Amendment to the Threshold of Default under the Insolvency Code: Some Drafting Concerns

[Rohan Deshpande practices as a counsel at the Bombay High Court, and would like to thank Mihir Naniwadekar for his comments on a draft version]

Section 4 of the Insolvency and Bankruptcy Code, 2016 sets out the threshold of default for the purpose of invocation of insolvency proceedings under the Code. If a corporate debtor commits a default in repayment of debt towards a financial or an operational creditor for an amount greater than or equal to the amount specified in section 4, the creditor can take recourse to the provisions of the Code.

Until 23 March 2020, the text of section 4 stated as under:

4. Application of this Part. –

(1) This Part shall apply to matters relating to the insolvency and liquidation of corporate debtors where the minimum amount of the default is one lakh rupees:

Provided that the Central Government may, by notification, specify the minimum amount of default of higher value which shall not be more than one crore rupees.

In view of the disruptive effect of the Covid-19 pandemic upon Indian businesses, as an alleviative measure, the Government of India issued a notification on 24 March 2020 increasing the aforesaid limit to the maximum extent of Rs. 1 crore, as prescribed under the proviso to section 4 of the Code. The notification reads as follows:

In exercise of the powers conferred by the proviso to section 4 of the Insolvency and Bankruptcy Code, 2016 (31 of 2016), the Central Government hereby specifies one crore rupees as the minimum amount of default for the purposes of the said section.

Previously, authors have analysed the Notification on this blog (here and here). Undoubtedly, such increment under the notification raises more questions than answers, some of which have already been discussed in the aforesaid posts. However, I would like to proffer a contrasting perspective to that of one of the authors, as shared in their post dated 25 March 2020 (first hyperlink above).

The authors have argued in the above post that “… it goes without saying that any application filed henceforth shall meet the increased threshold” and that “… in case where the operational creditor has sent a demand notice and application is not yet filed, the intent and tune of the Code seems to imply that the application can be filed only if the revised threshold is met, and not otherwise.”. It is my view that the notification will be applicable only prospectively, and if a corporate debtor has already defaulted on any debts prior to the Notification, applications pending before the relevant National Company Law Tribunal (“NCLT”) as on 24 March 2020 or filed even subsequent to the coming into force of the notification (by financial as well as operational creditors) in relation to such defaults, will be valid. The rationale behind my view is three-fold.

First, the intention of the notification can be reasonably interpreted as constituting a relief-oriented measure to protect corporate debtors from the deleterious impact of the Covid-19 pandemic upon their businesses. Having said that, the notification does not result in any general relaxation or waiver of the provisions of the Code and does not change or in any manner affect what happens after a default is committed (both of which, in any event, cannot be done under the guise of the proviso to section 4). The only thing that the notification does is that it enhances the limit of what constitutes a default. The mischief sought to be avoided cannot be construed as being one which saves corporate debtors from the trigger of insolvency even in cases where defaults towards creditors have taken place before the pandemic and the resultant financial crisis. Such an interpretation would be contrary to the intention of the executive in exercise of its power of delegated legislation. In fact, the Government is already mulling amending the Code so as to provide for a six-month embargo during which recourse to the provisions of the Code cannot be taken by creditors. Thus, if the intention was to provide for a blanket protection to corporate debtors from being dragged to the NCLT irrespective of when or to what extent a default has taken place, then even the Government seems to be sensitive to the fact that it would require a legislative amendment, and that mere issuance of the notification would not suffice.

Secondly, the provisions of the Code contemplate applicability of the specific provisions of sections 7, 8 and 9 to pre-existing defaults, i.e., defaults which predate the application by a financial creditor, and a demand notice or invoice demanding payment which is subsequently the basis of an application by an operational creditor. Prior to proceeding in any manner under the Code, a default is thus axiomatic, since a financial creditor is not required to issue any insolvency notice prior to filing of an application, while even in the case of operational creditors, a default is not deemed to occur after non-payment of a debt in response to an insolvency notice, but beforehand. Additionally, it must be remembered that the Code does not prescribe any timeline, either for filing of an application for insolvency before the NCLT after commission of a default (in case of financial creditors), or for issuance of an insolvency notice (in case of operational creditors) after a default has taken place. Neither is there any stipulation that an application must be filed by an operational creditor within a specified time after delivery of an insolvency notice. An application may be filed well beyond the period of ten days given to the corporate debtor to either demonstrate repayment of the debt claimed to be in default or to raise a valid dispute under section 8(2) of the Code. Any enquiry as to limitation is, thus, confined to the general law of limitation, viz., the Limitation Act, 1963, and the interpretation of the Supreme Court in B. K. Educational Services (P.) Ltd. v. Parag Gupta, solely as to the question of whether or not the default has taken place three years prior to the coming into force of the provisions of the Code. It must be noted, however, that even this decision does not state with clarity as to what will be the time-barring date for cases such as where the insolvency notice is sent by an operational creditor within the limitation period of three years from the default having taken place, but the application subsequently filed is beyond three years calculated from the date of default.

If this hurdle is overcome, in the absence of any other time-bound stipulations of the Code, all that a creditor has to specify within its application to the NCLT (subject, of course to completion of other formalities), is the date on which the default has taken place (see Form 1 and Form 5 notified under the Insolvency and Bankruptcy (Application to Adjudicating Authority) Rules, 2016), and to justify that the default has indeed taken place on that date. Therefore, in an application filed subsequent to the notification, if a creditor satisfies the NCLT that the default has taken place prior to the notification, such an application will be maintainable.

