Amidst several reforms presented by the Government for the promotion of ‘Ease of Doing Business’ in India, one landmark development in the dynamic world of insolvency and bankruptcy was the introduction of the ‘Insolvency and Bankruptcy Code, 2016’ (“IBC” or “Code”). Prior to the enactment of IBC, the insolvency resolution process in India had been puzzling. Simultaneous operation of a long list of statutes, overshadowing each other made the resolution process sluggish. These statutes, inter-alia, include the Sick Industrial Companies Act 1985, the Recovery of Debt Due to Banks and Financial Institutions Act 1993, and the Companies Act, 2013.
The disparity between laws and a cramped court system led to a huge pile-up of non-performing assets and tied-up of money of banks which accelerated unviability of banks as overwhelming provisioning and uneven caution led to a deceleration in lending especially to the needy segment of the population. Thus, to consolidate the existing legal framework for insolvency and bankruptcy in the country, a single code was created to define and simplify the process of insolvency resolution. The Code, passed after great deliberation and pursuant to several committee reports, is an effort at an inclusive reform of a broken framework of the insolvency resolution process. However, since the enactment of the Code, it’s various provisions have time and again been challenged before High Courts and the Supreme Court as it is newborn legislation with its own set of issues and it is therefore gradually fine-tuned here and there with harsh and broken realities of the corporations and economy after issues crop up pointing to inadequacy or inadvertency in law. Despite all the challenges, opportunities have also arisen for the country due to radical changes introduced by the law and new mechanisms and energy perpetuated in the insolvency and bankruptcy framework in India.
This article delves on the constitutional validity of the Insolvency and Bankruptcy Code with the landmark judgement of Swiss Ribbons Pvt. Ltd. & Anr. Vs. Union of India. In addition to that, it also shed light on the regulatory framework of the Code. Lastly, it has also concisely evaluated the impact of Covid-19 in reference to the suspension of IBC on the Insolvency and Bankruptcy Regime for a certain period of time.
Evolution of Insolvency law in India
The provisions of IBC started becoming applicable particularly, to companies incorporated under the previous companies’ legislation, companies governed by special act with few exceptions, LLPs and other body corporates as notified by the Central Government, on December 1, 2016, and despite its share of challenges, the Code has contributed to robust debt market in India as secured and unsecured creditors have been accorded higher priority over the government taxes in the distribution of assets and waterfall mechanism. The insolvency law in India has its starting point from the English law.
In India, a legal framework to manage insolvency and bankruptcy was first felt in the three Presidency towns of Bombay, Calcutta, and Madras, where the British carried on the trade. The Provincial Insolvency Act of 1907, replaced by the Provincial Insolvency Act of 1920, was the first insolvency law for non-Presidency areas and dealing with insolvency of individuals, which may also include proprietors. Further, the Presidency-towns Insolvency Act, 1909 had been enacted to cover the insolvency of individuals, partnerships, and association of individuals in Presidency towns.
The Law Commission of India in its report of February 1964 recommended combining the two Acts to form a single code on insolvency. However, the recommendation was never implemented. The Presidency-towns Insolvency Act continues to be one of the most important laws for insolvency regime covering individuals. While the insolvency resolution process is well-defined under IBC now, rules for individual bankruptcy are yet to be notified. Although the Presidency-towns Insolvency Act has been repealed under Section 243 (1) of Insolvency and Bankruptcy Code, which reads as follows-
Section 243: Repeal of certain enactments and savings
The Presidency Towns Insolvency Act, 1909 (3 of 1909) and the Provincial Insolvency Act, 1920 (5 of 1920) are hereby repealed.
However, as rules are not framed for insolvency of individuals except personal guarantors to corporate debtors, therefore there are no notified rules for individual insolvency despite provision of Section 243, when reading with Section 1, has come into force from the date of commencement of code. As a result, on harmonious interpretation, it can be said until and unless rules are framed, Section 243 is ineffective and individual insolvency laws still subsist. There is also a limited interplay between SARFAESI and IBC. Under SARFAESI, secured creditors could foreclose, recover by auction of properties etc. their dues however with the implementation of code, it is often experienced that erring debtor approach adjudicating authority for automatic route of the moratorium, after insolvency commencement date by initiating before the CIRP process under the Code, and as a result take a stay on foreclosure, recovery etc. thereby preventing the earlier available remedy under SARFAESI with the secured creditors.
Nonetheless, IBC is a model law, both in principle and design as it incorporates various recommendations of past committees that were not taken into account earlier.
