Case Comment: Swiss Ribbons Pvt. Ltd v. Union of India

The authors explore the reasoning of the Hon’ble Court in establishing Swiss Ribbons as the footing of this economic legislation and corporate bankruptcy law in India. This case comment analyses the challenges put against Insolvency and Bankruptcy Code, 2016, and the Hon’ble Court’s endorsement of the Code from its inception. It highlights the key issues of conflict and affirms the disputed provisions of the Code as non-arbitrary in a comprehensive judgment.

In January 2019, the Hon’ble Supreme Court of India’s judgment in the case of Swiss Ribbons Pvt. Ltd. & Anr v. Union of India preserved the validity of the recent insolvency legislation passed by the Parliament in 2016.

Background

In 2015, while contemplating a legislative framework for bankruptcy and insolvency in the country, the UNCITRAL Legislative Guide on Insolvency (hereinafter “UNCITRAL Guidelines“) was a significant benchmark in setting the principles of the new insolvency law in India.

The UNCITRAL model emphasized on an insolvency regime wherein debtors and creditors follow the insolvency process in a collective, equitable, and fair manner. The aim was to preserve the economic value of all stakeholders in a time-bound process by allowing enterprises to either revive or liquidate and distribute their assets to all stakeholders involved.

Deriving benefit from these principles, the report of the Bankruptcy Law Reforms Committee Report (hereinafter “BLRC Report”) emphasized on structuring an insolvency legislative framework that aimed to achieve insolvency and bankruptcy issues efficiently.

It stressed on resolving these issues in less time, with low loss in recovery, and achieving a higher level of debt financing across several types of debt instruments.

In the subsequent year, India came up with a unified code dealing with matters of insolvency and bankruptcy. The Insolvency and Bankruptcy Code, 2016 (hereinafter “Code” or “Insolvency Code”) emerged as paramount economic legislation that changed the entire scenario of debt recovery in the country. The Insolvency Code shifted the paradigm of company management from the control of the debtor to the creditor. The Code’s core objectives focused on helping in reorganizing a resolution of the corporate in a limited time frame whereby all the interests of the stakeholders stand balanced.

In 2018, the legislation was put under question for its constitutional validity. Assailing the constitutional validity of the Insolvency Code, ten writ petitions and a special leave petition was filed in the Hon’ble Supreme Court of India (hereinafter “Supreme Court” or “Hon’ble Court). The petition challenged the legislative scheme of §7, §12A, §29A, §53 contending that they don’t pass through the test of constitutionality, and is violative of Article 14[1] of the Constitution of India. Delivered on 25th January 2019, the judgment dealt with all contentions put forward by the petitioners and gave a comprehensive understanding of the law, that is now known to be its foundation altogether.

Legal Reasoning

1. Tribunal – Appointment of Members and Administrative Support

The first challenge contended before the Hon’ble Court was the appointment of members of the National Company Law Tribunal (hereinafter “NCLT”) and National Company Law Appellate Tribunal’s (hereinafter “NCLAT”). The issue was in dispute due to a contrary preceding decision of the Supreme Court in the Madras Bar Association case[2] concerning the appointment of members. Unravelling the ambiguity, the Supreme Court stated that the Companies Amendment Act 2017 amended §412, which was applicable from January 3, 2018, in furtherance to which a committee was constituted in 2015 to appoint members of NCLT.

It was further contended that instead Ministry of Law and Justice, the Ministry of Corporate Affairs was giving administrative support to the NCLT and NCLAT. Elucidating this contention, the Hon’ble Court rectified the error concerning the administrative support provided to the tribunals and stressed that the law should be followed in ‘letter and spirit’[3]. The additional claim regarding NCLAT on seating in Delhi being inefficacious was put forward, to which the court ordered the set-up of circuit benches within six months.

