Constitutional Validity of Insolvency and Bankruptcy Code, 2016

The Insolvency and Bankruptcy Code, 2016 gives the creditors with a comprehensive solution for recovery of dues from willful defaulters. While this legislation has been facing teething issues and inconsistencies from its inception, the proactive approach of the government in improving this liquidation law from time to time has led to its significant implementation.

Like any fresh legislation, issues concerning the constitutional validity of the Code have been asked by various stakeholders time and again. It has been alleged that the Code violates Article 14 of the Constitution of India and is biased in nature. In a plethora of applications made to various National Company Law Tribunals (‘NCLT(s)’) and High Courts, the operational creditors have demanded that the classification of creditors as operational creditors and financial creditors is manifestly arbitrary and there is no understandable differentia applied by the legislators in making such a demarcation.

Moreover, in the aftermath of the 2017 Amendment of the Code which was finally amended by 2018 Amendment of the Code, another provision that led to large hue and cry was the bar put on promoters from bidding for their own company under Section 29A. The Code forced the sale of the Company to new bidders and was quarreled to be against the fundamental right of the promoters. Moreover, another claim concerning to the inequitable nature of Section 29A was raised and it was contended that the exclusion of the relative of an ineligible person, who is otherwise qualified to be the resolution applicant is extremely capricious.

Reacting to a series of petitions that had challenged the constitutional validity of various provisions of the Code, the Supreme Court in the case of Swiss Ribbons Private Limited and Anr v. Union of India and Ors (Bench of Hon’ble Mr. Justice Rohinton F Nariman and Hon’ble Mr. Justice Navin Sinha) confirmed the validity of the Code in its entirety laying rest to several issues which resulted due to the departure of the Code from previous insolvency laws. The Court, taking inspiration from the verdict in Bhavesh D. Parry v. Union of India was of the opinion that – ‘matters of policy are best left to the wisdom of the legislature, and in policy matters, the accepted principle is that the courts should not interfere’.

The judgment dealt with important issues pertaining to the admission process, lack of participation of operational creditors in the Committee of Creditors (‘CoC’) and the bar put on the defaulting promoters and their relatives from participating in the resolution plan, all of which significantly changed the way the insolvency law operated in our country.

The Court made several inspections in response to the arguments put forth by the petitioners. Analysis drawn by the Court related to their ruling is as follows –

Classification of creditors

The petitioners had contested that financial creditors and operational creditors rendered money to the debtor either in terms of financial assistance or goods sequentially. The division among them makes no real difference in terms of the object to be obtained by the Code that is, either an insolvency resolution plan or liquidation as an end result. The petitioners had discussed that even if the Court believes that there exists a logical distinction between the 2 types of creditors, the operational creditors are discriminated and are discussed with hostility.

The Court mentioned that there is an actually intelligible differentia between the 2 creditors which immediately relates to the object sought to be attained under the Code. The key results made by the Court are –

(i) financial creditors have defended creditors and operational creditors are unsecured creditors as payment for goods to the operational creditors is not secured by mortgage documents;

(ii) the quantum of money due to the operational creditors is considerably shorter than the money owed to the financial creditors;

(iii) repayment of debt to a financial creditor is organized under diverse schedules and default in payment draws a penalty and a similar scenario does not exist for operational creditors; and

(iv) the financial creditor is needed to determine the existence of default by the debtor whereas the operational creditor simply claims his right of payment.

The Court also examined the role played by the two set of creditors in furtherance of the Code. Basis its observation, the Court said that the nonexistence of operational creditors in the CoC has a valid basis and is not violative of their rights. The viability and usefulness of the business of the corporate debtor are largely assessed by the financial creditors while providing the debt and they are in a better position to judge the resolution plan as matched to the operational creditors explaining their presence in the CoC.

Consequently, preservation of the corporate debtor as a going concern while guaranteeing maximum recovery for all creditors being the underlying purpose of the Code, there exists a substantial discrepancy between financial creditors and operational creditors and the operational creditors are not distinguished against under the Code.

The validity of Section 29A

Moreover, a four-fold contention against the legality of Section 29A was heard by the Court. In its conclusions, the court noted the following.

(i) Vested rights of promoters to engage in the recovery process of a corporate debtor have been undermined by retrospective application of Section 29A;

(ii) Moreover, an erstwhile promoter who may outbid all other applicants and may be able to form the most comprehensive resolution plan is kept out of the process;

(iii) Also, a personal account may be classified as a non-performing asset (NPA) despite him not being a willful defaulter;

(iv) Lastly, the relatives of the promoters who are within the qualification criteria are barred from participating in the resolution process.

The Court observed that it is resolved law that a statute is not retrospective merely since it has an impact on existing rights or because a part of the requirements for its action is drawn from a time predecessor. There exist no vested rights of participation in any resolution applicant and the same can be connoted to the widespread denial of such resolution applications due to lack of feasibility. With respect to the participation of the relative of an ineligible person, the Court pointed that if it is not shown that such ‘related person’ is connected with the business of the activity of the resolve applicant, he cannot be excluded under Section 29A(j). Hence, Section 29A is constitutionally valid and is applicable in its entirety.

Section 12-A upheld

The relevant claim against Section 12A was that approval of 90% of the CoC is needed to allow withdrawal of a petition made under Section 7 or 9 of the Code. The Court observed that this threshold has been confirmed in the Insolvency Law Committee Report as withdrawal is a major decision and requires significant discussion. Also, the Code assigns the NCLT with the role to finalize such departure. This indicates that the CoC does not have the last say and hence, this provision passes the constitutionality test.

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