[An analysis of E. S. Krishnamurthy & Ors. v. M/s Bharath Hi Tech Builders Pvt. Ltd(2021)]
The insolvency and bankruptcy process in India has a tumultuous history, as has Indian capitalism. From the forced liberalisation of the Indian economy as a result of the IMF conditions imposed on India during the 1991 economic crisis, according to Dr Ashok Desai (ex-economic advisor to the reforms team), to the intense bureaucratic red-tapism surrounding the insolvency and bankruptcy process until the enactment of the IBC 2016, the perception of an Indian capitalist has been markedly different from that of its western counterparts. Dare I say that India’s perception of capitalism is archaic and needs systemic overhaul?
Such was the view of the Bankruptcy Law Reforms Committee Volume 1 2015 formed to document the rationale and design of what would later be known as the Insolvency and Bankruptcy Code, 2016. “In comparison to the size of the economy, India has some of the lowest credit. This is a difficult situation, especially for a young emerging economy like India, which is known for its entrepreneurial zeal. Such dynamism necessitates not only reform, but urgent reform,” the report argued.
An argument raised by one of the arguing councils in the Supreme Court Judgement on Tuesday regarding the NCLT’s refusal to admit a petition filed under Section 7 of the IBC exemplifies this anachronistic view of bankruptcy and its imposition on the interpretation of the IBC:
“On the above hypothesis, it has been submitted that the appellants are utilising the process to facilitate recovery whereas the primary focus of IBC is to ensure revival and continuation of the corporate debtor, and to protect it from corporate death”[1] the judgement read.
This purposive interpretation of the legislation is incorrect and contradictory to the goal envisioned by the bankruptcy law reforms committee in 2015. The report recognized the significance of a business failure in a market economy. It emphasised the importance of a proper re-negotiation process between creditors to finance the going concern using a new arrangement of liability and explicitly stated that if this wasn’t possible, then the best outcome for society would be a rapid liquidation process. Furthermore, referring to liquidation as “creative destruction,” the report argued that with such arrangements in place, the liquidation process will run smoothly, with greater competitive vigour and competition. In 2016, India’s debt recovery rate fell to a new low of approximately 20.8 percent. As a necessary consequence, empowering creditors was desirable and necessary because when creditors have weak rights, resulting in a low recovery rate, they become averse to lending which eventually disrupts India’s entire credit culture. The report explicitly stated that while creditors and debtors can negotiate business viability, the final decision must remain in the hands of the creditors. The NCLT has usurped the creditors’ power as outlined in the IBC and issued judgments that outrightly disregard the legislative intent of the 2016 Code.
The IBC’s purpose was never to protect corporate debtors, but rather to ensure that the process of insolvency and bankruptcy in India was governed by a single code in order to avoid procedural delays and increase debt financing levels across the country as mentioned in the preamble of the I & B code, 2016:
“An Act to consolidate and amend the laws relating to reorganisation and insolvency resolution of corporate persons, partnership firms and individuals in a time bound manner for maximisation of value of assets of such persons, to promote entrepreneurship, availability of credit and balance the interests of all the stakeholders including alteration in the order of priority of payment of Government dues and to establish an Insolvency and Bankruptcy Board of India, and for matters connected therewith or incidental thereto” [2]
One should not think of the arguing council’s submission in the above judgement as a mere court argument, but rather as a perception shared by a large proportion of the Indian population. This perception contrasts with that of other capitalist countries, where bankruptcy is regarded as a “fresh start” rather than a shameful act. An extreme example of this is when Alan Greenspan, the former chairman of the United States Federal Reserve, said, “personal bankruptcies are soaring because Americans have lost their sense of shame!” Bankruptcy is unquestionably bad, however it is not shameful. Rather, bankruptcy is an inevitable byproduct of free market capitalism. Businesses will either succeed or fail.
The IBC’s purpose is not to keep debtors from failing, but to have a mechanism in place that outlines the process of insolvency or otherwise streamlines debt recovery by creditors. The NCLT is recognized as the adjudicating authority for all matters concerning insolvency and bankruptcy under section 61 clause 1 of the IBC[3]. Unfortunately, similar anachronistic perceptions of bankruptcy have riddled the NCLT in the past – a fact that’s reflected in its countless judgments (some of which even go against established precedents and statutes).