2. Financial Creditors vis-à-vis Operational Creditors – A Reasonable Classification?

The maintainability of application for the initiation of the Corporate Insolvency Resolution Process (hereinafter “CIRP”) depends on whether the applicant is either a financial creditor[4]or an operational creditor[5] under Code. The pre-requisite of a person to be a financial creditor is the debt owed to fall under the ambit of a financial debt[6]. Financial creditors advance credit as a term loan or working capital, which helps assess the viability of the corporate debtor’s business. Whereas, operational creditors advance credit against the debt, which relates to the operation of business[7] in quadruple categories, including goods, services, employment, and government dues[8].

The operational debtor may dispute the legitimacy of the claim in furtherance of his entitlement to service of notice of the default[9]. A fair trial is piloted once the Adjudicating Authority[10] is satisfied with the existence of default. A notice will be issued to the corporate debtor[11], and adjudication shall occur after the debtor is heard[12]. Whereas, there is no service of notice to the financial debtor, neither does he have the prerogative to dispute the substance of the claim[13].

Even though both creditors can initiate the CIRP, there is an intelligible differentia that can be manifested by the evidence presented by the two[14]. The initiation of the CIRP also lays down a classification in both classes of creditors, as the operational debts tend to be recurring in nature and are of a smaller amount than compared to financial debtors and may not be precisely mirrored on information utility records[15].

The leeway of disputed debts is higher for operational creditors as compared to financial creditors. The debts of operational creditors being smaller ensures that these debt claims aren’t competent to put the corporate debtor into the CIRP prematurely or pledge the extraneous considerations process. This results in facilitating the restructuring of debt outside formal proceedings through informal negotiations between creditors and corporate debtors[16] . Hence, deliberating on the above-mentioned reasoning the Supreme Court declared intelligible differentia between financial and operational creditors.

3. Proof of CIRP and CIRP Commencement

Post a trigger under §7 by a financial creditor; the Adjudicating Authority has to determine the existence of a default based on the definite evidence or information utility provided by the financial creditor. If the information utility provided is accurate or substantial, liability under §65[17] and consequent punishment under §75[18] arises for the financial creditor.

The legislative policy of the Code is also to safeguards the interests of the corporate debtor. However, if the Adjudicating Authority finds itself satisfied with the existence of default, the insolvency application is admitted. Since the requirement to prove a default only exists for a financial creditor and not an operational creditor who only has to establish a right to his payment or ‘claim’ under §8(1), it significantly establishes a material difference between the two classes.

Section 21 and 24 – Constitutional Validity

The Committee of Creditor (hereinafter “CoC”) is formed when a moratorium is passed following the declaration of insolvency of a creditor. The prerogative to vote for CoC is not provided to the operational creditors[19]. Neither shall the operational debtors be allowed to be the part of the committee of creditors unless the extent of their aggregate dues amounts to 10% aggregate of the owed debt[20]. In the precedential case, such classification is considered to be prejudiced and patently arbitrary[21].

Conversely, the Supreme Court upheld differentiation after considering the essence of the debts of both the classes along with their financial proficiency and magnitude of evidence as a pre-requisite to elicit the proceeding of insolvency resolution. The Hon’ble Court said that CoC deliberates on powers to ultimately decide if an entity would be an ongoing concern or liquidate. The CoC members should have the proficiency to assess the viability and be willing to adapt terms of prevailing liabilities in negotiations[22].

Section 24 was furthermore modified to permit the operational creditors to be a part of the meeting of the CoC but deprived of voting rights. After the amendment, the addition of Regulation 38, wherein the operational creditors were given priority in payment over financial creditors; it strengthened their rights by incorporating the principle of equitable and fair dealing of rights of operational creditors.

4. Section 12A – Constitutional Validity

The petitioner challenged §12A on the grounds of unconstitutionality and claimed it to be s contrary to the precedent held by Supreme Court in 2017 in the Uttara Foods[23] judgment. The retrospective effect applied to §12A, which was inserted by The IBC (Second Amendment) Act 2018, deliberates on the allowance of withdrawal of application under §7, 9, or 10 by Adjudicating Authority along with the approval of CoC with ninety percent voting share[24]. The applicant had to request the NCLT for withdrawal of application[25], although there is no provision permitting the withdrawal post admission of the application.

