Supreme Court’s judgment in Innoventive Industries: Opening a can of worms? – By Mr. Rakshit Assudani

Supreme Courts judgment in Innoventive Industries: Opening a can of worms?

– By Mr. Rakshit Assudani,
5th year B.B.A., LL.B. student at O.P. Jindal Global University, Sonepat

Brief Summary of the case:

Being the first-ever judgment rendered under the Insolvency and Bankruptcy Code, 2016 (“IBC”), this case marks a paradigm shift in the law. In casu, the court was concerned with three major issues: first, the scope of argument by a corporate debtor when a financial creditor files an application to initiate corporate insolvency resolution process (“CIRP”) under Section 7; second, the maintainability of an appeal filed by the erstwhile directors of the corporate debtor; and third, the issue of repugnancy between the IBC and the Maharashtra Relief Undertaking (Special Provisions) Act, 1958 (“MRA”). Considering the facts of the case, Innoventive Industries Ltd. (“Corporate Debtor”) owed certain financial debts (raised by way of a term loan, working capital, and external commercial borrowing) to ICICI Bank (“Financial Creditor”). On account of labour problems, it failed to repay the debts and a Master Restructuring Agreement was executed to implement the restructuring proposal. While the agreement was in operation, the debts were suspended by virtue of notifications issued under the MRA. However, with the enactment of the IBC during the pendency of the notifications, the Financial Creditor initiated CIRP by filing an application under Section 7.

Before the NCLT, the Corporate Debtor argued that the debts were not due as they had been suspended pursuant to the notifications. Hence, there was no default. However, refuting this argument, the NCLT admitted the application upon perusing the evidence of default. It further held that the IBC, being central legislation, would prevail over the state legislation. Aggrieved by this, the Corporate Debtor preferred an appeal before the NCLAT. Upon considering the amended Section 424 of the Companies Act, 2013 along with various landmark judgments on the principles of natural justice, the NCLAT held that an opportunity of being heard, in the form of a limited notice, must be provided to the corporate debtor. Despite this, the NCLAT dismissed the appeal on account of useless formality; the corporate debtor had already been heard at the time of the admission. It was further held that there was no repugnancy between the IBC and the MRA. Thereafter, the erstwhile directors of the Corporate Debtor preferred an appeal. At the outset, the Supreme Court (SC) held that the erstwhile directors could not prefer an appeal on behalf of the corporate debtor. The rationale being that the management of the corporate debtor vested in the interim resolution professional (“IRP”). Thereafter, upon analysing the definitions of claim, debt, and default under sub-section (6), (11), and (12) of Section 3 read with Section 7(5), the Court held that the scope of inquiry under Section 7 is limited; an opportunity of being heard cannot be provided to a corporate debtor except if the debt is not payable in law or in fact. In essence, the SC agreed with the contention of the Financial Creditor that an argument can only be raised if the debt is not due. If the NCLT is satisfied that a default has occurred (debt is due and has not been paid) and the application is complete, then it must admit the application. While dealing with repugnancy, the Court held that the non-obstante clause under Section 238 of the IBC would prevail over the MRA.

Without delving into the issue of repugnancy, this article would analyse the judgment of the SC on the scope of argument and maintainability of appeal. This article argues that firstly, this judgment leads to a discrepancy that offers scope for varying interpretations regarding the existence of default in case of a disputed debt; and secondly, the SC erred in holding that the erstwhile directors of the corporate debtor cannot maintain an appeal.

Analysis:

Considering the scope of argument by a corporate debtor at the time of initiation of CIRP, the SC has not considered the principles of natural justice. Notably, the IBC does not expressly provide for an opportunity of being heard to the corporate debtor. However, Section 420 of the Companies Act, 2013 provides that a reasonable opportunity of being heard must be given by the NCLT before passing any order. Furthermore, Section 424 provides that the NCLT and the NCLAT must be bound by the principles of natural justice while dealing with any proceeding. In view of these provisions, the NCLT has a two-fold duty as laid down in Section 7(4) and (5): ascertainment of existence of the default as well as being satisfied of the same. Thus, mere ascertainment from the records is not enough. Accordingly, as the proceedings are adversarial in nature, the NCLT must consider the documents furnished by both the parties’ viz. the creditor and the corporate debtor. This reasoning is consistent with the Calcutta High Court decision in Sree Metaliks limited & Ann. However, the grant of such an opportunity must not be absolute; the exceptions to principles of natural justice may be applicable on a case-to-case basis.

