An unsettling precedent under IBC

In a widely reported order, the Supreme Court allowed a debtor to settle a claim with a creditor after the collective resolution process was triggered under the Insolvency and Bankruptcy Code (IBC), 2016. The short story of the litigation leading up to the Supreme Court order is as follows. In June 2017, the National Company Law Tribunal (NCLT), the adjudicating tribunal under the IBC, had admitted an application for triggering the IBC against a debtor. Thereafter, the debtor and the creditor who had applied for triggering the IBC, settled their claim. The debtor appealed to the National Company Law Appellate Tribunal (NCLAT) to set aside the order of the NCLT that triggered the IBC. At the NCLAT, both the debtor and the creditor acknowledged that their claim had been settled.

The NCLAT dismissed the appeal on two grounds. One, that after the IBC was triggered, there was no provision in the IBC to allow the creditor to withdraw her application for triggering it on the basis of a settlement between a debtor and the creditor. Two, the NCLAT had no inherent powers to take such a settlement on record and set aside the order passed by the NCLT triggering the IBC. The NCLAT order, thus, effectively ruled that once the resolution process was set in motion, it could not be reversed on grounds that the debtor had settled with the creditor. The parties appealed to the Supreme Court, which set aside the order passed by the NCLAT. In this article, we argue that the order of the Supreme Court is ill-considered for two reasons.

First, the Supreme Court order is not aligned with the policy and legislative intent underlying the IBC. Under the IBC, once an application for triggering the IBC is admitted, a resolution process begins. A resolution process is essentially a collective action proceeding where all the creditors vote on the manner in which they should restructure their debts to ensure optimal recovery. Allowing a debtor to settle with a creditor and terminate the collective action proceeding, effectively compromises the interests of other creditors, who are part of such a proceeding. This intent is reflected in Volume I of the report of the Bankruptcy Law Reforms Committee, which lays out the rationale underlying the design of the IBC. It provides that all creditors, who have the capability and willingness to restructure their liabilities, must be part of the negotiation process that follows the trigger of the insolvency resolution process. A theme that cuts across the report is that the Code will respect the rights of all creditors equally.

Ordinarily, nothing should prevent a willing debtor and a willing creditor from compromising and settling their claims. However, once a resolution process is in motion, it puts all the creditors at par. Hence, all the creditors effectively become “parties” whose rights will be affected by the outcome of the resolution process. The order of the Supreme Court states that it accepts the settlement between the debtor and the creditor who triggered the IBC “since all the parties” are before the court. However, it is unclear if “all” the creditors, who were entitled to participate in the resolution process, were, in fact, present before the court. If they were not present, the order fails to recognise the purpose of the collective action process that the IBC has put in place. If they were present, then it is unclear why the same outcome could not be achieved through a quick resolution process where all the creditors would knowingly vote in favour of the settlement, without jeopardising the potential to recover their own dues.

In India, we have previously seen instances where debtors have chosen to preferentially pay some creditors to the exclusion of other creditors, who are similarly placed. For instance, in 2015, Amtek Auto was reported to have selectively paid some bond holders in preference to others, under the same bond agreement. The idea of a resolution process is to precisely pre-empt such conduct where big investors are most likely to be paid out to the exclusion of or preferentially over the others. Court rulings that bless such compromises jeopardise the potential of a collective action proceeding.

Second, after an insolvency resolution process commences, a compromise between the debtor and any creditor, to the exclusion of all other creditors, contravenes the specific statutory procedure established under the IBC. The Supreme Court order does not offer any rationale for overriding the provisions of the IBC. The Court has passed this order in exercise of its powers under Article 142 of the Constitution, which provides the Supreme Court with the discretionary power to pass any order necessary for doing complete justice in any cause before it. The jurisprudence that has evolved in this field shows that such contravention is not encouraged under Article 142.

Although the powers of the apex court under Article 142 are wide and give preference to equity over law, the means of achieving complete justice have been circumscribed by the court itself in former judgments. Of the various instances wherein the ambit of complete justice has been debated upon, it is best summarised in the case of the Supreme Court Bar Association versus the Union of India (1998), as under:

“The Supreme Court has always been a lawmaker and its role travels beyond merely dispute-settling... but the substantive statutory provisions dealing with the subject matter of a given case cannot be altogether ignored by the Supreme Court while making an order under Article 142... These powers are not meant to be exercised when their exercise may come directly in conflict with what has been expressly provided for in a statute dealing expressly with the subject.”

This principle has subsequently been followed in several cases, where parties have approached the court to exercise its powers under Article 142. The order of the Supreme Court does not elaborate why it chose to depart from this well-settled principle to over-ride the provisions of the IBC and allow the debtor to settle with a creditor, to the exclusion of other creditors who are entitled to a seat in the resolution process under the IBC.

Although the order under Article 142 does not constitute a binding precedent as it is meant to apply to the specific case before it, this opens the floodgates for such settlements coming up for consideration by the Supreme Court in the future. Allowing such discretion to be exercised to do complete justice may indeed end up doing injustice to other creditors. Also, it may effectively render the Code and procedures established therein, ineffective and redundant.

The writers are researchers at the Finance Research Group at the Indira Gandhi Institute of Development Research, Mumbai

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