Still, the Adjudicating Authority had granted permission if there was settlement[26]. If there is no scope of the settlement, the application can be withdrawn as per the procedure mentioned in the Code[27]. This can happen before admission of application[28], before the constitution of CoC[29] and before the issue of the invitation of expression of interest[30]. If there is withdrawal, the resolution process shall continue unless there are any exceptions[31]. Furthermore, an application for withdrawal of application can only be made before the Adjudicating Authority and not Resolution Professional[32].

The main thrust against §12A is the high threshold of ninety percent voting share of CoC to allow withdrawal. If the CoC arbitrarily rejects the settlement or withdrawal claim, the NCLT and the NCLAT can overrule or set aside such arbitrary decisions after manifesting the same[33]. Hence, §12A passed the constitutional muster as well.

5. Prima Facie Evidence of Default

It was argued by the petitioners that private information utilities are devoid of proper governance and norms, which make the evidence of a debt inconclusive and unreliable. However, relying upon the Information Utilities Regulation 20[34] and 21[35], it is clear that whenever a receipt of default is submitted, an expeditious procedure of authentication and verification of the default follows. The information of the default is sent to all concerning parties and sureties to the debt. Further, the debtor has the opportunity to authenticate and verify the debt.

Hence, it is apparent that the evidence of default prima facie and the corporate debtor has enough chance to rebut the same. Therefore, the challenge of the petitioners’ failed.

6. Resolution Professional – A CIRP Facilitator

The Resolution Professional possesses the administrative power in its duties under the Code[36], but he does not have adjudicatory powers. The Resolution Professional has to vet[37]and verify[38] the claims under the CIRP Regulations[39] to determine the amount of the claim[40]. Whereas, the liquidator can admit and reject claims[41] after consolidating[42] and verifying[43] them as per the guidelines under the Code.

The liquidator’s duties are quasi-judicial as he determines the claims[44]. This can be appealed against to the Adjudicating Authority[45]. The liquidator can act without prior approval of the CoC[46], which has the power to replace the Resolution Professional. The administrative functions performed by the Resolution Professional are overseen by the CoC and Adjudicating Authority as he is a mere facilitator of CIRP.

Section 29A- Constitutional Validity

The primary objective of introducing §29A was to certify that the persons who are accountable for the insolvency are not a part of the CIRP to expedite effective corporate governance[47]. After the conception of the CIRP, applications are invited with respect to potential resolution proposals. Here the dilemma of who shall be eligible to apply is cleared out.

For example, any person who is disqualified under the Companies Act as a director cannot apply or any person prohibited by law[48]. This provision does not restrict any person willing to participate in the process of acquisition of assets of the company or submission of a resolution plan, which results in the apprehension of misconduct and misuse of the provision.

No vested right is granted to the resolution applicant for approval of the resolution plan. The plan is considered only after analyzing its feasibility and viability, followed by the requisite voting share of 66% by the financial creditors[49]. Hence, there was never an existence of vested rights; and a question of deprivation did not stand.

Another claim contended by petitioners was the unequal treatment of the equals when a former manager should have the right to participate in the resolution process unless acts contradictory or is guilty of malfeasance[50].

Section 29A includes categories of ineligible persons, including persons guilty of fall foul of the law, wrongdoing, non-payment of debt in the grace period; these persons according to the proviso[51] are barred from purchasing the assets due to the non-payment of debts of the corporate debtor. Hence, the plea was rejected, and §29A continues to apply not only to the resolution applicants but also liquidation[52].

Furthermore, the aspect of Non-Performing Asset (hereinafter “NPA”) was deliberated[53], a grace period of one year is available to the NPA account holder to pay off the debt as the account is classified as a substandard asset, but if a person is unable to do so, he shall not be eligible to be a resolution applicant according to the legislative policy.

The argument of ‘Related party’ [54]was put forward, and it was contended that the mere fact of a qualified person being a relative of an ineligible person is not passable to exile such a person from being a resolution applicant. The doctrine of nexus was applied, the section must be read noscitur a sociis with the categories of persons who are connected with resolution applicant in regards to business activities, failing to show the nexus such person cannot be disqualified under the Code[55].

