Initiating CIRP in Contravention to Inter-Creditor Agreement: Reconciling Contrary Approaches
Raunak Rai Maini
(4th year student at National Law University, Jodhpur)
I. Introduction
It is trite law that an agreement whose object defeats the provision of any law is void. This principle has been codified u/s 23 of the Indian Contract Act, 1872 whereby agreements whose consideration or object are unlawful are considered void.
The term “law” in the expression would seem to include any enactment or rule of law for the time being in force in India.[1] This principle, however, is not without exception because it has been recognized that a party may contract out of a statute and waive any benefits conferred upon him by such statute, even if such waiver is not explicitly contemplated by such statute.[2]
In the context of the aforementioned dilemma, this article shall seek to address whether an inter-creditor agreement (that governs the rights & obligations of lenders in a syndicated loan arrangement) can override the mechanism provided for initiating Corporate Insolvency Resolution Process [CIRP] under the Insolvency and Bankruptcy Code, 2016 [IBC].
II. CIRP under the IBC
The IBC provides for initiation of the CIRP process by three classes of persons: financial creditor, operational creditor, and the corporate debtor itself. For the purposes of this analysis, I shall be restricting the scope of this article to Sec. 7 of the IBC as that deals with initiation of CIRP by the financial creditor.
Sec. 7(1) explicitly provides that a financial creditor can either by itself or jointly … file an application for initiating corporate insolvency resolution process against a corporate debtor. The Section, therefore, does not necessarily mandate joint action per se by virtue of the usage of “or” whereby even an individual financial creditor can initiate the process independently.
This question arose for consideration by the NCLAT in Amitabh Kumar Jha Vs. Bank of India & Anr. [2020] ibclaw.in 101 NCLAT [Amitabh]. Herein, Amitabh Kumar was the Director of a company against which a CIRP proceeding had been admitted u/s 7 by the Adjudicating Authority (AA) and he had filed an appeal against the same.
The applicant had previously contended that an inter-creditor agreement entered between the creditors contemplated collective action and no member could take action against a default in its individual capacity. While brushing aside this argument, the AA observed that an inter-creditor agreement could not have an overriding effect as Sec. 238 of the Code provides overriding effect to the provisions of IBC. It is also relevant to note that the occurrence of default was never disputed by the corporate debtor.
The lender, on the other hand, whose share constituted around 7.75% of the entire amount, contended that since the corporate debtor was not a party to the inter-creditor agreement, he could not derive any benefit from it.
NCLAT observed that “it would be a travesty of justice to raise a plea that since the Creditors has an inter se agreement in regard to enforcement of the liability of the debtor qua the Creditor, an individual Creditor should not be permitted to enforce its right arising under a contract in regard to discharge of liability for loan advanced by the Creditor which is otherwise payable in law and not barred by any legal framework including the law of limitation.”
Further, the debtor has no locus to meddle with the internal arrangement and affairs of the Creditors in regard to their joint or individual interests. What also seems to have persuaded the Tribunal was the fact that the initiation of the insolvency process was not disputed by any of the other lenders who were parties to the inter-creditor agreement. Though that too should not have mattered owing to the wording of Sec. 7.
The decisive principle enunciated, therefore, is that the statutory right across the ambit of Section 7 of the ‘I&B Code’ cannot be curtailed or made subservient to any ‘Inter-Creditor Agreement’.
III. Contrary approach
While Amitabh Kumar seemed to have settled this question, a decision of a coordinate bench of NCLAT in Mr. Rakshit Dhirajlal Doshi Vs. IDBI Bank Ltd. (2022) ibclaw.in 932 NCLAT [Rakshit] (delivered after Amitabh Kumar) brings a further nuance in the scope of this discussion.
In Rakshit, a similar challenge arose to the decision of the AA in admitting a Sec. 7 application for CIRP. A contention advanced by the corporate debtor was that one of the respondents (IDBI Bank) did not have any locus standi to invoke Sec. 7 because as per a deed of guarantee, only the security trustee (who represented all banks and financial institutions) could invoke the guarantee and consequently file a CIRP application.
IDBI Bank contended that in the adjudication of a Sec. 7 application, NCLT is only required to examine the existence of valid debt and valid default, and no further enquiry or examination of any objection or contractual clauses is permissible, as is held in Innoventive Industries Ltd. v. ICICI Bank and Anr. (2017) ibclaw.in 02 SC by the Supreme Court.
Additionally, it was contended that though the security trustee is to act on behalf of all the banks and financial institutions as their agent pursuant to the security trust agreement, it does not bar any individual bank from taking action under its own financing agreement. It was also mentioned that the Inter-se Agreement provides that any lender can take action without approval of other lenders at any matter, which is not expressly stated in the Inter-se Agreement.
Upon analysing the security trust agreement, the Tribunal concluded that it is clear that the ‘Event of Default’ cannot be declared by an individual bank under the individual financing documents of the participating banks in the Bank of Baroda consortium and recourse must be taken to the Security Trustee Agreement and the Inter-se Agreement.
