Section 10 to file or not to file

The article analyzes the evolving jurisprudence

around Section 10 and its interplay with other

provisions of the IBC

Under the Insolvency and Bankruptcy Code, 2016

(“IBC”), a creditor or the corporate debtor itself,

can initiate the Corporate Insolvency Resolution

Process (“CIRP”) of the debtor. While financial

and operational creditors can initiate corporate debtor’s

CIRP by filing an application with the National Company

Law Tribunal (“NCLT”) under Sections 7 and 9 respectively,

a ‘corporate applicant’ (which includes the corporate

debtor) can initiate corporate debtor’s CIRP under Section

10 of the IBC.

Since December 2016, many debtors have initiated their

own CIRP under IBC. This right given to the debtor is

very welcome as it gives an opportunity to the debtor to

bring about resolution of its insolvency in cases where its

creditors may be reluctant to do so.

In India, such a right to voluntarily initiate resolution

process existed even before the IBC, albeit in very different

forms - mainly as the right of an ‘industrial firm’ to make

a reference under the Sick Industrial Companies (Special

Provisions) Act, 1985 (“SICA”), for its revival. Admittedly,

SICA was a failed experiment for various reasons. SICA was

also routinely abused by the promoters who continued to

be in possession of the assets and enjoyed the unending

moratorium and protection provided by SICA.

Since admission of CIRP under the IBC also leads to

moratorium for the benefit of the debtor, the possibility of

abuse of Section 10 of the IBC by corporate debtors cannot

be ruled out. Nevertheless, Section 10 needs to be read in

light of Section 65 (fraudulent or malicious initiation of

proceedings) and Section 66 (fraudulent trading or wrongful

trading) of the IBC. This article analyzes the developing

jurisprudence around Section 10 and its interplay with

other provisions of the IBC.

Section 10 Requirements

Section 10 application can be filed by a ‘corporate

applicant’ (which includes the corporate debtor as also its

members and individuals in charge/control in certain

circumstances). Under Section 11 of the IBC, debtors

undergoing a CIRP or whose CIRP was completed 12 (twelve)

months preceding the date of the application or who have

violated a prior resolution plan or in respect of whom a

liquidation order has been made are barred from making

Section 10 application.

The trigger threshold for filing Section 10 application is low

– a payment default of INR 1 lakh or more by the corporate–

a threshold most companies, even if solvent, will not find

difficult to cross. However, while the trigger threshold is

low, the application requirements under Section 10 are

quite cumbersome, as compared to an application by the

creditors. To reduce the information asymmetry (between

the debtor and the creditors) as a part of triggering the CIRP,

the corporate applicant is required to provide extensive

information such as details of creditors, evidence of debt

and default, books of accounts, balance sheets, statement

of affairs etc.

NCLT’s Discretion To Reject Section 10

Application

A question arises that if there is a payment default and the

debtor is not barred under Section 11, does the NCLT have

discretion to reject the debtor’s application? Admittedly,

except for non-completion of the CIRP application, Section

10 does not provide any ground for rejection.

In the context of financial creditor’s application under

Section 7, in Innoventive Industries Ltd. v. ICICI Bank¹,

the Hon’ble National Company Law Appellate Tribunal

(“NCLAT”) held that once NCLT is satisfied as to the matters

in Section 7, it is required to admit the case and beyond

that, it is not required to look into any other factor. If the

same rationale is applied, even in Section 10 cases, the

NCLT should not look beyond Section 10 requirements (i.e.

payment default and application being complete).

However, interestingly, NCLTs are issuing notices to

creditors under Section 10 and are hearing their objections

to admission of debtor’s application. Section 10 applications

are being heard by NCLTs in detail and debtors are being

asked to explain why their application should be admitted.

And there are at least four cases of rejection of Section

10 application by NCLTs on grounds that the debtor made

a filing with an ulterior motive to take advantage of the

moratorium provisions of IBC.

In Leo Duct Engineers and Consultants Ltd.² and Antrix

Diamond Exports Pvt. Ltd³, NCLT, Mumbai noted that the

admission of Section 10 application will stay/stall the

proceedings against the debtor and its guarantors, and

this, rather than turnaround of its business, appears to be

the motivation of the debtor to approach NCLT. NCLT further

held that it is not sufficient to meet the requirements of

Section 10 and that it has to consider the merits of each

case and see beyond what meets the eye. NCLT dismissed

the application on the basis that irreparable loss will be

caused to creditors and admission will provide uncalled for

protection to the debtor and guarantors.

Similarly, in Unigreen Global Private Limited⁴, Principal

Bench, Delhi, observed that corporate debtors were trying

to abuse the IBC for only taking benefit of moratorium on

actions against the corporate and its directors. In Krishna

Kraftex Private Limited⁵, NCLT, Delhi observed that it cannot

mechanically admit Section 10 applications as it will

open a floodgate of people forming companies, incurring

expenses and then enjoying the moratorium. NCLT

further held that since no claims were made against the

company, the company cannot be declared to be in default

and that it barely had any assets which needed resolution

under IBC.

Section 65

Under Section 65 of the IBC, penalties may be imposed on the

applicant if it initiates CIRP ‘fraudulently or with malicious

intent for any purpose other than for the resolution of

insolvency’ of the debtor. The section is peculiarly worded

as it stresses on ‘intent’ of the applicant linked to ‘purpose’

of filing - which, as per Section 65, should be ‘resolution

of insolvency’. However, the entire IBC proceeds on the

premise that a ‘payment default’ (rather than actual

insolvency) should be the trigger point for CIRP admission

as non-payment is viewed as an early sign of impending

insolvency. Therefore, Section 65 leaves a lot to subjective

satisfaction of NCLTs on what may appear to them as the

‘intent’ of the debtor in filing Section 10 application.

