Creditors with Rejected Claims: Methods to Address Inadequacies under the IBC

[Anchit Jasuja and Preksha Mehndiratta are 3^rd year law students at the Gujarat National Law University, Gandhinagar]

The Insolvency and Bankruptcy Code, 2016 (‘IBC’) confers the resolution professional with the duty to collate and verify all claims submitted to him by the creditors. While the resolution professional does not formally have the power to reject claims, in practice the resolution professional can deny the verification of claims due to reasons such as the debt being barred by limitation, late filing of the claims or improper format of the proof of the debt. This ‘rejection’ of the claim can ordinarily be remedied by filing an application under section 60(5) of the IBC before the adjudicating authority to challenge the rejection of the claim, which if successful, would lead to the inclusion of the claim in the information memorandum. However, there are many instances such as in Santosh Wasantrao Walokar v. Vijay Kumar Iyer where a resolution plan has been passed while the challenge to the rejection of the claim had not been considered by the adjudicating authority.

This is especially problematic due to the decision of the Supreme Court in Committee of Creditors of Essar Steel India Limited v. Satish Kumar Gupta where the court held that no claims can exist apart from those acknowledged in the resolution plan, which has been interpreted to mean that all claims which are not acknowledged in the resolution plan are extinguished. In this context, the authors analyse the position of rejected claims under the IBC to point out the inadequacies in the resolution process in dealing with rejected claims and propose solutions to deal with those inadequacies.

Status of Rejected Claims

Prior to the Supreme Court’s decision in Essar Steel, when the National Company Law Tribunal (‘NCLT’) in Prasad Gempex v. Star Agro Marine Exports Pvt. Ltd. was faced with a situation where the resolution plan had been approved while the challenge to the rejection of a claim was pending, the NCLT held that while the resolution plan could not be modified to accommodate a previously rejected claim, it would be open to the creditor to pursue the claim in other fora even after the approval of the resolution plan. However, such an approach was rejected by the Supreme Court in Essar Steel where the court declared that a successful resolution applicant cannot be faced with ‘undecided’ claims after the approval of the resolution plan and thus no claims can exist apart from those decided by the resolution professional or the adjudicating authority. 

The rejection of the approach adopted in Prasad Gempex by the Supreme Court in Essar Steel has led to the creditors whose claims have been rejected by the resolution professional being left without an effective remedy, if the resolution plan is approved before the challenge to the rejection of the claim is considered. Such a situation arose in Santosh Wasantrao Walokar v. Vijay Kumar Iyer where claims of certain creditors had been rejected by the resolution professional and such rejection had been challenged during which time a resolution plan had been approved. Due to the approval of the resolution plan, the tribunal did not decide the petitions challenging the rejection of the claims and rather relied on Essar Steel to hold that all claims would be extinguished. In situations like these, the corporate debtor is discharged from the claim of a creditor without the creditor having an opportunity to avail a remedy against the rejection of claim, thus causing serious prejudice to the rights of the creditors. 

Remedying the Situation

To avoid a situation where prejudice is caused to rights of a creditor with a rejected claim under the Essar Steel regime of discharge, there are two problems which have to be addressed. First, the excessive rejection of claims without due consideration to the evidence on record and second, the lack of procedural timelines governing the challenges to rejection of claims under section 60(5) of the IBC.

Reducing Excessive Rejection of Claims

As held by the Supreme Court in Swiss Ribbons v. Union of India, the resolution professional does not have quasi-judicial powers, but merely has administrative powers. This position has been expanded in Navneet Kumar Gupta v. Bharat Heavy Electricals Limited, where it has been held that the resolution professional cannot reject a claim without taking the evidence which substantiates the claim into account.

Due to the lack of quasi-judicial powers, every claim which requires judicial determination in order to be admitted has to be decided by the adjudicating authority. Thus, any creditor with a rejected claim, wishing to challenge such rejection, has to mandatorily approach the adjudicating authority who would make a de novo review on the validity of the claim, thus increasing the caseload on the adjudicating authority and thereby delaying the admission of the claim.

