Strength In Numbers? IBC Passes Another Constitutional Test

  • Samaksh Sood
  • 07:05 PM, 01 Mar 2021

On March 13, 2020, the Insolvency and Bankruptcy Code (Amendment) Act, 2020 (Amendment) was enacted in place of an Ordinance dated December 28, 2019. The Amendment, inter alia, brought about changes in the mechanism through which homebuyers and holders of debentures and other securities (being financial creditors) can initiate the corporate insolvency resolution process (CIRP). The Amendment also made alterations to the list of persons who are not entitled to make an insolvency application against a corporate debtor and absolved the corporate debtor from offenses committed before the initiation of CIRP. The Amendment was challenged through multiple petitions disposed by the Supreme Court on January 19, 2021, through a decision titled Manish Kumar v. Union of India and Another. 

In this article, the author discusses the 465-page decision of the Apex Court passed by a Bench comprising Justice Rohinton Fali Nariman, Justice K.M. Joseph & Justice Ajay Rastogi in Manish Kumar v. Union of India and Another. 

A) Impugned sections of the Amendment 

The SC had to adjudicate on the constitutional validity of Sections 3, 4, and 10 of the Amendment. Briefly, these sections state the following: 

  1. Section 3 of the Amendment adds three provisions to Section 7 of the Principal Act. The first proviso states that for CIRP to be initiated by holders of debentures and other securities (as defined in clauses (a) and (b) of Section 21(6A) of the principal act), the insolvency application must be filed by a minimum of one hundred such creditors in the same class or ten percent of the total number of creditors in the class, whichever is less. The second proviso applies the same numerosity requirement as the first proviso of either one hundred creditors or ten percent of the total number of creditors for CIRP to be initiated by allottees under a real estate project. The third proviso states that where an insolvency application has been filed by creditors referred to in the first and second proviso before the commencement of the Amendment, such applications shall be modified to comply with the Amendment within thirty days of the commencement of the Amendment, failing which, the applications will be deemed as withdrawn. 
  2. Section 4 of the Amendment incorporates an additional explanation to Section 11 of the Principal Act. The explanation clarifies that nothing contained in Section 11 (Persons not entitled to make an application) of the principal act shall prevent a corporate debtor from initiating CIRP against another corporate debtor. 
  3. Section 10 of the Amendment inserted a new Section 32A into the Principal Act. This section provides for the ablution of the liability of the corporate debtor for crimes committed before the CIRP, provided that after the approval of the resolution plan, there is a change in the management or control of the corporate debtor.    

B) Challenges to the impugned sections 

  1. Concerning the numerosity requirement introduced through Section 3 of the Amendment, it was contested that there was no rational basis to treat these two classes (debenture and other security holders and homebuyers) differently from other financial creditors. On behalf of homebuyers, various other arguments on practical grounds were raised. It was contended that there is no central repository or other such mechanisms that collate information of various homebuyers and enable them to carry out coordinated action. It was also contended that the threshold requirement had the effect of disqualifying homebuyers as financial creditors, a stand which the government was estopped from taking in light of the Supreme Court's decision in Pioneer Urban Land and Infrastructure Ltd where it was clarified that homebuyers have always been considered as financial creditors in terms of the Code. 
  2. With regard to the third proviso introduced by Section 3 of the Amendment, it was contended that homebuyers had been conferred a substantive right through Section 7 of the Code, which cannot be taken away by establishing a procedure. Further, it was argued that substantial costs had been incurred in court fees and legal expenses to file insolvency applications. Treating them as withdrawn for want of compliance with proviso one and two of Section 3 of the Amendment will cause unreasonable prejudice to applicants. 
  3. On the explanation introduced by Section 4 of the Amendment, it was contended that Section 11 of the Code unequivocally bars a corporate debtor from initiating CIRP against another corporate debtor. The newly introduced explanation has the effect of abrogating the original intention of the main provision. 
  4. Regarding the ablution of prior criminal liability of the corporate debtor, it was contested that immunity granted to assets acquired from the proceeds of crime and criminal liability arising from the activities of the erstwhile management for offenses committed before the CIRP seriously jeopardizes the interest of the creditors. It also has the effect of defeating the provisions of the Prevention of Money Laundering Act, 2002.

C) Findings of the SC

  1. At the outset, the SC commented that it would be unrealistic to expect perfection from any laws enacted by the parliament. Inherently, laws are bound to have certain logistical and other difficulties in their operation. However, those would not suffice to decree a law as unconstitutional. What is required for such a pronouncement is demonstrating that the impugned laws depart from constitutional limits. Specifically, the SC noted that the parliament enjoys wide latitude in designing economic laws and has the freedom to experiment with the same.  
  2. With regard to the threshold requirement, the SC held that what distinguished homebuyers (and debenture and securities holders) were their numerosity, heterogeneity, and individuality in decision making. In other words, the SC noted that given the different interests, one homebuyer could initiate CIRP, to the detriment of both the corporate debtor and other homebuyers who may not desire that the corporate debtor be put through CIRP. While it was acknowledged that there might be logistical difficulties in implementing the threshold requirement, it was held that these are not reasons enough to strike down the Amendment. It was also highlighted that there are alternative remedies available to homebuyers under the RERA and the Consumer Protection Act. Further, the estoppel argument was not appreciated as it was clarified that the Amendment does not disqualify homebuyers as a class of financial creditors. The SC concluded by stating that the threshold requirement furthered the objective of the Code as it shields the corporate debtor from frivolous/avoidable insolvency applications. 
  3. On the insertion of the Explanation to Section 11 of the Principal Act, the SC held that the intention of the Legislature was always to ensure that the corporate debtor cannot file an application against itself. It cannot be said that the legislative intent was to bar the corporate debtor from initiating CIRP against another corporate debtor because such a move would maximize the value of the assets of the corporate debtor. Any interpretation to the contrary would frustrate the purpose of the Code. 
  4. Lastly, on the ablution of criminal liability of the corporate debtor for crimes committed prior to the CIRP, the SC held that there was no case made out against Section 10 of the Amendment. It was noted that there were safeguards built into the Amendment to ensure that the persons who were liable for the crimes are accordingly punished. It was also clarified that there are preconditions (change in management and control of the corporate debtor) for the ablution of liability. On a policy level, it was noted that often, differing public interests need to be delicately balanced. In this circumstance, the balance is maintained between ensuring that the future management can further the business of the corporate debtor without any encumbrances caused by the erstwhile management and ensuring that those individuals, directly and indirectly, responsible for the crimes committed by the corporate debtor are brought to justice. 

Concluding Remarks

Bearing in mind the fact that the Code has been abused continuously as a tool for money recovery, it is a welcome development to increase the threshold limit for admission of an application for a class of shareholders that are numerous, heterogenous, and isolated in their decision making from one another. However, while the practical difficulties mentioned by the petitioners may not have a direct bearing on the constitutionality of the Amendment, it is undoubtedly the onus of regulatory authorities that the threshold limits can be practically met by any creditors who have a bonafide claim against a corporate debtor. In the author's opinion, allowing the corporate debtor to initiate CIRP against another corporate debtor and providing for the ablution of prior criminal liability also push forth the agenda of the Code in ensuring that asset values are maximized and that post CIRP, the corporate debtor can be a going concern. However, given that the immunity from criminal liability is far-reaching, it once again poses a regulatory challenge to ensure that the correct persons from the prior management are brought to justice and have no involvement, directly or indirectly, in the new management of the corporate debtor.