The applicability of §29A(c) and (h) was questioned as it excludes §240A excludes Micro, Small, and Medium Enterprises (MSMEs). The CoC’s formation is to supervise the Code’s operation to prevent hardship to any class of enterprises. If facing thriving within such problems, the Government follows the recommendations of the CoC in enacting §240A.

6. Section 53 – Constitutional Validity

The contention was based on the arbitrary treatment of operational creditors in the event of liquidation as they stand at the lowest in the hierarchy to gain profit as customarily all creditors, including unsecured creditors who are also considered as a part of financial creditors rank above operational creditors[56].

The analysis of discrimination deliberated that the difference between financial creditors and operational creditors is that the former is secured, and the latter is unsecured. When financial debts are repaid, it infuses capital back in the banks, financial institution and economy as a whole which results in the smooth flow of money that is lending money to other after the repayment of debts[57].

This reasoning constructs intelligible differentia and includes workmen’s dues in the category of unsecured debts. However, the interest of such dues stands secure under all circumstances. Since there is a differentia prevalent, and protection of legitimate interest, the Supreme Court upheld the heart of the provision.

Disposition

Swiss Ribbons put the Insolvency and Bankruptcy Code, 2016 under the constitutional muster. In a judgment delivered on 25th January 2019, the Supreme Court of India disposed of the petitions and upheld the legislation’s constitutional validity. The Court said that there exists a presumption of constitutional validity with every legislation.

In this process, the law cannot possibly anticipate all situations and abuses that may come in the way, and certain inequities and crudities may arise. However, on this basis, economic legislation cannot be struck down in on the ground of invalidity. Hence, the Supreme Court allowed the legislation to pass the test of constitutionality and termed is a “successful experiment”.

In the present case, the petitioners’ claim that the classification between financial creditor and the operational creditor was arbitrary, discriminatory, and violative of Article 14 of the Constitution of India. This argument was struck down by the Hon’ble Court as it ruled that there exists an intelligible differentia between the classes of creditors.

It is a fact that the UNCITRAL Guidelines played an important role in curating the objectives of the Code, one such objective being ensuring equitable treatment for similarly situated creditors. The Court highlighted that all creditors needn’t be given an identical treatment but should be treated in a manner where the priority of claims of a similar class is treated equally[58].

The next part of the Swiss Ribbons judgment deals with the constitutional validity of §12A of the Insolvency Code. The Court thought that once the adjudicating authority admits an insolvency petition under §7 to §9, it is a collective proceeding and not an individual one. The primary role of §12A is to ensure a 90% consensus of the CoC to allow the withdrawal of such a petition.

In any case, such consensus is not there, or the COC (majorly consisting of financial creditors) arbitrarily rejects a settlement or withdrawal claim, the Adjudicating Authority has the power to intervene and set aside the decision under §60 of the Code. The Court established that §12A passes the test of constitutionality and is not violative of Article 14.

Similarly, when deciding upon the validity of §53 of the Code, The Court held that there exists an intelligible differentia between the financial (secured) creditors and operational (unsecured) creditors. Hence, §53 does not attract a violation of Article 14. Further, by not allowing operational creditors a voting power in the CoC as given in §21 and 24 of the Code is not violative of Article 14. Since under §30(2)(b) read with §31, their rights are safeguarded, and the principle of fair and equitable treatment applies.

Next, the Hon’ble Court determined the constitutionality of §29A of the Code. The Court stated that the application of §29A does not stop at resolution applicants but also follows in liquidation. Further, it also held that a “connected person” under §21A(j) only includes a person who has a connection with the business activity of the resolution applicant. The court applied the section in entirety along with its retrospective application. The Court observed that resolution professional acts on the direction and approval of the CoC and is merely a facilitator of the resolution process.

Concluding this judgment, Justice Nariman noted that the Code’s objective is not to be a mere recovery forum for creditors. The legislation aims to preserve the corporate debtor’s business and ensure its revival while ensuring a creditor’s maximum recovery.

