IBC Simplified – Swiss Ribbons v UOI
June 23, 2021
A summary of the Supreme Court judgment in the matter of Swiss Ribbons v Union of India ~ By Sara Jain
This case dealt with the constitutional validity of various provisions of the Insolvency and Bankruptcy Code, 2016 (‘Code’).
- Whether the Insolvency and Bankruptcy Code, 2016 is constitutionally valid? (to be proved by issues 2-7)
- Whether the distinction between financial and operational creditors is arbitrary and unconstitutional under Article 14 of the Constitution?
- Whether Section 12A is void under Article 14 of the Constitution?
- Whether powers given to information utilities are excessive in determining default under the Code?
- Whether the powers of resolution professionals are adjudicatory in nature?
- Whether Section 29A is void under Article 14 of the Constitution?
- Whether Section 53 is void under Article 14 of the Constitution?
Issue 1: General Observations on constitutionality
Pre-existing state of law
- The law prior to the enactment of the Code provided for the powers of creditors and debtors under two different legislations.
- This resulted in two major problems: firstly, there was a lack of clarity regarding jurisdiction because of multiple forums and secondly, the adjudicating authorities did not always have business or financial expertise. This led to delays and stays, which eventually eroded the economic value of an insolvent entity.
Determining the constitutional validity of economic legislations
- Relying on a plethora of national and international judgments, the Supreme Court highlighted the scope of the constitutional validity in case of economic legislations like the Code.
- It stated that essentially economic legislations are based on trial and error methods and cannot provide for all solutions. While adjudging the constitutionality of economic legislations, courts should consider the generality of its provisions and not its crudities, inequities, and possibilities of abuse.
Objects of the Code: Preamble
- The Court emphasized on the hierarchy of the objectives the Code seeks to achieve through its Preamble and Statement of Objects and Reasons.
- The primary objective is reorganization and insolvency resolution in a time-bound manner for maximization of value of the assets of the corporate debtor. This would promote entrepreneurship, which would further result in enhancing viability of credit.
Issue 2: Financial and Operational Creditors
(a) Classification is arbitrary and violative of Article 14
- Nature of debt: The principal distinction between financial and operational creditors is obviously with respect to the nature of debt they provide. While financial creditors lend finance for the setting up or working of businesses, operational creditors offer credit in respect of the goods and services used by the corporate debtor.
- Capability to assess firm’s commercial viability: Financial creditors, in most cases, have the expertise to assess the commercial viability of a firm, which is typically not available with most operational creditors.
- Flexibility regarding debt modification: As a matter of fact, financial creditors are more willing to modify the terms of the debts provided. Operational creditors are not generally willing to take up the risk of restructuring their loans.
- Secured or unsecured: The financial creditors, particularly banks and financial institutions, are mostly secured creditors; and the operational creditors are largely unsecured creditors.
- Quantum of loan: The quantum of loan provided by operational creditors is generally lesser than that of financial creditors.
- Payment schedules: In case of financial creditors, the debt repayment has to be done in accordance with previously specified payment schedules. There is no such provision in case of operational creditors.
- Possibility of disputes: The possibility of disputes in debts is generally higher in case of operational creditors than their financial counterparts. This is primarily because the financial creditors like banks and financial institutions have proper documentation, while with operational creditors, many reasons can be cited for non-payment e.g. quality issues with product, non-receipt of goods etc.
- Frequency: While operational creditors provide credit on a recurring basis, i.e. as and when goods/services are purchased, financial creditors indulge in one-time transactions.
On the basis of these differences, the Supreme Court opined that there exists an intelligible differentia between financial and operational creditors. The fact that financial creditors generally have the expertise to determine the commercial viability of entities, and they are more interested in the continuation of the business of the corporate debtor, their inclusion in the Committee of Creditors is plausible. Thus, the classification is not violative of Article 14 of the Constitution, as it is not arbitrary.
(b) Requirement for operational creditors only to give notice of default
- The petitioners contended that the existence of different procedures for initiation of CIRP for financial creditors (under Section 7) and operational creditors (under Sections 8 and 9) is inherently discriminatory in nature.
- They argued that while operational debtors are given notice of default and a possibility to dispute the genuineness of the claim, no such provision has been prescribed for financial debtors.
- The Supreme Court highlighted the shift in legislative policy from “inability to pay debts” to “determination of default”. There are four reasons for the same: (i) predictability and certainty; (ii) safeguarding the interests of the corporate debtor; (iii) the fact that the cause of default is irrelevant and protecting the economic interest is crucial during financial stress; (iv) liquidation should only happen upon failure of resolution process.
- The Court emphasized that the distinction is not arbitrary or discriminative by highlighting the relationship between a ‘claim’, ‘debt’ and ‘default’. In simple terms, a ‘claim’ gives rise to a ‘debt’ when it becomes due. Thereafter, a ‘debt’ gives rise to a ‘default’ when it becomes due and payable. The process is:
Claim —- Debt —– Default
- While operational creditors ‘claim’ a right to payment of liability, financial creditors prove ‘default’ by showing that the ‘debt’ has become due and payable. Therefore, the amount provided by operational creditors only becomes a ‘debt’ when it is proved that it is due. This additional requirement is not mandatory for financial creditors.
