Vidarbha Industries Judgment – Time For Financial Creditors To Exercise Discretion?

Section 7 of the Insolvency and Bankruptcy Code, 2016 provides that if a default has occurred with respect to repayment of a loan undertaken, a financial creditor must file an application to the Adjudicating Authority to begin a Corporate Insolvency Resolution Process (CIRP) against the Corporate Debtor, either individually or together with other financial creditors. The financial creditor must submit an application in the format and manner specified by law. The records of a regulated information utility may be used by the Adjudicating Authority to determine the existence of a default within fourteen days of receiving the application. Where the Adjudicating Authority is satisfied that a default has occurred and the application is complete, and there is no disciplinary proceeding pending against the proposed resolution professional, it may, by order, admit such application. The Adjudicating Authority may reject the application if default has not occurred or if the application is incomplete. The Adjudicating Authority is empowered only to verify whether a default has occurred or not. Based upon its decision, the Adjudicating Authority must then either admit or reject an application respectively. The Adjudicating Authority cannot compel a party to the proceedings before it, to settle a dispute.

Section 7(5)(a) reads as “where the Adjudicating Authority is satisfied that a default has occurred and the application under sub-section (2) is complete, and there is no disciplinary proceedings pending against the proposed resolution professional, it may, by order, admit such application;”[¹]

The Apex court in Innoventive Industries Ltd. v. ICICI Bank & Another², and Mobilox Innovations Pvt. Ltd. v. Kirusa Software Pvt. Limited[³] laid down the tests to be applied by the National Company Law Tribunal (NCLT), for admission of section 7 and section 9 application.

In Innoventive Industries Ltd. v. ICICI Bank & Another³, court held that if debt and default are established and the section 7 application is defect free it must be admitted by the NCLT.

In Mobilox Innovations Pvt. Ltd. Vs. Kirusa Software Pvt. Limited, following a thorough examination of the rules pertaining to requests made by an Operational Creditor under Section 9 of the IBC, the Supreme Court established the following guidelines.:

When examining an application under section 9 of the IBC, the NCLT will have to determine: i. Whether there is an “operational debt” of more than 100,000 ⁴

ii. Whether or not the documentary proof submitted with the application demonstrates that the debt is due, payable, and unpaid.

iii. whether there is a dispute between the parties involved or whether any records of pending litigation or arbitration proceedings were filed prior to receipt of the demand letter.

However, the Apex court, in its recent judgement in Vidarbha industries power Ltd v. Axis Bank Ltd⁵ held that section 7(5)(a) of the code confers a discretionary power by a financial creditor for initiation of CIRP and such power is required to be exercised with caution.

WORD ‘MAY’ IN SUB-SECTION (5) 

The word ‘may’ in sub-section(5) denotes that it is the discretion of the authority to accept or reject the application. The discretion for acceptance or rejection of the application, should not be exercised by the authority on subjective criteria. The authority ought to consider all facts and evidence furnished by the financial creditor along with the application before it admits or rejects it.⁶

Proviso to sub- section (5) contains a limitation on the power of Adjudicating Authority for rejecting an application. It states that before rejecting the application under clause (b) of sub section (5), the authority shall give a notice to the applicant to rectify the defect in his application within seven days of receipt of such notice from the Adjudicating Authority. It is well settled principle of administrative law that a quasi-judicial body like tribunal and appellate tribunal in exercise of its powers and discharge of its functions should be guided by the principles of natural justice.⁷ 

Upon satisfaction of the conditions laid down in section 7(5)(a), the tribunal is duty bound to accept the application for initiation of corporate insolvency resolution process. If any of the conditions as stated in section 7(5)(b) is present, the tribunal must reject the application. The discretion of the tribunal ends upon fulfilment of all the conditions relevant for admission of the application or fulfilment of one of the conditions relevant for rejections of the applications.⁸

The Gujarat High Court in Essar Steel India Ltd v. Reserve Bank of India⁹ indicate that the tribunal should make a decision based on judicial discretion in accordance with the requirement of laws, facts, evidence and circumstances placed before it. Upon its satisfaction it may either accept or reject the application, that is, if the conditions of acceptance are fulfilled, it must admit it. If any of the conditions of rejection is fulfilled, it must reject the application.

