Discretionary power of the Adjudicating Authority to reject CIRP applications under Section 7(5)(a) of the IBC

4th August, 2022 - 11:38 am Categories: Legal Issues 0 Comments

The National Company Law Tribunal and the National Company Law Appellate Tribunal has traditionally held that it is mandatory for the Corporate Insolvency Resolution Process(CIRP) to be initiated once the existence of a debt has been established under Section 7(5) of the Insolvency and Bankruptcy Code, 2016. There was no separate interpretation of Section 7(5) and Section 9(5) and the difference in the use of terms “may” and “shall” in the otherwise identical provisions.

However, the same was challenged and the Supreme Court, in a recent judgement, has distinguished between the terms “may” and “shall” as provided in the Code while observing that the Legislature had consciously laid down such provisions. Hence, it is only reasonable that this distinction is recognised.

In this article, we will explore the scope of discretion that was exercised by the Adjudicating Authority since the enactment of the Insolvency and Bankruptcy Code, 2016 and the implications on the same, subsequent to the recent Supreme Court judgements.

INITIATION OF CIRP BY ADJUDICATING AUTHORITY

In the case of Swiss Ribbons Private Limited v. Union of India[1], the Supreme Court held that once it had been established that the Corporate Debtor had fallen behind in the repayment of its debts, the Adjudicating Authority was required to admit an application of the financial creditors under Section 7(5) of the Code and initiate CIRP.

Section 7(4) states that the Adjudicating Authority must ascertain the existence of default within 14 days of the application by the financial creditor subsequent to which, an order would be passed by the Adjudicating Authority to admit the application. However, the discretion of the Adjudicating Authority in this provision had not been substantially called into question as the provision seemed to be fairly unambiguous regarding the obligation of Adjudicating Authority after the period on 14 days was over.

The above presumption was broken when in the case of Surendra Trading Company v  Juggilal Kamlapat Jute Mills Company Limited and Ors.[2], the Supreme Court, of its own accord stated that there is a specific distinction between the usage of the terms “may” and “shall” by the Legislature. Further, this observation of the Supreme Court was cited in Vidarbha Industries Power Limited vs Axis Bank Limited[3], wherein the discretion of the Adjudicating Authority to admit an application under Section 7(5) and the distinction between Section 7(5) and Section 9(5) was substantially called into question. The above-mentioned judgements have been discussed in the next section of this article.

SUPREME COURT JUDGEMENTS

• Surendra Trading Company v. Juggilal Kamlapat Jute Mills Company Limited and Ors.
• Interpretation of “may” in Section 7(5) of the IBC

In this case, the Supreme Court underlined the discretionary power that is indicated by the use of the term “may” in Section 7(5)(a) and Section 10(4) of the IBC. The Court expressed the view that the provisions were directory and not mandatory. The Court stated the following in its judgement:

“23) … that period of fourteen days within which the adjudicating authority has to pass the order is not mandatory but directory in nature would equally apply while interpreting proviso to sub-section (5) of Section 7, Section 9 or sub-section (4) of Section 10 as well…”

The significance of the judgement was that it was the first time wherein the court recognised the discretionary power of the Adjudicating Authority due to the use of the word “may” and not “shall” in Section 7(5) of the IBC:

“7(5) Where the Adjudicating Authority is satisfied that—

(a) a default has occurred and the application under sub-section (2) is complete, and there is no disciplinary proceedings pending against the proposed resolution professional, it may, by order, admit such application;”

• Vidarbha Industries Power Limited vs Axis Bank Limited

Issues

1. If there is a distinction between Section 7(5) and Section 9(5) of the Insolvency and Bankruptcy Code, 2016.
2. Whether Section 7(5) of the Insolvency and Bankruptcy Code, 2016 is a mandatory provision.

Interpretation and Ruling

With regard to the first issue, the court held that Section 9 of the IBC lays down the manner in which the CIRP might be initiated by an operational creditor. The operational creditor serves a notice or invoice demanding payment. If 10 days expire after the delivery of such notice or invoice without the operational creditor receiving the payment due or a notice of dispute by the corporate debtor, the operational creditor can file an application before the Adjudicating Authority to initiate CIRP. Further, the provisions under Section 9(5)(i) provides the conditions to be fulfilled for the application to be admitted by the Adjudicating Authority while the provisions under Section 9(5)(ii) provides the circumstances under which the Adjudicating Authority must reject the application. On the contrary, Section 7(5) of the Code deals with the initiation of CIRP by the financial creditors.

The Court further observed that the Legislature has applied its wisdom to the framing of these provisions and has used the word “may” in Section 7(5) which deals with the CIRP application of the financial creditors while it has used the term “shall” in an otherwise similar provision Section 9(5) while dealing with the applications of operational creditors. Therefore, the application by the operational creditors under Section 9(5) is intended to be a mandatory provision which the Adjudicating Authority is bound to accept if it meets all the requirements of the Code. However, the Court interpreted Section 7(5) as a discretionary provision in which the Adjudicating Authority is able to consider the facts and circumstances surrounding the case, such as the economic condition and financial health of the Corporate Debtor before accepting the application for initiation of the CIRP. On a further elaboration, the court observed that the financial creditors operate their business through investment whereas the operational creditors run the business of supply of goods and services. The impact of non-payment has far flung consequences for the operational creditor as compared to the financial creditor. Hence, the differentiation between them is a conscious step by the legislature.

Therefore, the Adjudicating Authority has the power to reject or keep in abeyance the CIRP application of the financial creditor but not so for the operational creditor. The Court held that the Adjudicating Authority and NCLAT had erred in holding that there was no option on their part but to initiate CIRP if the Corporate Debtor was in default.

REMARKS

The Court decision in Vidarbha Industries Power Limited vs Axis Bank Limited would significantly affect the manner in which the CIRP is conducted in India. It would mean that the Adjudicating Authority would effectively yield more discretionary power in admitting applications for CIRP initiation under Section 7(5) of the IBC. It is a remarkable shift in position wherein the Adjudicating Authority can decide whether the financial condition of the Corporate Debtor warrants a CIRP. However, the Court also stated that this discretion cannot be exercised in an arbitrary manner. Since this is a relatively new judgement, it is expected that a need would arise for the Court to lay down extensive guidelines regarding the exercise of the said discretion in the future.

Author: Subham Bhowal – a student of Symbiosis Law School (Hyderabad), in case of any queries please contact/write back to us via email chhavi@khuranaandkhurana.com or at Khurana & Khurana, Advocates and IP Attorney.

References:

[1] (2019) 4 SCC 17

[2] CIVIL APPEAL NO. 8400 of 2017 in the Supreme Court

[3] CIVIL APPEAL NO. 4633 OF 2021 in the Supreme Court