In the cases mentioned above, the fact that proceedings

were initiated/will be initiated against the guarantors or

directors appears to have weighed in heavily on NCLTs’

minds in determining debtors’ intent - NCLTs ultimately

held that the intent was only to seek moratoriumrelated

protections. However, the question is whether the

moratorium really gives protection to the guarantor or

directors of the company? Admittedly, a moratorium under

Section 14 of the IBC is imposed only for actions against

the debtor. In Schweitzer Systemtek India Private Limited⁶,

(where creditors argued that the debtor has filed Section

10 application to thwart their attempts to recover the

property of the guarantors), while NCLT, Mumbai recognized

that imposition of moratorium has been used to frustrate

recovery proceedings in certain cases, it admitted the

application on the basis that moratorium would prohibit

action only against properties of the debtor (not the

guarantors).

Further, even if moratorium applies, it only applies during

the CIRP period (which as per the IBC, cannot extend beyond

6 (six) to 9 (nine) months). Failure to approve a resolution

plan within such period leads to mandatory liquidation.

Importantly, during this period, it is the creditors (and not

the debtor) who are in possession and decide the fate of

the company. The creditors can take a decision to liquidate

the company or approve a resolution plan which could

entail sale of company’s assets or change in control. This

is very different from debtor in possession regime under

SICA where moratorium could be

enjoyed forever. Therefore, to a

large extent, the threat of abuse of

Section 10 seems unwarranted. It

is difficult to envisage a situation

where promoters would put

an otherwise solvent company

into CIRP and run the risk of its

liquidation or change in control

just to enjoy 6 (six) to 9 (nine)

months’ moratorium. And if the

company is insolvent, then let

the creditors who are seeking

recoveries decide the fate of the

company. The fact that moratorium

is sought by the debtor against

recovery proceedings cannot itself

be a ground to impute fraudulent/

malicious intent – especially when

the very purpose of CIRP is to

provide a calm period and prevent

dissipation of assets of the company during such period.

Section 66

Lastly, Section 10 must be read in light of Section 66 (2) of the

IBC. Under this provision, a director can be made personally

liable to contribute to the corporate debtor’s assets if before

the insolvency commencement date, such director knew or

ought to have known that there was no reasonable prospect

of avoiding the commencement of CIRP; and such director

did not exercise due diligence in minimizing the potential

loss to the company’s creditors. To make the director liable

under this provision, proceedings may be initiated before

the NCLT by the resolution professional.

Therefore, for the first time in India, directors can be made

personally liable for what is generally known as wrongful

trading or insolvent trading. Section 66 (2) is based on

‘wrongful trading’ provision of Section 214 of the UK

Insolvency Act, 1986. Wrongful trading occurs when the

directors have continued to trade past the point when

they knew, or ought to have concluded that there was

no reasonable prospect of avoiding company’s insolvent

liquidation and they did not take every step with a view

to minimizing the potential loss to the creditors. During

this time, the directors need to be extremely careful when

considering whether to continue to trade, or not. Importantly,

the liability is not for trading during this period but failure

to take steps to minimize the losses to the creditors.

Section 66 (2) of IBC will force directors of Indian

companies to evaluate what to do in case of

impending insolvency. The insolvency may be a

temporary issue in which case the directors may

determine that it is beneficial to continue trading, or the

directors may take some steps to improve trading conditions.

However, at a point when they realize that it may not be

beneficial to continue trading as is,

they must exercise due diligence to

minimize losses to creditors. Such

due diligence may be in the form of

taking steps for turnaround – and

it is in this context that the right

to initiate CIRP under Section 10

becomes important. If the directors

believe that a turnaround process

outside IBC is not feasible or proper,

then they must question if CIRP

under IBC will help in minimizing

losses to the creditors. If the answer

is yes, Section 10 almost takes the

color of a duty cast on the directors

to make an application for initiation

of CIRP of the company.

It may be noted that in the UK, while

deciding wrongful trading cases,

the courts place some weight on

whether the directors took professional advise (when the

company started going insolvent), and if so, what that

advise was. Therefore, it would be useful for directors of

Indian companies to seek professional advise on turnaround

mechanics to help them decide whether to file or not to file

under Section 10 of the IBC.

Conclusion

While there is some fear of abuse of Section 10, it is an

important tool in the hands of the corporate debtors when

deciding how to resolve their insolvency, especially in cases

where creditors are not interested or are dragging their feet

on deciding an outside IBC resolution plan. However, the

success of this provision will depend on how jurisprudence

around Sections 65 and 66 develops. While Section 65

provides a disincentive to file (considering the risk of NCLT

determining ‘malicious or fraudulent intent’ on the part of

the debtor), Section 66 provides an incentive to directors to

file (to avoid personal liability for wrongful trading). It may

be mentioned that some of the cases referred to above are

pending in appeal before NCLAT which is actively looking

at the question whether NCLT has discretion to reject

debtor’s application on grounds of potential abuse of the

moratorium provisions.

Footnote:
1. Company Appeal (AT) (Insolvency) No. 1 & 2 of 2017, Judgment dated 15 May 2017.
2. C.P. No. 1103/I&BP/NCLT/MAH/2017, Order dated 22 June 2017.
3. C.P.

No. 1104/I&BP/NCLT/MAH/2017, Order dated 20 June 2017.
4. Company Petition No. IB-39 (PB)/2017, Order dated 08 May 2017.
5. Company Petition No. IB- 78

(ND)/2017, Order dated 15 May 2017.
6. T.C.P. NO.1059/I&BP/NCLT/MB/MAH/2017, Order dated 03 July 2017.

Disclaimer – The views expressed in this article are the personal views of the author and are purely informative in nature.