By virtue of this judgment, the corporate debtor can make an argument only if the debt is not due i.e. it is not payable in law or in fact. This effectively restricts the opportunity of being heard of the corporate debtor. In such a scenario, it may happen that there is a dispute regarding the existence of the debt. The determination of whether the debt is actually due or not can only be made by delving into the merits of the case. However, following the judgment of the Court, the NCLT does not give an opportunity to the corporate debtor to present its case. Hence, the application would be admitted despite there being a disputed debt as long as it has become due. In addition, the IBC provides a very wide definition of default; it includes any part of the debt as long as the threshold is satisfied. Thus, CIRP can be initiated even for a part of the debt, and for the remaining part, a claim can be submitted before the resolution professional. The SC, not having expressly overruled the NCLAT judgment on this aspect, has agreed with it by necessary implication. This leads to a discrepancy regarding the definitional framework of the IBC and provides scope for differing interpretations.

Considering the maintainability of an appeal by the erstwhile directors, the SC has reached an incorrect conclusion, as it has not interpreted the law as a whole. Rather, the judgment has been entirely based on Section 17, read in isolation. While the IRP is in charge of the management of the corporate debtor, Section 19 and 61 of the IBC must also be considered. Section 19 provides that all the personnel of the corporate debtor must extend assistance to the IRP. Furthermore, Section 61(1) provides that any aggrieved person can prefer an appeal to the NCLT or the NCLAT. Although the SC opined that the erstwhile directors would not qualify as aggrieved persons, it failed to take into consideration the fiduciary duty of the directors under Section 166 of the Companies Act, 2013.

A conjunct reading of Section 17 and 19 of the IBC makes it apparent that only the corporate governance functions of the directors would get suspended. The filing of an appeal, not being a governance function, is outside the purview of the duties of the IRP. This argument finds support in the judgment of Steel Konnect (India) Pvt Ltd v Hero Fincorp Ltd., which lays down that the powers of the directors are not suspended, rather only the functions as a Board of Directors (“BOD”) are suspended. Moreover, the members of the BOD continue to be registered as directors with the Registrar of Companies even after being suspended. More importantly, it could not have been the intent of the legislature to allow the IRP to undertake the function of filing an appeal. The reason being that the IRP has a vested interest in challenging the CIRP by virtue of being appointed under the same process. This leads to a precarious position resulting in a conflict of interest for the IRP.

In this light, the erstwhile directors, owing a fiduciary duty to the corporate debtor, can prefer an appeal under Section 61 of the IBC. This has been the case in a plethora of recent judgments. Moreover, in Babulal Vardharji Gurjar v Veer Gurjar Aluminium Industries Pvt Ltd., it has been expressly mentioned in the judgment itself that the appeal was preferred by the erstwhile directors. This further strengthens the argument that the Innoventive ruling is incorrect and does not hold any water. To overcome this loophole, it is a frequent practice to implead the IRP and the corporate debtor as respondents in the appeal preferred by the erstwhile directors. This effectively removes the conflict of interest and gives a locus standi to the erstwhile directors.

Conclusion and Implications:

Through this judgment, the SC has allowed an application to be admitted against the corporate debtor even if the debt is disputed (it may not exist if merits are considered). This leads to negative consequences as the initiation of insolvency proceedings tarnishes the image and reputation of the corporate debtor. Moreover, in light of the inclusion of homebuyers as financial creditors and the move towards consumer bankruptcy, the fact that this judgment has been frequently cited to ascertain default becomes slightly problematic. The reason being that such a new class of financial creditors would essentially lead to an increase in applications being filed on the basis of non-payment of financial debts that are disputed. In addition, such a class of financial creditors would not have records with the information utilities and would have to rely on other evidence to establish default.

Furthermore, being posed with a question of conflict of laws, the SC effectively answered the constitutional question of conflict of lists by conducting an in-depth analysis of the repugnancy provisions. However, it missed an opportunity as it failed to address the larger issue of conflict of IBC with other substantive laws. More so because none of the cases after the Innoventive ruling have attempted to address this issue.

In conclusion, despite having an opportunity to interpret the provisions and establish a sound framework for future litigation, the SC has opened up larger definitional and foundational issues and left some others unanswered. It remains to be seen how the SC reconciles the reasoning of this judgment in the future.

 


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