Key Features of the Code
The Code provides for uniform and specialized forums to manage insolvency proceedings. The purpose of bringing such uniformity is to minimize the uncertainty that arises due to the multiplication of proceedings, consequent delay and eventual loss of money. Further, to enable such consolidation, the Code repealed and replaced several laws that are inconsistent with its provisions. Additionally, the Code has several imperative features in respect of corporate debtors, which are as follows:
- Comprehensive Law: IBC is an all-inclusive law which envisages and has separate insolvency process for individuals, companies, and partnership firms. This process can be initiated by both debtors and /or creditors.
- Low-Time Resolution: Section 12 of the Act provides for a maximum time limit for completion of the insolvency resolution process – 180 days, which may be extended by 90 days. Additionally, the Amendment Act No. 26 of 2019 specified a mandatory limit of 330 days, inclusive of all extensions for completion of the process.
- Adjudicating Authority: The Code provides for constitution of a new regulatory authority namely the Insolvency and Bankruptcy Board of India (hereinafter referred to as ‘IBBI’). The Adjudicating Authorities established under the Code are the National Company Law Tribunal (hereinafter referred to as ‘NCLT”) – for Companies and LLPs; Debt Recovery Tribunal (hereinafter referred to as DRT) – for Individuals and Partnership Firms.
- Licensed Insolvency Professionals: The process of insolvency resolution is managed via licensed professionals.
- Initiation of proceedings: Under the Code, the process of corporate insolvency can be initiated by a financial creditor, an operational creditor or the company itself.
- Early-detection devices: The Code, to accomplish its aim has set some early-stage provisions which can be initiated on the first signs of default. The Adjudicating Authority can be approached, before a party becomes insolvent, at the outset of a default.
- Interests of workmen and employees: Section 36 of the Code protects the interest of workmen and employees by excluding their dues under the provident fund, pension funds and gratuity from the debtor’s assets.
- Moratorium: Section 14 of the Code is one of the most striking provisions. During the period of moratorium, as granted by the Adjudicatory Authority, the actions of the creditors will be stayed.
- Cross-border Insolvency: According to Section 3(27) of the Code, Property includes money, goods, actionable claims, land and every description of property situated in India or outside India and every description of interest including present or future or vested or contingent interest arising out of, or incidental to, property.” The Code hereby tries to address the issue of cross-border insolvency by including property “situated in or outside India” given the multi-jurisdictional spread of assets of large corporations.
- Committee of Creditors (hereinafter referred to as ‘CoC’): This Committee is responsible for deciding important affairs of the company. The constitution of a CoC has been envisaged under Section 21 of the Code, according to which all financial creditors shall be a part of the CoC.
Regulatory framework – Corporate Insolvency Resolution Process (“CIRP”)
The IBC 2016 is a paradigm shift in the law. The Code has not only helped rich corporates but has also been a sigh of relief for Micro, Small and Medium Enterprises by ensuring faster liquidation process and debt recovery. Section 7 and Section 9 of the Code allow financial and operational creditors, respectively of a defaulting company to file an application for initiation of CIRP before the Adjudicating Authority, the NCLT. Simply stated, a financial creditor could be any person to whom a business debt is owed or a person to whom such amount is legally assigned or transmitted. For example- banks or other financial institutions; Operational Creditor could be any person to whom an operational debt is owed and includes any person to whom such amount has been legally assigned or transferred for goods or services done by them. For example- vendors and suppliers, employees, government etc.
Until recently, the threshold for triggering CIRP under the Act was a minimum default of INR 1 lakh. However, the Central Government through a gazette notification has specified INR I crore as the minimum amount of default for initiation of proceedings under the Code. This increase in the threshold comes in the wake of COVID-19 crisis which has affected MSMEs severely.
Although the Code provides for initiation of the process, it does not directly initiate a liquidation process and promotes resolution over liquidation. However, if a debtor is not in a position to repay the debt, the company is restructured or liquidated. The application made by the financial or operational creditor to the NCLT for initiation of Corporate Insolvency Resolution Process (hereinafter referred to as ‘CIRP’) has to accept or rejected within 14 days by NCLT. After the application is accepted, the board of directors is suspended and placed under an independent interim resolution professional. The control of management over the affairs of the company is, thus, terminated and a moratorium becomes effective. Further, a CoC is formed which consists of all financial creditors, within 30 days of acceptance into CIRP after verification of claims. Within 7 days of the formation of CoC, the Committee has to either appoint the IRP as the Resolution Professional or appoint a new Professional for the CIRP process. Lastly, a resolution plan for the company has to be approved within 180 days (can be extended for a period of 90 days) from the commencement of CIRP. On the approval and sanction of such a plan by the NCLT, it becomes binding on the Corporate Debtor. However, if the plan is not sanctioned, then the NCLT is obliged to liquidate the assets of the Corporate Debtor and distribute them as per the provisions of Section 53 of the Code.
The constitutional validity of the Code – Swiss Ribbons Pvt. Ltd. & Anr. Vs. Union of India
In a landmark judgment, the Hon’ble Supreme Court of India had upheld the constitutionality of IBC in its entirety.