HISTORY AND FACTS OF THE JUDGEMENT
The respondent had defaulted on its loan payments and the creditors appealed to the NCLT to initiate insolvency proceedings. The NCLT disposed of the petition on grounds mentioned below and gave the creditors three months to settle.
In its order dated 28th February 2020, the NCLT disposed of the application of the appellants on primarily four grounds:
- Respondent’s genuine efforts to settle disputes. The adjudicating authority alluded to the 140 disputes already settled.
- Settlements were still underway with 40 other investors.
- The Procedure under IBC is summary in nature, hence it could not be inappropriate to apply it in individual cases.
- Initiation of CIRP would jeopardise the interests of the home-buyers who have invested in the respondent’s project.
In doing so, the NCLT gave the respondent three months to resolve the disputes and advised that the remaining petitioners could approach the adjudicating authority if any other disputes arose in the future. Following the decision of the NCLT, the aggrieved parties appealed to the NCLAT. The NCLAT decided in favour of the respondent and dismissed the appeal on grounds such as:
- the Covid-19 pandemic,
- the settlement process was already set in motion,
- and the interests of the home buyers.
After the decision of the NCLAT, the appellant moved to the apex court as the court of last resort.
The central question therefore remained was whether NCLT was correct in their approach of rejecting the appellant’s petition under section 7(5) of the IBC[4] at the pre-admission process and directing them to settle. The court agreed with Advocate Srijan Sinha, who appeared on behalf of the appellant that the adjudicating authority acted outside of their jurisdiction under sections 7(5) and 7(1) of the IBC.
Section 7(5) of the IBC states:
“Where the adjudicating authority is satisfied that
a) 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 applications:
b) Default has not occurred or the application under sub section (2) is incomplete, or any disciplinary proceeding is pending against the proposed resolution professional, it may, by order, reject such application:
Provided that the adjudicating authority shall, before rejecting the application under clause (b) of the sub section (5), 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.”
The court cited Section 7 (5) of the Insolvency and Bankruptcy Act, stating that in clause (a) of subsection 5, the adjudicating authority “may, by order” admit the application or by clause (b) “may, by order” reject the application. The statute now only gives the adjudicating authority two options: reject or accept the application, and any other action taken by the authority would be in violation of the powers granted to it by the statute. The court also cited the case of Innovative Industries v. ICICI Bank, in which it was determined that the adjudicating authority would only have to determine whether a “default” had occurred, and if it answered in the affirmative, it would have to admit the application, except in cases where the application was incomplete. Hence prima facie, forcing a creditor to settle at the “pre admission process” was beyond the powers conferred on the NCLT.
In another case, Pratap Technocrats Ltd & Ors. v. Monitoring Committee of Reliance Infratel Limited & Anr.[5], it was held that the adjudicating authority’s jurisdiction arises within and as a result of the statutory framework, and that both the adjudicating authority and the appellant authority are required to follow the provisions of the statute. With particular reference to the IBC, the court in Arun Kumar v. Jindal Steel & Power Ltd. warned the adjudicating and appellate authorities against any judicial interference with the framework established by the IBC.
The Supreme Court here, in its judgement dated 14th December 2021, allowed the appeal, and set aside the order of the NCLAT dated 30th July 2020.
COMMENT
In an earlier order, the NCLT granted the creditors an additional three months to settle the dispute, preferring to avoid liquidation and, inevitably, causing further delay. The report of the insolvency and bankruptcy committee emphasises the importance of businesses failing in a free-market economy. When negotiations between creditors fail, the best outcome for society is immediate liquidation with no delays. This clearly demonstrates that the IBC’s legislative purpose was never to avoid liquidation, but rather to avoid delay.
