Record of Default under Section 7 application of IBC: Whether Mandatory or Directory? – By Modit Mendiratta

Introduction

The “Record of Default” provision in Section 7 of the Insolvency and Bankruptcy Code (IBC)[1] is a crucial aspect of the corporate insolvency resolution process (CIRP) for financial creditors. It determines whether a default has occurred and allows creditors to seek recourse under the IBC. However, there is an ongoing debate about whether this provision is mandatory or directory.

Understanding the nature of the “Record of Default” provision is essential, as it sets the threshold for initiating the CIRP. Whether it is mandatory or directory has significant implications for creditors and debtors, impacting the initiation and outcome of insolvency proceedings. This article explores the arguments and judicial interpretations surrounding the provision, shedding light on its implications within the broader IBC framework.

Issues being faced by Financial Creditors

The Corporate Insolvency Resolution Process (CIRP) in India aims to address financial distress and resolve insolvency cases. However, financial creditors, such as banks and non-banking financial companies (NBFCs), face various challenges in initiating the CIRP. Another challenge is the non-applicability of the Bankers Book Evidence Act to NBFCs and other lenders. This exclusion creates a disparity in the evidentiary framework, making it difficult for these creditors to establish the authenticity and accuracy of their records during the CIRP initiation process. It puts NBFCs and other lenders at a disadvantage and weakens the effectiveness of the CIRP. Financial creditors also struggle with the strict compliance requirements related to the ‘record of default’ under the IBC. Minor discrepancies or procedural errors can lead to the rejection of applications, causing delays and hindering the creditor’s ability to recover their dues. The strict compliance framework presents challenges for financial creditors with legitimate claims. Furthermore, financial creditors face obstacles in providing alternative proofs of defaults when a comprehensive record of default is not available. Certified account statements, although substantial evidence, are often considered insufficient due to the strict adherence to the record of default requirement. This limited acceptance of alternative proofs complicates the initiation of the CIRP and prolongs the resolution process, affecting the creditor’s ability to recover their outstanding dues efficiently.

Prevalent Law as on date

The Financial Creditors can initiate the Corporate Insolvency Resolution Process (CIRP) by filing an application before the National Company Law Tribunal (NCLT) as provided under Section 7 of IBC, 2016[2] with relevant evidence of default and outstanding dues against the corporate debtor.

Section 7(3)(a) of the IBC, 2016 is reproduced below:

“(3)The financial creditor shall, along with the application furnish

(a) record of the default recorded with the information utility or such other record or evidence of default as may be specified” [3]

This provision of the Insolvency and Bankruptcy Code, 2016 mentions that the financial creditor shall provide a record of default which implies that it is compulsory for the creditor to provide a record for default and on this reasoning only a notification was issued the NCLT on which mentioned that providing a record of default is mandatory for the financial creditor but soon this notification was declared ultravires by the Calcutta High Court in the case of Univalue Projects Pvt. Ltd. vs Union of India [2020] ibclaw.in 25 HC [4]. Therefore the provision was declared to be Directory in nature by this Judgement.

Soon After this position was set by the High Court an Amendment was made to the Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations, 2016 where Regulation 2A was introduced by a notification. The regulation 2A is reproduced below:

“[2A. Record or evidence of default by financial creditor.

For the purposes of clause (a) of sub-section (3) of section 7 of the Code, the financial creditor may furnish any of the following record or evidence of default, namely:-

(a) certified copy of entries in the relevant account in the bankers’ book as defined in clause (3) of section 2 of the Bankers’ Books Evidence Act, 1891 (18 of 1891);

(b)an order of a court or tribunal that has adjudicated upon the non-payment of a debt, where the period of appeal against such order has expired.]”

This particular provision employs the term “may,” indicating that the legislative intent was for it to possess a directory nature. However, it is pertinent to note that no judicial pronouncements have hitherto provided a definitive interpretation on this matter. Consequently, greater clarity on this issue is anticipated in the future. Nevertheless, based on the wording of the provision itself, one can assert that the court intended for this provision to be construed as directory in nature. The unfolding of subsequent legal developments and judicial decisions will ultimately shape the comprehension and application of this provision.

 Analysis

The provision of CIRP in the IBC, 2016 was introduced to expediate the process and give distressed companies another chance of revival. One of the requirements under this is Record of Default which a lot of times gets really difficult to get as provided in the Section 7(3)(a) read with Regulation 2A of IBBI Rules, 2016. And also since the parliament has used the words “May” it cannot be said that the intention was to make this requirement Mandatory. Calcutta High court has already quashed one such Notification issued by the NCLT to be Ultravires.

The established principle is that the inclusion of the term ‘may’ in a statutory provision does not necessarily indicate that the provision is merely directory in nature. When determining the legal significance of the word ‘may,’ the court must take into account several factors. These factors include the objective and framework of the Act, the surrounding context and circumstances in which the words are utilized, the purpose and benefits intended to be accomplished through the use of this term, and similar considerations.

In the case of Badarla Ramakrishnamma v. Vattikonda Lakshmibayamma[5], the court emphasized the need to determine whether a provision is mandatory or directory by considering whether non-compliance with the requirement undermines the fundamental validity of the matter at hand. It is often challenging to precisely differentiate between what is mandatory and what is directory, or what constitutes an irregularity versus a nullity in a specific case. When evaluating the impact of contravening a provision on the proceedings, it is crucial to examine the purpose and objective of the particular provision in question.

In the case of P.T. Rajan v. T.P.M. Sahir[6] the court stated that “a provision in a statute which is procedural in nature although employs the word “shall” may not be held to be mandatory if thereby no prejudice is caused.” As the Regulation 2A of the IBBI rules, 2016 is a recent introduction, there are currently no existing cases that have provided an interpretation of this provision. However, considering the principles established in the mentioned cases, the use of the word “may” in the provision, and the overarching objective of the IBC to ensure an expedited process, it can be argued that the provision should be considered as directory in nature.

Conclusion

The nature of the “Record of Default” provision under Section 7 of the Insolvency and Bankruptcy Code (IBC) continues to be a subject of debate. While the provision employs the term “may,” indicating a directory nature, no definitive judicial interpretations have been provided thus far. However, based on established principles and precedents, as well as the objective of the IBC, it can be argued that the provision should be regarded as directory.

The term “may” does not necessarily indicate that strict compliance is mandatory, but rather allows for some discretion based on the circumstances. The intention behind this provision is to expedite the corporate insolvency resolution process (CIRP) and provide distressed companies with an opportunity for revival.

The recent introduction of Regulation 2A to the IBBI Rules further supports the argument for a directory interpretation. The regulation provides alternative evidence of default, reinforcing the notion that strict adherence to a specific record of default is not the sole requirement.

However, given the absence of specific cases dealing with this provision and its interpretation, further judicial pronouncements are needed to provide clarity on whether the “Record of Default” provision should be considered mandatory or directory.

Reference:

[1]The Insolvency & Bankruptcy Code, 2016, § 7, No. 31, Acts of Parliament, 2016 (India).

[2] Id.

[3] The Insolvency & Bankruptcy Code, 2016, § 7(3)(a), No. 31, Acts of Parliament, 2016 (India).

[4] Univalue Projects Pvt. Ltd. v. Union of India, [2020] ibclaw.in 25 HC.

[5] Badarla Ramakrishnamma v. Vattikonda Lakshmibayamma, 1957 SCC OnLine AP 24.

[6] P.T. Rajan v. T.P.M. Sahir, (2003) 8 SCC 498.