Lost in a Labyrinth: NCLT’s Journey from Admission to Withdrawal under the IBC

[Siddharth Jasrotia is a IV year student at the Maharashtra National Law University, Mumbai]

The National Company Law Tribunal’s (“NCLT”) power to allow the withdrawal of insolvency petition has been subject to immense judicial scrutiny over the past few years, often resulting in conflicting outcomes. The inception of section 12-A in the Insolvency and Bankruptcy Code, 2016 (“IBC”) further amplified the prevailing uncertainty, specifically in cases where withdrawal application was filed prior to the constitution of committee of creditors but post admission of insolvency petition. Supreme Court’s recent decision in Kamal K. Singh v. Dinesh Gupta has taken a path not possibly conceivable under the Insolvency Law Committee’s Report and earlier Supreme Court decisions in Swiss Ribbons (P) Ltd. v. Union of India and Indus Biotech Pvt. Ltd. vs. Kotak India Venture (Offshore) Fund.

This post critically evaluates the jurisprudential developments leading to the decision in Kamal Singh, highlights the inconsistent and erroneous stand taken in the said decision, and emphasizes on the need for immediate legislative intervention in this regard.

NCLT’s Power to Allow Withdrawal: Pre-section 12-A Era

Prior to 2018, there was no provision under the IBC providing for the withdrawal of insolvency petition once it was admitted. However, IBC was not bereft of the concept of withdrawal. Rule 8 of the Insolvency and Bankruptcy (Application to Adjudicating Authority) Rules, 2016 provided a mechanism to withdraw the insolvency petition before its admission. The prime object and purpose of IBC are not to penalise the defaulter but rather to ensure the survival of the corporate debtor and prevent the knock-on effect. When a settlement is reached between the creditors and the corporate debtor, or when after the initiation of the Corporate Insolvency Resolution Process (“CIRP”), the debtor acquires a sound financial status, allowing withdrawal of insolvency petition is necessary to prevent unwarranted litigation costs and abuse of the process of the Court. The need to allow withdrawal in just cases, was realised by the Indian judiciary much before the legislature. In Lokhandwala Kataria Construction Private Limited v. Nisus Finance and Investment Managers LLP, the Supreme Court, for the very first time allowed withdrawal of insolvency petition (post-admission) after a compromise was reached between the creditors and the corporate debtor. The Court gave similar findings in Mothers Pride Dairy India Private Limited v. Portrait Advertising and Marketing Private Limited. Pertinently, these decisions were given by the Apex Court by invoking its inherent powers under Article 142 of the Indian Constitution.

However, certain hesitation on the part of the Court was visible. Affirming National Company Law Appellate Tribunal’s (“NCLAT”) decision, the Supreme Court in Lokhandwala Katari held that NCLT ‘cannot invoke’ its inherent powers under rule 11 of the National Company Law Tribunal Rules, 2016 (“NCLT Rules”) to allow withdrawal of insolvency petitions post its admission. This was premised on the ground that for the purpose of IBC, only rules 20-26 of the NCLT Rules are applicable, and consequently, rule 11 has no application to insolvency proceedings. Evidently, this decision led to the creation of an enormous legal anomaly. By holding that NCLT cannot allow withdrawal, but withdrawal is permissible if the Supreme Court so allows under Article 142, the Court created an unnecessary burden on the parties (and on itself) since the parties seeking withdrawal then have to either directly invoke Supreme Court’s jurisdiction or appeal against an order of NCLT refusing the withdrawal. Critically appraising this legal anomaly, the Supreme Court in Uttara Foods and Feeds Private Limited v. Mona Pharmachem,recommended that the legislature should amend IBC and the Rules thereto for allowing withdrawal/ settlement post admission of insolvency petition.

NCLT’s Power to Allow Withdrawal: Post Introduction of section 12-A

In light of the aforementioned factual and legal difficulties, section 12-A was inserted by the Insolvency and Bankruptcy (Second Amendment) Act, 2018. This Section provided that the NCLT may allow withdrawal of a petition ‘admitted’ under section 7, section 9 or section 10 of IBC, on an application made by the applicant with the approval of ninety per cent voting share of the Committee of Creditors (“COC”). This Section was surprisingly silent on what criterion is applicable when withdrawal is sought ‘after admission’ of insolvency petition but ‘prior to the formation of the COC’. To fill this legal gap, the Court in Swiss Ribbons held that NCLT could allow/reject an application for withdrawal by invoking its inherent powers under rule 11 of NCLT Rules if the COC has not been constituted. It can therefore be analysed that the Supreme Court impliedly overruled its earlier verdict in Lokhandwala Katari as far as the applicability of rule 11 of NCLT Rules to insolvency proceedings is concerned. Even though both Lokhandwala Katari and Swiss Ribbons are division-bench decisions, Swiss Ribbons is considered as the current governing law since it was rendered in light of the changed legislative scheme post inception of section 12-A. Subsequently, an amendment was brought in 2019 to regulation 30-A(1)(a) of Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations, 2016 (“CIRP Regulations”) providing that an application under section 12-A may be made to NCLT ‘before’ the constitution of COC by the applicant through the interim resolution professional (“IRP”).