“It can thus be seen that the primary focus of the legislation is to ensure revival and continuation of the corporate debtor by protecting the corporate debtor from its own management and from a corporate death by liquidation. The Code is thus beneficial legislation which puts the corporate debtor back on its feet, not being mere recovery legislation for creditors.[59]”

Critical Analysis

“The defaulter’s paradise is lost. In its place, the economy’s rightful position has been regained.”

R.F. Nariman, J.

The Hon’ble Supreme Court of India in its judgment of Swiss Ribbons Pvt. Ltd. v. Union of India dated 25 January 2019 reinforced the validity of the Code. The Court assumed a broader stance to uphold the Code’s constitutionality and referred to it as a “beneficial legislation” relating to economic matters.

The Court solidly adhered to the principle of “judicial hands-off qua economic legislations” and termed the legislation a “successful experiment” where the defaulter’s paradise is now lost. It can be said that the Court assumed the role of a “rescue” operator by limiting the challenges of a corporate debtor and facilitate smooth implementation of the resolution process.

It is a fact that a financial creditor best determines the validity and feasibility of a corporate debtor’s enterprise. Financial creditors provide them with debt and better judge the resolution plan in circumstances of CIRP. A similar scenario, unfortunately, does not exist in the case of an operational creditor.

By prioritizing financial creditors, the Court has taken a step further towards achieving the objective of the Code- “putting the economy back in its rightful position” by allowing repayment of financial debts, and the consequent flow of financial resources in the commercial market. By pointing out intelligible differentia between operational and financial creditors, the Code ensures the preservation of the intent of the economic legislation. It seeks to increase the rate of recovery of debts in the economy.

NCLAT and NCLT are rightful adjudicating authorities when it comes to dealing with matters concerning insolvency. The benches have the power to review the insolvency proceedings, check for arbitrariness, and have a general oversight on every player’s activities in the insolvency process. The Adjudicating Authority overlooks the process from its commencement and ensures maximum preservation of all stakeholders’ interests in the process.

Penning down the verdict, Justice Nariman highlighted the Insolvency and Bankruptcy Code, 2016 as an economic, legislative experiment that successfully passed the constitutional muster. The Code not only provides a mechanism to the defaulter to revive but ensures a fair and efficient procedure to facilitate it. The power granted to the Tribunals only makes the process more just and righteous. Preserving of interests of all stakeholders is the objective of the Code, and the judgment only affirms strongly.

Hence, as quoted by Hon’ble Justice Nariman, it is indeed true that the Code is putting the economy into its rightful position, and depriving a defaulter of a paradise, that was available before the Code.

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Authored by: Priya Ganotra & Sharvari Manapure

National Law University, Nagpur

This Case Comment was shortlisted in 2nd Amity National Case Comment Writing Competition 2020

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References

[1] The Constitution of India, 1950, Article 14- “The State shall not deny to any equality before the law or equal protection of laws within the territory of India.”

[2] Madras Bar Association v. Union of India, (2010) 11 SCC 67.

[3] Swiss Ribbons Pvt. Ltd. & Anr. v. UOI, W.P (Civil) No. 99 of 2018, ¶19.

[4] Insolvency and Bankruptcy Code, §5, (2016).

[5] Ibid.

[6] Ibid.

[7] L. Sai Charan & Aibel Mathew Siby, Operational Creditors-A need for Equitable Treatment, (1 February 2019), 102 taxmann.com 179 (Article).

[8] See Supra Note 4.

[9] Insolvency and Bankruptcy Code, §8(1), (2016).

[10] Insolvency and Bankruptcy Code, §5(1), (2016) – “Adjudicating Authority for the purposes of this part means NCLT.”

[11] Insolvency and Bankruptcy Code, §7(5), (2016).

[12] Innoventive Industries Ltd. v. ICICI Bank and Anr., (2018) 1 SCC 407.

[13] Insolvency and Bankruptcy Code, §7(1), (2016).

