Two steps back?: Dismissal of review petition before Supreme Court in Vidarbha Industries vs Axis Bank Ltd

The article has been co-authored by Mr. Sanjeev Sharma, Partner and Mr. Arunav Guha Roy, Designate Partner at Saraf and Partners. 

The Hon’ble Supreme Court recently dismissed the review petition filed by Axis Bank Ltd.[2] against its decision rendered in Vidarbha Industries^[3] and upheld the Apex Court’s ruling that the Adjudicating Authority and the Appellate Authority under the Insolvency and Bankruptcy Code  (‘the Code’) need to be mindful of the corporate debtor’s financial health and viability while admitting a petition under Section 7 of the Code and that they should exercise reasonable discretion while admitting or rejecting such an application, for the initiation of corporate insolvency resolution proceedings (‘CIRP’) against a corporate debtor for a single instance of default. By doing so, the Supreme Court has reiterated the ruling set out in Vidarbha Industries. 

Vidarbha Industries was a significant turnaround to what was till now widely understood to be the settled position under Section 7 of the Code. Before the decision, the settled law required adjudicating authorities to admit an application seeking initiation of CIRP filed by a financial creditor under Section 7 of the Code, after being satisfied with two conditions viz. the existence of a financial debt and an admission of default of the debt. The decision in Vidarbha Industries tweaked this position by asking the adjudicating authorities under the Code i.e., the National Company Law Tribunal (‘NCLT’) to look beyond merely the existence of financial debt and its default. The decision by the Supreme Court allowed the corporate debtor a respite in an application filed under Section 7 of the Code, by relying on the literal interpretation of similarly worded provisions i.e., Section 9(5)(a) and Section 7(5)(a).  

In the facts of the case, after an application under Section 7 of the Code had been filed by the financial creditor for a default of an amount of approximately Rs. 533 crores before the NCLT, the corporate debtor filed an application seeking a stay on the NCLT proceedings, on the pretext that there were ongoing proceedings in the Supreme Court that in all probability would allow the corporate debtor to realize an amount that exceeded the amount in default and thereby ensure repayment of the debt. The NCLT had rejected the stay application on the grounds laid down under Section 7 of the Code. Section 7 of the Code, in its ordinary language, allows for the admission of an application for CIRP once it is satisfied that there is an existence of debt and admission of default. It also reasoned on the part of the financial creditor that the legislative intent behind the Code was to achieve hasty disposal of issues, with the help of expeditious timelines, which in this case would be affected if the application was not admitted. The NCLT held that the proceedings before the Supreme Court qualified as extraneous matters that would cause unnecessary delays which in the CIRP which was not a desirable outcome. The National Company Law Appellate Tribunal (‘NCLAT’), as an appellate authority under the Code, concurred with the ruling by the NCLT and dismissed the appeal. The corporate debtor then moved to the Supreme Court which ruled in favour of the corporate debtor. 

The Supreme Court, while rendering its decision, engaged in a literal interpretation of Section 7(5)(a) of the Code and held that the admission of an application under Section 7 was discretionary rather than mandatory. It observed that the provision employs the phrase ‘may admit’ which provides a scope for the adjudicating authority to either admit or reject a CIRP application, even after satisfying itself with the existence of debt and admission of default. This was the volte-faceto the judicial precedents set by the Supreme Court in Innoventive Industries^[4] and Swiss Ribbons^[5]. The Supreme Court drew attention to the fact that the legislative intent of the Code was primal in this case as the Code employed the phrase ‘shall admit’ in Section 9(5)(a) which allows an operational creditor to initiate CIRP. The Supreme Court, therefore, reasoned that the objective of the Code was not to penalize solvent companies for a single case of default on the financial debt. It was also observed that it is essential that the NCLT takes measures to investigate relevant factors such as the feasibility of initiating CIRP, the financial health and viability of the corporate debtor, and surrounding circumstances and arguments raised by the corporate debtor. The Supreme Court in Vidarbha appears to have made a conscious differentiation between the financial and operational creditors due to a distinction in their nature of business and implied that non-payment of dues would weigh more heavily against operational creditors as compared to financial creditors. 

The Supreme Court was of the view that Section 7 should be treated with caution and should not be implemented arbitrarily or capriciously to the disadvantage of either of the stakeholders. The Court concurred with the opinion of the NCLT with regard to a timely resolution of disputes and admitted to the fact that while extraneous matters should not act as a hindrance, the financial health and viability of the corporate debtor would not be extraneous and thus would need to be taken into consideration by the NCLT. The Supreme Court accordingly held that a receivable by the corporate debtor, in the form of an award by the Appellate Tribunal for Electricity of Rs. 1730 crores, being an amount exceeding the amount claimed to be in default by the financial creditor, could not have been disregarded by the NCLT and NCLAT. Moreover, it was ruled that the existence of debt and its default merely gave the right to the creditor to initiate CIRP and the NCLT was required to apply its mind to relevant factors, including the feasibility of initiation of CIRP. However, while the Supreme Court noted that extraneous factors act as a hindrance to the timely resolution of applications under the Code, it did not outline an exhaustive list of situations that would qualify as ‘extraneous’ in a given scenario. This may gradually open the doors to tribunals applying different levels of subjectivity while assessing the merits of applications filed for the initiation of CIRP.   

