Interpretational issues in IBC

The Insolvency and Bankruptcy Code, 2016

("IBC") brings a tectonic shift in jurisprudence

relating to corporate insolvency. Given this

sudden shift, both lenders and debtors are

struggling to understand the implication of IBC for

them. Unlike the erstwhile law, IBC provides for a

two-stage process to deal with corporate insolvency.

In stage I, the corporate undergoes a corporate

insolvency resolution process ("CIRP") during

which, the committee of the corporate's financial

creditors ("CoC") attempts to

resolve insolvency of the corporate.

If the CIRP fails, the corporate

enters stage II for its mandatory

liquidation. Stage I must precede

stage II.

Stage I can be initiated by a

financial creditor, an operational

creditor, or the corporate itself, on

occurrence of a 'payment default'

by the corporate, by filing an

application before the relevant

National Company Law Tribunal

("NCLT"). Since December 2016

(when the IBC provisions relating to

corporate insolvency were notified),

multiple applications have been

filed under the IBC for initiation

of CIRP and many interesting

questions of interpretation have

come up in these applications. This

article discusses some such key

interpretational issues.

Definition of financial creditor

and operational creditor

To trigger CIRP, a creditor must either be an operational

or financial creditor of the corporate. Terms 'financial

creditor' and 'operational creditor' have been defined

in the IBC and are being currently debated before the

National Company Law Appellate Tribunal ("NCLAT")

in several appeal cases.

In one appeal case, the issue is whether the applicants,

who had booked flats with AMR Infrastructures Ltd.

("AMR"), and who were promised monthly 'assured

returns' by AMR (until possession) are financial

creditors of AMR. 'Financial creditor' is a person to

whom a financial debt is owed and the term 'financial

debt' has been defined in the IBC to mean "a debt

along with interest, if any, which is disbursed against

the consideration for the time value of money and includes...". The NCLT, Delhi (where the CIRP

application was filed) discussed the meaning of

financial debt, especially the term 'time value of

money' in detail and held that the amount paid by

applicants was for purchase of property (and not

as consideration for the time value of money) and

therefore, 'assured returns' do not fall within the

definition of financial debt¹.

Interestingly, in other appeal cases (three of

which are also against AMR), the issue was

whether the applicants, who were claiming refund

of advances given for booking units, on account

of delay in giving possession are operational

creditors of the real estate companies. In a

series of cases², NCLT, Delhi held that 'operational

debt' (as defined in the IBC) does not include

debt other than a financial debt and is confined

to only four categories, viz. goods, services,

employment and government dues. NCLT held that

since the advances were sought to be recovered

on account of delay in possession (and the debt

did not arise on account of these four categories),

the applicants are not operational creditors of the

companies.

As per the aforesaid cases, claim for refund of

advance/deposit and assured returns promised by

the builder may not qualify either as a financial

or an operational debt. It would be interesting

to see if the NCLTs take the same interpretation

where refunds are demanded for other kinds of

advances or for security deposits (subject of course

to refund conditions being met). Admittedly, in

certain cases, claims for such refund will

qualify as a debt. It is unlikely that the Legislature

intentionally left out certain kinds of debts

from the IBC. Therefore, these cases demonstrate

the inherent limitation in the way financial and

operational debt is defined in the IBC. While

straightforward cases of financial debt (such as

a loan) would pose no problem, the answer is

not clear where complex financial instruments

and transactions are involved, for example, debt

instruments with equity linked returns. Similarly,

if operational debt is limited to only four categories

of claims, certain kinds of debts may not fall in any

specific bucket. It may now be up to the judiciary

to fill the lacunae in definitions of financial and

operational debt and extend the same to all kinds

of debt.

The disputed interpretation of

dispute

While a financial creditor can trigger CIRP by filing a

CIRP application on occurrence of a payment default, an

operational creditor has to jump through more hoops to

initiate CIRP. In case of payment default, an operational

creditor must first send a demand notice to the corporate

and if the corporate issues a 'notice of dispute', NCLT has

to reject the operational creditor's application. If neither

a notice of dispute is issued nor is there any record of

dispute with an information utility, then, subject to the

application of the operational creditor being complete, the

NCLT has to mandatorily admit the CIRP application of the

financial creditor.

One of the most interesting issues that has come up

before NCLTs is the meaning of 'dispute' in the notice

of dispute. The reason – inelegant drafting of Section 8

(2) (dealing with issuance of notice of dispute) and the

term 'dispute' – which seems to suggest that a dispute is

valid only if a suit or an arbitration proceeding is pending

before receipt of demand notice by the corporate. Now,

the moot question is whether it is really the legislative

intention that in the absence of such suit or arbitration

proceedings, non-payment of operational debt is enough

to start CIRP of a corporate, even if the debt is otherwise

disputed?

