Redefining the Contours for Admitting an Application by Financial Creditors

[Kavya Lalchandani is a Master of Corporate Law student at University of Cambridge]

In a judgement dated 12 July 2022, in Vidarbha Industries Power Limited v. Axis Bank Limited, the Supreme Court (SC) ruled that admission of the application under section 7(5) of the Insolvency and Bankruptcy Code (IBC or the Code) which is made by a financial creditor is discretionary while admission of an application under section 9(5) of IBC is mandatory. Section 7(5) IBC deals with the admission of claims filed by the financial creditor while section 9(5) therein deals with the admission of claims filed by an operational creditor. This article aims to analyse the judgement.

Background Facts

The appellant/corporate debtor was given a contract for the implementation of the Group Power Project (later converted to the Independent Power Project (IPP)) after undergoing an international bidding process conducted by Maharashtra Industrial Development Corporation (MIDC) and the appellant was also allowed to increase its capacity. Further, the Maharashtra Electricity Regulatory Commission (MERC) also permitted it to enter into a Power Purchase Agreement (PPA) with Reliance Industries Limited (RIL). In 2013, the Ministry of Coal directed Coal India Limited to enter into a Fuel Supply Agreement with projects having an aggregate capacity of 78,000 MW. The appellant did not find its place in the list of eligible power projects with the requisite capacity. The application of conversion to IPP was approved and MERC also granted approval to RIL to have the requisite supply from both the units of the appellants under the consolidated PPA.

In 2015, the Final Tariff for the plant of the appellant was approved by MERC for financial years 2014-15 and 2015-16. In 2016, due to the rise in prices for coal procurement, the appellant approached the MERC for truing up aggregate revenue requirement and determination of the tariff. The MERC dismissed the application whereby it disallowed a substantial portion of the actual costs and also capped the tariff for 2016-2017 to 2019-2020.

Against this order, an appeal was preferred by the Appellant before Appellate Tribunal for Electricity (APTEL) for the disallowed fuel costs. APTEL ruled in favour of the appellant and a significant sum was recoverable vide said order of the APTEL. When an application was filed by the Appellant for the implementation of APTEL’s order in front of MERC, MERC appealed against the said order in the SC. This appeal is currently pending.

The appellant could not implement the directions of the APTEL due to the pendency of the appeal. This had led to a temporary shortage of funds with the appellant and hence it defaulted on the debts.

Order by the NCLT and the NCLAT

The financial creditor, Axis Bank, made an application under section 7 of the Code to initiate Corporate Insolvency Resolution Process (CIRP) against the appellant for default in payment before National Company Law Tribunal Mumbai (NCLT). The appellant then filed an application to stay the proceedings due to the pendency of the appeal before the SC. The NCLT held that applications are to be disposed of in a timebound manner as the Code is a special legislation and placed reliance on the judgement of Swiss Ribbons v Union of India which strongly advocated for timebound resolution of the companies ‘in the red’. The judgement in Swiss Ribbons was interpreted to mean that no extraneous circumstance should stand in the way of expeditiously disposing of an application made under the Code, and refused to stay proceedings. The NCLT also went on to say that the “inability of the Corporate Debtor in servicing the debts or the reason for committing a default is alien to the scheme of the Code….This Authority is required only to see whether there has been a debt and the Corporate Debtor defaulted in making the repayments”.

The National Company Law Appellate Tribunal, on appeal, upheld the order of the NCLT, against which the appeal was preferred by the appellant. Both the orders indicated at the mandatory nature of section 7(5) of the Code.

Judgement by the Supreme Court

The SC agreed that the expeditious nature of the proceedings is integral to proceedings under the IBC and that no extraneous matter should be considered while admitting the application. However, the departure point was “what constitutes as extraneous for the purposes of the admission of the application and the matters concerning the financial viability and health were not extraneous”. The amount of claim that was realisable according to the order of the APETL was more than what was owed by the appellant. This factor cannot be completely overlooked. The financial debt and consequent default only gives the right to the creditor to apply for initiation of CIRP but it does not bind the adjudicating authority (AA) to turn blind eye to the background factors of the default. The AA ought to apply its mind considering the relevant factors while accepting an application under section 7(5).

The Distinction Between Section 7(5)(a) and Section 9(5)

Section 7(5) uses the word ‘may’ signifying that NCLT has discretion even after the application of the financial creditor is complete and there are no pending proceedings against the proposed resolution plan. Usually the word ‘may’ is interpreted as being directory in nature, whereas ‘shall’ is a mandatory requirement. According to the rule of literal interpretation, the provision is discretionary and purposive interpretation cannot be applied as there is no ambiguity in the provision. This conclusion was bolstered by the fact that a similar provision under section 9(5) where the NCLT has to take a decision to accept or reject the application made by the operational creditor is mandatory in nature. Under the said provision, the NCLT within 14 days of the application being made and satisfaction of the conditions stated under section 9(5)(i) shall accept the application. Since similar provision has been worded differently for the financial and operational creditor, they have to be interpreted differently. The Court went on to state that there is a deliberate differentiation that has been created because the financial creditor and operational creditors have different business models. While the former is engaged in the business of investments, the latter is in the form of the supply of goods and services. When a financial creditor extends credit it is of the nature of long-term contracts and operational creditor neither can compete with the size of the financial creditor nor has secured long-term contracts. The impact of the non-payment is far more serious for the operational creditors than the financial creditor. It is due to this that the operational creditors with the claims of undisputed debts have rigid and inflexible provisions.

On the other hand, in the context of financial creditors, the NCLT can keep the application in abeyance (as there is no time limit prescribed for the same) or it can even reject it if it deems fit while exercising its discretion. The fact that an application has been rejected by NCLT does not bar the financial creditor from filing a fresh application if the dues remain unpaid.

The Goal of IBC and the Judgement in Swiss Ribbons

The goal of the IBC is not to penalise the debtors which are temporarily unable to pay their debts. The question of meeting the timelines does not arise if the company is still solvent or not yet bankrupt. In any case, the timeline for the process does not start from the filing of the application but its admission. The Court further said that observations regarding timely resolution, ignoring the extraneous factors and debt and default model in Swiss Ribbons, cannot be read like a statute since the judgements are precedents that have to be read in a particular context.

Analysis

This ruling may seem to put the financial creditors on a backfoot. Their rights have always been respected under the Code and in fact, when operational creditors get nil payment under a proposed resolution plan, financial creditors are relatively better off in most cases. But the consequences may or may not be very far-reaching because it is not a claim about possible recovery or a pending appeal in the given case, but rather that the appellant has a right vested in it given by an authority to recover an amount which is more than the debt that the financial creditor is seeking to recover. This means this judgement will be a good precedent only when there are very similar facts. Otherwise the AA may hold that there are other factors which can be categorised as extraneous and deny relief to such corporate debtors.

– Kavya Lalchandani

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