Recent Supreme Court judgment on IBC may weaken insolvency regime

Source: The post is based on an article “Recent Supreme Court judgment on IBC may weaken insolvency regime” published in the Indian Express on 22nd July 2022. 

Syllabus: GS 3 Issues and Challenges pertaining to growth and development of Indian Economy; Effects of Liberalization on the Economy, Changes in Industrial Policy and their Effects on Industrial Growth. 

Relevance: Insolvency and Bankruptcy Code 

News: Recently, the Supreme Court of India passed an important judgment on insolvency and bankruptcy in the Vidarbha Industries Power Ltd. v. Axis Bank Case.  

SC recently held that the National Company Law Tribunal (NCLT) cannot admit an insolvency application filed by a financial creditor merely because a financial debt exists and the corporate debtor has defaulted in its repayment.  

What are the concerns associated with the judgment? 

A critical element for any corporate insolvency law is the point of trigger. It means the law must clearly provide the grounds on which an insolvency application against a corporate debtor should be admitted. If there is any confusion at this stage, precious time could be wasted in litigation. 

On the other hand, if the law is clear and litigation can be minimised, the distressed business could be resolved faster. Its value could be preserved. And all stakeholders collectively would benefit.  

Therefore, the government should develop objective legal criteria for an effective corporate insolvency law. 

What were the points of triggers that can be used for initiating insolvency proceeding? 

(1) The balance-sheet test is one method for determining insolvency at the point of trigger. However, the balance-sheet test is vulnerable to the quality of accounting standards. Therefore, the Bankruptcy Law Reforms Committee (BLRC) did not favour this test in the Indian context 

(2). The BLRC recommended a twin-test. In this, a filing creditor should only provide a record of the liability (debt), and evidence of default on payments by the corporate debtor. It provides a clear and objective trigger for insolvency resolution. This test was expected to minimise litigation at the admission stage of the insolvency application, and enable quicker resolution of distressed businesses. 

Possible Implication of the SC ruling 

(1) The SC interpretation of the law could fundamentally reshape a crucial innovation in the IBC framework. 

(2) The SC’s latest ruling is likely to cause failure of the twin-test, recommended by the BLRC. Now, even if the NCLT is satisfied that the corporate debtor has defaulted, it would not be able to admit the case for resolution if the corporate debtor resists admission on any other grounds.  

(3) Now, the corporate debtors are likely to use this precedent to the fullest to resist admission into IBC. 

(4) There would be more litigation and delay at the admission stage, enhancing the risks of value destruction in the underlying distressed business and all stakeholders collectively would suffer.  

(5) The IBC may well end up like the Sick Industrial Companies (Special Provisions) Act, 1985 (SICA). The SICA was also subjected to pro-revivalist judicial approach in various judgments. This led to the establishment of the Board for Industrial and Financial Reconstruction (BIFR) as a specialist tribunal to ensure speedy resolution of distressed industrial companies. The BIFR became a haven where companies could seek shelter from their creditors for years. This led to a lot of delays as well as facilitating the managers to siphon off assets in the interim.