Introduction
The Insolvency and Bankruptcy Code, 2016 (IBC, 2016) is a comprehensive legislation dealing with matters related to the functioning of an insolvent company and the disposal of its assets if required. However, before proceeding under the provisions of IBC, it is pertinent that the adjudicating authority takes a decision on whether the company can be considered insolvent.
The provisions of IBC, 2016, per se, doesn’t mention the evaluation method which shall be employed while determining the insolvency of the company. However, section 6 clearly tilts the scales towards the Cash Flow Test for determining the company’s state of affairs. The hon’ble supreme court further reiterated the same in the case of Swiss Ribbons (P) Ltd. V. Union of Indiawherein the court favoured the Cash Flow Test as it provided certainty on the insolvent nature of the company and its inability to pay off its dues on time based on well-grounded evidence corroborating such cogent stance. However, the test in recent times has faced severe backlash on matters related to abuse of its applicability to initiate the Corporate Insolvency Resolution Process (CIRP) as a method to realize unpaid dues.
Cash Flow Test
Determination of solvency of a company can be predominantly achieved by three different ways. They are as follows:
- Ability to Pay/Cash Flow Solvency Test
The solvency of a company is determined on the basis of the capability of company to pay off its debt as and when they come due.
- Balance Sheet Solvency Test
To analyse whether the value of the assets of the company is more than that of the liabilities of the company.
- Capital Adequacy Test
This test takes into consideration the capability of a company to take financial setbacks as they come without losing its capability to pay off its long- and short-term loans.
With each having several inconsistencies in them, none of the aforementioned tests can be labelled as the perfect test to determine solvency of a company. However, in light of ease in determining the existence of debt and certainty on matters related to default, the Cash Flow Test has been the accepted approach for the determination of solvent nature of the impugned company. The Companies Act, 1956 under section 433(e) provided for Cash Flow Test for the determination of solvency of the company. The same was further carried forward in the IBC, 2016, through section 6 of the same.
Resolution, not recovery
The very threshold for initiation of CIRP under section 7 is at such a low pedestal that even a single default is sufficient to attract provisions of IBC, 2016, irrespective of the company’s financial health or capability to pay off the debt in the near future. This provides the creditors’ opportunity to misuse the IBC regime as an alternative method to extract unpaid debt from the corporate debtors without approaching an appropriate forum for recovery, like the Debt Recovery Tribunal.
In light of such misdoings, the Adjudicating Authority is now declining to initiate CIRP as the grounds of default under section 6 are more frivolous than concerning in nature for the continuance of the companys’ existence. The NCLAT, in the case of Agarwal Veneers v. Fundtonic Service (P.) Ltd. had declined to initiate CIRP on similar grounds. It found the appellants to be using provisions of IBC, 2016, as a debt recovery measure under the colour of a petition for Insolvency Resolution Process under the Code. The NCLAT opined that,
“The Preamble of IBC is carefully worded to describe the spirit and objective of the Code to be ‘Reorganisation’ and ‘Insolvency Resolution’, specifically omitting the word ‘Recovery’. The Parliament has made a conscious effort to ensure that there is a significant difference between ‘Resolution’ and ‘Recovery’.”
Hence, the condonation of passing off debt recovery attempts as CIRP shall be an incorrect application of procedure whose legislative intent is altogether different. In the aforementioned case, the NCLAT noted that application of initiation of CIRP for a miniscule amount should be an incorrect application of provisions of IBC, 2016. Especially if the company concerned is a solvent one which shall have to subsequently face severe backlash in terms of its standing in the market.
The NCLAT, further in the case of Binani Industries v. Bank of Baroda & Anr. differentiated between the terms “recovery” and “resolution”. The NCLAT held that recovery is a method of disposing of corporate debtor assets to pay off the dues, while resolution under IBC, 2016 is an effort to augment the company’s capability to pay off its debt. The issue was finally laid to rest in the landmark case of Vidharbha Industries Power Ltd. v. Axis Bank.
Discretionary power of Adjudicating Authority under section 7(5)(a)
Under the IBC, 2016, post the filing of an application for initiation of CIRP, it can only be initiated if the Adjudicating Authority has satisfied himself based on records available under section 7(5)(a) of IBC, 2016 that default has ensued and the application is valid in law. However, the hon’ble supreme court in the Vidharbha Industries Power Ltd. case gave the provision a broad interpretation by stating that the Adjudicating Authority has the discretion under section 7(5)(a) to reject Application for initiation of CIRP even when conditions of Default and Debt are fulfilled.
It was the court’s view that the unpaid debt and default are just essential grounds required to apply for initiation of CIRP. However, the final decision rests with the Adjudicating Authority based on the facts present before it whether CIRP should be initiated. These facts can have a bearing on the necessity of CIRP, the general financial health of the company, the past track record of the company on matters of default etc. Hence
This aforementioned interpretation of the court was based substantially on the term “May” used in section 7(5)(a), which in the opinion of the Court is broad enough to provide the Adjudicating Authority necessary leeway. However, at the same time, the court noted that such discretion vested with Adjudicating Authority is restricted to Applications for CIRP filed by Financial Creditors and not Operational Creditors, as section 9(5)(a) uses the term shall, which is mandatory in nature. The court found it to be a conscious decision of the Legislative Authority to differentiate between the two in light of their evident differences.
Furthermore, Rule 11 of the NCLT Rules, 2016 is of particular importance as it explicitly states that the NCLT has inherent powers to pass such an order as and when required to prevent any act which shall amount to an abuse of powers of NCLT as a justice dispensing authority. Hence, the NCLT, irrespective of the Judgment, shall have the power to reject any application which is not in furtherance of its basic tenet.
Analysis
The culmination of hon’ble apex court Judgment in the Vidharbha Industries Power Ltd. case, decisions of NCLAT, in numerous cases, and Rule 11 of NCLT Rules, 2016, shall act as a potent weapon against misuse of IBC for initiation of CIRP for recovery of debt. The court provided section 7(5)(a) with a broad interpretation. The NCLT now has the authority to analyze multiple aspects related to the company and not allow for initiation of CIRP because of a temporary default if the company’s finances are sound in nature. It now rests upon the adjudicating authority to closely scrutinize the circumstance of each case and thereafter decide whether the same attracts provisions of IBC or should be dismissed in light of its colourable nature.
However, to further protect the insolvency regime in India from its misuse, the legislative authority can explicitly incorporate safeguards such as the Balance Sheet Insolvency Test as a secondary method of determination of solvency for statutory protection of corporate debtors’ interest. The legislative authority can further take a cue from the Singapore’s court of appeal judgment in the case of Sun Electric Power Pte Ltd v. RCMA Asia Pte Ltdwherein the court laid down multiple guidelines while determining whether the entity is cash flow insolvent or not on matters related to the quantum of debt, the value of company’s current assets, state company’s business, whether a default has ensued, etc. An interesting aspect of these guidelines is that they act as a combination of Cash Flow Insolvency Test and Balance Sheet Insolvency Test providing a two-prong protection from potential misuse of IBC, 2016.
(This article is authored by Mr. Pritesh Raj, currently a 4th year B.A. LL.B. (Hons.) student at the National University of Study and Research in Law, Ranchi. The author can be contacted at: prpriteshraj@gmail.com)
NUALS Restructuring and Insolvency Law Journal 