Background to the Case
The constitutional validity of the Code had been at the center of the debate since its inception. However, given the contradictory views that the legal fraternity and the industry hold about the Code, it was very well expected that the validity of the Code would be in question.
Before the issue came up before the Apex Court, the validity of the Code has been pondered upon on several occasions. The first such case came before the High Court of Calcutta in Akshay Jhunjhunwala & Anr. Vs. Union of India & Ors, wherein the issue related to the classification of operational and financial creditors. The petitioner, in this case, argued that there was an absence of nexus between the object sought to be achieved and the classification of creditors under the Act. The issue was whether it is proper to put financial creditors on a higher pedestal than the operational creditors and whether such provision is violative of Article 14 of the Constitution of India. Nevertheless, the Court herein upheld the Constitutional validity of the Code and agree with the arguments of the Respondents. The Court observed that the classification of creditors has been done with reasonable differentia and thus it does not violate any provision of the Constitution. Further, the Bankruptcy Law Reforms Committee (hereinafter referred to as ‘BLRC’) gives the basis to treat financial creditors in a particular manner in insolvency proceedings against a company. This judgment delivered by the Calcutta High Court was the first occasion where the constitutionality of the Code was upheld. This has paved the way for the construction of jurisprudence around the IBC.
Apart from the challenge before the Calcutta High Court, the constitutional vires of the Code has been subjected to several challenges before various High Courts. One such case came before the Gujarat High Court in Shivam Water Treaters Private Limited v. UOI. These attacks on the validity of the Code, as well as the constitution of NCLT prompted the Apex Court to direct the Gujarat High Court – “not to enter into the debate pertaining to the validity of the Insolvency and Bankruptcy Code, 2016 or the constitutional validity of the National Company Law Tribunal.”
Relevance of the Case
Eventually, on 25th January 2019, the Supreme Court in Swiss Ribbons settled the debate. The case holds a special place in the jurisprudence on IBC and has laid down the foundation for insolvency law in India.
Facts of the Case
Over a period of time, several writ petitions, as well as Special Leave Petitions were filed before the Supreme Court against the validity of IBC. The Judgment dealt only with the question of law and thus, the individual facts of the case were not presented.
Issues before the Court
- Constitution of NCLT and NCLAT: Appointment of members of NCLT and NCLAT contrary to the judgment of the Supreme Court in Madras Bar Association v. Union of India. Further, the issue related to the seat of NCLAT only being at Delhi, which would render the remedy inefficacious. The petitioners also argued that the administrative support of NCLT and NCLAT should be from the Ministry of Law and Justice, whereas presently the Authorities function under the Ministry of Corporate Affairs.
- Classification of Creditors: The issue pertained to the distinction provided under the Code between the financial and operational creditors as being violative of Article 14 of the Constitution of India. The Petitioners contended that Section 21 and 24 of the Code do not provide a single vote to the operational creditors in the Committee of Creditors. Section 12A of the Code requires the approval of 90% of the voting share of CoC and thus, the issue is a crucial one.
- The Resolution Professional has been dispensed with Adjudicatory Authority which is violative of basic principles of justice.
- The Petitioners argued that Section 29A of the Code cannot be applied retrospectively.
- A blanket ban on participation of all promoters of the corporate debtor is arbitrary and does not treat everyone equally.
- Section 53 of the Code is arbitrary and violates Article 14 of the Constitution of India, since operational creditors rank below all other creditors, including other unsecured creditors.
Judgment of the Supreme Court
- With regards to the appointment of members of NCLT and NCLAT, the Supreme Court took note of the Companies (Amendment) Act 2017 and the affidavit filed by the Ministry of Corporate Affairs and accordingly observed that two judicial and executive members are to be appointed in the NCLT and NCLAT and thus, upheld the appointments. However, relying on its earlier judgment, the Supreme Court held that administrative support for all Tribunals has to come from the Ministry of Law and directed the Union of India to follow the same.
- The Court also directed the Union of India to set up Circuit Benches of NCLAT within a period of 6 months. Relying on its earlier judgment, the Apex Court said that “permanent Benches needed to be established at the seat of every jurisdictional High Court. And if that was not possible at least a Circuit Bench required to be established at every place where an aggrieved party could avail of his remedy.”
- The Supreme Court also upheld the distinction made between the financial and operational creditors. The Court referred to the provisions of the Code, the Bankruptcy Law Reforms Committee report and the Insolvency Law Committee report, 2018 and held that there is clearly an intelligible differentia between the classification and the object sought to be achieved by the Code. Owing to the differences between the nature of operations, the viability, and ability of the financial and operational creditors to assess and restructure debt, the classification is constitutionally valid and does not violate any provision of the Constitution.
