The Vidarbha Ruling: Opening up Pandora’s Box
[Sanya is a student at Jindal Global Law School.]
The Insolvency and Bankruptcy Code 2016 (IBC) was enacted with the intention of simplifying and fastening the process of insolvency proceedings in India while ensuring maximization of value to all stakeholders. Prompt acceptance of defaulting enterprises into the corporate insolvency resolution process (CIRP) to stop additional value degradation due to delay is a crucial step in achieving this goal. However, the Supreme Court in the recent case of Vidarbha Industries Power Limited v. Axis Bank Limited (Vidarbha) has put forth a contention that will have contradictory implications.
This article examines the Supreme Court’s judgement in this particular case and examines the dire consequences that it will have on the effectiveness on a ground-breaking legislation such as the IBC.
One Step Forward, Two Steps Back
The initiation of a CIRP can be done by a financial creditor (FC) or an operational creditor (OC) under Section 7 and Section 9 of IBC respectively. These provisions were probed into and given clarity on in the landmark judgement of M/s Innoventive Industries Limited v. ICICI Bank and Another. (Innoventive). Prior to Innoventive, there was uncertainty surrounding the factors National Company Law Tribunals (NCLT) should consider when assessing an application under Section 7 of the IBC. Common defences used by corporate debtors (CD) included the claim that the default was unintended, brought on by events outside their control, or they were otherwise financially solvent. The Supreme Court's dual objective tests of ‘debt’ and ‘default’, which were established in Innoventive, helped resolve and streamline the Section 7 application adjudication process, bringing an end to this ambiguity. It was stated by the Supreme Court that,
“The moment the adjudicating authority is satisfied that a default has occurred, the application must be admitted unless it is incomplete...”.
This statement made by the court in Innoventive has been the benchmark for NCLTs and NCLATs to decide cases pertaining to Section 7 of the IBC until 12 July 2022 when the Supreme Court gave the judgement for Vidarbha Industries Power Limited v. Axis Bank Limited. The court decided that despite the court being convinced of the existence of a debt and the CD being in default, Section 7(5)(a) of IBC given the NCLT discretion to refuse to admit an application for CIRP submitted by an FC. Contrastingly, it is also noted that, if an application for CIRP submitted by an OC satisfies the same conditions of ‘debt’ and ‘default’, the NCLT has to mandatorily admit the application. The court pointed out that typically, the word ‘may’ is directory and the phrase ‘may admit’ gives admission discretion. However, the term ‘shall’ implies a rule that must be followed. The court assumed the legislation’s intentions by stating that the use of the word ‘may’ in Section 7(5)(a) in contrast to the use of the word ‘shall’ in Section 9(5)(i) by the legislature meant to imply the discretionary powers that were intended to be given to the court in matters of Section 7(5)(a). The court suggested that this difference in the use of words for two provisions that are almost similar in nature was a conscious effort made by the legislators to imply that the OC will be impacted more severely than the FC in case of a non- payment of admitted dues. It held that in cases where the application for the CIRP is filed by a FC, the court can take all relevant factors like the financial capability of the CD in exercising its discretionary power to not admit the application if it deems fit. However, in cases where the application is filed by an OC, it is mandatory for the court to admit such an application. It inferred that there is a need for the NCLT to ‘apply its mind to relevant factors’ because the IBC does not intend to ‘penalize solvent companies, temporarily defaulting in repayment of its financial debts’. Additionally, a note of caution was given by the court expressing that such discretionary powers should not be used in an arbitrary manner.
Should the Law Have Room for Subjectivity?
While a note of caution for the courts to not use these discretionary powers arbitrarily is added in the Vidarbha ruling, it is important to note that there is an absence of clarity on the parameters for this discretion. The court’s statement in this judgement reverses the clock by taking us back to the chaotic era where the factors of ‘default’ and ‘debt’ were not established by the Innoventive case. Judgements were given differently according to the differing facts of the case and circumstances of the CD. The lack of a proper test to establish whether or not a company should be brought into insolvency proceedings created a considerably unfair and chaotic situation which is why the Court considered the recommendations of the Bankruptcy Law Reforms Committee and shifted the parameter for CIRP from ‘inability to pay’ debt to ‘default’ in paying debt. This ruling established the unimportance of the cause of default during financial distress and established that as long as a CD had ‘defaulted’ in repayment of ‘debt’, they could be filed for insolvency. Therefore, the fact that the Court in Vidarbha has stated otherwise gives the insolvency law a significant room for subjectivity.
Objectivity in deciding if a CD should be brought into the CIRP can be seen in the insolvency laws of the United Kingdom and the United States of America as well. The UK insolvency law allows a single creditor or a group of creditors to file an application for insolvency proceedings to be started given that the company which is the debtor is obligated to pay more than £750 and the debt is not disputed. Similarly, the American insolvency law allows one or more creditors to file a petition with the Bankruptcy Court under Chapter 7 of their Bankruptcy Code which qualifies a debtor for insolvency proceedings given that the remaining amount after subtracting the debtor’s expenses from their gross income is not sufficient to clear the debt. Hence, it is evident that the insolvency laws in the UK and the USA also use similar parameters of ‘default’ and ‘debt’ to admit an application filed by a creditor for insolvency proceedings which has clearly been working perfectly well in the UK and the USA, as well as India.
Therefore, the ruling in Vidarbha has failed to move alongside not only the landmark judgement in Innoventive, but also the insolvency laws in other prestigious countries and led the Indian insolvency law to considerable amount of subjectivity, which is harmful for the country’s insolvency law in the long run because it makes it incomprehensible and unfair to a certain extent. The insolvency regime in India has already been facing an issue of delays in admission of CIRP applications which is further ignited by the passing of this judgement. IBC has never been seen as a recovery mechanism, however, financial order among the CDs has significantly improved due to the fear of being sent into the CIRP given that the parameters for the same are fixed, which has been hindered by Vidarbha.
This ruling will open up a pandora’s box to multiple claims of the debtor’s inability to pay along with requests for the circumstances of the debtor to be considered by the court before sending the company into insolvency. The entire purpose of IBC being enacted was to establish an effective framework for insolvency resolution in a time-bound manner which has been hampered by this ruling. Looking into the ability of the CD to pay the debt and its financial health not only questions the aim of IBC, but also adds a significant delay in the admission of CIRP applications which in turn decreases the effectiveness of IBC in entirety.