Background
The Supreme Court yesterday delivered its first substantive ruling under the Insolvency and Bankruptcy Code, 2016 (the “Code”) in Innoventive Industries Limited v. ICICI Bank. Incidentally, this relates to the first corporate insolvency case to be admitted by the National Company Law Tribunal (“NCLT”) after the Code came into effect in December 2016. The Supreme Court rejected a vociferous challenge to the insolvency proceedings mounted by the corporate debtor, Innoventive, and ruled in favour of the financial creditor, ICICI Bank. In doing so, the Court reemphasized the creditor-friendly nature of the Code.
After Innoventive went into financial difficulties, it agreed upon a corporate debt restructuring plan with its creditors. Under a master restructuring agreement dated 9 September 2014 (the “MRA”) entered into between Innoventive and its creditors, there were two-way terms by which not only was Innoventive required to meet some obligations, but the creditors were to infuse certain funds to enable Innoventive to stay afloat financially. On 7 December 2016, ICICI Bank initiated the corporate insolvency resolution process (the “CIRP”) under the Code in respect of Innoventive. The corporate debtor took refuge under the provisions of the Maharashtra Relief Undertakings (Special Provisions) Act, 1958 (the “Maharashtra Act”) under which Innoventive’s liabilities were suspended by way of a moratorium. However, during a subsequent hearing, Innoventive raised another issue that its inability to pay its debt was due to the failure of creditors to make good their financial commitments under the MRA. This objection was not raised during the first hearing.
The NCLT admitted ICICI Bank’s application initiating the CIRP by holding that the Code would prevail of the Maharashtra Act in view of the non-obstante clause under section 238 of the Code. The NCLT also declared a moratorium as required by the Code. On appeal, although the National Company Law Appellate Tribunal (“NCLAT”) did not disturb the conclusion of the NCLT, on the point of law it did not find any repugnancy between the Code and the Maharashtra Act. It is against the order of the NCLAT that Innoventive appealed to the Supreme Court.
Issues and Ruling
The most significant issue before the Supreme Court relates to the possible conflict between the Code and the Maharashtra Act. Innoventive argued that given the moratorium already in place under the Maharashtra Act, there was no debt payable by Innoventive, and hence the provisions of the Code could not have been invoked. In addressing this conflict, a large part of the Supreme Court’s attention was focused on the constitutional question of which law would prevail, i.e., the Code or the Maharashtra Act. After analyzing a great deal of the case law under article 254 of the Constitution and on the principles of repugnancy, the Supreme Court found that while the Maharashtra Act derives its source from Entry 23, List II (State List) in the Seventh Schedule to the Constitution,[1] the Code is attributable to Entry 9, List III (Concurrent List).[2] The Court enumerated the legal position as follows:
55. It is clear, therefore, that the earlier State law is repugnant to the later Parliamentary enactment as under the said State law, the State Government may take over the management of the relief undertaking, after which a temporary moratorium in much the same manner as that contained in Sections 13 and 14 of the Code takes place under Section 4 of the Maharashtra Act. There is no doubt that by giving effect to the State law, the aforesaid plan or scheme which may be adopted under the Parliamentary statute will directly be hindered and/or obstructed to that extent in that the management of the relief undertaking, which, if taken over by the State Government, would directly impede or come in the way of the taking over of the management of the corporate body by the interim resolution professional. Also, the moratorium imposed under Section 4 of the Maharashtra Act would directly clash with the moratorium to be issued under Sections 13 and 14 of the Code. It will be noticed that whereas the moratorium imposed under the Maharashtra Act is discretionary and may relate to one or more of the matters contained in Section 4(1), the moratorium imposed under the Code relates to all matters listed in Section 14 and follows as a matter of course. In the present case it is clear, therefore, that unless the Maharashtra Act is out of the way, the Parliamentary enactment will be hindered and obstructed in such a manner that it will not be possible to go ahead with the insolvency resolution process outlined in the Code. Further, the non-obstante clause contained in Section 4 of the Maharashtra Act cannot possibly be held to apply to the Central enactment, inasmuch as a matter of constitutional law, the later Central enactment being repugnant to the earlier State enactment by virtue of Article 254 (1), would operate to render the Maharashtra Act void vis-à-vis action taken under the later Central enactment. Also, Section 238 of the Code reads as under:
“Sec. 238. Provisions of this Code to override other laws.-
The provisions of this Code shall have effect, notwithstanding anything inconsistent therewith contained in any other law for the time being in force or any instrument having effect by virtue of any such law.”
