INTRODUCTION
In the recent landmark judgment given by the Hon’ble Supreme Court of India (on 12th July, 2022), in the matter of Vidarbha Industries Power Limited v. Axis Bank Limited (Civil Appeal No. 4633 of 2021), the Court held that, – while adjudicating an insolvency application filed by a financial creditor under section 7 of the Insolvency and Bankruptcy Code, 2016 (“Code”), the National Company Law Tribunal (NCLT) had discretionary powers to decide as to whether or not to admit the said Application even when the default of the financial debt has been proved. These discretionary powers had to be exercised taking into consider relevant factors including the financial health and viability of the corporate debtor, and the feasibility of the Corporate Insolvency Resolution Process considering that the object of the Code is to try and revive a corporate debtor.
The Court particularly noted and emphasised the language of section 7(5)(a) of the Code which uses the phrase “it may by order, admit such application” which signified that NCLT had an option / discretion to not to admit the insolvency application unlike the petition filed by an operational creditor under section 9 of the Code which used the word “shall”.
The Update expounds and analyses the aforesaid judgment of the Supreme Court which has a substantial impact on the way the insolvency applications filed by the financial creditors will be dealt and decided by various benches of NCLT across India and the practical challenges it would pose in this regard.
FACTS OF THE CASE IN BRIEF
Vidarbha Industries Power Limited (“VIPL”) is a company engaged in the business of production of electricity for which tariff is regulated by the Maharashtra Electricity Regulatory Commission (“MERC”). Owing to disputes between VIPL and MERC in relation to determination of tariff, VIPL filed an appeal before the Appellate Tribunal for Electricity (“APTEL”) challenging MERC’s decision. APTEL allowed the appeal and it ordered MERC to pay a sum of INR 1,730 crore to VIPL. MERC filed an appeal before the Hon’ble Supreme Court of India in 2017 against the order of APTEL. The said appeal is currently pending adjudication by the Supreme Court.
Meanwhile, in 2020, Axis Bank Limited (“Axis”) filed an application u/s 7(2) of the Code (in its capacity as a financial creditor) before the NCLT for initiating Corporate Insolvency Resolution Process (“CIRP”) against VIPL for non-payment of its dues amounting to INR 553 crore.
VIPL sought for a stay on the NCLT proceedings on the ground that in view of the pending adjudication of appeal (filed by MERC against VIPL) by Supreme Court, it was unable to have the execution of the order of APTEL (which had ordered MERC to pay INR 1,730 crores to VIPL) and resultantly it was facing shortage of funds. As a further corollary, if the order of APTEL was executed, VIPL could clear all its outstanding dues of Axis (which dues were substantially lower than the amount which VIPL expected to receive from MERC).
NCLT dismissed the application for stay and admitted the Section 7 application on the grounds it was mandatory to admit the Section 7 application for initiation of CIRP once the existence of debt and admission of default thereof could be proved and that extraneous matters such as the MERC proceedings pending before the Supreme Court were irrelevant to be considered. In an appeal by VIPL, the National Company law Appellate Tribunal (“NCLAT”) concurred with the stance taken by NCLT. VIPL filed an appeal against the NCLAT Order before the Supreme Court of India under Section 62 of the Code.
QUESTION OF LAW WHICH REQUIRED ADJUDICATION BY THE SUPREME COURT
Whether it was mandatory for the NCLT to admit an insolvency application filed by a financial creditor under section 7 of the Code, once existence of the financial debt and its default was evidenced or did NCLT have any discretionary powers to refuse such admission considering other factors which are relevant?
SUPREME COURT’S JUDGMENT
NCLT had discretionary powers under Section 7(5)(a) of the Code for admission / refusal of the Insolvency Application filed by financial creditor – Use of word “may”
The Court noted that, – as per Section 7(5)(a) of the Code, when the NCLT is satisfied that a default has occurred, the application is complete and there are no disciplinary proceedings, then it ”may” by order admit the application.
The Court held that the meaning and intention of Section 7(5)(a) of the Code must be determined from the terminology of the provision in the context with the nature and design of the Code. The word ‘may’ is ordinarily directory. The expression ‘may admit’ in Section 7(5)(a) confers a discretion to admit the application. The use of the word ‘shall’ raises a presumption that a provision is mandatory. Hence, the use of the word ‘may’ instead of ‘shall’ in Section 7(5)(a) of the IBC expressly shows the intent of the legislature to make the provision discretionary and not mandatory, whereby the NCLT can reject an application even post existence of debt and/or admission of default.
