Commercial Wisdom vs. Judicial Wisdom: An Ongoing Debate of Primacy

[Kartik Singh is a 4th year B.A., LL.B. (Hons.) student at National Law University, Odisha, Cuttack]

The Insolvency and Bankruptcy Code, 2016 (IBC) was enacted with the objective of providing a time-bound insolvency resolution mechanism to a financially stressed company and saving it from liquidation. For the said purpose, the committee of creditors (CoC) comprising financial creditors is at the forefront of the administration of the corporate debtor. The CoC considers and approves resolution plans which could revive the stressed company, subject to the final approval of the plan by the adjudicating authority, i.e., the National Company Law Tribunal (NCLT).

The CoC decides the viability of the resolution plan according to its commercial wisdom as regards the outstanding debts and assets of the corporate debtor. However, the ambit of this ‘commercial wisdom’ of the CoC has always been a topic of discussion, particularly in the context of judicial interference exercised by courts over the decision-making power of the CoC. In the recent past, several relevant questions have been raised about the poor commercial wisdom the CoC have displayed in many cases by accepting massive haircuts on the total dues.

One such recent example is the case of Videocon Industries where the CoC, exercising its commercial wisdom, accepted a haircut of around 96% on the total dues. The NCLT Mumbai, while accepting the resolution plan, rightly questioned the acceptance of a massive haircut and requested the concerned resolution applicant to increase the pay-out. The issue has again gained prominence after the observations of the NCLT Chennai in the matter of Siva Industries and Holdings Limited, where it rejected the commercial wisdom of the CoC and applied its judicial wisdom to decline the resolution plan approved by the CoC.

Facts of the Case

IDBI Bank filed an application under section 7 of the IBC to initiate corporate insolvency resolution process (CIRP) against Siva Industries which was admitted by the NCLT. After a perusal of several bids by prospective resolution applicants, the CoC could not finalize the resolution plan since neither of them amassed the requisite majority of 66% of the votes.

Thereafter, the erstwhile promotors of Siva Industries submitted a proposal to the CoC of a “onetime settlement offer”, subject to the CoC withdrawing the CIRP under section 12A of the IBC. The erstwhile promotors offered Rs. 328.21 crore as the settlement amount as against their total admitted amount of Rs. 4,863.88 crore i.e., a haircut of 95%, which was accepted by the CoC, and the withdrawal application was passed with the majority of 90% as mandated by section 12A of the IBC. Siva Industries approached the NCLT submitting that the conditions of section 12A have been duly fulfilled and requesting the withdrawal of the CIRP.

Order of the NCLT

The NCLT questioned the commercial wisdom of the CoC in approving the settlement plan proposed by the erstwhile promotors of Siva Industries which, in its opinion, was not in the best interests of the creditors. Terming the settlement plan as a “business restructuring plan”, the NCLT observed that the promotor of Siva Industries is trying to restructure the loans granted by the financial creditors under the pretext of a settlement proposal to be given under section 12A of the IBC, which cannot be protected under the commercial wisdom of the CoC.

Therefore, since the settlement plan is against the spirit and falls outside the contours of the IBC, the duty of the adjudicatory authority cannot be circumscribed on the ground that the “commercial wisdom” of the CoC has deemed the settlement to be appropriate. The “judicial wisdom”, in such a scenario, would override the commercial wisdom of the CoC. Accordingly, the NCLT rejected the settlement plan and ordered that Siva Industries be liquidated.  

Judicial Stance on Commercial Wisdom v. Judicial Wisdom

The stance of the judiciary on the question of the primacy of commercial wisdom over judicial wisdom has been fairly consistent, with the courts siding with the commercial wisdom of the CoCs over judicial wisdom. However, the judicial wisdom of the courts has been given due importance too. One of the first rulings on this aspect is the decision of the Supreme Court in K. Sashidhar v. Indian Overseas Bank. The Court gave paramount importance to the CoC and acknowledged its crucial role in the administration of the CIRP within the prescribed time frame. It respected the contribution of the legislature in drafting the IBC which, purposely and consciously, did not endow the NCLT with any power to challenge the decision of the CoC taken in its commercial wisdom.

However, the Court also clarified that the commercial wisdom of the CoC is subject to certain limitations imposed under section 32 read with section 61(3) of the IBC. Thus, it was emphasized where there was no element of common prudence or basic ‘commercial wisdom’ on part of the CoC, the NCLT could invoke its judicial wisdom.

On similar lines, the Mumbai Bench of the NCLT in State Bank of India v. Ushdev International Limited observed that where the CoC does not exercise the commercial wisdom cautiously, the “NCLT can neglect such an illogical, unreasoned, unfounded and unsound decision of the CoC”

The primacy of commercial wisdom over judicial wisdom was again reiterated in the landmark case of Committee of Creditors of Essar Steel India Limited v. Satish Kumar Gupta that, under normal circumstances, the judicial wisdom of the courts cannot encroach upon the commercial wisdom of the CoC. It is upon the CoC to decide the feasibility and viability of a resolution plan after taking into account all aspects of the plan. However, in a situation where the commercial decision of the CoC violates the basic contours of the IBC, the NCLT would be justified in using its judicial wisdom and rejecting the decision of the CoC in respect of approval or rejection of a resolution plan.     

What Lies Ahead in the Dispute?

A careful perusal of the aforementioned rulings indicates that the commercial wisdom of the CoCs cannot be questioned by the courts, except on limited grounds. The courts have recognized the crucial role played by the CoCs and found that it is the best judge to understand and take commercial decisions for the business. 

The erstwhile promotors of Siva Industries have sought to challenge the order of NCLT to liquidate Siva Industries before the National Company Law Appellate Tribunal (NCLAT). The essential question before the NCLAT would be whether the decision of the CoC, in agreeing with the settlement plan, i.e., accepting a 95% haircut and withdrawing the CIRP against Siva Industries, is within the contours and the spirit of the IBC.

Prima facie, the decision of the CoC seems a commercial decision which, according to established precedents, cannot be overturned by the NCLAT using its judicial wisdom, since the settlement plan is premised upon the lenders taking a haircut, thereby forming part of the commercial wisdom of the CoC. However, the NCLAT could also concur with the NCLT to observe that settlement plan is a facade put up by the promotors in an attempt to take back control of the stressed company.

Scope for Improvement?

The Videocon and Siva Industries cases present an argument on the need to review section 12A of the IBC, which indirectly allows acceptance of a one-time settlement offered by the erstwhile promotors of the corporate debtor, often with a haircut, as a part of the resolution plan. This is contrary to the objective of section 29A of the IBC, which debars erstwhile promotors from bidding for their companies since they are majorly responsible for company undergoing insolvency proceedings in the first place.

While taking haircuts is generally accepted in insolvency cases, the extent of the haircuts taken has been a contentious issue in the recent past. It is understandable that exercising commercial wisdom is the exclusive domain and expertise of the CoC. However, an objective criterion must be put in place to govern such exercise of commercial wisdom. A dedicated code of conduct for CoCs, similar to other jurisdictions, may resolve internal conflicts within the CoCs and prevent litigation from other stakeholders with respect to exercising the commercial wisdom, particularly in the context of approval or rejection of a resolution plan.

In conjunction with the Insolvency and Bankruptcy Board of India, the Ministry of Corporate Affairs has already commenced the mechanism for issuing a code of conduct for creditors. However, it remains to be seen what aspects of commercial wisdom would be covered by such a code of conduct. 

Kartik Singh

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