EXPLAINING THE LATEST AMENDMENT TO SECTION 11: A SIGH OF RELIEF TO CORPORATE DEBTORS UNDERGOING CIRP
Ashuthosh V, Student, Institute of Law, Nirma University
The Insolvency and Bankruptcy Code (IBC) was introduced by Arun Jaitley in the Lok Sabha in 2015 and the code subsequently received the assent of the President of India on 28th May 2016. The need for initiating such a code is to ensure that the debtors do not evade the law after wilfully defaulting the banks and its creditors. The Code was established in the after effects of various debt evasions by corporate debtors (CD).
The aim of the law was to provide a single legislation for insolvency and bankruptcy issues such that the interests of small investors or creditors are upheld. The law seeks to protect such small and medium scale businesses from bad debts by ensuring that maximum amount which is due is recovered from irrecoverable debts of the debtor.
Another objective of the Code is to ensure that the debtor is seen as a going concern instead of liquidating or winding up the business. The essence of the Code is to provide for a resolution plan within a time-bound process. The resolution is proposed to ensure that the CD is a going concern and that the creditors receive the amount which is due.
SITUATION BEFORE THE IBC (AMENDMENT) ACT, 2020: THE CATASTROPHIC SIDE OF SECTION 11
Section 11 of IBC provides for those persons who cannot make an application to initiate the
Corporate Insolvency Resolution Process (CIRP). Such persons are:
“(a) a corporate debtor undergoing a corporate insolvency resolution process;
(b) a corporate debtor having completed corporate insolvency resolution process twelve
months preceding the date of making of the application;
(c) a corporate debtor or a financial creditor who has violated any of the terms of resolution
plan which was approved twelve months before the date of making of an application under
this Chapter; and
(d) a corporate debtor in respect of whom a liquidation order has been made.”
The object of the provision is to safeguard the interests of financial or operational creditors from CD who will try to disturb the proceedings by causing an unnecessary delay. Despite its object, the provision is found to be unreasonable as a literal explanation of this section provides for a barrier to CD who fall under clause (a)-(d) from making an application to initiate CIRP. It acts contrary to the objectives of the law which is to ensure that the resolution process is dealt with in a time-bound manner so that the CD’s enterprise continues as a going concern and the amount due to the creditors is received. Secondarily, it seeks to ensure that maximum value is realized even from non-performing assets of the enterprise of the corporate debtor.
The above provision restricts the CD from applying for a CIRP against its debtors. This will eventually drive the debtor to move into liquidation if the value of available assets is not requisite to satisfy the amount owed to the creditors.
The provision seeks to ensure that CD do not fraudulently use the law in order to initiate CIRP against its debtors who further do the same as the cycle of business has made the situation such that every company has its own set of creditors and debtors. The absence of such a provision shall create a situation of continuous submission of applications initiating CIRP by one CD o another and it shall revolve around to complete a full circle.
Section 25(1) of IBC states that it shall be the duty of the Resolution Professional (RP) to preserve and protect the assets of the CD. The debt owed to business of the CD in the form of bills receivable shall be a short-term asset for the business. Thus, it is the duty of the RP to ensure that such debt of the CD is recovered as it an asset and it would help settle the demands of the creditors.
However, by the application of Section 11 in its literal sense, the CD or the RP who is the representative of the CD is barred from initiating a CIRP against its debtors, even though the CD is genuinely applying for CIRP as a creditor in order to recover the debts it owes so as to settle the claims of the creditors. Moreover, this section makes it difficult for CD in the service sector as they would not have much physical assets and their main assets comprise of such debts (bills receivable).
This position of law is erroneous and propagates unequal practice as a creditor is allowed to initiate CIRP against a CD after the completion of the previous one but, the CD is not allowed to initiate CIRP against its debtors in the capacity of a creditor unless a year passes by after the completion of its previous CIRP.
JUDICIAL SCRUTINY BY THE COURT: A RAY OF HOPE
In Forech India Pvt. Ltd. v. Edelweiss Assets Reconstruction Company Ltd., the NCLAT in its order dated 23.11.2017 decided that appeal made by the appellant would not be accepted. The appeal was that the application made under Section 7 must not be maintainable as the respondent is a CD that is undergoing a winding up proceeding which makes Section 11 bar them from initiating CIRP. The Appellate Tribunal rejected the same on the grounds that no order was passed by the High Court to undergo winding up procedure of the company and thus, the company is to be treated as a Financial creditor and not a CD which would erase the application of Section 11 and make the application made under Section 7 of IBC maintainable.
