CONSTITUTIONAL VALIDITY OF INSOLVENCY AND BANKRUPTCY CODE
A strong insolvency regime serves two purposes. It saves businesses that are viable and facilitates the exit of those that are not. The Insolvency and Bankruptcy Code (IBC), 2016, has been designed to create such a regime in India. Before the IBC, India neither had an efficient rescue mechanism nor a satisfactory exit route for businesses. The IBC offers a market-directed, time-bound mechanism to resolve insolvency, wherever possible, or exit, where required. The Insolvency & Bankruptcy Code 2016 (“IBC”), enacted to address the troubling shortcomings in existing staggered insolvency laws in India and to bring them under one umbrella, is set up to face a monumental challenge and equally monumental expectations. The 2016 Code applies to companies and individuals. It provides for a time-bound process to resolve insolvency. When a default in repayment occurs, creditors gain control over debtor’s assets and must take decisions to resolve insolvency within a 180-day period. To ensure an uninterrupted resolution process, the Code also provides immunity to debtors from resolution claims of creditors during this period. The Code also consolidates provisions of the existing legislative framework to form a common forum for debtors and creditors of all classes to resolve insolvency.This article would analyze the constitutional validity of the Insolvency and Bankruptcy code.
Like any fresh legislation, issues pertaining to the constitutional validity of the Code have been raised by various stakeholders time and again. It has been alleged that the Code violates Article 14 of the Constitution of India and is discriminatory in nature. In a plethora of applications made to various National Company Law Tribunals and High Courts, the operational creditors have claimed that the classification of creditors as operational creditors and financial creditors is manifestly arbitrary and there is no intelligible differentia applied by the legislators in making such a demarcation. Furthermore, in the aftermath of the 2017 Amendment of the Code which was subsequently amended by 2018 Amendment of the Code, another provision that led to massive hue and cry was the bar put on promoters from bidding for their own company under Section 29A. The Code forced the sale of the Company to new bidders and was argued to be against the fundamental right of the promoters. Additionally, another claim pertaining to the inequitable nature of Section 29A was raised and it was argued that the exclusion of the relative of an ineligible person, who is otherwise qualified to be the resolution applicant is extremely capricious. Responding to a series of petitions that had challenged the constitutional validity of various provisions of the Code, the Supreme Court in the case of Swiss Ribbons Private Limited and Anr v. Union of India and Ors upheld the validity of the Code in its entirety laying rest to several issues which arose due to the departure of the Code from previous insolvency laws.
The Court, taking inspiration from the verdict in Bhavesh D. Parry v. The Union of India was of the view that – ‘matters of policy are best left to the wisdom of the legislature, and in policy matters, the accepted principle is that the courts should not interfere’. The judgment dealt with significant issues pertaining to the admission process, lack of participation of operational creditors in the Committee of Creditors and the bar put on the defaulting promoters and their relatives from participating in the resolution plan, all of which significantly changed the way the insolvency law operated in our country. The Court made several observations in response to the arguments put forth by the petitioners. Analysis drawn by the Court pertinent to their ruling is as follows,
Financial Creditors and Operational Creditors:
The apex court went on to classify the differences between financial creditors and operational creditors –
- A perusal of the definition of financial creditor and financial debt makes it clear that a financial debt is a debt together with interest, if any, which is disbursed against the consideration for time value of money. It may further be money that is borrowed or raised in any of the manners prescribed in Section 5(8) or otherwise, as Section 5(8) is an inclusive definition. On the other hand, an ‘operational debt’ would include a claim in respect of the provision of goods or services, including employment, or a debt in respect of payment of dues arising under any law and payable to the Government or any local authority.
- Most financial creditors, particularly banks and financial institutions, are secured creditors whereas most operational creditors are unsecured, payments for goods and services as well as payments to workers not being secured by mortgaged documents and the like. The nature of loan agreements with financial creditors is different from contracts with operational creditors for supplying goods and services. Financial creditors generally lend finance on a term loan or for working capital that enables the corporate debtor to either set up and/or operate its business. On the other hand, contracts with operational creditors are relatable to supply of goods and services in the operation of business Financial contracts generally involve large sums of money. By way of contrast, operational contracts have dues whose quantum is generally less.
- In the running of a business, operational creditors can be many as opposed to financial creditors, who lend finance for the set up or working of business. Financial creditors have specified repayment schedules, and defaults entitle financial creditors to recall a loan in totality. Contracts with operational creditors do not have any such stipulations. The forum in which dispute resolution takes place is completely different. Contracts with operational creditors can and do have arbitration clauses where dispute resolution is done privately.
Validity of section 29A of the Code:
Furthermore, a four-fold contention against the validity of Section 29A was heard by the Court. In its findings, the court noted the following.
(i) Vested rights of promoters to participate in the recovery process of a corporate debtor have been impaired by retrospective application of Section 29A;
(ii) Further, an erstwhile promoter who may outbid all other applicants and may be able to formulate the most comprehensive resolution plan is kept out of the process;
(iii) Also, a person’s account may be classified as a non performing asset (NPA) despite him not being a willful defaulter;
(iv) Lastly, the relatives of the promoters who are within the eligibility criteria are barred from participating in the resolution process.
The Court observed that it is settled law that a statute is not retrospective merely since it has an impact on existing rights or because a part of the requisites for its action is drawn from a time antecedent. There exist no vested rights of participation in any resolution applicant and the same can be connoted to the widespread rejection of such resolution applications due to lack of feasibility. With respect to the participation of the relative of an ineligible person, the Court pointed that if it is not shown that such ‘related person’ is connected with the business of the activity of the resolution applicant, he cannot be excluded under Section 29A(j). Therefore, Section 29A is constitutionally valid and is applicable in its entirety.
Section 12-A upheld:
The relevant contention against Section 12A was that approval of ninety percent of the CoC is required to allow withdrawal of a petition made under Section 7 or 9 of the Code. The Court observed that this threshold has been substantiated in the Insolvency Law Committee Report as withdrawal is a major decision and requires significant deliberation. Also, the Code assigns the NCLT with the role to finalize such withdrawal. This indicates that the CoC does not have the last say and therefore, this provision passes the constitutionality test.
Conclusively, Justice Nariman while penning the verdict stated that, ‘the experiment contained in the Code passes the constitutional muster. The judgment reiterates the contribution of the Code in increasing the flow of financial resource to the commercial sector in India as a result of repayment of financial debts. It also promotes ethical practices and is considered as a landmark step towards a better economy enhancing the rate of recovery of debts in the country.