On the face of it, the Supreme Court’s decision seems to have ensured a balance between the rights of the corporate debtor and the financial creditor, allowing for an extra layer of protection for otherwise healthy and solvent companies; by preventing them from getting embroiled in proceedings for isolated cases of defaults. What is pertinent to note here is that the judgment tends to be very case specific to the facts of the case and may not suit the needs of other corporate debtors in similar matters that might come up in the future. Notably, the Supreme Court denied initiation of CIRP on the ground that the corporate debtor was otherwise financially sound, if not for receivables tied up in other proceedings. Therefore, the decision may prevent financial creditors from initiating frivolous proceedings against corporate debtors. However, the decision fails to provide a set body of guidelines that every adjudicating authority would be required to follow in the event such a matter arises. The decision may also not lead to an absolute bar on applications being filed by financial creditors for multiple defaults committed by corporate debtors. 

Another important aspect of the decision is that while the Supreme Court advocated the use of literal interpretation of statutes in interpreting the Code, it read into what Section 7 of the Code provided and consequently ended up undertaking a purposive interpretation of the said provision. Notably, Section 7 does not specifically provide for the NCLT to look into the financial health or viability of the corporate debtor and this is an added responsibility that Vidarbha now levies on the NCLT by reading into the word “may” provided in Section 7(5), as opposed to “shall” mentioned in Section 9(5) of the Code. Moreover, while dealing with this minute distinction in similarly worded provisions of Section 7 and Section 9 the Supreme Court appears to have failed to consider that while evaluating the feasibility of the initiation of CIRP, the financial health and viability of the corporate debtor may be a relevant ground to consider even in an application filed by an operational creditor and not merely a financial creditor. 

Furthermore, while Section 9(5)(ii) of the Code provides, and the Apex Court has observed as much, that the NCLT must necessarily reject an application for initiating CIRP for the unpaid operational debt if there is a prior notice of dispute, various judgments have been rendered holding that such dispute must be plausible[6] and not be a patently feeble legal argument or an assertion unsupported by evidence[7] or be in the nature of a “moonshine defense” dispute done merely evade the initiation of CIRP[8]. Pertinently, such decisions have been rendered despite the Code stipulating that the NCLT ‘must’ reject a petition if the notice of dispute has been served, without there being any additional requirement for the NCLT to adjudicate on the nature or tenability of the dispute. Hence, it may be argued that a literal interpretation of the Code may not be appropriate if the same defeats the objective of the Code. In fact, the Solicitor General in the review proceedings argued as much, that certain observations made in Vidarbha could be interpreted in a manner that might be contrary to the aims and objectives of the Code and render the law infructuous. However, this argument was dismissed while holding that Vidarbha was made in the context of the case at hand and that it is settled law that a judgment was not read as provisions of a statute. 

It may also be noted that the decision in Vidarbha is predicated on the premise that the foremost objective of the Code is to try and first revive the corporate debtor and not spell its death knell.[9] However, a perusal of the scheme of the Code makes it evident that the mere admission of an application under Section 7 of the Code does not spell a “death knell” for a corporate debtor. The objective behind the Code was to transfer poorly run companies from weaker hands to stronger ones, who would be able to maintain financial discipline and prevent persistent defaults in their obligations. Upon admission of the application, a committee of creditors of the corporate debtor convenes and vote on a ‘resolution’ plan which is aimed at reviving the company. It is only when the resolution plan fails to bear fruit, that liquidation proceedings commence. Similar observations were made by the Apex Court itself in Innoventive Industries wherein the Apex Court noted that “When a firm (referred to as the corporate debtor in the draft law) defaults, the question arises about what is to be done. Many possibilities can be envisioned. One possibility is to take the firm into liquidation. Another possibility is to negotiate a debt restructuring, where the creditors accept a reduction of debt on an NPV basis, and hope that the negotiated value exceeds the liquidation value. Another possibility is to sell the firm as a going concern and use the proceeds to pay creditors. Many hybrid structures of these broad categories can be envisioned...”. The Apex Court also observed that “From the viewpoint of creditors, a good realisation can generally be obtained if the firm is sold as a going concern. Hence, when delays induce liquidation, there is value destruction. Further, even in liquidation, the realisation is lower when there are delays”. It is therefore evident that each time an insolvency application is admitted, the same only allows the creditors to get together and enter into deliberations on how to revive the defaulting company, with the help of certified resolution professionals, as opposed to the corporate debtor immediately being liquidated, which in any event is averse to the interests of creditors. Therefore, by putting the commencement of the corporate insolvency resolution process under the Code at the discretion of the adjudicating authority, the Supreme Court’s decision in Vidarbha could have the effect of preventing the effective revival of stressed companies by experienced resolution professionals. 

It may therefore be said that the Apex Court’s decision shifts the focus from the ‘existence’ of debt and its ‘non-payment’, being the stated intention behind the Code, to the ‘inability to pay’ debts which warrants us to look back at the winding up jurisprudence from the pre-insolvency era, where even if a company defaulted in payment of its debts, it could prevent liquidation by demonstrating that it had the “ability to pay” its debts. Interestingly, the Apex Court in Vidarbha noted that the Code does not countenance dishonesty or deliberate failure to repay the dues of an operational creditor. However, it remains to be seen if the different standards for financial creditors held in Vidarbha would increase the risk of such failure or dishonesty being countenanced on the part of financial creditors. 

The change from the pre-insolvency regime to the enactment of the Code was done to provide a timely and effective legal framework for the resolution of insolvency matters, as was observed by the Supreme Court in Swiss Ribbons and Innoventive and prevent the frustration of creditor’s rights. However, it will have to be seen whether the decision in Vidarbha furthers this objective or leads to tribunals arriving at different interpretations as to when to admit applications for default of financial debt.  

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