The underlying philosophy of an insolvency regime is starkly different from a traditional civil dispute between two or more parties. The 2018 Report of the Insolvency Law Committee as well the Supreme Court’s decision in Swiss Ribbons stipulates in unambiguous terms that an insolvency proceeding is equivalent to a ‘wrong in rem’. The legislative intent behind IBC is to deter ‘individual’ actions and focus on the interest of ‘all’ the creditors. The Supreme Court in Indus Biotech further clarified that insolvency proceedings take an ‘in rem’ nature having erga omnes effect ‘after’ a petition is ‘admitted’ under sections 7, 8 or 9 of the Code. Therefore, once a petition is admitted, irrespective of who filed the petition (operational creditor/financial creditor/corporate debtor), the same becomes an application on behalf of all the creditors and no longer remains a proceedings between the ‘applicant creditor’ and the corporate debtor. Accordingly, post-admission of the insolvency petition, a withdrawal application has to be decided after taking into consideration the ‘interest of all’ the creditors of the corporate debtor. The legislative scheme under section 12-A caters to this need by providing for approval by 90% of COC. However, there is no legal provision under the IBC addressing this need when an application for withdrawal is made before the constitution of the COC. The only guiding criteria in this regard is the verdict in Swiss Ribbons, wherein the Court held that while adjudicating a section 12-A application under rule 11, the NCLT shall (i) hear all the ‘concerned parties’ and (ii) consider all ‘relevant factors’ on the facts of each case. Therefore, the legal position appears to be settled that because of the ‘in-rem’ nature of insolvency proceedings, even if the COC has not been formed, the NCLT has to take into consideration the interest of ‘all’ the creditors of the corporate debtor and a mere settlement between the applicant creditor and the corporate debtor will not justify the approval of section 12-A application.

Kamal K. Singh v. Dinesh Gupta and Another: The Scuffle Begins

In Dinesh Gupta v. Rolta India Limited, a withdrawal application was filed before the NCLT by the operational creditor who initiated the CIRP. The operational creditor was an employee of the corporate debtor, who, along with other ex-employees, filed for insolvency under section 9 for arrears of salaries and other dues. After the admission of the insolvency petition but prior to the formation of COC, a settlement agreement was entered between certain operational creditors (including the applicant creditor) and the corporate debtor. The settlement agreement contained terms to the effect that the corporate debtor will make payment of dues only upon approval of the withdrawal application by the NCLT. While adjudicating the withdrawal application, the NCLT took into consideration the submissions by the withdrawal applicant, the management of the corporate debtor, the IRP, and the financial creditors. The NCLT noted that claim worth Rs. 5,434.74 crores was filed by the financial creditors, Rs. 2.66 crores by the operational creditors, and Rs. 86.41 crores by the workmen & employees of the corporate debtor. Referring to Supreme Court’s decisions in Swiss Ribbons and Indus Biotech, NCLT concluded that even if the original creditor has settled its dispute with the corporate debtor prior to the constitution of COC, the application for withdrawal can be rejected in the interest of all the creditors of the corporate debtor in light of the fact that after admission of the petition, insolvency proceedings adopt an in-rem character.

Accordingly, after noting that settlement was specific to only a few employees (that too contingent on approval of withdrawal application) and no settlement was reached with the financial creditors, the NCLT rightly disallowed the withdrawal application. The in-rem nature of CIRP does not permit prejudice being caused to substantial claims of financial creditors and even leaves scope for employees wanting settlement to claim their debt as operational creditors, at an equal footing with the financial creditors under section 53 of IBC. This decision of NCLT was appealed before the Supreme Court in Kamal Singh by the management of the corporate debtor. Shockingly, by a very brief order, the Supreme Court set aside the decision of NCLT by observing that settlement between the corporate debtor and the applicant creditor prior to the constitution of COC was a justifiable ground for allowing withdrawal under section 12-A.

This decision of the Apex Court hits at the very core of the underlying philosophy of the IBC. Even though the Court made a reference to Swiss Ribbons, the manner in which it applied the ratio laid in Swiss Ribbons is completely erroneous. This decision is in complete disregard of the verdicts in Swiss Ribbons and Indus Biotech which expound on the in-rem nature of insolvency proceedings. Once an insolvency petition is admitted, it is presumed to be on behalf of all the creditors of the corporate debtor and therefore, the Court could not have allowed withdrawal merely on the ground that a settlement was reached between the applicant creditor and the debtor, especially when the NCLT has on appreciation of the merits of the case observed that allowing withdrawal would cause grave prejudice to the financial creditors. It is advised that to prevent further judicial inconsistency, the legislature must actively amend the CIRP Regulations and explicitly provide for criteria upon which NCLT should adjudicate an application for withdrawal prior to the constitution of COC. Furthermore, in line with the object and purpose of IBC, an explanation to regulation 30-A(1)(a) must be added, providing that mere ‘settlement of claim between the applicant creditor and the corporate debtor’ is not a sufficient ground for allowing withdrawal of insolvency proceedings, and rather ‘interest of all’ the creditors must be taken into account.

– Siddharth Jasrotia