Supreme Court reaffirms mandatory admission of insolvency in debt and default

Posted On - 5 June, 2023 • By - Souvik Ganguly

The Insolvency and Bankruptcy Code (Code) provides the right to a financial creditor to make an application to the National Company Law Tribunal (NCLT) for initiation of corporate insolvency resolution process (CIRP) against a corporate debtor in the event the debtor fails to repay its debt owed to the creditor. The Code as well as precedents developed by insolvency courts have consistently held that the test for admission of an insolvency application of a financial creditor is twofold, existence of a debt and default on that debt. However, in a departure from this position, in July 2023, the Supreme Court of India (Supreme Court) in Vidarbha Industries Power Limited v. Axis Bank Limited (Vidarbha Industries) held that the NCLT has discretion to reject an insolvency application of a creditor if there are good reasons to do so, such as financial health and viability of a corporate debtor even if there is existence of debt and default. Please read our views on Vidarbha Industries here.

Recently, the Supreme Court in M. Suresh Kumar Reddy v. Canara Bank and Others (Suresh Kumar Reddy) has distinguished Vidarbha Industries and reaffirmed the twofold test established in previous judgments of the insolvency courts in relation to admission of insolvency applications. In this article, we discuss the judgment in Suresh Kumar Reddy and give our views on its impact on the insolvency regime in India.

Facts of the case

An application for initiation of corporate insolvency resolution process was filed by Canara Bank (Bank) against Kranthi Edifice Private Limited (Kranthi Edifice) before the NCLT. The NCLT admitted the application. A suspended director of Kranti Edifice (Erstwhile Director) challenged the admission order of the NCLT before the National Company Law Appellate Tribunal (NCLAT), which also got rejected. Aggrieved, the Erstwhile Director approached the Supreme Court and contended that a proposal for one time settlement was submitted to the Bank, and a sum of INR 60 Million was also deposited with the Bank. He also argued that Kranthi Edifice defaulted due to the Bank’s failure to extend bank guarantees despite the request from the State of Telangana. He further contended that pursuing the insolvency application was a coercive step by the Bank and was prohibited by an interim order of the Telangana High Court.

The Erstwhile Director cited Vidarbha Industries to canvass an argument that the NCLT has discretion to reject an insolvency application if there are valid reasons to do so. In view of this, the Erstwhile Director urged that the CIRP was a result of the Bank’s refusal of the settlement proposal and extension of bank guarantee and hence, the application of insolvency must not be admitted against it. The Bank countered that Vidarbha Industries was based on specific facts which were not present in this case. The Bank also cited the Supreme Court’s decision E.S. Krishnamurthy and Others v. Bharath Hi-Tecch Builders Private Limited (E.S Krishnamurthy), asserting that if the NCLT finds debt and default, it must admit the insolvency application.

Supreme Court’s views

The Court referred to the judgments of the Supreme Court in Innoventive Industries Limited v. ICICI Bank and Another and E.S. Krishnamurthy which state that the NCLT is required to first ascertain if debt owed to a financial creditor has become due and payable. Subsequently, it needs to inquire whether the debt is outstanding vis-à-vis the corporate debtor. If both these questions are answered in the affirmative, there is not much discretion left to the NCLT to reject the insolvency application of the financial creditor.

The Supreme Court further noted that the additional grounds such as solvency and viability of a corporate debtor introduced in Vidarbha Industries were challenged before the Supreme Court in a review petition where it was categorically held that such observations must only be understood to be made for the specific facts of the case and must not be treated as universally applicable. It was also clarified that views expressed in a judgment cannot be taken to reflect the actual provisions of a statute. The Code as well as various judgments interpreting the Code clearly state that the NCLT’s discretion is limited to the satisfaction of debt and default, therefore, Vidarbha Industries cannot be relied upon to deviate from this settled position. Accordingly, the Supreme Court rejected the application of the Erstwhile Director and upheld the admission order of NCLT.

Our thoughts

The Bankruptcy Law Reform Committee’s (BLRC) Interim Report[1] assessed the historical shortcomings of India’s insolvency regime and outlined the policy objectives for designing a new insolvency law. It identified “excessive court discretion” as a primary cause of delays in the previous laws. Hence, the Code was formulated to minimize judicial intervention and maximize asset value within specific timelines. However, Vidarbha Industries introduced subjective evaluation by granting discretionary powers to the NCLT to consider the underlying reasons for a corporate debtor’s default. In our view, this approach would have definitely diluted the Code’s objective of prompt debt resolution and corporate revival. Although the Code provides a period of 14 days for either admitting or rejecting the insolvency application, practically it may take months for admission of an insolvency application. Therefore, the additional discretionary powers will only serve to further delay the CIRP process.

It is noteworthy that the Ministry of Corporate Affairs, through a notice on 18 January 2023[2], has proposed amendments to the Code to address the concerns raised by Vidarbha Industries. The proposal suggests amendment to the Code to clarify that the NCLT is only required to ascertain the occurrence of a default and fulfillment of the procedural requirements for initiating CIRP. Once a default is established, NCLT is mandated to admit the application and commence the CIRP. Additionally, Vidarbha Industries is currently under challenge before a three-judge bench of the Supreme Court in the matter of Maganlal Daga HUF and Another v. Jag Mohan Daga and Others.

The judgment in Suresh Kumar Reddy is significant as it upholds the objectives of the insolvency regime and protects the interests of corporate debtors and financial creditors. However, it should be noted that both Vidarbha Industries and Suresh Kumar Reddy have beendecided by two-judge benches, potentially diluting the precedential value of Vidarbha Industries without explicitly overruling the same. In light of these conflicting judgments, it would be advantageous for the larger bench of the Supreme Court to settle the controversy surrounding the grounds for admitting insolvency applications by financial creditors, ensuring clarity and a definitive resolution.

Authors: Souvik Ganguly, Altamash Qureshi and Shrishti Mishra

The information contained in this document is not legal advice or legal opinion. The contents recorded in the said document are for informational purposes only and should not be used for commercial purposes. Acuity Law LLP disclaims all liability to any person for any loss or damage caused by errors or omissions, whether arising from negligence, accident, or any other cause.