India: Departure From The Default-Based Test: A Hotbed Of Anomalies

The Insolvency and Bankruptcy Code, 2016 ("Code") was introduced as a measure by the Government of India ("Government") to revive the industrial health of the country and to provide a better alternative mechanism to the rather sick, Sick Industrial Companies Act, 1985 ("SICA"). Prior to the introduction of the Code, The Bank Law Reform Committee presented its report¹ to the Government, where "default"² was preferred as the triggering point of the corporate insolvency resolution process ("CIRP") under the Code and accordingly, the Code under Section 6 provides that CIRP may be initiated where any corporate debtor commits default.

The rationale behind the stress on the occurrence of default as the triggering point of CIRP can be understood from the notes on clauses as appended to The Insolvency and Bankruptcy Code, 2015 bill ("Bill") presented before the Lok Sabha,³ which provide that a default-based test helps in early intervention and revival of the distressed debtor can be effectively done rather than at the later stage where revival becomes difficult.⁴ It was further provided that a default-based test serves a simple and uniform test for triggering the CIRP.

Subsequently, the path was followed by the courts through various pronouncements. For instance, the Hon'ble Supreme Court of India in M/s Innovative Industries Limited vs. ICICI Bank Ltd.⁵ held that the moment the adjudicating authority has satisfied itself with the occurrence of debt, it shall admit the application unless it is incomplete. Further, in Swiss Ribbons Pvt. Ltd. & Ors. vs. UOI & Ors.⁶, the Hon'ble Supreme Court held that with the introduction of the Code, the legislative policy has shrugged away from the concept of "inability to pay the debt" to "determination of default." With the subsequent shift in the policy, the financial creditor was required to prove an obligation on part of the debtor to pay and the debtor's failure to fulfil such obligation. However, the recent trend in jurisprudence shows signs of deviation from this settled test.

The Hon'ble Supreme Court of India vide its judgement dated 12.07.2022 passed in Vidarbha Industries Power Limited vs. Axis Bank Limited⁷ clarified that it is not mandatory for the adjudicating authority under Section 7(5) of Code, to initiate CIRP against a corporate debtor who was in default of payment of an undisputed debt, and the adjudicating authority has to consider the grounds made by the corporate debtor against its admission on its own merits. The Hon'ble Court further stressed on the language of Section 7(5) of the Code to observe that the legislature chose to use the word "may" in respect of an application for initiation of CIRP made by a financial creditor but has used the word "shall" in an identical Section 9(5) of Code for application for initiation of CIRP filed by an operational creditor.

In the instant case, the Respondent, Axis Bank, being the financial creditor of the Appellant filed an application under Section 7(2) of the Code for initiation of CIRP against the Appellant. Seeking a stay on CIRP, the Appellant filed a miscellaneous application on the ground of pendency of the Civil Appeal No. 372 of 2017 before the Hon'ble Supreme Court whereby the Hon'ble Court had to decide upon the implementation of an order of APTEL. The said order of APTEL, which was in favour of the Appellant, could enable the Appellant to clear the outstanding liabilities of the Respondent bank. However, the application filed by the Appellant was dismissed and NCLT refused to stay the insolvency proceedings against the Appellant. The Appellant filed an appeal before the Hon'ble National Company Law Appellate Tribunal ("NCLAT") which was also dismissed by NCLAT.

The Appellant preferred an appeal before the Hon'ble Supreme Court, which found favour in the arguments of the Appellant that the object of the Code was not to spell the death knell of the corporate debtor and the adjudicating authority is not devoid of powers to defer the hearing of a petition under Section 7 of the Code if there are orders in favour of the debtor, implementation of which can wipe out the debt in question. While the Hon'ble Court took into account that time bound CIRP of the corporate debtor was necessitated to preserve its economic value and no extraneous reasons could come in its way, it drew a balance and opined that viability and overall financial health of the corporate debtor are not extraneous matters which cannot come in way of the CIRP. Importantly, the Hon'ble Court observed that the NCLAT and NCLT had erred by restricting themselves to only two aspects for triggering the CIRP under Section 7 of the Code, i.e., (i) existence of debt and (ii) default in repayment of the debt.

The observations of the Hon'ble Supreme Court have certainly brought up incongruities in the insolvency regime. While the notes appended to the Bill, as discussed above, prescribed for a default-based test, the Vidarbha judgement gave the adjudicating authority an additional responsibility of looking into the viability and financial health of the corporate debtor, on which the contesting parties may present divergent views. The Code envisaged a quicker process for the revival of distressed assets which was possible only with time-bound admission of petitions and the default-based test made the process simple and provided for uniformity. Moreover, since the inception of the Code, the adjudicating authorities have time and again held that the proceedings under Code are summary in nature.⁸ However, the additional adjudication process on the corporate debtor's financial health may turn out to be time-consuming which shall diminish the Code's viability. It is pertinent to note that the health of any economy/market is majorly determined by the condition of its financial institutions, and this ruling certainly puts them on a back seat.

Interestingly, as an effort to cure the anomaly, the Ministry of Corporate Affairs issued a Notice⁹ dated 18.01.2023 inviting public comments on the changes under consideration in the Code. The Notice under Clause 3.2 proposes to clarify that the adjudicating authority while considering an application for initiation of CIRP by the financial creditor is only required to satisfy itself with the occurrence of default and fulfilment of the specified procedural requirements and nothing more. It further proposes that once the default is established, then it becomes mandatory for the adjudicating authority to admit the application and initiate CIRP. With the intention of the government made clear by the said Notice, it is hoped that the much-needed corrective steps shall be taken by way of the proposed amendment.

Footnotes

1. The report of Bankruptcy Law Reform Committee Volume I: Rational and Design, 04 November 2015, accessible at: https://ibbi.gov.in/BLRCReportVol1_04112015.pdf

2. ibid, at Clause 5.2.1.

3. The Insolvency and Bankruptcy Code, 2015, accessible at: https://prsindia.org/files/bills_acts/bills_parliament/2015/Insolvency_and_Bankruptcy_code,_2015.pdf

4. ibid, at Clause 6, at Pg. 115

5. (2018) 1 SCC 407

6. (2019) 4 SCC 17

7. (2022) 8 SCC 352

8. Indo Alusys Industries Ltd. vs. SWM Metal Pvt. Ltd. Company Appeal (AT) (Insolvency) No. 409 of 2019; Amritvani Exim Pvt. Ltd. vs. Ajanta Offset & Packaging Ltd. IA 1528/ND/2022 in CP No. IB-1526/ND/2019; Argentium International Pvt. Ltd. vs. UTM Engineering Pvt. Ltd. & Ors. IA No. 3172/ND/2021 in IB No. 248/ND/2019; Small Industries Development & Ors. vs. International Mega Food Park Ltd. & Ors. CA No. 600/2019 in CP(IB) No. 174/Chd/Pb/2018

9. Invitation of comments from the public on changes being considered to the Insolvency and Bankruptcy Code, 2016, 18 January 2013, accessible at: https://www.mca.gov.in/content/dam/mca/pdf/IBC-2016-20230118.pdf

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