Case Comment on Vidarbha Industries Power Limited Vs. Axis Bank Limited,  (2022) – Mahima Jayan

Case Comment on Vidarbha Industries Power Limited Vs. Axis Bank Limited,  (2022) 

Adv. Mahima Jayan
LL.M, O. P. Jindal Global University

Introduction

The case (2022) ibclaw.in 118 SC discussed in this comment is an appeal under Section 62 of the Insolvency and Bankruptcy Code, 2016 (hereinafter referred to as “IBC” or “Code”), before the Supreme Court (SC) against the judgment and order passed by NCLAT, Delhi, whereby the Tribunal refused the pray of appellant and corporate debtor, Vidarbha Industries Power Limited, to stay corporate insolvency resolution proceedings (hereinafter referred to as “CIRP”) initiated by the financial creditor, Axis Bank Ltd., initiated under Section 7 of IBC.

The Respondent initiated a CIRP before NCLT Mumbai based on a default of Rs 553 crores on 15th January 2020. The Appellant sought a stay citing a pending appeal in favor of the appellant before the SC, whereby the appellant was unable to realize a sum of Rs 1,730 crores. The AA found no merits and dismissed the stay application, which was further appealed before NCLAT, New Delhi. The NCLAT denied the stay stating that the Adjudicating Authority’s (hereinafter referred to as “AA”) role under Section 7 was to admit or reject such application based on two criteria: existence of debt and existence of default.

Hence, the pivotal legal issue put forth, in this case, was whether the role of AA in admitting or rejecting a CIRP application under Section 7(5) is mandatory or discretionary.  The ratio of this case implies that the AA has the discretion to reject or delay the admission of a CIRP in its discretion, however, it was limited by the facts of the case. This case is of significance as it triggered a pandora of proceedings before the NCLT seeking it to apply its mind and delay or reject an application under section 7(5) which goes against the objectives of IBC.

Thus, this case comment attempts to critically analyze the SC’s interpretation of Section 7(5) of the Code and to capture the current position with respect to this matter. Part 2 of the comment details the case’s background, analyzing the legal provisions and the arguments made by both parties. Part 3 deals with the ratio and the author’s observations and conclusions and Part 4 provides a conclusive statement on the issue.

Background

The question of law in the case arises based on Section 7 of the Code which stipulates the manner in which a Financial Creditor can initiate a CIRP by filing an application with adjudicating authority. The issue arose specifically with Section 7(5) which states that AA ‘may’ by order

1. admit if it is satisfied that a default has occurred, the application is complete and there are no pending disciplinary proceedings against the resolution professional
2. Reject if its satisfied default has not occurred, the application is incomplete, or any pending disciplinary proceedings exist against the resolution professional

It has been compared with a very identical provision under Section 9 dealing with the application by Operational creditors. Section 9(5) states the AA shall admit or reject on the satisfaction of whether the application is complete, whether there is an undisputed and unpaid operational debt, whether the demand notice has been served, and whether there exist any pending disciplinary proceedings against the resolution professional. ¹

The Learned Senior Advocate Jaideep Gupta, on behalf of the Appellant, submitted that the stay application was necessitated by extraordinary circumstances, citing the default was caused only because it could not realize the decree against MERC. Adv. Gupta contended that the term “may” in Section 7(5) conjointly read with Rule 11 of NCLT Rules, 2016² can be interpreted to provide a discretionary power to NCLT to reject an application, even in case there is an existence of default, for meeting the ends of justice and to achieve the overall objective of the Code.³ He emphasized that IBC’s primary objective is the revival of the company, and when there are orders favorable to the CD that facilitate the liquidation of its debts, the NCLT can retain its authority to reject or defer the admission of the CIRP application.

Senior Advocate Dhruv Mehta, representing the Respondent, opposed the appeal stating that the Appellant has admitted the default and the AA has rightly declined the stay proceedings initiated against under Section 7 of IBC. The counsel relied on Swiss Ribbons judgment⁴, whereby it was observed that the Legislative policy has shifted from ‘inability to pay debts’⁵ to ‘determination of default’. The Counsel derived that Section 7(5)(a) imposes a mandatory rather than discretionary obligation on the AA to admit a Financial Creditor’s application upon establishing that a CD has defaulted in its dues. Adv. Mehta further substantiated this argument by placing reliance on the Innoventive Industries⁶ case whereby the objective of IBC was to develop a framework for expeditious and time-bound insolvency resolution.

The case was further filed for review in which one major precedent was discussed. This shall be discussed in detail in the Analysis section.

Analysis

The SC, focussing on the objectives of the Code, emphasized the need to conduct the CIRP in an expeditious and time-bound manner to ensure the revival of the company and prevent the value depreciation of assets.⁷ Despite NCLT and NCLAT deeming Section 7(5) mandatory, SC affirmed the AA’s discretion to consider CIRP feasibility and CD’s health, beyond the existence of debt and default.