To illustrate, if a default of Rs. 1 lakh or more but less than Rs. 1 crore has been committed by a corporate debtor, ‘A Ltd.’, towards an operational creditor ‘B’, and/or a financial creditor ‘C’ before 24 March 2020, in my view, ‘C’ can file an application under section 7 of the Code for initiation of insolvency against ‘A Ltd.’ before the jurisdictional NCLT after 24 March 2020, while ‘B’ can not only issue an insolvency notice against ‘A Ltd.’ after 24 March 2020 but, upon ‘A Ltd.’ failing to meet the requirement under section 8(2), file an application under section 9 before the NCLT. Similarly, if ‘B’ has already served an insolvency notice upon ‘A Ltd.’ prior to 24 March 2020, then ‘B’ can sustain an application before the NCLT relatable to such insolvency notice even after 24 March 2020. If applications are already filed by ‘B’ and/or ‘C’ which are pending adjudication as on 24 March 2020, these possess an even stronger presumption regarding their maintainability. Any variation in the law to the detriment of these creditors will be outside the purview of delegated legislation, necessitating a legislative amendment, presumably similar to the third proviso inserted to section 7(1) of the Code by the Insolvency and Bankruptcy Code (Amendment) Act, 2020 (as argued within the first hyperlinked article above).

Lastly, any interpretation contrary to the aforesaid would result in retrospectivity, and there is extensive jurisprudence to sustain the view that the notification cannot be construed in a manner which makes it retrospectively applicable to defaults which have taken place prior to 24 March 2020. The notification is a piece of delegated legislation which has been issued in exercise of powers conferred by the Parliament upon the Central Government under the proviso to section 4 of the Code. Neither does the said proviso nor the general power of the Central Government to notify rules and regulations for carrying out the provisions of the Code under sections 239 and 240 (assuming that the power to notify under section 4 falls within these sections), vest the Central Government with the power to issue notifications with retrospective effect. In absence of a specific power under the conferring statute, it is a settled position of law that the delegate does not have the power to give retrospective effect to subordinate legislation.

In any event, the hallowed principle of statutory interpretation, as laid by the Supreme Court in a catena of decisions, including that of a three-judge bench in K.C. Arora v. State of Haryana (1984), is attracted, viz., that every statute is prima facie prospective, and “unless there are words in the statute sufficient to show the intention of the Legislature to effect existing rights, it is deemed to be prospective only.” The Common Law principle can be traced as far back as 1861, to Midland Railway Co. v. Pye (142 Eng. Rep. 419 : 10 C.B., N.S. 191), as cited and applied by the Privy Council in Young v. Adams (1898). In the words of the Constitution Bench of the Supreme Court “The idea behind the rule is that a current law should govern current activities. Law passed today cannot apply to the events of the past. If we do something today, we do it keeping in view the law of today and in force and not tomorrow’s backward adjustment of it.

In the present case, the language of the notification is wholly insufficient to demonstrate any intention regarding its retrospective operation. The increment of the threshold of default is neither declaratory nor clarificatory in nature, which could have resulted in its retrospectivity (see also B. K. Educational Services (P.) Ltd.). Moreover, the notification affects substantive rights, which have accrued and vested in favour of creditors under the position prevailing prior to the notification, and is not merely procedural in nature. Accordingly, the notification must be deemed to be prospective, since in the absence of language which expressly or by necessary implication manifests a contrary intention, “a statute divesting vested rights is to be construed as prospective”. The presumption regarding validity of applications which are filed and pending adjudication as on 24 March 2020 is further bolstered on this account.

Thus, it is my view that corporate debtors, who have defaulted in repayment of debt of an amount which is less than Rs. 1 crore but greater than Rs. 1 lakh prior to the notification, will continue to be governed by the threshold of default applicable before 24 March 2020. The notification does not bar such defaults from being taken to their logical conclusion, and corporate debtors can face proceedings under the Code even after 24 March 2020, while all applications by creditors which are pending as on this date will also continue to be valid and maintainable. In such cases, the scope of enquiry before the NCLT will not be altered or widened due to the Notification, but shall be confined to a determination of whether or not there is a default by the corporate debtor within the meaning of the provisions existing as on the date of the alleged default. Fresh applications or insolvency notices pertaining to defaults occurring after 24 March 2020 will necessarily have to satisfy the heightened threshold limit of Rs. 1 crore under the notification, since otherwise the same will not amount to a default at all for the purposes of the Code.

Before concluding, it must be stated that the ambiguous language employed within the notification, coupled with the lack of clarity regarding its application to pre-existing defaults as well as the absence of an effective date certainly compound the matter. But, this would appear to be an instance of drafting inefficiency, with the prospective applicability of the notification and its interpretation in the manner aforesaid being the preferable view. If any additional relaxation was intended by the Government beyond the limited enhancement of the threshold of default, a reasonable construction of the notification in its present form does not advance the same and will require an amendment to the Code. However, given the likelihood of various NCLT benches taking a divergent view on matters of interpretation, this controversy is sure to meet its demise in the annals of the Supreme Court.

Rohan Deshpande

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