It is clear that the later non-obstante clause of the Parliamentary enactment will also prevail over the limited non-obstante clause contained in Section 4 of the Maharashtra Act. For these reasons, we are of the view that the Maharashtra Act cannot stand in the way of the corporate insolvency resolution process under the Code.
While the aforesaid constitutional question formed the substantial part of the Supreme Court’s analysis, there were two other incidental questions of relevance. The first was whether Innoventive’s payment obligations to financial creditors was contingent upon the infusion of funds by creditors under the MRA. The Supreme Court answered in the negative, for procedural as well as substantive reasons. On the procedural count, it was found that Innoventive raised the argument as an afterthought at the second hearing and beyond the prescribed 14-day period. Substantively, upon an analysis of the MRA, the Court found that the payment obligations of Innoventive were unconditional and not subject to infusion of funds by creditors. Hence, it was not open to Innoventive to rely on the lack of creditor funding under the MRA to stall the CIRP under the Code.
The second incidental question (albeit an important one from a corporate insolvency perspective) pertained to who can challenge the CIRP. In the present case, it was the company, Innoventive, which had mounted a challenge to the process and preferred the appeals. However, once the insolvency proceeding was admitted by the NCLT and moratorium declared, the directors of the company are no longer in management. Hence, it is likely that the directors would have to file objections in their individual capacity as interested persons rather than as directors of the company. Although the Supreme Court indicated its views, it did not decide the question. It noted:
According to us, once an insolvency professional is appointed to manage the company, the erstwhile directors who are no longer in management, obviously cannot maintain an appeal on behalf of the company. In the present case, the company is the sole appellant. This being the case, the present appeal is obviously not maintainable. However, we are not inclined to dismiss the appeal on this score alone. Having heard both the learned counsel at some length, and because this is the very first application that has been moved under the Code, we thought it necessary to deliver a detailed judgment so that all Courts and Tribunals may take notice of a paradigm shift in the law. Entrenched managements are no longer allowed to continue in management if they cannot pay their debts.
Analysis
In providing the aforesaid ruling, the Supreme Court has sought to elaborate on the background and policy behind the Code, including by examining the report of the Bankruptcy Law Reform Committee. The slant of the Court ruling clearly demonstrates the need for a stringent corporate insolvency framework in India, which was answered by the enactment of the Code. This demonstrates a paradigm shift from the erstwhile insolvency framework which followed a “debtor-in-possession” approach to one that is more creditor-friendly. This is particularly so because the management of the debtor company loses control upon admission of an insolvency petition, thereby giving considerable authority to the interim (and subsequently the final) resolution professional. Some have argued that such a creditor-controlled approach is suitable for jurisdictions that are replete with companies with controlling shareholders (or promoters). Such an approach will likely address any moral hazard problems due to excessive risk-taking by the promoters. The Supreme Court’s affirmation of the creditor-orientation of the Code will arguably strengthen the hands of creditors, whether financial or operational, and incentivize them to take more companies into the insolvency process. At the same time, the question remains whether the pendulum has swung too far in favour of the creditors.
As for the two supplemental issues considered by the Supreme Court, there are two lessons from its ruling. First, the Court has reemphasized that time is of the essence in the CIRP. The corporate debtor must file any objections or challenges within the stipulated time-period, or they will forfeit their opportunity to rely upon them. Second, if challenges are to be mounted from the corporate debtor’s side, especially in promoter-driven companies, they must be brought by the former directors or promoters in their individual name. It is logically inappropriate for the company to be an objector, when it is not only the subject-matter of the insolvency proceedings, but upon admission of the insolvency petition its management is vested in the interim resolution professional.
Given the spate of insolvency proceedings that have arisen in the last few months, it is reasonable to assume that the Supreme Court will be called upon to answer more questions relating to the Code in the ensuing period.
[1] Entry 23, List II: “Social security and social insurance; employment and unemployment.”
[2] Entry 9, List III: “Bankruptcy and insolvency”.