First Among Equals: Solving the Baffling Conundrum of Indian Insolvency Law
[Aastha Agarwalla and Daksh Aggarwal are students at Campus Law Centre, Faculty of Law, University of Delhi.]
The ‘equitable treatment of similarly placed creditors’ is a well-established principle in insolvency laws. The legislative guide of the United Nations Commission on International Trade Law (UNCITRAL) clearly states that “The insolvency law should specify that all similarly ranked creditors, regardless of whether they are domestic or foreign creditors, are to be treated equally with respect to the submission and processing of their claims.” The intent of the provision is to treat creditors with similar legal rights at par with each other and to ensure that they are preferentially placed i.e. in accordance with their relative ranking and claims demanded.
Recently, the Supreme Court of India (SC) overruled the fanciful verdict of the National Company Law Appellate Tribunal (NCLAT) in the case Committee of Creditors of Essar Steel India Limited Through Authorised Signatory v Satish Kumar Gupta and Others (Essar Steel Case II) as the NCLAT tweaked the aforementioned rule as laid down in Standard Chartered Bank v Satish Kumar Gupta. RP of Essar Steel Limited and Others (Essar Steel Case I). The Adjudicating Authority emphasized on the pari passu rule (ranking equally) and held that the financial creditors (FCs) would get approximately 60% of the admitted claims, about the same as operational creditors (OCs). Succinctly, the tribunal put the two classes of creditors on equal footing.
In this article, the authors aim to study the approach taken by the SC in observing that the equality principle cannot be stretched to treating un-equals equally as per the Insolvency and Bankruptcy Code 2016 (Code) and how the preferential treatment of the creditors can forestall the unprecedented crisis in the area of insolvency law.
Foundation of the Judgment: A Sound Statutory Mandate
Giving voice to the legislative intent in illuminating detail, the SC suitably stated that an “equality for all” approach would incentivize the FCs to vote for liquidation rather than resolution as they are on the top of the preferential ladder in the former case. The apex court rightly asserted that this exercise, if adopted, “would defeat the entire objective of the Code which is to first ensure that resolution of distressed assets takes place and only if the same is not possible should liquidation follow.”
The Bankruptcy Law Reforms Committee, tasked with the responsibility of drafting a unified framework to resolve the matters of insolvency and bankruptcy, clearly states that “In the Insolvency Resolution Process, the financial creditors had the power to choose the best solution to keep the entity as a going concern, with the condition that the liabilities of the other creditors will be fully met within a reasonable period in the implementation of the solution….”
It was argued that the amended Regulation 38 of the Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations 2016 and Section 30(2)(b) of the Code, explicitly or implicitly, prioritize the claims of the OCs over the FCs. However, the highest judicial court opined that complete authority to decide on commercial decisions with respect to the resolution plans is vested entirely with the commercial wisdom of Committee of Creditors (CoC), formed under Section 21 of the Code, solely comprising of the FCs. The final court of appeal also concluded that “the fact that the operational creditors are given priority in payment over all financial creditors does not lead to the conclusion that such payment must necessarily be the same recovery percentage as financial creditors.”
In the light of the above discussion, it can be rightly concluded that the creditors with different security interests of varied nature, value and kind cannot be placed on an equal footing.
Legal Scrutiny of the Judgment
One of the essential propositions that supplement the principle of pari passu is the ‘par condicio creditorum’ or ‘equal treatment of creditors’. Under this proposition, some actions taken in the insolvency process can be nullified if they favour a certain class of creditors. However, secured transactions have been the fundamental exception to this theory. It is settled by the judgment of apex court in Swiss Ribbons Private Limited and Another v Union of India that most FCs are secured creditors, whereas most OCs are unsecured. The division bench of the SC opined that “since equality is only among equals, no discrimination results if the court can be shown that there is an intelligible differentia which separates two kinds of creditors.” Hence, the court accordingly concluded that the distinction between FC and OC is “neither discriminatory, nor arbitrary, and therefore non-violative of Article 14.”
However, in the matter of Essar Steel Case I, the NCLAT deviated from the well settled judicial dictum, and by treating OCs at par with FCs, postulated an undesirable theory — equal treatment of different classes of creditors.
The SC, negating the impugned order of the NCLAT, correctly made the following observations in Essar Steel Case II by adopting a visionary approach:
The real position of the creditors is purely a matter of equity as every creditor strikes a fundamentally different commercial bargain with the corporate debtor which also includes grant of security interest by the debtor to the creditor.
The SC fittingly described the significant role of the FCs as the catalysts for economic growth. The highest court notably opined that FCs, as capital providers, make affordable credit accessible to the enterprises. This practice “enables business ventures to run their operations and increases the capacity of enterprises to expand.” Secured creditors, by facilitating corporate restructuring, specifically promote financial prosperity.
The SC acknowledged the representation made by the Federation of Indian Chambers of Commerce and Industry to the Ministry of Corporate Affairs. The court subscribed to the argument that ranking secured creditors over unsecured creditors allows banks to lend to companies at lower rates of interests and if there is a deviation from the same, “borrowing rates for all classes would go up in the future because banks cannot be sure of protecting their losses.
Fortunately, the apex court, echoing the doctrine ‘treat similar similarly and treat different differently’ enshrined in Article 14 of the Constitution, invalidated the flawed legal reasoning of the NCLAT and recognized the principle of giving priority to secured FCs.
Equitable Treatment vis-a-vis Equal Treatment: An International Perspective
The SC accepted that the principle of ‘classification of creditors’ is well recognized across various jurisdictions in the world owing to the acceptance of the said principle by the International Monetary Fund (IMF) and the World Bank (WB) under the international insolvency regime. The IMF in its report – ‘Orderly & Effective Insolvency Procedures – Key Issues’ and the WB in its research paper ‘Principles for Effective Insolvency and Creditor/Debtor Regime’ have clearly suggested that “for having an effective insolvency system there shall be equitable treatment of similarly situated creditors and differential treatment of creditors that are not similarly situated may be necessary as a matter of equity.” Therefore, the principle of ‘treat similar similarly and treat different differently’ with the respect of the creditors has been well accepted in the international jurisprudence of insolvency law.
Taking note of the impugned order passed by the NCLAT in the Essar Steel Case I and the catastrophic consequences that may follow, the Insolvency and Bankruptcy Amendment Act 2019 was notified by the Ministry of Corporate Affairs as a remedy to render the order ineffective. Section 6 of the said amendment statute unequivocally states that in a resolution plan, the payment of debts must be in an order of priority amongst creditors as laid down in Section 53(1), thereby reflecting the consistent legislative intent of giving preference to secured FCs over every other class of creditor.
Adding to the misery, the NCLAT, in October 2019, passed another troubling order in the case of Pr. Commissioner of Income Tax-6, Chennai v M/s Star Agro Marine Exports Private Limited and Others and held that OCs must be treated at par with the FCs. However, now when the apex court has specified the preferential order of the creditors in an unambiguous manner, the impugned order of the NCLAT in aforementioned case stands nullified. The SC impeccably establishes the supremacy of the ‘doctrine of security recognition’ (as implicitly stated in 'Principles of International Insolvency' by Philip R Wood) which considers secured creditors as the super-priority creditors in the event of insolvency.
UNICTRAL, Legislative Guide on Insolvency Law 2004, p. 264.
Civil Appeal Number 8766-67 of 2019.
Company Appeal (AT) (Ins.) Number 242 of 2019.
The Report of the Bankruptcy Law Reforms Committee Volume I: Rationale and Design, November 2015, p. 99.
 Comp. App. (AT) (Ins.) No. 717 of 2019.