In other jurisdictions such as the United Kingdom, the court in The Matter of Lehman Brothers International (Europe) (In Administration), has affirmed that administrators (equivalent to the resolution professional) have quasi-judicial powers which allow them to make judicial determinations with respect to the admissibility of the claims. Such an approach of giving quasi-judicial powers to resolution professionals is especially appealing in India due to instances where the determination of whether a creditor falls under the definition of operational creditor or a financial creditor has to be decided by the adjudicating authority even though the resolution professional could also make such a determination which can been seen in ICICI Bank Limited v. Anuj Jain where the NCLT upheld the determination made by the resolution professional. Further, if the creditor is aggrieved by the determination made by the resolution professional, he may challenge the decision by approaching the adjudicating authority.

Prescribing Time Limits

While the resolution professional has to verify each claim within seven days from the receipt of the claims,[1] neither the IBC nor the regulations under the IBC prescribe a duty on the adjudicating authority to decide the challenge to the rejection of the claim within a specified time period. Section 12 of the IBC directs that the Corporate Insolvency Resolution Process (‘CIRP’) shall be completed within 180 days and the time period may only be extended on an application by the resolution professional after directions from the Committee of Creditors. A creditor whose claim has been rejected by the resolution professional would not be a part of the Committee of Creditors and thus would have no say in requesting the adjudicating authority to extend the time period for the CIRP in order to accommodate the time required by the adjudicating authority to decide a challenge to the rejection of a claim.

In the United Kingdom, Rule 14.33 of the Insolvency (England and Wales) Rules, 2016 tackles the problem by allowing the administrator to postpone the distribution of dividends. Further, Rule 14.34(2) mandates that as long as a petition to determine the validity of the rejection of a claim lies in a court, the administrator cannot proceed with the distribution of dividends. Such an approach attempts to put all creditors who have made claims to be on an equal standing to ensure that no creditor is unfairly prejudiced from the rejection of a claim.

In India, such a provision does not exist, thereby putting the onus of protecting the interests of creditors whose claims have been rejected on the adjudicating authority. However, the adjudicating authority has not been able to adequately protect the interest of creditors with rejected claims since in cases such as Santosh Wasantrao Walokar v. Vijay Kumar Iyer, the Mumbai bench of the NCLT approved a resolution plan even when multiple petitions challenging the rejection of claims had been pending before the same bench. A similar situation was seen in multiple cases prior to Essar Steel such as Encote Energy (India) Pvt. Ltd. v. V. Venkatachalam and Kotak Mahindra Prime Ltd v. Mr. Bijay Murmuria, where the adjudicating authority had approved resolution plans even when petitions challenging the rejection of claims were pending. This can be remedied by prescribing timelines for the adjudicating authority to dispose of the challenges to the rejections of claims.

The need for timelines and caution in approval of resolution plans is not just needed on part of the adjudicating authority, but even for the creditor with the rejected claim. The IBC prescribes that the appeal to a rejection of the claim by the liquidator has to be appealed within 14 days of the decision of the liquidator. However, a similar provision imposing a time limit on the creditor with a rejected claim to approach the adjudicating authority is missing. This may allow claims by lax creditors and frivolous claims to be made before the adjudicating authority at any stage of the CIRP which may disrupt the CIRP. This is even more concerning due to the tendency of the adjudicating authority to admit claims even at a stage where the CIRP would be disrupted such as the admission of claims after the Committee of Creditors had approved the resolution plan in cases such as Credit Suisse Funds AG v. Kumar Kapadia and PRC International Hotels Pvt. Ltd. v. S. Mukanchand Bothra. Thus, another timeline prescribing the time-period during which a challenge to the rejection of a claim could be filed, is also needed.

Conclusion

While the discharge of all claims after the approval of the resolution plan as envisioned in Essar Steel is an effective tool towards value maximization of assets, the CIRP framework needs to be fine-tuned in a manner which ensures that the discharge of all claims does not cause prejudice to the interests of certain creditors. In order to safeguard the interests of creditors with rejected claims, there may lie a solution in empowering the resolution professional to make quasi-judicial determinations in line with the law in foreign jurisdictions. However, even if such a solution is not adopted, the NCLTs have to be careful of approving resolution plans while challenges to the rejection of a claims is pending. Such an approach would also be helped by the imposition of mandatory or directory time limits upon the NCLTs to decide challenges to the rejection of claims. Unless the IBC is fortified with mechanisms to reduce and efficiently deal with the rejection of claims, creditors whose claims are rejected would continue to face prejudice.

– Anchit Jasuja & Preksha Mehndiratta

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[1] Regulation 14, Indian Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations 2016