The Conundrum between Principle of Natural Justice and Section 7 of IBC 2016 – By Tanya Tekriwal and Shilpi

The Conundrum between Principle of Natural Justice and Section 7 of IBC 2016

“The universal and absolute law is that natural justice which cannot be written down, but which appeals to the hearts of all.” – Victor Cousin

By Tanya Tekriwal and Shilpi, 5th Year, B.A.LL.B. (Corp. Hons.) National University of Study and Research in Law, Ranchi

Natural justice has been an inherent part of the justice system since its inception. It encapsulates the basic principles and cannot be done away with. As remarked by Lord Esher, “natural justice is the natural sense of what is right and wrong.” The basic objective behind the enactment of the Insolvency and Bankruptcy Code, 2016 (hereinafter the “IBC”) is to “consolidate and amend the laws dealing with the reorganization and insolvency resolution of the corporate persons, partnership firms and individuals.” Part II of the IBC provides for “Insolvency Resolution and Liquidation for Corporate Persons.” The IBC lays out that a financial creditor under section 7; an operational creditor under section 9; and the corporate applicant under section 10 can file an application for initiating corporate insolvency resolution process (hereinafter the “CIRP”).

According to the provisions of section 7, if a corporate debtor commits a default, financial creditor single-handedly or many financial creditors conjointly may file an application to the Adjudicating Authority to initiate the CIRP. The procedure for the operational creditor is different from that of the financial creditor. As per section 8 of the IBC, the Operational creditor is bound to deliver a “demand notice” of the operational debt to the corporate debtor for demanding the payment of the due amount. An operational creditor can make an application before the Adjudicating Authority for initiation of CIRP only after service of the demand notice.

The provision for “demand notice” allows the corporate debtor to pay the default to the operational creditors before filing any application for CIRP. Section 7 is silent about service of any such notice and hence the financial creditor can directly file an application before the Adjudicating Authority. As per Section 5(1) of the IBC, NCLT is the Adjudicating Authority under IBC. As part II of the IBC provides for CIRP for Corporate Persons, the Companies Act, 2013 (hereinafter the “CA, 2013”) is the Bible to deal with the relevant issues. Section 424 of the CA, 2013 lays down the procedure to be followed by the Tribunal. It provides that the Tribunal and the Appellate Tribunal can frame its rule of procedure. But following the principles of natural justice is a sine qua non. The Tribunal is bound to follow the principles.

In Sree Metaliks Ltd. & Ors. v. The Union of India & Ors [2017] ibclaw.in 03 HC, the absence of following the principle of natural justice under Section 7 of the IBC was challenged before the Calcutta High Court. In this case, the petitioner argued that when a petition is filed under section 7 of the IBC, the corporate debtor is not provided with a reasonable opportunity of hearing.  The Court observed, “Where a statute is silent on the right of hearing and it does not in express terms, oust the principles of natural justice, the same can and should be read into.” The Court decided that pursuant to section 424 of the CA, 2013, the Adjudicating Authority is bound to provide a “reasonable opportunity of hearing” to the corporate debtor when it receives an application filed under section 7 of the IBC.

Moreover, the Court went a step further and added that the Adjudicating Authority “may proceed to pass an ex-parte ad interim order, however, after recording the reasons for grant of such an order and why it has chosen not to adhere to the principles of natural justice at that stage.” This observation by the Courts empowers the Adjudicating Authorities to depart from the fundamental principle of rules of justice under extenuating circumstances.

In the case of Starlog Enterprises Ltd. v. ICICI Bank Ltd. (2017) ibclaw.in 65 NCLAT, NCLAT had to decide whether as per Section 424 of the CA, 2013, the impugned order pronounced by the NCLT in absence of the notice to the Appellant resulted in the violation of the principles of rules of natural justice. NCLAT relied on the order passed in Sree Metaliks Ltd. & Ors. v. The Union of India & Ors [2017] ibclaw.in 03 HC, declaring that “it is a mandatory duty of the ‘adjudicatory authority’ to issue notice before admitting an application under Section 9 of the Code.” The NCLAT observed that the Adjudicating Authority admitted the application under section 9 of IBC before serving a notice to the corporate debtor. NCLAT held that the order of NCLT was violative of the principle of natural justice.

In the cases where the operational creditor skips serving the notice to the other party, the Adjudicating Authority will dismiss the application. The decision pronounced in Era Infra Engineering Ltd. v. Prideco Commercial  Pvt. Ltd. (2017) ibclaw.in 214 NCLAT, aligned with the same principle. In this case, the respondent (the operational creditor) failed to serve the “demand notice” to the appellant, owing to which NCLAT dismissed the application.

The Apex Court in Innoventive Industries Ltd. v. ICICI Bank [2017] ibclaw.in 02 SC discussed the contrast between the scheme of section 7 and section 8 of the IBC. The Court held that-

“29. The scheme of Section 7 stands in contrast with the scheme under Section 8 where an operational creditor is, on the occurrence of a default, to first deliver a demand notice of the unpaid debt to the operational debtor in the manner provided in Section 8(1) of the Code. Under Section 8(2), the corporate debtor can, within a period of 10 days of receipt of the demand notice or copy of the invoice mentioned in sub-section (1), bring to the notice of the operational creditor the existence of a dispute or the record of the pendency of a suit or arbitration proceedings, which is pre-existing – i.e. before such notice or invoice was received by the corporate debtor. The moment there is the existence of such a dispute, the operational creditor gets out of the clutches of the Code.

30. On the other hand, as we have seen, in the case of a corporate debtor who commits a default of financial debt, the adjudicating authority has merely to see the records of the information utility or other evidence produced by the financial creditor to satisfy itself that a default has occurred. ”

Rule 4 of the Insolvency and Bankruptcy (Application to Adjudicating Authority) Rules, 2016 states an additional rule that needs to be complied by the financial creditors after making an application for initiating CIRP under section 7 of the IBC. Pursuant to Rule 4(3), a financial creditor(s)/applicant(s) are responsible for notifying the corporate debtor regarding the application by sending him a copy of the same after filing it. In the matter of Sree Metaliks Ltd. & Ors. v. The Union of India & Ors [2017] ibclaw.in 03 HC, the Court held that “A proceeding for declaration of insolvency of a company has drastic consequences for a company. Such proceedings may end up in its liquidation. A person cannot be condemned unheard.”

 Conclusion

Rule 4 prescribes that when a financial creditor(s) files an application before the Adjudicating Authority to initiate CIRP, he has to send the copy of that application to the corporate debtor. However, in such circumstances, it will come to the corporate debtor’s attention only after the application has been filed before the Adjudicating Authority. It will deny him the reasonable opportunity of hearing. In light of such circumstances, the authorities should make it sine qua non for the financial creditor(s) to notify the corporate debtor by serving him the notice before making an application to the Adjudicating Authority.