Change in principles for initiation of CIRP by financial creditors

The judgment of the Supreme Court in Vidarbha Industries Power Ltd. v. Axis Bank Ltd.¹ has brought about a remarkable shift in principles governing initiation of corporate insolvency resolution process (CIRP) by the financial creditors.

Background

The Insolvency and Bankruptcy Code, 2016 (IBC)² was brought in to streamline the insolvency process of corporates in India, to reduce the delays in the insolvency process and to consolidate and simplify multiple legislations that existed earlier.

The IBC lays an emphasis on the aspect of “default” in paying the debt. This is highlighted in earlier judgments of the Supreme Court on IBC. In Innoventive Industries Ltd. v. ICICI Bank³ (Innoventive) the Supreme Court held that the scheme of IBC is to ensure that when a default takes place, the insolvency resolution process begins. Thus, the application must be admitted the moment NCLT is satisfied that a default has occurred.

This was further reiterated in Swiss Ribbons (P) Ltd. v. Union of India⁴, that non-payment of dues is a trigger in the current insolvency regime. It further held that legislative policy in India has shifted from the concept of “inability to pay debts” to “determination of default”. Thus, moment there is a default and if this can be shown to NCLT, then NCLT had to initiate insolvency resolution process.

Vidarbha judgment

This position however has received a jolt by the pronouncement in Vidarbhacase⁵. In this case, Vidarbha Industries Power Ltd., the appellant challenged the order of NCLAT⁶ which had rejected its appeal for stay on CIRP initiated by Axis Bank Ltd. The stay was sought on the ground that Vidarbha was to receive a sum of Rs 1730 crore from Maharashtra Electricity Regulatory Commission (MERC), pursuant to an order of Appellate Tribunal of Electricity (APTEL). However, MERC had filed a civil appeal before the Supreme Court which was pending. Here, though Vidarbha may have defaulted in making payments to Axis Bank Ltd., yet the reasons for it were that it was to receive an amount larger than the debt to the creditor.

It is in this context, the Supreme Court held that Section 7(5)(a)⁷ IBC confers a discretionary power on the NCLT to admit an application of insolvency after the financial creditor has proved the existence of default. It held that Section 7(5)(a) is directory and not mandatory in nature. It also referred to the difference in the language employed by the legislature in provisions relating to financial creditors and operational creditors and held that the legislature intended the provisions of financial creditors to be discretionary. It has directed the NCLT to apply its mind to relevant factors including the feasibility of initiation of CIRP, order of APTEL referred to above and the overall financial health and viability of the corporate debtor under its existing management. It held that NCLT has to exercise its discretion to admit an application under Section 7 and it may initiate CIRP upon satisfaction of debt and default unless there are good reasons to not admit the said petition.

Thus, according to Vidarbha case⁸, the reasons for non-payment of debt have to be gone into and considered on its own merits along with other considerations such as awards, decree, financial health, and viability. This discretionary power of NCLT cannot be exercised arbitrarily or capriciously. While considering the reasons for non-payment of dues, it could be due to various reasons some of which may be straightforward genuine case while others may fall into different shades which are explained below.

Shades of non-payment of debt

The non-payment of debt can be classified into the following four shades—

1. Pure white

In these cases, a court would have restricted corporate debtor from making the payment to the creditors. The Reliance Nippon Life Asset Management Ltd. v. Dewan Housing Finance Corpn. Ltd.⁹ case is a good example of this. In a suit filed against DHFL by Reliance Nippon Life Asset Management Ltd. seeking money decree in sum of Rs 479,21,29,113, the Bombay High Court passed an interim order on 10-10-2019 temporarily injuncting DHFL from making further payments to any secured and unsecured creditor of DHFL without the sanction of the Court¹⁰. The CIRP was initiated against DHFL on 3-12-2019 by NCLT, Mumbai on an application filed by RBI¹¹. This application for initiation of CIRP ought to have been rejected as although there was a debt and there is a default, yet the default is due to an interim order of the Court operating against DHFL. Therefore, CIRP initiated against DHFL should now be set aside, in view of the Bombay High Court order as well as the Vidarbha case¹².

In such cases, although it is advisable that the creditors should approach the court concerned which has prohibited release of payments, they will have to satisfy the court their locus in the case, and it will perhaps lead to two or more creditors conducting parallel proceedings against one company outside of IBC regime.

2. Light grey

In these cases, there is a delay in enforcement of arbitration award or financial award won by corporate debtor against a third party. This was the situation in Vidarbhacase¹³. The application was therefore rightly rejected in Vidarbha¹⁴ by ordering the NCLT to scrutinise the application for initiating CIRP by financial creditors as explained in foregoing paras.

However, in order that the creditors should not remain remediless, it is advisable that the creditors should come together and join the corporate debtor company to request the arbitral institution or court to expedite the honouring of the award. This approach is also not free from difficulties as creditors will not have locus to be a party in the proceedings unless some rights under the contract through which arbitral award is sought to be enforced is assigned or beneficiary interest is transferred. A stranger cannot be made a party to the lis between two private parties. Moreover, arbitration award also has to be executed to realise the amounts and by merely being a party will not serve much useful purpose.

3. Grey

These are cases when money is due to corporate debtor from a company which has delayed making payment and corporate debtor had filed a recovery suit. This was the case in GTL Infra. Here GTL Infra was to receive dues from Aircel. Hence the IBC application by creditors of GTL Infra was rejected. Here also for creditors to become party to the proceedings between corporate debtors and its debtors is not fraught with difficulties as earlier case.

Also, in this head would fall the Videocon Industries case. Videocon had filed a case against DOT for damages of Rs 10,000 crore for loss caused due to cancellation of licences after 2G scam. Videocon was admitted to IBC prior to the clarity provided by the Supreme Court in Vidarbha case¹⁵ on Section 7(5)(a). Thus, it is the responsibility of the resolution professional (as an officer of Court/NCLT) to approach NCLT to determine whether Videocon Industries should be retained or discharged from CIRP/IBC and if it is to be retained, approach the appropriate court for expediting its order on case relating to compensation/damages for cancellation of 2G licences to protect the interest of all the stakeholders.

But this being a case of damages, a caution has to be sounded as the claim for damages is a liquidated amount and damages will have to be proved at trial.

4. Deep grey

These are cases where the corporate debtor is to receive payments from third party however that third party has delayed making payments and the corporate debtor has also not taken any steps to recover the said amount i.e. by way of filing suit for recovery of money. In this case, it is just and equitable that CIRP be initiated against the corporate debtor because it could not show its bona fides, such as any steps taken to recover the amounts due and therefore their defence if any will crumble.

From the above four shades, it can be concluded that although there is change in the principles by which claims of financial creditors are to be admitted in IBC, NCLT is now required to exercise its powers with discretion and judiciously and not in a mechanical manner or routine manner.

Conclusion and way ahead

The NCLT should thus consider existence of debt and default as well as other factors which are instrumental in such default. Whether such defaults are attributable to inefficient management of business in the ordinary course or due to factors within the control of the company, should be analysed. Now every debt would have some defence like loss of business, decreasing scope in particular business domain, pending litigation, etc. The NCLT should see the overall relation between the parties in the past, probability of dues getting cleared from arbitration, litigation and similar other considerations relating to monies receivable to the corporate debtor before initiating CIRP on an application by financial creditors.

NCLT should thus make the fullest application of the principle of Vidarbha judgment¹⁶ to make insolvency process more pronounced, precise and equity oriented.