Author: Shravani Kale, ILS law college
Abstract
In the landmark case of Swiss Ribbons (2019), the Supreme Court upheld the constitutionality of the Insolvency and Bankruptcy Code (IBC), emphasising that the preamble of the Code does not support asset liquidation of a corporate debtor as the first option. Instead, liquidation is viewed as a last resort, to be considered only in instances where the resolution professional does not receive a viable resolution plan, or if any suggested plan is turned down by the National Company Law Tribunal (NCLT) or the creditors’ committee. Since its introduction, the IBC has undergone extensive legislative review, resulting in various important amendments in November 2017, June 2018, August 2019, and March 2020. Additionally, in response to the economic turmoil caused by the COVID-19 pandemic, an ordinance was issued in 2020 to safeguard the interests of corporate debtors. In the ongoing discussions surrounding the IBC, several petitions challenging the constitutional validity of its provisions have been presented before the Supreme Court. Regardless, as the Court has already addressed issues pertaining to the constitutional validity of the IBC, the specifics of individual cases are deemed irrelevant to the broader legal discourse.
To the point
The IBC represents a major shift from previous insolvency laws in India, and several of its important characteristics are unique even when considered on a global scale. There are some main distinguishing aspects of the IBC when compared to other established legal systems. First off, there is no need for an insolvency test because the admission criteria are limited and are based only on the occurrence of default. Secondly, there are no class rights, as the structure consists of a single creditors’ committee made up exclusively of financial creditors, treating both secured and unsecured creditors equally in voting matters. The Government successfully demonstrated to the Supreme Court that these measures have been effective, yielding substantial results in the initial years following the law’s enactment. A key factor in upholding the law was the Government’s strong commitment to addressing the non-performing assets (NPA) crisis through the introduction of the Insolvency and Bankruptcy Code (IBC). Moreover, the Government has remained responsive to prevailing challenges, amending the law to better align with the evolving needs of the situation.
Legal Jargon
The issues before the court were –
(i) Whether the appointment of members to the NCLT and NCLAT in accordance with the ruling in Madras Bar Association v. Union of India?
(ii) Whether the distinction between financial creditors and operational creditors constitutes discrimination, arbitrariness, and a violation of Article 14 of the Constitution?
(iii) Whether Sections 21 and 24 of the IBC violate Article 14 of the Constitution due to the exclusion of operational creditors from participating in the voting process of the committee of creditors.
(iv) Whether Section 12A of the IBC is a violation of Article 14 of the Constitution?
(v) Whether the Resolution Professional have any powers to make judicial decisions?
(vi) Whether Section 53 of the IBC infringes upon Article 14 of the Constitution?
Proof
The Supreme Court defended differential treatment between two categories of creditors, financial and operational. The court established that financial creditors are distinctly separate from operational creditors, and this distinction is rooted in an intelligible differentia that directly relates to the objectives of the Code. The bench elucidated the differences between these two types of creditors, noting that a review of the definitions of financial creditor and financial debt clarifies that a financial debt encompasses a debt, along with any accrued interest, which is disbursed in consideration of the time value of money. Furthermore, it may consist of money borrowed or raised in various manners specified in Section 5(8) or otherwise, as Section 5(8) offers an inclusive definition. In contrast, ‘operational debt’ refers to claims arising from the provision of goods or services, including employment, as well as debts owed under applicable laws to the Government or any local authority.
The judiciary has upheld Section 12A of the Code. The requirement that 90 per cent of the committee of creditors must approve any withdrawal is the primary source of concern with this clause. This substantial threshold has been clarified in the Insolvency Law Committee Reports, which explain that all financial creditors must collectively agree to permit such withdrawals. Ideally, an omnibus settlement involving all creditors should be established. Therefore, the necessity for ninety per cent approval—representing a vast majority of financial creditors—ensures that individual withdrawals or settlements receive adequate consensus. Moreover, it is important to note that the committee of creditors does not possess the final authority on these matters as delineated in Section 60 of the Code. If the committee arbitrarily denies a valid settlement or withdrawal claim, the NCLT, and subsequently the NCLAT, can overturn such a decision under Section 60. Consequently, this provision also withstands constitutional scrutiny.
The bench noted that the Insolvency Resolution Professional possesses only administrative powers and lacks adjudicatory authority. Under the Code, the resolution professional is entrusted with administrative responsibilities rather than quasi-judicial or adjudicatory functions. It further highlighted that even when the resolution professional is required to make a ‘determination’ under Regulation 35A of the IBBI (Insolvency Resolution Process for Corporate Persons) (Third Amendment) Regulations, 2018, their role is limited to applying to the Adjudicating Authority for appropriate relief based on that determination. The bench emphasised that, unlike the liquidator, the resolution professional cannot undertake several actions without the committee of creditors’ approval as per Section 28 of the Code. This committee may, by a two-thirds majority, replace a resolution professional if they express dissatisfaction with their performance. Consequently, the resolution professional’s primary role is to facilitate the resolution process, and both the committee of creditors and the adjudicating authority have control over their administrative duties.
The challenge against Section 29A of the Code, which pertains to the eligibility of individuals to be considered resolution applicants, has been comprehensively addressed in this judgment. The bench referred to prior cases in which it was established that resolution applicants do not possess a vested right to participate in the resolution process. The petitioners contended that Section 29A(c) treats unequal entities as equals, arguing that a competent former manager should not be grouped with a poorly performing one. They claimed that excluding competent former managers from the resolution process contradicts the underlying objective. The bench, however, dismissed this argument, emphasising that the ineligibility criteria are not limited to instances of wrongdoing. It stated that the categories of individuals deemed ineligible under Section 29A encompass not only those who have engaged in malfeasance or have violated the law in some manner, but also those who are unable to settle their debts within the provided grace period. Furthermore, this proviso bars such individuals from acquiring assets of the corporate debtor when they have either willfully evaded or been unable to fulfil their debt obligations. The legislative intent that underpins Section 29A continues to be relevant not only for resolution applicants but also for the context of liquidation. Therefore, this plea is also rejected.
The judgment provides a nuanced interpretation of Section 29A(j), which defines ‘related party.’ The court addressed the argument that simply being a relative of an ineligible person is insufficient to disqualify someone from serving as a resolution applicant, provided they are otherwise qualified. The ruling established that unless it can be demonstrated that such a ‘related person’ is involved in the business activities of the resolution applicant, they cannot be disqualified under Section 29A(j).
In challenging Section 53 regarding liquidation, it is important to note that operational creditors hold the lowest priority for repayment, ranking below all other creditors, including unsecured financial creditors. The court explained that the distinction between secured financial debts and unsecured operational debts arises from their relative significance in fulfilling the objectives of the Insolvency Code. Repayment of financial debts injects capital into the economy, allowing lenders to support other businesses. This creates a legitimate differentiation concerning the Code’s aims. Thus, as long as there is a legitimate interest tied to the statute’s objectives, Article 14 is not infringed.
Case laws
Madras Bar Association v. Union of India (2015): This landmark case established guidelines for the National Company Law Tribunal’s (NCLT) and National Company Law Appellate Tribunal’s (NCLAT) composition and appointment procedure while contesting the legitimacy of the two panels. The Supreme Court upheld the tribunals’ constitutional validity but directed the government to make changes ensuring judicial independence within their structure—a standard referenced in Swiss Ribbons when reviewing NCLT/NCLAT’s adjudicatory role and appointments.
Innoventive Industries Ltd. v. ICICI Bank (2017): As the first major Supreme Court judgment on the IBC, it clarified the process and threshold for admitting insolvency petitions under Sections 7 and 9. The Court held that the existence of a default is the only requirement for admission, emphasising the IBC’s shift from a “sick company” regime to a creditor-in-control resolution mechanism. This method forms the foundation of many principles endorsed in Swiss Ribbons.
State Bank of India v. V. Ramakrishnan (2018): The Supreme Court clarified that the Section 14 moratorium (which freezes all creditor actions during insolvency resolution) applied only to the corporate debtor, not personal guarantors. This differentiation of liability enhances Swiss Ribbons’ intricate understanding of the rights of both creditors and debtors.
Conclusion
In conclusion, the Court reaffirms the necessity of respecting legislative judgment in the realm of social and economic policy, allowing for intervention only when such judgment is evidently arbitrary. A careful application of checks and balances is crucial, with a primary focus on fostering robust economic growth rather than hindering it through premature constitutional challenges. This ruling not only elucidates the legislature’s intent to facilitate the resolution and revival of corporate debtors but also empowers creditors and stakeholders in their pursuits. The impact of this judgment will be profoundly felt as it encourages a greater number of pre-insolvency settlements and accelerates the resolution of corporate debts during insolvency proceedings.
FAQs
What was the main obstacle faced by the IBC in Swiss Ribbons?
Petitioners argued that the IBC discriminates between financial and operational creditors, especially regarding voting rights and priority in repayment, and thus violates Article 14 of the Constitution
How did the Court justify the distinction between financial and operational creditors?
It found “intelligible differentia”, holding that financial creditors provide long-term finance based on the time value of money, unlike operational creditors.
What is the rationale behind Section 53’s liquidation priority order?
Financial debts are prioritised over operational debts, justified by the law’s objectives to ensure capital flows and economic stability; workmen’s dues remain highly protected.
What protections are in place if a resolution withdrawal under Section 12A is refused without justification?
If the Committee of Creditors unjustly denies a valid settlement or withdrawal, the affected party has the option to appeal to the NCLT/NCLAT under Section 60 of the IBC.