The Court analyzed the differential standards under Sections 7 and 9 of IBC for Financial Creditors and Operation creditors and emphasized the legislature’s intention of choosing ‘may’ instead of ‘shall’. Relying on the Lalitha Kumari⁸ case, the court observed that the literal rule interpretation is to be applied when the words of a statute are unambiguous. Hence, the court interpreted Section 7(5) conferring discretionary power to NCLT, cautioning its exercise contingent on certain facts and circumstances.

The court’s conclusion stemmed from analyzing the legislature’s intent while interpreting the term ‘may’. The term ‘may’ in a literal sense presumes a discretionary power while ‘shall’ presumes a mandate, however, such presumptions can be rebutted based on the scope of enactment and consequences flowing from the construction. The Court compared the term with Section 9(5), which uses ‘shall’ in the cases of operational creditors, and deduced that it provided differing powers to AA, one is discretionary and one is mandatory.

The objective of IBC as rightly pointed out by Adv. Gupta is to first revive over liquidation. Financial stresses that a company faces are mostly temporary, necessitating AA scrutiny to safeguard the interest of the CD.

However, Adv. Mehta on the other hand has rightly pointed out that it is the objective of IBC is to complete the CIRP in an expeditious and time-bound manner. Providing NCLT such discretionary power to reject or delay the proceedings based on the viability and financial health of the company will defeat the purpose of the Code.

The IBC emerged amid India’s NPA crisis⁹ and lack of consolidated insolvency laws. The Author argues that granting AA discretionary power to analyze the merits of the company and admit a resolution process would revert to the pre-IBC situation, as the NCLT could reject any application until it believes the company to have poor financial health. It is to tackle this issue the BLRC report suggested and IBC implemented the cash flow test of insolvency whereby default acts as the test of determining insolvency.¹⁰ The Companies Act¹¹ earlier provided the trigger to be “inability to pay debts” which was widened by the interpretation¹² of the courts as similar to the Balance sheet test.  The balance sheet is adopted when a comparison of the asset side and liability side of the balance sheet to ascertain the insolvency of the debtor corporation. The balance sheet test considers external factors that lead to defaults. In India, the courts unofficially implemented this test by considering the contingent and prospective liabilities while determining insolvency.¹³ Further, Section 7(5) provides two courses of action to the NCLT to admit or reject the application for initiation based on satisfying the conditions specified. Hence, it is evident that the legislature is avoiding the delay caused by the courts in the earlier legal framework by analyzing the financial health of the company and limiting the AA to determine insolvency merely based on the existence of default of repayment.

Further, the judgment of the instant case states that the challenged award affecting the CD’s ability to repay on time is not extraneous. The Author disputes this observation that this award is an extraneous matter, as it does not arise in the ordinary course of business of the company and the appeal was filed four years before the initiation of CIRP. This suggests the financial stability of the company which in itself indicates insolvency as per the balance sheet test.

Hence, even though the term used in Section 7(5) of the Code is ‘may’ which is different from the term ‘shall’ under Section 9(5), permitting such discretionary powers goes against the objectives of IBC. Hence, there arises an ambiguity, and the literal rule of interpretation cannot be applied. Instead, it has to be presumed that the term ‘may’ can imply ‘shall’ if it is required to achieve the legislative object and here the AA has to consider only default as the triggering point of CIRP and not the financial health of the company and viability of CIRP.

The SC reviewed the judgment, on the ground that the Court did not consider the ratio of the Krishnamurthy¹⁴ case, whereby it was held that the AA is empowered to verify whether a default has occurred or not and has only two courses of action under Section 7(5). The SC while disposing of the petition clarified that the Krishnamurthy case addressed a different legal question and suggested interpreting a statute cannot be considered as a statute and the current interpretation is only limited to the facts and circumstances of the present case.¹⁵

However, this interpretation has led to a surge in cases whereby NCLT started exercising discretionary power by delaying the admission or rejecting CIRP applications even if there exists a debt and default. The NCLT rejected the application of CIRP even after fulfilling the twin test on grounds such that CIRP was adversely affecting homebuyers¹⁶ or based on the financial health of the company¹⁷. This created legal uncertainty on the maintenance of such applications which defeated the purpose of law and slowly turned the position into chaos as it was before IBC.