Since IDBI Bank had not declared the ‘Event of Default’ in accordance with the Inter-se Agreement entered into between participating banks of the Bank of Baroda consortium and the Security Trustee Agreement, it could not be called a valid ‘Event of Default’.
It was, therefore, held that locus standi of the respondent IDBI Bank in taking unilateral action for declaring an ‘Event of Default’ in the repayment of the loan advanced by it was not established as the IDBI Bank, being a participating bank of the Bank of Baroda consortium, was bound to act under the clauses/provisions of the Inter-se Agreement and the Security Trustee Agreement and the order of the AA was set aside.
This, in essence, made the statutory right of initiating CIRP u/s 7 subservient to an inter-se agreement.
IV. Reconciling the two approaches
The ambiguity evident from a perusal of both the decisions came to be discussed in the recent case of IDBI v. Textrade wherein the Mumbai Bench of NCLT was deciding whether a Sec. 7 application should be allowed against the corporate debtor.
As one would expect, the corporate debtor relied upon Rakshit to contend that only the lead bank could initiate any proceedings for default under the credit facilities pursuant to the inter-se agreement. The financial creditor, on the other hand, relied on Amitabh Kumar to contend that a statutory right cannot be made subservient to an inter-creditor agreement.
Interestingly, the Tribunal in IDBI notes that none of the Counsel could confirm whether the decision in case of Amitabh Kumar was brought to the knowledge of Hon’ble Bench in the case of Rakshit, also whether the decision in the case of Rakshit was brought to the knowledge of Hon’ble Bench in the case of in the case of M/s. GVK Energy Ltd. Vs. Axis Bank Ltd. (2023) ibclaw.in 271 NCLAT (a case that had followed Amitabh Kumar Jha).
The Tribunal distinguished the case from Rakshit on the ground that it did not deal with whether even after declaration of ‘event of default’, can it be said that the individual member is still barred from initiating proceedings u/s 7 of the Code. Hence, the CIRP application was admitted by following Amitabh Kumar.
If we were to take the principle established by Amitabh Kumar, the decision in Rakshit would be erroneous because in effect, it indirectly restricts the right of the financial creditor to initiate CIRP by filing an application u/s Sec. 7 by making it contingent on compliance with an inter-se agreement which can manifest in forms such as security trust deeds.
Hypothetically, if the security trust agreement were absent, the financial creditor could have initiated CIRP because the definition of default provided under Sec. 3(12) is broad enough to also include non-payment of the amount due to any of the creditor. Hence, the effect of the decision is to frustrate the understanding of what constitutes default, by insisting on compliance with the security trust agreement before approaching the AA for relief.
The explanation to Sec. 7 provides that for the purposes of this sub-section, a default includes a default in respect of a financial debt owed not only to the applicant financial creditor but to any other financial creditor of the corporate debtor. Hence, if the applicant in Rakshit is able to evidence the occurrence of a default, giving overriding effect to the security trust deed would also go against the principle in Sec. 238 which seeks to provide overriding effect to IBC.
IV. Conclusion
As is evident from the discussion above, the decision in Rakshit ought to be overturned for the furtherance of judicial certainty on a crucial point of law. Though it has been distinguished by NCLT, Mumbai from Amitabh Kumar on the basis that it deals with a situation prior to the event of default, the principle enunciated in Rakshit can still be extrapolated to give primacy to an agreement in the nature of a security trust deed.
This confusion is furthered by the fact that these decisions are rendered by coordinate benches of the NCLT and it is not easy to ascribe authoritative value to any one of them in light of there being no discussion on the principle advanced by the NCLAT in Amitabh Kumar in Rakshit.
Keeping in mind the interest of the financial creditor u/s 7, overturning the decision would be a key step in maintaining consistency with respect to the rights of a creditor in his individual capacity – unbridled by inter-se agreements to the contrary.
This, in my opinion, would further the spirit of the IBC and ensure that its sheen for the financial creditor is not lost by allowing corporate debtor to defeat an initiation u/s 7 on procedural compliance with an agreement that it is not a party to.
Reference
[1] Mulla, The Indian Contract Act 126 (16th ed. 2022).
[2] HR Basavaraj v. Canara Bank, 2010 12 SCC 458.
Disclaimer: The Opinions expressed in this article are that of the author(s). The facts and opinions expressed here do not reflect the views of IBC Laws (http://www.ibclaw.in). The entire contents of this document have been prepared on the basis of the information existing at the time of the preparation. The author(s) and IBC Laws (http://www.ibclaw.in) do not take responsibility of the same. Postings on this blog are for informational purposes only. Nothing herein shall be deemed or construed to constitute legal or investment advice. Discussions on, or arising out of this, blog between contributors and other persons shall not create any attorney-client relationship.
Follow for daily updates:
