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Adjudicating Authority Not Bound To Accept Financial Creditor's CIRP Application: IBC-Section (7)(5)(A) Is Not Mandatory

In a recent case by the name of Vidarbha Industries Pvt. Ltd. vs. Axis Bank [i], the Hon'ble Supreme Court has held that the language of the Section 7(5)(a) of the Insolvency and Bankruptcy Code, 2016 (hereinafter IBC) is not mandatory but discretionary. And the Adjudicating Authority (NCLT) is not bereft of its power to dismiss an application by a Financial Creditor seeking Insolvency Proceedings against a Corporate debtor even if the debtor has defaulted to pay back the Financial Creditor. The present Article is an attempt to give its readers an insight into the above-mentioned judgement of the Apex Judiciary.

Facts of the case:
  1. The present Appeal was made under Section 60 of the IBC against an order of National Company Law Appellate Tribunal (hereinafter 'NCLAT') dated 02.03.2022. whereby the tribunal had dismissed the application to stay the proceedings initiated by Respondent against Appellant for initiation of Corporate Insolvency Resolution Process (hereinafter CIRP) under Section 7 of IBC.
  2. The Applicant had filed an appeal in 2016 before Appellate Tribunal for Electricity (hereinafter APTEL). The APTEL decided the matter in favor of the Appellant and directed the Maharashtra Electricity Regulatory Commission (hereinafter MERC) to pay Appellant a sum of Rs. 1730 Crores.
  3. MERC however, challenged this order of APTEL before the Supreme Court in year 2017.
  4. The Appellant was running short of funds, and according to Appellant implementation of the above mentioned APTEL order will allow the Appellant to clear all dues and liabilities.
  5. However, in 2020 Axis Bank being one of the Financial Creditor to the Appellant filed an application under Section 7(2) of IBC before NCLT, Mumbai to initiate CIRP against the Appellant Company.
  6. The Appellant however, filed a miscellaneous application before NCLT the same year, seeking stay of the CIRP proceedings as long as the matter between Appellant and MERC was pending before the Supreme Court.
  7. By an order in year 2021 the NCLT dismissed the application of the Appellant seeking stay of CIRP proceedings. The Appellant later filed an appeal against the order of NCLT before the NCLAT, however, the same was also dismissed by the Tribunal.
  8. The reasoning of NCLT and NCLAT was based upon the judgment of Supreme Court in the matter of Swiss Ribbons v. Union of India [ii] where the hon'ble court has held that in such matters time is of the essence and thus the Adjudicating Authorities shall endeavor to dispose of the matter in a time bound matter.��� And therefore the NCLT rejected the application to stay the proceedings on the basis that it would unnecessarily derail the CIRP proceedings.
  9. NCLT has further held that the Adjudicating Authority is only required to see two things: a) whether there has been a debt; and b) the corporate debtor defaulted in making repayments. These, two aspects when satisfied would trigger Corporate Insolvency. And thus, the fact that another relevant case pending before the Apex Court will not disturb the CIRP proceedings here. And the reason of NCLT was upheld by NCLAT too. Aggrieved by it the Appellant has appealed before the Supreme Court under the present Petition.

Issues raised before the supreme court for adjudication:
  1. Whether Section 7(5)(a) of IBC is a mandatory or a discretionary provision. In other words, is the expression 'may' to be construed as 'shall', having regard to the facts and circumstances of the case.

Arguments raised by-the appellant
  1. The Appellant argued that it has filed applied for a stay of proceedings before NCLT only because of extraordinary circumstances, where the Appellant had not been able to pay the dues of the Respondent, only because an appeal filed by MERC. Had it not been the case the Appellant would have already paid the Respondent.
  2. The Appellant argued that on a bare reading of section 7(5)(a) of the IBC the use of word 'may' indicate that it is not mandatory for NCLT to admit all the application, wherever there is a debt and a default by Corporate Debtor. The Appellant further argued that the section 7(5)(a) of the IBC enables NCLT to reject an application, even if there is a debt, for any reason that it may deem fit, for meeting the end of justice.
  3. The Appellant had made a parallel between the section 7(5)(a) of the IBC and the section 10(4) of the IBC, which has already been declared by the Supreme Court itself to be discretionary and not mandatory, in the matter of Surendra Trading Company vs. Juggilal Kamlapat Jute Mills Company and Ors.[iii]
  4. The Appellant also argued that the object of the IBC is to first try and revive the company and not to nail its coffin. This objective of the IBC cannot be kept aside while dealing with an application under the section 7 of the IBC or while interpreting the same. Further the Appellant argued that where there is a favourable order in favour of the corporate debtor, implementation of which would enable the corporate Debtor to pay its debt, the NCLT is not emancipated of its power to reject an application made under the section 7 of the IBC, for sake of justice.