In 2023, the SC in the Suresh Kumar Reddy¹⁸ case the same question of whether the NCLT was under an obligation to admit the application if it satisfies the tests under Section 7(5) was brought up. The court held that the review order of the Vidarbha Industries case suggested that the interpretation is with respect to the factual matrix of the particular case, and thus observed the decision of the Vidarbha¹⁹ case cannot be considered as taking a contrary view and overruling  E S Krishnamurthy and Innoventive Industries case. Hence, the view taken in Innoventive Industries prevails, emphasizing that AA under Section 7(5) is only required to verify the existence of default, disregarding dispute over the debt unless it’s a legally bared or not yet due debt. This can be considered as the current position as it has been relied upon by AA’s admitting or rejecting the applications under Section 7(5).²⁰

Conclusive Statement

The decision of the SC in the Vidarbha case is critically analyzed as it goes against the objectives of IBC and is similar to the positions that courts took prior to the IBC era which led us to the stage of economic downfall due to an increase in NPAs. The court limited the judgment to the facts of the case but kept the interpretation open which led to a legal uncertainty whereby NCLT could admit and reject applications according to their whims and fancies. Even though the decision of Suresh Kumar Reddy attempts to rectify the problem caused by the case, the position of Vidarbha does not stand overruled as it is still considered that if the facts of the case don’t warrant the AA to use its discretionary power, the AA is limited by Section 7(5).²¹

The Ministry of Corporate Affairs in its notice inviting comments for its amendment expresses its intent to amend Section 7(5) such that AA must admit applications that satisfy the conditions thus, nullifying the position established by the Vidarbha Industries case and bringing back legal certainty promised under the code into the market.²²

References:

1. Insolvency and Bankruptcy Code of 2016, S. 9(5)
2. NCLT Rules of 2016, Rule 11 Inherent Powers- Nothing in these Rules shall be deemed to limit or otherwise affect the inherent powers of the Tribunal to make such orders as may be necessary for meeting the ends of justice or to prevent abuse of the process of the Tribunal
3. Insolvency and Bankruptcy Code of 2016, Preamble
4. Swiss Ribbons Private Limited and Anr. v. Union of India (2019) ibclaw.in 03 SC
5. Companies Act of 1956, S 434
6. Innoventive Industries Ltd. v. ICICI Bank and Anr. (2017) ibclaw.in 02 SC
7. Insolvency and Bankruptcy Code of 2016, Preamble and BLRC Report, 2015.
8. Lalita Kumari v. Government of Uttar Pradesh and Ors. (2014) 2 SCC 1 [14] & Hiralal Rattanlal v. State of Uttar Pradesh (1973) 1 SCC 216 [22]
9. Vishwanathan N.S., It is not Business as Usual for Lenders and Borrowers, Speech Delivered at National Institute of Bank Management (2018), Reserve Bank of India – Speeches’ <https://rbi.org.in/Scripts/BS_SpeechesView.aspx?Id=1055>
10. Heaton JB, ‘Solvency Tests’ (2007) <https://papers.ssrn.com/abstract=931026>
11. Companies Act of 1956, S 434
12.  Gujarat State Financial Services Limited v. Megabyte Consultancy Services Pvt. Ltd. 1999 (2) Comp LJ 4 (Bom).
13.  ‘The Role of Insolvency Tests: Implications for Indian Insolvency Law’ <https://www.tandfonline.com/doi/epdf/10.1080/24730580.2022.2129197?needAccess=true>
14.   E.S. Krishnamurthy and Ors. v. Bharath Hi-Tech Builders Pvt. Ltd. Civil Appeal No 3325 of 2020 decided on December 14, 2021 (2021) ibclaw.in 173 SC.
15.  Axis Bank Limited v. Vidarbha Industries Power Limited [1] Review Petition (Civil) No. 1043 of 2022 decided on September 22, 2022 (2022) ibclaw.in 118 SC
16.  Bank of Maharashtra v. Newtech Developers & Developers Pvt. Ltd., C.P. (IB) No. 2465/ 2019 (NCLT, New Delhi)
17.  IndusInd Bank Ltd. v. Hacienda Projects Pvt. Ltd., C.P. (IB) No. 419/ 2022 (NCLT, New Delhi)
18.  M. Suresh Kumar Reddy v. Canara Bank and Ors. Appeal (Civil) No. 7121 OF 2022 decided on May 11, 2023 (2023) ibclaw.in 67 SC
19.  Axis Bank Limited v. Vidarbha Industries Power Limited [1] Review Petition (Civil) No. 1043 of 2022 decided on September 22, 2022 (2022) ibclaw.in 118 SC
20.  Bank of India Limited. v. B.D. and P. Hotels (India) Private Limited CP (IB) No.226/MB-IV/2022 decided on June 23, 2023 (NCLT, Mumbai) (2023) ibclaw.in 286 NCLT & Allied Hi-Tech Industries Private Ltd. v. Karvy Data Management Services Limited CP(IB) No. 25/7/HDB/2022 decided on September 20, 2023 (NCLT, Hyderabad)
21.  Allied Hi-Tech Industries Private Ltd. v. Karvy Data Management Services Limited CP(IB) No. 25/7/HDB/2022 decided on September 20, 2023 (NCLT, Hyderabad)
22.  MCA, Invitation of comments from the public on changes being considered to the Insolvency and Bankruptcy Code, 2016,  File No. 30/38/2021-Insolvency dated 18.01.2023.

https://www.mca.gov.in/content/dam/mca/pdf/IBC-2016-20230118.pdf