Shardul Shroff Misha October 14 2022 Supreme Court's Vidarbha ruling undermines India's insolvency law Shardul Amarchand Mangaldas & Co | Insolvency & Restructuring - India Shardul Shroff, Misha Insolvency & Restructuring IntroductionDecisionCommentIntroductionThe Supreme Court judgment in the Vidarbha Industries Power v Axis Bank case has spread controversy after overturning settled law, requiring adjudicating authorities to look beyond the existence of debt and default while deciding on the admissibility of applications filed under section 7 of the Insolvency and Bankruptcy Code 2016. The Court stayed admission of an insolvency application filed against a defaulting corporate debtor in light of a favourable order, which entitled it to an amount more than the debt due and payable to the financial creditor. The decision centred on two similarly worded provisions of the code in sections 9(5) and 7(5)(a).DecisionApplying the rule of literal interpretation, it was held that since section 7(5)(a) employs the words "may admit", the adjudicating authority had the discretion to admit or reject an insolvency application despite the default in payment of financial dues. The Court warned that such discretion should not be exercised in a capricious or arbitrary manner.Contrary to its own decisions in the Innoventive Industries and Swiss Ribbons cases, the Court held that even where a default has been established, the adjudicating authority may consider the expedience of the application, factoring in, among other things, the overall financial health and viability of the corporate debtor.Considering the possibility of the debtor regaining financial health, the Court observed that solvent companies cannot be penalised for temporary defaults. As a consolation to financial creditors, it clarified that rejection of the application will not deprive financial creditors of their right to initiate fresh proceedings if financial dues continue to remain unpaid. In contrast to section 7(5)(a), section 9(5) of the code uses the term "shall", implying that an adjudicating authority must admit an application under section 9 filed by an operational creditor that is complete and compliant with the code in all respects.The Supreme Court noted that the legislature has consciously differentiated between financial creditors and operational creditors due to inherent differences in the nature of their business, and that non-payment of dues is likely to impact operational creditors far more adversely than financial creditors.CommentThis ruling will have far-reaching ramifications on the ability of financial creditors to initiate timely proceedings against defaulting debtors and will also exacerbate the prevailing problem of inordinate delays at the admission stage. At a time when attempts are being made to expedite admissions by strengthening the information utility framework, the Supreme Court has opened the floodgates to countless litigations countering or challenging admissions of section 7 applications.The Court's reasoning to stay the admission of the insolvency application is expected to be used by defaulting corporate debtors in a wide array of scenarios, contending they are otherwise solvent companies that only temporarily defaulted on their repayment of financial dues.While section 7(5)(a) is in clear terms held to be discretionary in nature, the judgment is riddled with other ambiguities. The determination of factors such as the overall financial health and viability of the corporate debtor is likely to be subjectively and inconsistently interpreted by different adjudicating authorities, leading to significant dilution of the objective test of establishing default for initiating the corporate insolvency resolution process (CIRP) against a corporate debtor. This will result in spending further precious judicial time assessing the eligibility of a corporate debtor for admission of the insolvency application. Such delays directly contribute to value erosion, which is of great concern for distressed businesses.While the right of financial creditors to refile an insolvency application if dues continue to remain pending is unimpaired, the commencement criteria for such re-initiation of the CIRP are unclear.A healthy competitive market allows for the steady entry of new firms and exit for distressed businesses. This ensures the allocation of resources to efficient and productive ventures. The failure of insolvency law to provide for a predictable and quick exit can have catastrophic consequences on an economy, leading to a higher cost of credit and reduced economic growth. The availability of cheap credit is intrinsically linked to the protection of creditor rights to efficiently resolve debts in a time-bound manner.The Vidarbha Industries judgment clogs this right of financial creditors by not allowing an easy exit route to the capital stuck with insolvent debtors, preventing the reallocation of resources from failing companies to profitable businesses. Initiation of the CIRP is a business decision that requires commercial acuity. Judicial discretion cannot be allowed to override the commercial wisdom of creditors in exercising their rights under the code. Unless clarified, this judgment will have adverse effects on the success of the code as sound insolvency law.For further information on this topic please contact Shardul S Shroff or Misha at Shardul Amarchand Mangaldas & Co by telephone (+91 11 4159 0700) or email ([email protected] or [email protected]). The Shardul Amarchand Mangaldas & Co website can be accessed at www.amsshardul.com.