Arguments raised by the respondent
  1. The Respondent argued that the Appellant being in admitted default, the NCLT had rightly refused to stay the CIRP proceedings. The Respondent for this relied on Swiss Ribbons (supra).
  2. Respondent further argued that the section 7(5)(a) of the IBC is mandatory in nature and the Adjudicating Authority under this section is under obligation to admit application of a Financial Creditor under section 7 of the IBC, when the Authority has found that a Corporate Debtor has defaulted.
  3. Respondent argued that since there was no dispute that the Appellant had defaulted to repay the Respondent, thus the Adjudicating Authority was obliged to admit the application under Section 7 of IBC.
  4. Respondent relied on the judgment of the Supreme Court in Innoventive Industries Ltd. vs. ICICI Bank and Anr.[iv] to argue that the objective of IBC was to provide a fast-track insolvency resolution process, and thus the Section 7(5)(a) shall be read as a mandatory provision to fulfil the objective of the code.

Judgment of the hon'ble supreme court
  1. The hon'ble Supreme Court held that the legislature had must applied its wisdom in choosing the word 'may' in Section 7(5)(a) of the IBC. The meaning and intention of Section 7(5)(a) of the IBC shall be ascertained from the language of the provision. In the light of it, the Apex Court held that the effect of the provision is as directory or discretionary and not mandatory.
  2. The NCLT in the present case failed to appreciate that the question initiation of CIRP could only arise if the companies were bankrupt or insolvent and not otherwise.
  3. The hon'ble Supreme Court allowed the appeal, and quashed the impugned awards made by the NCLT and NCLAT in favour of the Appellant, and further directed the NCLT to re-consider the application of stay moved by the Appellant on merits.

Reasoning of the Hon'ble Apex Court
  1.  The hon'ble Supreme Court has held that NCLAT eared in holding that NCLT was only required to see whether there had been a debt and the Corporate Debtor defaulted in paying back such debt, to allow an application for initiation of CIRP under Section 7 of IBC.
  2. According to the hon'ble Court the existence of a debt and a default by Corporate Debtor in relation to such debt only gives a right to the Financial Creditor to apply for initiation of CIRP. However, the Adjudicating Authority must apply its mind to relevant factors including the feasibility of CIRP.
  3. To further elaborate, the hon'ble Justice Indira Banerjee has compared the Section 7(5)(a) of the IBC with Section 9(5) of the IBC, this Section 9 provides that the NCLT 'shall' within 14 days of the receipt of an application made by an Operational Creditor, admit the application. According to Justice Banerjee the Legislature has on a purpose used the word 'may' in Section 7(5)(a) of the IBC with relation to initiation of CIRP by a Financial Creditor but has used the word 'shall' in another almost parallel and cyclostyle provision of Section 9(5) of the IBC with relation to initiation of CIRP by an Operation Creditor. This choice of different words in almost similar provisions clearly shows that the two provisions are intended to convey different meaning. And thus, it is apparent that it was the intent of the Legislature to give a discretionary nature to the Section 7(5)(a) of the IBC and a mandatory nature to Section 9(5) of the IBC.
  4. This Difference of nature is a natural and logical corollary of the differences between a Financial Creditor, which is usually a secured creditor and is for a much longer duration, and an Operational Creditor which is neither secured nor for a long term.
  5. The NCLT has been conferred with discretion to admit an application of the Financial Creditor as it is a much-secured creditor and has strong financial backing, while the power to admits an application made by an Operational Creditor is mandatory keeping in mind its week status.
  6. The Court further held that the objective of the IBC is not to penalize solvent companies, temporarily making default in making of financial debt, because of extraordinary situations by initiation of CIRP. Section 7(5)(a) of the IBC, therefore, confers discretionary power to the NCLT to admit an application of a Financial Creditor under Section 7 of the IBC for initiation of CIRP.
  7. The NCLT must consider the grounds made by the Corporate Debtor against admission of CIRP, on its own merit and special nature, as was the case in present Appeal. In this case, the Adjudicating Authority (NCLT) has simply brushed aside the case of the Appellant that an amount of Rs.1,730 Crores was realizable by the Appellant in terms of the order passed by APTEL in favour of the Appellant, with the cursory observation that disputes if any between the Appellant and the recipient of electricity or between the Appellant and the Electricity Regulatory Commission were inconsequential.

Bottom line
  1. It is well settled that the objective of the IBC was to provide a legal machinery to resolve insolvency and debt recovery in a time barred, for maximization of the value of the assets of such company or person and thus, balancing the interest of all the stakeholders and matters connected therewith. However, it is also the objective of the IBC to first try and revive the company and not to spell its death knell. This objective cannot be lost sight of, while exercising the power under Section 7 of IBC.
  2. This judgment sets a good precedent for upcoming case dealing with initiation of CIRP proceedings by a Financial Creditor against a Corporate Debtor, as it asks the Adjudicating Authorities to apply its mind while hearing such application and not to start the CIRP proceedings against a solvent company or against a company which is because of some extraordinary conditions has defaulted temporarily without hearing the matter of the Corporate Debtor on merits.

  1. 2022 SCC OnLine 841
  2. (2019) 4 SCC 17
  3. (2017) 16 SCC 143
  4. (2018) 1 SCC 407

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