Supreme Court of India (“SC”) upholds constitutional validity of the Insolvency and Bankruptcy Code, 2016 (“IBC”)

By INSOL INDIA EDITORIAL Posted On : February 20, 2019

The SC in the case of Swiss Ribbons Pvt. Ltd. & Anr. vs. Union of India & Ors. (“Swiss Ribbons Matter”), has upheld the constitutional validity of the IBC. The SC reiterated the principals that scope of judicial review of an economic legislation is limited and that it does not sit in judgment over such legislation unless it is palpably arbitrary. The SC reviewed various provisions of the IBC under challenge, examined their rationale and rejected almost every group of challenges raised before it.

 

The three key rulings of the SC in the Swiss Ribbons Matter are as follows: 

 

  1. Unfavorable treatment of operational creditors

 

  • The SC noted that financial creditors are mostly secured creditors, lesser in number, having specified repayment schedules including provisions of default, etc., and typically involve large sums of money.
  • The SC also observed that financial creditors involved in assessment of viability of corporate debtors, engage in restructuring of loans and business, and have a completely different dispute resolution mechanism under their respective financing documents. In contrast, operational creditors are more in number, are unsecured and their claims are smaller.
  • Based on these reasons, it concluded that there is a clear intelligible differentia having nexus to the objects of the IBC. The different treatment of financial and operational creditors under the IBC is therefore valid and sustainable under Article 14 of the Constitution of India.

 

   2.  Scope of Section 29A of the IBC

 

  • The SC reiterated its previous decision in the case of ArcelorMittal India Private Limited vs. Satish Kumar Gupta & Ors., that Section 29A of the IBC is a ‘see through provision’. The SC held that since a resolution applicant has not vested right, the challenge to Section 29A of the IBC on the ground of retrospectivity was rejected. It was also held that there is no vested right in an erstwhile promoter to bid for the property of the corporate debtor in liquidation under the IBC.
  • The one year period prescribed under Section 29A(c) of the IBC, which relates to disqualification of a resolution applicant for an account being classified as a non-performing asset) was held to be reasonable. The SC reasoned that this one year period is in addition to the 90 days provided under the RBI Master Circular on ‘Prudential norms on Income Recognition, Asset Classification and Provisioning pertaining to Advances’. Thus, the legislative policy of disqualifying a person who is unable to service his own debt beyond a period of 90 days 12 months cannot be faulted.
  • A contention was raised that disqualification under Section 29A (c) of the IBC treats unequals as equals in that it makes no distinction between a good erstwhile manager and a bad erstwhile manager. The SC rejected this contention on the ground that Section 29A is not restricted to malfeasance. In support of this conclusion, the SC pointed out that as per Section 29A (a) of the IBC, a person may be an undischarged insolvent for no fault of his; or under Section 29A (e), a person may be disqualified to act as a director where he has not furnished the necessary financial statements on time.
  • Finally, the SC read down the definition of ‘relative’ in context of Section 29A (j) of the IBC. The SC held that the definition of ‘relative’ will include only those persons who are connected with the business activity of the resolution applicant.

 

3.    Validity of Section 12A of the IBC

 

  • With respect to the challenge to Section 12A of the IBC, the SC held that IBC proceedings, once admitted, are proceedings in rem and therefore the body which is to oversee the corporate insolvency resolution process i.e. the committee of creditors (“COC”) must be consulted before any individual corporate debtor is allowed to settle its claim.
  • The rationale behind the 90% requirement under Section 12A of the IBC is that all financial creditors have to be involved in order to permit such a withdrawal. Further, in the absence of anything material to establish arbitrariness, the high threshold is in the domain of legislative policy and not amenable to judicial review.
  • Even in cases where the COC has not been constituted, the National Company Law Tribunal can exercise its inherent powers under Rule 11 of the National Company Law Tribunal Rules, 2016 to allow withdrawal of an application filed for initiation of the corporate insolvency resolution process against a corporate debtor under the IBC.