SC Clarifies Discretionary Nature of Section 7(5)(a), IBC for Admission of Application

[Anshita Dave and Abhyudaya Yadav are 4th year B.A., LL.B. (Hons.) students at Dharmashastra National Law University, Jabalpur]

The issue concerning the nature of section 7(5)(a) of the Insolvency and Bankruptcy Code, 2016 (the “Code”) has been addressed by the Supreme Court of India in its recent decision in Vidharbha Industries Power Ltd v. Axis Bank Ltd. (12 July 2022), wherein the Court has categorically dealt with the question concerning the power of the National Company Law Tribunal (“NCLT”) to exercise its discretion while admitting an application under the provision for initiation of corporate insolvency resolution process (“CIRP”). To begin with, section 7(5)(a) states as follows:

“(5) Where the Adjudicating Authority is satisfied that –

(a) a default has occurred and the application under sub-section (2) is complete, and there is no disciplinary proceedings pending against the proposed resolution professional, it may, by order, admit such application;”

The appeal came up as a challenge to the decision of National Company Law Appellate Tribunal (“NCLAT”) for upholding the initiation of CIRP of the corporate debtor by its financial creditor, Axis Bank, on the ground that the provision does not cast a mandate upon the adjudicating authority to admit such an application only because a debt is in existence. In this post, the authors seek to analyze the ruling and examine whether it is in consonance with the objective behind the Code, which is value maximization and revival of financially distressed entities.

Factual Background

Vidarbha Industries Power Ltd. is a generating company within the meaning of the Electricity Act, 2003 (“Act”) having a 600 MW coal-fired thermal power plant. Reliance Industries Ltd. (“RIL”) was desirous of procuring power from Vidarbha’s unit and thereupon entered into a Power Purchase Agreement (“PPA”) with it. The supply of power to RIL, in terms of the Agreement, commenced in April 2014. Thereafter, in March 2015, the Maharashtra Electricity Regulatory Commission (“MERC”), an authority empowered under the Act to determine the tariff chargeable by electricity generating companies approved the final tariff of the power plant of Vidarbha for the financial years (“FY”) 2014-2015 and 2015-2016.

However, Vidarbha was aggrieved by the disallowance of the actual fuel cost for the aforesaid financial years, and it challenged the order passed by MERC before the Appellate Tribunal for Electricity (“APTEL”). The said appeal was allowed by APTEL with a direction to MERC to allow the actual fuel costs as claimed. Hence, Vidarbha was to receive a sum of Rs. 1,730 crores in terms of APTEL’s order.

For the execution of the directions passed by APTEL and, in particular, for the realization of funds due to it, Vidarbha preferred an application before MERC. However, MERC also went in appeal to the Supreme Court against the order of APTEL in view of which the directions of APTEL could not be implemented. This resulted in Vidarbha being short of funds and consequently incapable of discharging its debts in spite of its intention to do so.

Being a financial creditor of Vidarbha, Axis Bank Ltd. filed an application before NCLT, Mumbai under section 7(2) of the IBC for initiation of CIRP. In an effort to stay these proceedings until the pendency of MERC’s appeal, the Vidarbha moved a miscellaneous application, although the same was dismissed by the NCLT and subsequently by the NCLAT. In view of the aforesaid facts, Vidarbha preferred an appeal before the Supreme Court.

Issue

The issue which came up for consideration in this case was whether section 7(5)(a) of the Code is mandatory or directory, i.e., whether it is mandatory for the adjudicating authority to admit an application under section 7 of the Code for initiation of CIRP in each and every case when the existence of default transgressing the threshold is ascertained.

Ruling & Analysis

The Supreme Court set aside the order rendered by NCLAT. While addressing the concerned issue, the Court engaged in an extensive discussion pertaining to the nature and design of the Code in the light of relevant interpretative aid.

Section- 7(5)(a)- Mandatory or Directory?

At the very outset, the court referred to its decision in the case of Swiss Ribbons Pvt. Ltd. v. Union of India, and highlighted that the Code has been enacted for reasonably expeditious and time-bound resolution of insolvency. In view of the foregoing, the Court pointed out that while interpreting the contours of section 7, both the NCLT and the NCLAT proceeded on the premise that once the existence of default of debt is ascertained, the application under section 7 shall be mandatorily admitted. It noted that NCLAT erred in holding that the only thing which adjudicating authority must ensure while admitting an application is the existence of debt and the consequent default on the part of the corporate debtor in its repayment. However, if this line of reasoning is followed, as a corollary, the mere existence of a debt and its default thereof would entitle financial creditor to initiate the CIRP and the adjudicating authority would, under such a situation, be bound to accept such an application irrespective of any other relevant consideration. Thus, the question remains as to whether the word ‘may’ in section 7(5)(a) of the Code is to be construed as ‘shall’; in that case, it would be mandatory for the adjudicating authority to admit an application on the ascertainment of default in repayment of debt.