- This does not mean that financial creditors can easily drag corporate debtors into the CIRP. The Code ensures this does not happen by prescribing penalties malafide initiation of CIRP. Further, if there are any counterclaims or set-off available against the financial creditor, the Code does not interdict the corporate debtor from pursuing the same in the appropriate forum.
(c) No right to vote given to operational creditors in Committee of Creditors
- The petitioners contended that Sections 21 (Committee of Creditors) and 24 (Meeting of Committee of Creditors) of the Code are discriminatory as they do not provide the right to vote to operational creditors in the Committee of Creditors (“CoC”).
- Relying on the rationale of these provisions, the Hon’ble Supreme Court stated that the CoC should be composed of members who have the expertise to assess the commercial viability of the business and are willing to negotiate the terms of their contract.
- Financial creditors, such as banks and financial institutions, have already undergone a detailed market study before granting loans to the corporate debtor. Given their expertise and experience, they are in a better position to evaluate the resolution plan- as compared to operational creditors, who are primarily interested in recovering the amounts for their goods and/or services.
- Therefore, it is not viable to provide voting rights to operational creditors, as they may not have the expertise to assess the viability of the resolution plan.
Issue 3: Constitutionality of Section 12A
- The petitioners argued that Section 12A is arbitrary because (a) it mandates a high threshold of 90% for withdrawal of an insolvency application; and (b) it provides unbridled powers to the CoC to reject legitimate settlements.
- With respect to the first contention, the Court held that after an application is accepted by the NCLT, the proceedings become collective or in rem, and are not limited to the person who filed the application. The figure of 90% is a matter of legislative policy and thus not open to judicial interpretation.
- On the second contention, it was emphasized that the NCLT keeps a check on arbitrary actions of the CoC for rejecting a settlement- as in any case, NCLT has the last word on the matter.
Issue 4: Information Utilities
- It was contended that as information utilities are entrusted with the responsibility of checking whether default has occurred or not- there may be cases where private information utilities might function with the sole objective of profit making.
- The Court rejected this argument, stating that the evidence of default with an Information Utility is only prima facie evidence of default and can be rebutted by the corporate debtor.
Issue 5: Powers of Resolution Professionals
- The petitioners argued that the powers of the resolution professionals were adjudicatory in nature, and giving such powers to a non-judicial authority was violative of basic tenets of justice.
- On a perusal of Sections 18, 40 and 42 of the Code and Regulations 10-14 of the CIRP Regulations, it was held that the powers of the resolution professionals were merely administrative in nature, and not quasi-judicial or adjudicatory.
Issue 6: Constitutionality of Section 29A
- The constitutionality of Section 29A (Persons not eligible to be resolution applicants) was challenged on four grounds:
(a) The retrospective application of the Code has impaired vested rights of promoters
- The Court held that a legislation cannot be regarded as retrospective because it impacts existing rights or because a part of the requisites for its action is drawn from a time antecedent to its passing.
- Further, the promoters did not have any vested rights for consideration of the resolution plan and thus, application of Section 29A cannot impair their rights.
(b) Blanket ban on participation of all promoters by Section 29A(c)
- The petitioners argued that Section 29A(c) does not differentiate between ‘good’ managers and ‘bad’ managers by imposing a blanket ban on participation of all promoters. They contend that managers not guilty of any malfeasance or negligence should not be debarred from participating in the resolution process.
- The Supreme Court acknowledged the argument of the respondents and highlighted that in the entire scheme of Section 29A, it is not necessary that persons need to be criminals or have committed some fault on their own for being ineligible. For instance, Section 29A also debarred undischarged insolvents, who might not be insolvency for any fault of their own.
(c) One-year period under Section 29A(c) is arbitrary
- Section 29A(c) inter alia states that any person who has been classified as an NPA in accordance with RBI guidelines shall be debarred from being a resolution applicant, if at least one year has elapsed since the date of such classification till the commencement of CIRP of the corporate debtor.
- The petitioners contented that (a) according to RBI guidelines any person can be regarded as NPA, despite him not being a wilful defaulter and (b) the time period of one year specified is arbitrary.
- The Apex Court held that irrespective of whether a default was wilful or not, any person who cannot repay his debt is unfit to be a resolution applicant. Secondly, the time period of one year is a matter of legislative policy and, thus, cannot be interfered with by the Court.
(d) Related parties also debarred under Section 29A(j)
- The petitioners contended that Section 29A(j) debarred related parties of ineligible resolution applicants, irrespective of whether they had any business connection with them or not.
- The Supreme Court held that such an interpretation was inaccurate and only those parties would be considered ‘relative’ for the purpose of this provision have a connection with the business activity of the resolution applicant.
Issue 7: Section 53 violative of Article 14 of the Constitution
- The petitioners argued that in accordance with Section 53 of the Code, operational creditors would not get anything as they rank below all other creditors.
- The Hon’ble Court held that secured debts, which are primarily financial debts, were ranked higher than unsecured debts to further the objective of the Code to maximize availability of credit in the economy. Repayment of financial debts infuses capital in the economy, which can then be used to provide further loans. With regard to employees, the Court held that they have traditionally been kept above most other debts.
Conclusion: The Insolvency and Bankruptcy Code, 2016 is constitutional.