Constitutional Validity of Insolvency and Bankruptcy Code

Introduction

The Insolvency and Bankruptcy Code 2016 (the ‘Code’) provides the creditors with a comprehensive solution for the recovery of dues from wilful defaulters. While this legislation has been facing teething issues and inconsistencies from its inception, the proactive approach of the government in amending this liquidation law from time to time has led to its significant implementation. Issues about the constitutional validity of the Code have been raised by various stakeholders time and again like any other fresh legislation. The petition alleged that the Code violates Article 14 of the Indian Constitution and is discriminatory. In an abundance of applications made to various National Company Law Tribunals (‘NCLT(s)’) and High Courts across the country, the petitioners had 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, the Amendment by the 2018 Amendment of the Code, another provision was put on promoters from bidding for their own company under Section 29A. This Code forced the sale of the Company to new bidders and thus was argued to be against the fundamental right of the promoters. Additionally, another claim was raised about the inequitable nature of Section 29A 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 unstable.

Thus, Responding to these series of petitions that had challenged the constitutional validity of this Code, the Supreme Court through the case of Swiss Ribbons Private Limited and Anr v. Union of India and Ors (Bench of Hon’ble Mr. Justice Rohinton F Nariman and Hon’ble Mr. Justice Navin Sinha) upheld the validity of the Code in its entirety laying rest to several issues which arose due to the departure of the Code from the insolvency laws before it. The Supreme Court took inspiration from the verdict in the case of Bhavesh D. Parry v. Union of India which held 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’.

This judgment dealt with the significant issues about the admission process, lack of participation of operational creditors in the Committee of Creditors (‘CoC’) and the way bar puts the defaulting promoters from participating in the resolution plan, which led significant changes in the way insolvency laws operated in our country.

The Court also observed the response to these arguments put forth by the petitioners and the analysis drawn by the Court pertinent to their ruling is as follows –

Classification of creditors

The petitioners came up with contentions that the financial creditors and operational creditors provided money to the debtor either in terms of financial assistance or goods respectively. They also argued that the classification between them does not make any real difference in terms of the object to be achieved by the Code which is either an insolvency resolution plan or liquidation as a result. The petitioners further argued that even if the Court believes that there exists a logical distinction between financial and operational creditors, the later one is discriminated against and is treated with hostility.

Thus, it observed that there is an existing intelligible differentia between the two creditors which is directly related to the object sought to be attained under this Code. The key observations made by the Supreme Court are –

  1. financial creditors have secured creditors and operational creditors are unsecured creditors as payment for goods to the operational creditors is not secured by mortgage documents;
  2. the quantum of money due to the operational creditors is substantially less than the money owed to the financial creditors;
  3. repayment of debt to a financial creditor is organized under various schedules and default in payment attracts penalty and a similar scenario does not exist for operational creditors; and
  4. the financial creditor is required to prove the existence of default by the debtor whereas the operational creditor simply claims his right of payment.

The Court has also analyzed the role played by these two sets of creditors in furtherance of this Code where it observed that the absence of operational creditors in the CoC has a valid basis and is not violative of its rights. The viability and feasibility of the business of a corporate debtor is extensively assessed through the financial creditors while providing the debt and thus, are in a better position to evaluate the resolution plan than compared to the operational creditors and thus, explaining their presence in the CoC.

Therefore, preservation of the corporate debtor as a going concern while making sure that the maximum recovery for all creditors is the underlying intention of this Code. Thus, we can say that there exists a considerable difference between financial creditors and operational creditors, and the operational creditors are not discriminated against under this Code.

The validity of Section 29A

Furthermore, the contentions argued against the validity of Section 29A was heard by the Supreme Court where the following was noted:

  1. Vested rights of promoters to participate in the recovery process of a corporate debtor have been impaired by retrospective application of Section 29A;
  2. 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;
  3. Also, a personal account may be classified as a nonperforming asset (NPA) despite him not being a wilful defaulter;
  4. Lastly, the relatives of the promoters who are within the eligibility criteria are barred from participating in the resolution process.

Thus, The Supreme Court observed that it is a settled law that a statute is not ex post facto since it has an impact on the existing rights or the requisites for its action are drawn from a time antecedent. There are vested rights of participation in any resolution applicant and the same can be implied to the rejection of such resolution applications due to lack of feasibility. The Supreme court further held that the participation of the relative of an ineligible person, the Court has to point out that such ‘related person’ is not connected with the business of the activity of the resolution applicant or else 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 the 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.

Conclusion

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 resources to the commercial sector in India as a result of the 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.

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