The Court further went on to explain that the legislature used ‘may’ in Section 7(5)(a) of the IBC (which relates to application filed by a financial creditor) but used, ‘shall’ in the identical provision contained under Section 9(5)(a) which states that the NCLT ‘shall’ admit the application of an Operation Creditor on fulfilment of conditions stipulated in the section. This shows that ‘may’ and ‘shall’ in the two provisions are intended to convey a different meaning. It is apparent that Legislature intended to consciously differentiate and give two distinct meanings by making Section 9(5)(a) of the IBC mandatory and Section 7(5)(a) discretionary.
The Court emphasized on the rule of literal interpretation by citing the judgment of Lalita Kumari v. Government of Uttar Pradesh and Ors, and stated that when Section 7(5)(a) of the IBC is construed literally the provision must be held to confer a discretion on the power of NCLT.
Further, the Court held that, the subsistence of a financial debt and default in payment only gives the financial creditor the right to apply for initiation of CIRP, and that the Code intends on providing discretion to the NCLT to admit or refuse to admit a Section 7 petition keeping in mind the relevant factors including the feasibility of initiation of CIRP. However, at the same time, the Court cautioned the NCLT against arbitrary or capricious exercise of such discretion. Very importantly, the Court held that, – ordinarily NCLT would have to exercise its discretion to admit an application under Section 7 of the IBC and initiate CIRP on satisfaction of the existence of a financial debt and default on the part of the Corporate Debtor in payment of the debt, unless there are good reasons not to admit the petition.
Differential treatment with respect to admission of insolvency applications filed by Financial Creditor and Operational Creditor
The court expressed that a differentiation has been deliberately created between the admission of application of a Financial Creditor and that of an Operational Creditor owing to difference in their business models. While a Financial Creditor makes investments which are in the nature of long-term contracts, the Operational Creditor is engaged in the business of supplying goods and services due to which it cannot compete with the financial strength or the secured long-term contracts entered by the Financial Creditor. Hence, the impact of the non-payment is far more serious for the Operational Creditors than the Financial Creditor. Due to this reason the claims of operational creditors with undisputed debts have rigid and inflexible provisions under the Code wherein such applications have to be mandatorily admitted
However, in case of insolvency applications filed by operational creditors, if the facts and circumstances so warrant, NCLT can keep the admission in abeyance or even reject the application. The Court particularly specified that, in case of rejection of an application, the Financial Creditor is not stripped of the right to apply afresh for initiation of CIRP, if its dues continue to remain unpaid.
Matters which are not extraneous have to be considered while deciding on admission of Insolvency Application keeping in mind the object of the Code
The Court acknowledged that the expeditious nature of the proceedings is necessary for IBC proceedings and that no inessential or extraneous matters should be considered while admitting the application. However, the matters concerning the financial viability and health are not considered to be extraneous. The object of the Code is not to penalize solvent companies which have defaulted due to its temporary financial debts but it is to revive the company, the NCLT must apply its mind to the important and relevant factors such as the feasibility of initiation of the process, viability and overall financial health, surrounding circumstances..
The Court clarified that the NCLT has to consider the grounds presented by the Corporate Debtor against admission of the application, on its own merits. To illustrate – when admission is opposed on the ground of existence of an award or a decree in favour of the Corporate Debtor, and the award/decretal amount exceeds the amount of the debt, the NCLT would have to exercise its discretion under Section 7(5)(a) of the IBC to keep the admission of the application of the Financial Creditor in abeyance, unless there is good reason not to do so. The NCLT may, for example, admit the application of the Financial Creditor, notwithstanding any award or decree, if the award/decretal amount is incapable of realisation.
In that context, the Court held that the NCLT could not have disregarded APTEL’s award in favour of VIPL. As the amounts payable to VIPL under APTEL’s award far exceed the claim of the financial creditor (Axis Bank) the same could not be overlooked. Further, in relation to a generating company that operated under statutory control, the impact of MERC’s appeal on the financial health and viability of VIPL would have to be an important factor to which the NCLT was required to apply its mind.
OUR ANALYSIS AND VIEWS
The Supreme Court has made it clear that, – the existence of a financial debt and default only gives a right to a financial creditor to apply for initiating insolvency resolution process, but it is finally up to the discretion of NCLT whether or not to admit such application. NCLT may at its discretion refuse to admit such application considering relevant factors. It should be noted here that even while the Supreme Court has emphasised to consider relevant factors while deciding to admit insolvency applications filed by financial creditors, the Court has also categorically held that, – ordinarily NCLT would have to exercise its discretion to admit an application under Section 7 of the IBC and initiate CIRP on satisfaction of the existence of a financial debt and default on the part of the Corporate Debtor in payment of the debt, (Quote) “unless there are good reasons not to admit the petition”. Being guided by this ratio and principle, NCLTs are almost duty bound to admit insolvency applications unless putting a debtor under insolvency would be unfair; and this is most likely to happen only when there is concrete evidence to show that the debtor is entitled to receive a debt similar to the present case and receipt of such debt will in turn enable the debtor to satisfy the dues of the financial creditor.