Different NCLTs are taking different views, some holding

that a dispute means a dispute pending in a suit or an

arbitration before receipt of the demand notice and some

other opining that a dispute means any dispute raised

in a notice of dispute. Some of these cases went up in

appeal to NCLAT and NCLAT came up with an order

recently³, giving its view on the issue, and raising even

more interpretational questions. While on the one hand,

NCLAT held that the definition of 'dispute' is inclusive

and the term 'dispute' cannot be limited to a pending

suit or arbitration, on the other hand, NCLAT also held

that the corporate debtor must have taken some action

on the dispute under any Act or law before receipt of the

demand notice. The NCLAT has thus shifted the onus on

the corporate debtors to proactively take some action on

the dispute before receipt of the demand notice under

the Code (rather than the creditor taking an action for

recovering its dues). There are unanswered questions

– such as what happens if the corporate debtor had no

occasion to dispute the demand prior to receipt of the

demand notice? Or what if the corporate debtor did not

take any action on the dispute since he wanted to preserve

ongoing commercial relationship with his vendor?

Timelines under the IBC

The success of the IBC hinges on events taking place in

a time-bound manner. Towards this, the IBC prescribes

timelines for admission/rejection of CIRP applications

(fourteen days), rectification of defects in CIRP application (seven days), and most importantly, for completion of

CIRP (one hundred and eighty days, extendable to further

ninety days in certain cases).

In a recent decision⁴, NCLAT opined on these timelines

and held that the fourteen days' time period given to it

for admission/rejection of CIRP application is directory in

nature. On the other hand, the seven days' timeline given

to the applicant for rectification of defects and the time

period for completion of CIRP is mandatory. This means

that if CIRP is not completed within the one hundred

and eighty days' period (if not extended) or two hundred

and seventy days (if extended), the corporate must be

liquidated.

We see some challenges in adherence to these timelines.

Since the CIRP is driven by CoC (and overseen by an

Insolvency Resolution Professional ('IP")), the timeline is

completely dependent on how the CoC and IPs perform.

The first challenge would be formation of CoC itself.

Under the IBC, the interim IP is required to collate all

creditor claims and form CoC. This is included within the

one hundred and eighty days' timeline and pre-supposes

easy availability of complete and accurate data about the

corporate from information utilities (i.e. firms registered

under IBC which will stand ready to receive and deliver

financial information about a corporate). However,

registration and development of information utilities will

take some time and till an information-rich environment

is created, the formation of CoC itself would take time,

especially where claims and positions of creditors are

disputed or uncertain.

The second challenge would be inefficiencies that are

inherent in the decision-making process involving large

number of creditors, especially where public sector banks

are involved. In the context of CDRs/JLFs, we have seen

delays on account of lack of co-ordination among banks

in taking decisions and approving restructuring plans.

These issues are also going to arise during CIRP. And then

the question is why should the corporate be mandatorily

liquidated due to delays caused by the lenders themselves,

in coming to a decision about a resolution plan.

Conclusion

While the IBC is indeed very ambitious and bold in its

scope and intent, as more and more CIRP applications

are filed, one can expect a torrent of new and interesting

interpretational questions around the IBC, answers to

which shall contribute to the jurisprudence relating to

corporate insolvency in India.

Footnote:
1. Nikhil Mehta (HUF) & Ors. v. M/s AMR Infrastructures Ltd., C.P No. (ISB)-03(PB)/2017.

2. Col. Vinod Awasthy v. AMR Infrastructures Ltd., C.P. No. (IB)-10(PB)/2017,

Mukesh Kumar & Anr. v. AMR Infrastructures Ltd, C.P No. (IB)-30(PB)/2017, SajiveKanwar v. AMR Infrastructure, C.P No. 06/2017, Pawan Dubey v. J.B.K.

Developers Pvt. Ltd., C.P. No. (IB)-19(PB)/2017, Mr. Satish Mittal v. Ozone Builders & Developers Pvt. Ltd., C.P No. (IB)-66(PB)/2017.

3. Kirusa Software Private

Limited v. Mobilox Innovations Private Limited, Company Appeal (AT) (Ins) No. 6 of 2017.

4. JK Jute Mills Company Ltd. v Surendra Trading Company, Company

Appeals (AT) (Ins) No. 9 of 2017

Disclaimer

– The views expressed in this article are the personal

views of the author and are purely informative in nature.