In Jai Ambe Enterprise v. S.N. Plumbing Pvt. Ltd., the Mumbai Bench of the National Company Law Tribunal (NCLT) in its order dated 06.02.2018 rightly held that a RP who is representing a CD, is entitled to initiate CIRP under Section 9 of IBC against its debtors as the CD shall be considered to be taking up the role of a creditor in this situation and shall therefore, not be barred by Section 11 of IBC. In Paragraph 3 and 4 of the order the court decided that the outstanding debts of the CD shall be considered as ‘assets’ and by virtue of Section 25, it is the duty of the RP to recover the assets of the CD. Moreover, Section 60(2) [which provides that no two parallel Insolvency Proceedings shall take place against a CD] is not violated as the CD shall be considered as an Operational Creditor.
In M/s Mandhana Industries Ltd. v. M/s Instyle Exports Pvt. Ltd., the Delhi Bench of NCLT in its order dated 30.08.2018 took a decision that would lie contrary to the decision by the Mumbai Bench. It opined that the petitioner who was currently undergoing a CIRP would be barred by Section 11(a) from filing an application under Section 7 or 9. It did acknowledge that the respondent owed debts to the petitioner, thus making the petitioner a creditor but by the literal wording of Section 11(a), the RP of the petitioner who was already a CD against whom CIRP had been initiated, would not be able to initiate CIRP against the respondent.
In M/s Prowess International Pvt. Ltd. v. M/s Jai Balaji Industries Ltd., the Kolkata Bench of NCLT in its order dated 09.08.2018 decided that the application to initiate CIRP by RP on behalf of the petitioner was not maintainable under Section 9 of IBC. It was opined by the tribunal that the petitioner at the time of filing an application was undergoing a CIRP and thus, would be a CD and not an Operational creditor. Imposition of Section 11 would bar a CD from filing such application. However, it is to be noted that the application was held to be not maintainable under Section 9 of IBC and application of Section 11 was not further discussed by the tribunal.
ANALYSIS OF THE SITUATION AFTER THE IBC (AMENDMENT) ACT, 2020: NEED OF THE HOUR
A new Explanation II was inserted first by virtue of the IBC (Amendment) Ordinance, 2019 which was promulgated by the President on 28.12.2019. It further became the IBC (Amendment) Act, 2020 by receiving assent from the President on 13.03.2020. Section 4 of the Amendment Act provides that:
“For the purposes of this section, it is hereby clarified that nothing in this section shall prevent a corporate debtor referred to in clauses (a) to (d) from initiating corporate insolvency resolution process against another corporate debtor.”
The objective of inserting this explanation was to protect the CD by providing certain immunity in order to ensure a successful resolution process. The explanation clarifies the application of the provision which various tribunals interpreted in their own sense without having a common ground for agreement on the application of Section 11.
The explanation allows a CD to initiate CIRP against its CD by virtue of them now being a creditor. The amendment has sought to clarify the ambiguous and unsettled position of the law. It has ensured that there is no blockage for a CD to recover its dues from its debtors in order to pay back to its creditors in cases the assets of the company are insufficient for any such recovery.
It is to be noted that if such proceedings fall within the moratorium period under Section 14 and by virtue of Section 60(6), they shall be excluded while computing the period of limitation.
The Amendment proposes to strengthen the objective of the law by ensuring that resolution process takes place such that the creditors receive maximum amount possible and the debtors are left as a going concern instead of having to enter into liquidation.
Irrespective of the object of Section 11, which is to prohibit misuse of the law by the CD to create a never-ending chain of CIRP to stall or delay the resolution process, the law has been observed to be ambiguous and vague by the legislature. A clarification was imperative for the CDs as many resolutions were failing due to insufficient funds and the CDs barred from recovering their dues. This also led to many CDs ending up in liquidation process which is contrary to the object of the law that is to ensure that the value of assets of the CD are maximized and they are allowed to continue as a going concern.
There have been no cases which questioned the application of Section 11 from the enactment of the Amendment Act. The recent outbreak of coronavirus caused by the pathogen Covid-19 which has led to a global pandemic. This has resulted in a number of countries declaring a temporary ban on international travel. Further, most of the Covid-19 affected countries including India have initiated a temporary nation-wide lockdown from 28.03.2020. Thus, there have been no new cases that have had an issue with respect to the latest Amendment inserted or the interpretation of Section 11.
I believe that the Amendment has provided a balance between the interests of the creditors and the CD. It has been able to lift the cloud of uncertainty with respect to Section 11 on CDs which even the tribunals have not been able to reach a consensus on. The Amendment has ensured that the justice of CD shall prevail and that the objective of the law is upheld.
The position of law is still unclear as there is no case to assess the implication of the explanation clause and the same shall be clear with judicial interpretation in future cases.