However, after the recent judgment of Supreme Court in Vidarbha Industries the usage of the word ‘may’ in section 7(5)(a) indicates the legislative intent that the Adjudicating Authority need not admit an application by the financial creditor in each and every case. The court drew comparison between the section 7(5) and section 9(5) of the code and determined that the former provision uses the term ‘may’ while the latter uses the term ‘shall’. The legislature intended section 9(5) of the IBC to be mandatory and section 7(5) of the IBC to be discretionary. The court adopted the literal rule of interpretation and cited Lalit Kumari v. Government of Uttar Pradesh and Ors.¹⁰ By noting that the legislature used the word may when referring to the responsibility of the Adjudicating Authority in an application for CIRP initiated by a financial creditor under section 7 (5) but used the word shall when referring to an application for the same process being initiated by an operational creditor under section 9.

VIDARBHA INDUSTRIES POWER LTD V. AXIS BANK LTD¹¹

Facts: A power project implementation contract was given to Vidarbha industries. Vidarbha industries filled an application to the Maharashtra Electricity Regulatory Commission (MERC) for the determination of tariff rate due to the rise in fuel prices and operation of the power plant, but it was disposed of. Being aggrieved, the Appellant filed an appeal before Appellate Tribunal for Electricity (APTEL). The Appellate Tribunal for Electricity (APTEL), in response to an appeal, granted Vidarbha Industries an amount of Rs 1,730 crore (APTEL Award). Vidarbha Industries was unable to receive the money awarded in the APTEL award since this APTEL Award was the subject of an appeal before the Supreme Court (MERC Appeal).

Before the NCLT in Mumbai, Axis Bank filed a Section 7 application against VIPL in an effort to start the CIRP for a default of 553 crore. VIPL requested the NCLT to stay the insolvency proceeding on account of MERC pending appeal before Supreme Court but the same was refused on the ground that no extraneous matter could come in the way of expeditiously deciding insolvency proceedings. NCLT opined that satisfaction on two aspects, i.e., existence of debt and default by the corporate debtor, are sufficient to trigger CIRP against a corporate debtor. Upon challenge, the NCLAT approved the same view by adhering to the statutory provision and strictly interpreting it. Subsequently appeal filled before the Supreme Court to determine whether section 7(5)(a) is a mandatory or a discretionary provision.

Appellant argued that section 7(5)(a) of the IBC uses the word ‘may’ which must be interpreted to say that the NCLT has discretionary and not mandatory power to admit Sec. 7 or Sec. 9 applications, where there is existence of debt and a conjoint reading of section 7(5)(a) of the IBC with rule 11 of the National Company Law Tribunals Rules 2016 makes it clear that the NCLT, on examining the existence of debt and its default by a corporate debtor, has the discretion to admit or not admit an application for initiation of CIRP.

Respondent argued that section 7(5)(a) of IBC casts a mandatory obligation on the NCLT to admit an application filed by a financial creditor where there is an existing debt and a default in repayment of the same and second argument was that the object of IBC was to provide a framework for expeditious and time bound insolvency resolution and thus section 7(5)(a) should be construed as mandatory.

The Supreme Court allowed the appeal and set aside the order passed by NCLT and NCLAT. The court held that the section 7(5)(a) of the code confers a discretionary power on the authority to admit an application filed by a financial creditor for initiation of CIRP and such power is required to be exercised with caution. The Adjudicating Authority is required to apply its mind when considering feasibility of initiation of CIRP, against an electricity generating company operated under statutory control, the impact of MERC pending appeal, order of APTEL and the overall financial health and viability of the corporate debtor under its existing management.

CONCLUSION  

The Hon’ble Supreme Court in this judgment, enforced the application of mind by NCLT and not to mechanically admit the applications. NCLT may refuse to admit the case for resolution even if it is satisfied that a financial debt exists and that the corporate debtor has defaulted on any other grounds if the corporate debtor objects to admission on those grounds. Corporate debtors are likely to fully rely on this precedent to resist IBC admission. More lawsuits and delays at the admittance stage are the expected outcomes. The IBC might end up being similar to the SICA unless the NCLT actively limits the use of its own discretion at the admission stage.