- Section 12A of the Code was upheld. Since a CIRP is a proceeding in rem and cannot be terminated by a single creditor. Further, Section 60 of IBC makes it clear that the CoC does not have the last say and their decision can be overruled by the Tribunals.
- While observing that a Resolution Professional is merely a facilitator of the insolvency resolution process and the key functions are overseen by the CoC, the Court held that the powers of Resolution Professional are not violative of principles of justice.
- The Court observed that Section 29A is not retrospective in nature and is constitutionally valid. This is because there exists no vested right of the resolution applicant for consideration or approval of their resolution plan. Consequently, the validity of this Section was upheld. The Court clarified that apart from malfeasance, Section 29A of the Code also provided several other grounds for ineligibility for participating in the process. Thus, the question of treating unequal as equals would not arise.
- While reiterating its earlier points, the Supreme Court upheld the validity of Section 53 of the Code. Due to the relative importance of the two types of debt, there exists intelligible differentia to justify the classification of two creditors. Since the recovery of financial debts infuses capital into the banks which eventually lifts the economy, the object sought to be achieved was acceptable.
This decision of the Supreme Court will certainly put several issues regarding the interpretation and constitutionality of the Code to rest. While some decisions have more scope of interpretation, decisions such as setting up of Circuit Benches of NCLAT is a welcome step that has been applauded by the legal fraternity as well as the industry.
COVID 19 and the IBC
On June 5, 2020, the Ministry of Law and Justice, after various deliberations have finally notified the Insolvency and Bankruptcy Code (Amendment) Ordinance, 2020. This Amendment has inserted a new Section 10A titled “Suspension of initiation of the corporate insolvency resolution process.” The amendment has suspended any fresh CIRP processes to be initiated for defaults arising on or after 25th March 2020 for a period of six months, or such further period as may be notified, which shall not be more than one year. The COVID-19 pandemic has impacted the business globally, and the nationwide lockdown has disrupted normal activities. Thus, to ensure continuity of business and to protect MSMEs, such a step has been taken by the Government. However, the move has its pre-packed challenges and issues which would need proper implementation. Nevertheless, there have been contradictory views in the industry about the suspension of IBC. Only time will tell if the move is in the right direction or not.
Conclusion: How has IBC impacted the industry and the Indian economy?
Before the advent of IBC, the whole aim of insolvency law was the alleviation of the insolvency entity. However, this left the creditors uncared for. Further, due to the presence of too many laws and adjudicatory bodies, the process was cumbersome and ambiguous. This resulted in long drawn processes of insolvency, which even went on for decades. Once IBC was introduced, like any other significant step, the enactment of the Code was well-advertised. This led to an increase in investor confidence and the aim of ease of doing business came closer. Some of the reasons for such positive impacts have been the smaller time frame provided under the Act, maximizing the value of assets of an insolvent company, more stress on resolution rather than liquidation, etc. This crucial step has shifted the power in the hands of the creditors from the borrowers.
In 2020, India has jumped to the 63rd position in Ease of Doing Business, as compared to its 130th position in 2017. According to a World Bank statement, IBC has improved the recovery rate of stressed assets to 48% in two years, as compared to 26% in period before IBC was enacted. 2016 has been an important year due to several vital reforms such as Goods and Services Tax and the IBC. These developments have led to a jump in India’s global rank and it is expected that it will ensure immense thrust in the foreign investments and M&A activity in India.
Certainly, IBC has positively impacted the industry and has led to several resolutions and liquidations and thus, has put more money in the hands of the banks and financial institutions. However, the current situation, with the rise of COVID-19 is an extraordinary one.
- Law Commission of India, 26th Report on Insolvency Laws
- Devansh Sharma, What if you go broke like Vijay Mallya? Personal bankruptcy decoded, THE ECONOMIC TIMES
- The Insolvency and Bankruptcy Code
- Section 5(7), The Insolvency and Bankruptcy Code, 2016 (Act No. 31 of 2016)
- Section 5(20), The Insolvency and Bankruptcy Code, 2016 (Act No. 31 of 2016)
- Notification S.O. 1205(E)., Ministry of Corporate Affairs
- AIR 2019 SC 739
- AIR 2018 Cal 139
- (2018) 4 GLR 2724
- (2015) 8 SCC 583
- Union of India v. R. Gandhi, President, Madras Bar Association, (2010) 11 SCC 1
- Samrat Sharma, Has IBC been successful in reducing India’s stressed assets | INTERVIEW, FINANCIAL EXPRESS
This article has been written and submitted by Mr. Saksham Grover during his course of internship at B&B Associates LLP. Mr. Saksham is a fifth-year law student at the Delhi Metropolitan Education, Guru Gobind Singh Indraprastha University, Noida.
Moderated by Shubham Khunteta (Associate)