While the judgment has been given in backdrop of a situation wherein the debtor was in turn expecting payment from another debtor and such unrealised amount was far greater than the IBC defaulted amount, this judgment can nonetheless be used as a shield by defaulting corporate debtors to defend and justify financial debts. In some cases, financial creditors may rather choose to file a commercial summary suit against defaulting corporate debtors instead of spending time in insolvency proceedings.
While the judgment is certainly given in light of spirit of law and to protect otherwise financially stable corporate debtors, practical difficulties will arise in determining as what factors would or would not be relevant enough / extraneous to admit or refuse the admission of insolvency applications filed by financial creditors, as the judgement does not prescribe such guidelines / factors for NCLTs basis which they have to decide whether to admit or refuse such applications. It will not be surprising to see contradictory views given by different benches/tribunals in this regard. It may also happen that, insolvency applications filed by different financial creditors against the same corporate debtor at the same point in time would have to be considered and adjudicated basis the parameter of the amount of outstanding dues. For example, the debtor would owe say 100 crores to Bank ‘A’ and 500 crores to Bank ‘B’. The Debtor may have potential financial viability to satisfy debt of Bank ‘A’ but not Bank ‘B’. It may also happen that two financial creditors may have lent equal sums to the debtor but they may not even have pari passu rights over the assets of the debtor in case the Debtor defaults and it has the capacity to pay only 1 of the creditors. These unique scenarios may pose practical challenges for NCLT while deciding such applications.
In so far as this case is concerned, – in the event the Supreme Court reversed the decision of APTEL ordering MERC to pay the dues of INR 1,730 crores to VIPL or in the event the Court would order for payment of such sum which is lower than what has been decreed by APTEL, then Axis Bank may be entitled to file a fresh insolvency petition against VIPL considering the surrounding circumstances would change and the financial health of VIPL would have to be viewed in light of such changed circumstances.
The judgment creates a dichotomous situation wherein for insolvency applications filed by operational creditors, NCLT does not have discretionary powers to reject the application if there is an existence of default of an operational debt (if there is no pre-existing dispute with respect to the debt). In other words, when it comes to insolvency applications filed by operational creditors, NCLT does not have the liberty to consider any other factors such as financial health and viability of the corporate debtor unlike in the case of insolvency applications filed by financial creditors. The said distinction arises out from the reasoning by the Supreme Court that, – factors such as corporate debtor’s financial viability and solvency etc would not be material to consider when the application is filed by an operational creditor. With due respect to the Hon’ble Court, in our personal views, this reasoning seems to be flawed to us. Even in case of operational debts, one needs to take into account several factors surrounding the default of debt. The aforesaid dichotomy will again create practical difficulties wherein at a given point in time there are two insolvency applications pending against the same debtor, – one filed by a financial creditor and another by an operational creditor.
In so far as the difference between the words “may and “shall” is concerned, there are numerous cases (including foreign precedents) where the word “shall” has been construed as merely directory and cases where the word “may” is often read as “shall” or “must” when there is something in the nature of the thing to be done which makes it the duty of the person on whom the power is conferred to exercise the power. The use of the word ‘may’ or ‘shall’ is not conclusive and whether or not a provision is mandatory or directory would depend upon other circumstances also. It has a varying significance having regard to the context in which it appears. Though the word ‘may’ in its ordinary or primary sense is susceptible of a permissive meaning, decisions of the highest courts have recognised that a duty might exist, outside and apart from the particular provisions of a statute, whereby those on whom a power is conferred by the statute are under an obligation to exercise. The word ‘may’ though primarily permissive, has been in certain circumstances, treated as obligatory. It is a well settled principle of interpretation of statutes that where power is conferred upon public authority coupled with discretion, the word ‘may’ which denotes discretion, should be construed to mean a ‘command’.
It will be interesting to see how different benches of NCLT and also NCLAT interpret this judgment while deciding on insolvency applications filed by financial creditors.
DISCLAIMER: This update is not intended to address the circumstances of any particular individual
or organisation. It is recommended that professional advice be taken based on the specific facts and
circumstances. The Update does not substitute the need to refer to the original pronouncements and
all the views expressed in this Update are personal. The Firm hence disclaims any liability whatsoever
arising out of use of this Update for any purpose.