To facilitate quick resolution of troubled industrial businesses, the SICA established the Board for Industrial and Financial Reconstruction (BIFR) as a specialized tribunal. Contrary to what was expected of the law "on the books," the law "in action" quickly developed an infamous reputation for delays. Companies could seek shelter from their creditors for years in the BIFR, while managers syphoned off assets in the meanwhile.

The hon’ble Apex Court in Swiss Ribbons v. Union of India¹² have set the tone for the proceeding before the Adjudicating Authority in order to make all endeavour to dispose of the matter in a time bound manner. The observation of the Hon’ble Court may profitably be quoted as under:

“64. The trigger for a financial creditor's application is non-payment of dues when they arise under loan agreements. It is for this reason that Section 433(e) of the Companies Act, 1956 has been repealed by the Code and a change in approach has been brought about. Legislative policy now is to move away from the concept of “inability to pay debts” to “determination of default. The said shift enables the financial creditor to prove, based upon solid documentary evidence, that there was an obligation to pay the debt and that the debtor has failed in such obligation.”

“27. As is discernible, the preamble gives an insight into what is sought to be achieved by the code. The code is, first and foremost, a code for reorganization and insolvency resolution of corporate debtors. Unless such reorganization is effected in a time-bound manner, the value of the assets of such persons will deplete.”

Let us consider a hypothetical situation based on facts related to the Vidarbha Judgement in order to understand what issues may arise in the future as a result of this decision.

Illustration 1- Suppose A (Financial Debtor) defaulted on payment to an operational creditor. OC files an application under Section 9 of the IBC claiming that a default is made. A (Financial Debtor) claim that he is expecting an amount under an order which is challenged before the Supreme Court. Now, after the Vidarbha judgement, there is no effect in the case of the application filled by operational creditors under section 9. Application will be accepted according to the condition given in section 9. Upon fulfilment of the condition, the Adjudicating Authority has to accept the application.

Illustration 2-  Suppose A (Financial Debtor) defaulted on payment to a financial creditor. FC, filed an application under section 7(5) of the IBC. A (Financial Debtor) claim that he is expecting an amount under an order which is challenged before the Supreme Court. The main issue will arise in the financial creditor's case because after the Vidarbha judgement, the court confers the discretionary power on the Adjudicating Authority to admit an application of a financial creditor under section 7(5) for the initiation of CIRP.

The judgement made way for a fresh defence that can be availed by the corporate debtor against the initiation of CIRP against it by a financial creditor, especially where an award in favour of the corporate debtor is made in an appeal. The Court can now use its discretionary power to keep the admission of the application of the financial creditor in abeyance.

There will be a situation where a petition under both the provisions section 7 and section 9 of the IBC, is pending against the same corporate debtor. The Adjudicating Authority will keep the financial creditors under section 7(5) application in abeyance and the application by the operational creditor will be accepted under section 9.

[1] Section 7(5)(a), Insolvency and Bankruptcy Code, 2016.

[2] Innoventive Industries Ltd. v. ICICI Bank & Another [(2018) 1 SCC 407].

[3] Mobilox Innovations Pvt. Ltd. v. Kirusa Software Pvt. Limited [(2018) 1 SCC 353].

[4] The said amount was modified vide Notification No. S. O. 1205(E) dated 24.03.2020 by the Ministry of Corporate Affairs enhancing the minimum amount of default as Rs.1crore with effect from 24.03.2020.

[5] Vidarbha industries power Ltd v. Axis Bank Ltd, 2022 SCC OnLine SC 841.

[6] V.S. Wahi’s, Treatise on Insolvency & Bankruptcy Code, 144 (2018).

[7]Id. at 145.

[8] Ashish Makhija, Insolvency and Bankruptcy Code, 506, (2018).

[9] In Essar Steel India Ltd v. Reserve Bank of India [2017] 143 SCL 580 (Guj): [2017] 141 CLA 45 (Guj).

[10] Lalit Kumari v. Government of Uttar Pradesh and Ors, 2021 SCC Online SC 396.

[11] supra note 5.

[12] Swiss Ribbons v. Union of India, 2019 SCC Online SC 73.