The Court placed reliance on the judgment in Lalita Kumari v. Government of Uttar Pradesh and Hiralal Rattanlal v. State of Uttar Pradesh wherein the literal interpretation rule was held to be the first and foremost principle for construction of a statute. It emphasized that if the provision is unambiguous and the legislative intent clear, any interpretative aid other than literal rule is impermissible. Ordinarily the word ‘may’ is directory in nature as opposed to the word ‘shall’, and the phrase ‘may admit’ confers discretion to admit. Further, counsel appearing on behalf of the corporate debtors argued that the most identical provision to section 7(5)(a) is section 9(5)(a) of the Code wherein the word ‘shall’ is used. It was further contended that if the legislature had intended to make section 7(5)(a) mandatory in nature, it would have done so by using the term ‘shall’ as it did in its counterpart.

Referring to Swiss Ribbons and Innoventive Industries Ltd v. ICICI Bank, the Court observed that there can be no doubt that a corporate debtor who is in the red should be resolved expeditiously, following the timelines of the Code, and that no extraneous matters should be considered. Nonetheless, the financial health and overall viability of the corporate debtor is not an extraneous consideration. Further the title ‘Insolvency and Bankruptcy Code’ makes amply clear that this statute deals with revival of distressed entities and certainly its object is not to penalize the entities for short term defaults, since the Code is not a tool for mere recovery of debts. Therefore, in the context of the nature and design of the Code, it is clear that section 7(5)(a) confers discretion on the adjudicating authority to admit application of initiation of CIRP. Thus, before entertaining an application under section- 7 of the Code, the adjudicating authority may take certain factors into consideration in order to admit or reject an application.

Discretion – Not to be Unguarded

The Court did not delve into the issue as to whether such discretion is to be exercised necessarily by applying its mind in the application presented before it. It is a settled principle of administrative law that if a tribunal is conferred with some degree of discretion, then such tribunal shall, during the proceedings, exercise its discretion by applying its mind to the case, to further the objects of the relevant statute. However, such discretion can only be exercised on considerations furthering the objects of the Code and no other extraneous considerations which run contrary to it.

The authors contend that adjudicating authority, before admitting an application under provisions of the Code, should lay emphasis on the financial health and overall viability of the entity against which the application is filed. Neither did the Code prescribe the manner of exercising such discretion nor does the Court in its decision define the contours within which it is to be exercised. Therefore, the authors have attempted to articulate certain factors which could be taken into account.

The determination of financial health and overall viability of an entity could be based upon the following factors, which although are merely illustrative and not exhaustive in nature:

• Debt-Equity Ratio;
• Asset-Liability Structure;
• Any pending execution of decree in favor of the entity which entitles it an amount; and
• Any other sound principle of economics, which the tribunal deems appropriate.

A proper approach for the adjudicating authority to adopt is for it to take note of the financial position of the entity against which the application for initiation of CIRP is filed. Thereafter, if it is of the prima facie opinion that the same needs to be determined in light of advanced considerations, the factors proposed by the authors may be taken into consideration. In doing so, the adjudicating authority may ask the parties to furnish certain documents like balance sheet, annual financial statement, profit and loss account, etc. Further, as opposed to a mechanical application of provisions of the Code, the admission of an application should, in fact, be an attempt to revive a financially distressed entity.

Comments

The Court has rightly held that the nature of section 7(5)(a) of the Code is directory and not mandatory. The approach and reasoning undertaken by the Court will surely guide matters relating to the exercise in the future of discretionary powers of the adjudicating authority. However, authors are of the opinion that, while delineating the issue, the Court could have delved deeper into the aspect of extent of such discretionary powers, including as to when and how such discretion is to be exercised. The same time, at one place the Court noted that the NCLAT had failed to appreciate the fact that time bound initiation and completion of CIRP could arise only if companies were bankrupt and not otherwise. Nonetheless, by elaborating more, the Court could have provided guidance to enhance the adjudicatory mechanism, in the lines of propositions mentioned above.

– Anshita Dave & Abhyudaya Yadav