The Covid-19 pandemic has presented unprecedented challenges to countries all over the world. What began as a health crisis evolved into a business crisis. The central government and the Reserve Bank of India have announced a slew of measures to assist the struggling financial sector. However, it is critical to strike a balance between the government’s temporary actions to assist the financial sector and India’s credit culture. A thriving credit culture that adequately incentivizes borrowers to pay money on time is imperative for a healthy economy. Furthermore, the NCLT, as a creature of the statute, cannot usurp the power of the creditor in deciding the outcome of the proceedings under IBC by arbitrarily coercing the creditors to settle without initiating insolvency proceedings or forming a credit committee during the pre-admission process. Even after the NCLT’s three-month deadline had passed, the NCLAT decided to arbitrarily extend the delay in the initiation of the insolvency proceedings by citing Covid-19 as an excuse. It did so in order to avoid the company’s liquidation, but the longer the process of insolvency is delayed, the more likely it is that liquidation will be the only option because assets depreciate constantly. Furthermore, since assets suffer from rapid economic depreciation when proceedings are postponed, the liquidation value falls.. Therefore, using Covid-19 as an excuse to postpone the proceedings to avoid liquidation is an axiomatic oxymoron. In a decision, Justices DY Chandrachud and MR Shah acknowledged that even though the extraordinary circumstance of the Covid-19 pandemic may have had a significant impact on corporate debtors’ businesses, the authority cannot override the legislative intent of the statute. Doing so will engender outcomes that may threaten the IBC’s statutory authority.
This case was not the first time the NCLT abused the authority bestowed upon it by the IBC. The NCLT erroneously relied on rule 11 of the NCLT rules, 2016 in Asset Growth Fund & Ors v. CMRS project Pvt. Ltd in order to subvert the IBC.
The NCLT’s Rule 11 is as follows:
“Inherent Powers – Nothing in these rules shall be deemed to limit or otherwise affect the inherent powers of the Tribunal to make such orders as may be necessary for meeting the ends of justice or to prevent abuse of the process of the Tribunal.”
The Supreme Court has already ruled in Swiss Ribbons Pvt. Ltd v. Union of India that such NCLT powers should be used sparingly and only when there is an explicit lack of statutory provision. Furthermore, in ruling on an appeal filed by Gujarat Urja Vikas Nigam Ltd, the bench of Justices DY Chandrachud and M.R. Shah reiterated that the NCLT cannot do what the IBC does not authorise. The NCLT has not been given the authority to compel creditors to settle disputes during the pre-admission process. Its only authority is to reject or admit insolvency applications based on whether a default has occurred. Why, then, does the NCLT routinely overstep its authority by ruling against the IBC? The IBC has a more modern perspective on liquidation and insolvency that echoes the neoliberal western conception of capitalism, whereas NCLT, or rather Indians at large, are still stuck in the archaic mindset of considering insolvency as shameful and viewing it as something to be avoided at all costs.
The claim that the CIRP would jeopardise the interests of homebuyers is also incorrect because almost every business has employees, customers, and other stakeholders who would suffer if the company went bankrupt. If we apply the same logic to all companies, no company would ever be admitted under the IBC.
CONCLUSION
As can be seen, NCLT has used a variety of arbitrary reasons to undermine the IBC, despite the fact that NCLT has been stated to operate solely within the confines of the IBC numerous times. The primary cause of this occurrence is a value-laden predicament. The NCLT, or rather the Indian public in general, has an archaic view of bankruptcy that is incompatible with how the IBC envisions bankruptcy. The former values risk aversion and seek to avoid liquidation at all costs, whereas the IBC echoes a modern perspective on bankruptcy and liquidation, accepting it as a natural part of free-market capitalism. The latter also seeks a faster insolvency and bankruptcy process by reducing delays, whereas the former prefers to play it safe and allow for delays in order to create a debtor-friendly environment. The latter is based on the revival and development of India’s credit culture, whereas the former is based on the continuation of the corporate debtor. The IBC committee report refers to liquidation as “creative destruction,” whereas the Indian public refers to it as “corporate death.” India’s rank on the ease of doing business rose 14 places to 23rd in 2021, with the improvement of the insolvency resolution process playing a key role. People must see businessmen go bankrupt, banks recovering their money, and failed entrepreneurs picking themselves up and trying again for Indian capitalism to evolve.
[1] E S Krishnamurthy & Ors. v. M/s Bharath Hi Tech Builders Pvt. Ltd, Civ. App. 3325 of 2020 (Supreme Court) (Unreported)
[2] Insolvency and Bankruptcy Code, 2016.
[3] Insolvency and Bankruptcy code, 2016, §61(1)
[4] Insolvency and Bankruptcy code, 2016, §7(5)
[5] Pratap Technocrats Ltd & Ors. v. Monitoring Committee of Reliance Infratel Limited & Anr.. 2021 SCC OnLine SC 569. (2021) (India)
(This article is authored by Aditya Sushant Jain, a first-year law student at Jindal Global Law School. The author can be contacted at: 21jgls-asjain@jgu.edu.in)
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