction was challenged as arbitrary and contravening article 14 of the constitution as it did not distinguish a good manager from bad. The court disagreed and held that the objective of the code was to assist corporate debtors, not promoters or managers. The restriction on such applicants was proper.
Section 29A(j) was challenged for barring a resolution applicant merely for being related to an ineligible person. The court ruled that the restriction would apply only to persons who had a connection with the “business activity” of the ineligible persons in the past, or at the time of applying as a resolution applicant and not otherwise. The challenge against the non-applicability of disqualification criteria under section 29A to promoters of micro, small and medium enterprises (MSME) businesses was rejected by the court due to limited interest in the revival of such businesses. Usually, MSME promoters alone were interested in these businesses and if they were non-willful defaulters, the disqualification would not apply to them and this reasoning for the exemption of section 29A found favour with the court.
The approval of 90% of the committee of creditors with voting rights for withdrawal of proceedings after the start of the resolution process, since proceedings are in rem, was proper according to the court.
The insolvency code is here to stay!
Karthik Somasundram is a partner and Shreya Gupta is a senior associate at Bharucha & Partners.