India: Sick Companies Start With A Clean Slate - Supreme Court Clarifies

Introduction

The Supreme Court recently settled a long-standing question concerning unsecured creditors under the Sick Industrial Companies (Special Provisions) Act, 1985 ("SICA") regime. The Apex Court has set aside a 2011 Judgment of Delhi High Court in the case of Continental Carbon India Ltd. Vs. Modi Rubber Ltd ¹ wherein the High Court had held that an unsecured creditor had the option of not accepting the scaled-down value of its dues under the scheme sanctioned under SICA and could initiate proceedings for recovery of its debt once the company was rehabilitated in terms of such scheme.

Legislative Background and clean slate theory

SICA was repealed on 01.12.2016² to make way for the Insolvency & Bankruptcy Code, 2016 (hereinafter referred to as "Code"/"IBC"). The Code also provided that any proceedings before the Board or the Appellate Authority under SICA stood abated. Further, a company in respect of which such proceedings stood abated was given 180 days' time from the commencement of the Code to make reference to the National Company Law Tribunal under the Code.

To bring the sanctioned schemes in consonance with the IBC regime, legislature also amended the Sick Industrial Companies (Special Provisions) Repeal Act, 2003³, through Insolvency and Bankruptcy Code (Removal of Difficulties) Order, 2017. The amendment provided that sanctioned schemes under Section 18 of SICA were deemed to be approved resolution plan under sub-section (1) of Section 31 of the Code. Section 31 of the Code makes an approved resolution plan binding on all creditors of a corporate debtor.

Recently, the Supreme Court in the case of Ghanshyam Mishra and Sons Pvt Limited v. Edelweiss Asset Reconstruction Company Limited ⁴ and CoC of Essar Steel India Ltd. v. Satish Gupta & Ors.⁵ has held that the legislative intent behind the approval and binding nature of plan under Section 31 of IBC is to ensure that the successful resolution applicant starts from a 'clean slate' and the claims which are not part of the approved resolution plan will stand extinguished.

The NCLAT in the case of Shiv Shakti Interglobe v. KTC Foods Pvt. Ltd.⁶ has held that the clean slate theory is equally applicable to liquidation proceedings.

Continental Carbon (supra) and subsequent decisions of High Courts

The judgment of the Delhi High Court in Continental Carbon India Ltd. (supra) was later subject to scrutiny by co-ordinate benches of the Delhi High Court in Singer India Ltd. v. TVS Sewing Needles Ltd⁷ & Rishabh Agro Industries v. Union of India⁸ and referred to a larger bench.

Contrastingly, the Gwalior Bench of Madhya Pradesh High Court in M/s. Titagarh Wagons Limited v. M/s. Amar Forging Pvt. Ltd. & Ors.⁹ had relied upon the judgment in Continental Carbon India Ltd. (supra.) to pass similar orders.

Appeals arising out of the above judgments were before the Supreme Court in Modi Rubber Ltd v. Continental Carbon India Ltd.[10] and a batch of matters.

Supreme Court's Judgment in Modi Rubber Ltd v. Continental Carbon India Ltd. (supra.)

The Delhi High Court in Continental Carbon (supra) had held that an unsecured creditor may not accept the approved scheme and can wait for the company's net worth to become positive before claiming its debts. It was held that the provisions of Section 18(8)¹¹ of SICA which make the approved scheme binding on the creditors of the company, have to be read along with other provisions and must be based on consent. The Delhi High Court had observed that BIFR had no authority to mandatorily wipe the debt owned to unsecured creditors, unless they consented to it.

While allowing the appeal and setting aside the judgment of Delhi High Court in Continental Carbon (supra) the Apex Court observed that the legislative scheme is clear and there is no ambiguity since Section 18 of the Act does not provide for hearing of unsecured creditors during preparation or sanctioning of the scheme. It was observed that only the consent of the institution providing financial assistance, that too under Section 19(1), is required.

The Supreme Court held that the scheme under Section 18 of the Act must necessarily bind everyone otherwise it shall not be workable and the object and purpose of SICA will be frustrated. The Court observed that Section 18(8) of the SICA specifically makes the sanctioned scheme binding upon 'creditors' and thus, the intention of the legislature was very clear. The Court unequivocally held that to any interpretation that allows any class of persons to get out of the sanctioned scheme's ambit will render the scheme unworkable. The Court stressed on the necessity of some sacrifice by all concerned parties including the unsecured creditors to ensure that revival efforts are successful.

The Delhi High Court had held that the suspension of legal proceedings under Section 22 of the SICA the exclusion of period for limitation under Section 22(5) of the SICA clearly indicated that a creditor can wait till the time the sick company has become financially rehabilitated, before claiming its dues. However, disagreeing with the reasoning of the High Court, the Supreme Court observed that the intent behind the suspension of legal proceedings under Sections 22 and 22A of SICA was to protect the assets of the Sick Company and ensure that they are not untimely disposed to frustrate the scheme prepared by BIFR.

Further, the unsecured creditors before the Supreme Court had contended that there is no provision under the SICA to compel an unsecured creditor to accept the scaled down value of its dues. It was further contended that BIFR had no authority to scale down the debt without the consent of unsecured creditor. However, the Supreme Court held that no creditor can claim priority of their claims when prescribed entities mentioned in Section 19(1), including banks and financial institutions may be required to take severe cuts to help in the revival of the sick companies.

With respect to the contention that the scaling down of the dues was violative of Article 300A of the Constitution of India, the Apex Court held that the scaling down is done under Section 18 of the SICA and since the same is by authority of law, it cannot be said that it is violative of Article 300A.

The decision of the Supreme Court is in consonance with the clean-slate theory endorsed by the Supreme Court with respect to matters under IBC and the legislative intent of the amendments made to the Sick Industrial Companies (Special Provisions) Repeal Act, 2003, after the introduction of the Code.

Footnotes

1. 2012 (131) DRJ 294 (DB),

2. Sick Industrial Companies (Special Provisions) Repeal Act, 2003 was notified on 01.12.2016, repealing SICA.

3. Proviso to Section 4 of the Sick Industrial Companies (Special Provisions) Repeal Act, 2003

4. 2021 9 SCC 657

5. (2020) 8 SCC 531

6. 2022 SCC Online NCLAT 85

7. 2016 SCC OnLine Del 1331

8. 2017 SCC OnLine Del 7515

9. Civil Revision 96 of 2018

10. Judgment Dated 17.03.2023 in Civil Appeal No. 375 of 2017, Civil Appeal 377 of 2017, Civil Appeal 379 of 2017 and Civil Appeal 1755 of 2023

11. Section 18. Preparation and sanction of Schemes — ......(8) On and from the date of the coming into operation of the sanctioned scheme or any provision thereof, the scheme or such provision shall be binding on the sick industrial company and the transferee company or, as the case may be, the other company and also on the shareholders, creditors and guarantors and employees of the said companies.]

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