[14] The Report of The Bankruptcy Law Reforms Committee, Bankruptcy and Insolvency Information Utilities, Volume I: Rationale and Design, 4.3, (November 2015).

[15] The Insolvency And Bankruptcy Bill, 2015; Clause 8, Bankruptcy Law Reform Committee Draft, (March 2018)

[16] Ibid.

[17] Insolvency and Bankruptcy Code, §65, (2016).

[18] Insolvency and Bankruptcy Code, §75 (2016).

[19] Insolvency and Bankruptcy Code, §21(2) (2016).

[20] Insolvency and Bankruptcy Code, §24(3)(c) (2016).

[21] Shayara Bano v. Union of India, 5 (2017) 9 SCC 1.

[22] See Supra Note 3, ¶ 41.

[23] Uttara Foods and Feeds Pvt. Ltd. v. Mona Pharmachem, Civil Appeal No. 18250/2017.

[24] Ministry of Corporate Affairs, Report of The Insolvency Law Committee of March 2018.

[25] Corporate Insolvency Resolution Process Regulations, Rule 8, (2016).

[26] Lokhandwala Kataria Construction Pvt. Ltd. v. Ninus Finance & Investment Manager LLP, Civil Appeal No. 9279 of 2017.

[27] Corporate Insolvency Resolution Process Regulations, Rule 30A, (2016).

[28] See Supra Note 25.

[29] National Company Law Tribunal Rules, Rule 11, (2016)

[30] Corporate Insolvency Resolution Process Regulations, Rule 36A, (2016).

[31] Brilliant Alloys Pvt. Ltd.v. Mr. S. Rajagopal & Ors., SLP (Civil) No. 31557/2018.

[32] Federal Bank Ltd. Vs. Trio Fab (I) Pvt. Ltd.-MA 1421/2018 IN CP(IB)-1309/MB/2017 dated 29.11.2018.

[33] Insolvency and Bankruptcy Code, §60, (2016).

[34] Information Utilities Regulation, Regulation 20, (2017).

[35] Information Utilities Regulation, Regulation 21, (2017).

[36] Insolvency and Bankruptcy Code, §18, (2016).

[37] Corporate Insolvency Resolution Process Regulations, Rule 10, (2016).

[38] Corporate Insolvency Resolution Process Regulations, Rule 12, (2016).

[39] Corporate Insolvency Resolution Process Regulations, Rule 13, (2016).

[40] Corporate Insolvency Resolution Process Regulations, Rule 14, (2016).

[41] Insolvency and Bankruptcy Code, §40, (2016).

[42] Insolvency and Bankruptcy Code, §38, (2016).

[43] Insolvency and Bankruptcy Code, §39, (2016).

[44] Insolvency and Bankruptcy Code, §41, (2016).

[45] Insolvency and Bankruptcy Code, §42, (2016).

[46] Insolvency and Bankruptcy Code, §28, (2016).

[47] Chitra Sharma v. Union of India, Writ Petition (Civil) No. 744 of 2017.

[48] See Supra Note 3, ¶ 63.

[49] ArcelorMittal India Private Limited v. Satish Kumar Gupta and Ors, Civil Appeal No. 9402-9405/2018.

[50] See Supra Note 3, ¶ 66.

[51] Insolvency and Bankruptcy C0de, §35(1), (2016).

[52] See Supra Note 3, ¶ 69.

[53] Master Circular on Prudential Norms on Income Recognition, Asset Classification and Provisioning pertaining to Advances, Clause 2.1, Reserve Bank of India, (dated 01.07.2015).

[54] Insolvency and Bankruptcy Code, §29(A)(j), (2016).

[55] Attorney General for India and Ors. v. Amratlal Prajivandas and Ors., (1994) 5 SCC 54. ¶44

[56] See Supra Note 11.

[57] See Supra note 3, ¶84.

[58] UNCITRAL Legislative Guide on Insolvency Law, United Nations Commission on International Trade Law, Official Records of the General Assembly, 56^th Session, Supplement No. 17 (A/55/17), at 12.

[59] See Supra Note 3, ¶12.

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