India: Default Under Insolvency & Bankruptcy Code, 2016

Insolvency and Bankruptcy Code, 2016 (hereinafter, 'the Code') has been envisaged as a tool to assist debt laden companies to clear their dues and start afresh after undergoing the process of revival. only if they miss this chance for revival, the liquidation process is commenced. The event which triggers the applicability of the Code is 'occurrence of default'. It is thus necessary to determine what constitutes 'default'. Section 3(12) of the Code defines 'default' as non-payment of debt when whole or any part or installment of the amount of debt has become due and payable and is not repaid by the debtor or the corporate debtor, as the case may be. The phrase 'debt has become due and payable' means that the debt is payable at the present moment.5 Whenever, as per the contract between the parties, debt is payable after a certain point of time or on happening of a certain event, the debt becomes due only after that point of time. Thus, if in a case, the debt is payable and the person has not made the payment, a default can be said to have occurred and application for that can be brought.

The next question which arises is as to how this default or non-payment of debt is to be determined. Subsection 4 of section 7 states that the Adjudicating Authority shall ascertain the existence of a default from the records of information utility or on the basis of other evidence furnished by the financial creditor under sub-section (3). The provision reveals that default will be determined as per the submissions of the creditor or the records of information utility. The aforesaid provision does not provide an opportunity to the debtor to put forth his case.

Moreover, the scheme of Part II of the Code is such that u/s 9 if the creditor alleges default, the debtor may disprove it by evidence of repayment of operational debt u/s 8 or by bringing in a notice of dispute. But under section 7 there is no requirement of such notice to be furnished to the debtor before bringing in the application. Regulation 4(3) of the I&B (Application to Adjudicating Authority) Rules, 2016, provides for a copy of the application filed with the Adjudicating Authority to be dispatched to the corporate debtor. But the provisions of the Code do not afford an opportunity for the debtor to make his submissions with respect to the default. This deliberate omission on part of the legislature should be read as clear expression of its intent. Such scheme under section 7 is also consistent with the objective of the Code to ensure quick disposal of the application by NCLT and consequently, Insolvency Resolution Process. It provides a safeguard against frivolous and vexatious objections by the debtors to stall the application.

However, Adjudicating Authority has read in the provisions, the necessity of providing an opportunity to the debtors to make their submissions with respect to default. Ahmadabad bench of NCLT in M/s State Bank of India, Colombo v. Western Refrigeration Pvt. Ltd6 recognized that the most important function of the Adjudicating Authority u/s 7 is to ascertain the existence of default and that a default has occurred. It observed that to ascertain the same it is necessary to consider the documents filed by both Petitioner Bank as well as the Respondent Company and contention of both the parties.

The Tribunal relied on the Supreme Court's decision in Madhusudhan Gordhandas & Co. v. Madhu Woolen Industries Pvt. Ltd.7 wherein it was held as follows:

"the debt is bona fide disputed and the defense is a substantial one, the court will not wind up the company... The principles on which the court acts are first that the defense of the company is in good faith and one of substance, secondly, the defense is likely to succeed in point of law and thirdly the company adduces prima facie proof of the facts on which the defense depends."

In the Western Refrigeration case mentioned above the facts were that the proceedings u/s 7 were brought against the Guarantor. There was a liquidation proceeding pending against the Principal Borrower, and the Bank had filed a claim there as well. Moreover, the Guarantors had discontinued and determined the guarantee, notice of which had been duly served on the bank. The Petitioner bank however, did not bring this information to the knowledge of the bench. The bench while rejecting the petition went on to say that:

'The Adjudicating Authority need not be carried away by the documents filed by the Financial Creditor alone in all cases, but in a given case it shall consider the relevant bona fide pleas of Corporate Debtor in earlier proceedings in order to satisfy about the existence of default or occurrence of default."

Calcutta High Court in Sree Metaliks Limited and Another v Union of India8 and NCLAT in M/s Innoventive Industries Limited v ICICI Bank and Another 9 have observed that for an application u/s 7 of the Code, NCLT is obliged to afford a reasonable opportunity to the financial debtor to contest such claim of default by filing a written objection or any other written document. In the former case, the Calcutta High Court observed that u/s 424 of the Companies Act, 2013 the NCLT has to follow the principles of natural justice while disposing off proceedings before it.

Even though, the decision saves an innocent debtor from the grave effects the admission of application might have on its business and someone who might have valid defense against the default or who because of an inadvertent error failed to repay the debt, but had no intention of not paying, it also opens doors for many other objections by the debtors which might have no legal basis and been put forth merely to delay and frustrate the process. It is now to be seen, what possible consequences can this have on the working of the Code and strict timeline of 14 days (along with 10 days u/s 62) to dispose the application. If the Adjudicating Authorities are not strict on debtors bringing in trivial objections, it might have a hard time disposing the applications.

Furthermore, it is to be noted that the Code envisages establishment of information utilities which when once formed will record all financial information pertaining to debt and its payment. Once this Information Utility infrastructure comes into existence, it will be easier to determine the existence of default as these utilities will enable access to irrefutable and transparent evidence of the default. The records with the Utilities will serve as primary evidence with minimal possibilities of misinformation. Therefore, it is only a matter of time that default can be established with ease and accuracy without much aid by submissions of creditor or debtor.

Footnotes

5 Krishna Kilaru and Another v. Maytas Properties Limited Rep., by its Managing Director, Hyderabad, Krishna Kilaru and Another v. Maytas Properties Limited Rep., by its Managing Director, Hyderabad, MANU/AP/0745/2012.

6 17/7/NCLT/AHM/2017, delivered on 26.05.2017.

7 AIR 1971 SC 2600.

8 WP 7144(W) of 2017, CalHC.

9 Company Appeal (AT) (Insolvency) No. 1 & 2 of 2017, decided on 15.05.2017.

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