India: Case Note: Interpretation Of Section 7(5)(A) Of The Insolvency And Bankruptcy Code, 2016

In the case of State Bank of India v. Essar Steel India Ltd., C.P (I.B) No. 40/7/NCLT/AHM/2017, the National Company Law Tribunal, Ahmedabad Bench has interpreted Section 7(5)(a) of the Insolvency and Bankruptcy Code, 2016 ("the Code") to hold that the Adjudicating Authority has discretion to either reject or admit the application for initiating the Corporate Insolvency Resolution Process even if the application is complete in all aspects.

BACKGROUND

Standard Chartered Bank (SCB) and State Bank of India (SBI) initiated Corporate Insolvency Resolution Process under Section 7 of the Code read with Rules 4 and 9(1) of Insolvency and Bankruptcy (Application to Adjudicating Authority) Rules, 2016 against ESSAR Steel India Limited (ESSAR).

SCB and SBI had provided loan to Essar Steel Offshore Limited (ESOL), a wholly owned subsidiary of ESSAR. These loans were secured by the guarantee of ESSAR under the facility agreement. Subsequently, ESOL defaulted in payment of the loan amount due and as ESSAR was its guarantor, SCB issued demand notice to ESSAR after ESOL defaulted in repayment. ESSAR also failed to pay the amount due under the agreement. Meanwhile, ESSAR issued a letter to SCB suggesting a Debt Restructuring Proposal pursuant to which the outstanding amount would be paid over the period of 25 years along with interest. SCB rejected the said proposal. Thereafter, SCB filed an application for initiating Corporate Insolvency Resolution Process (CIRP) under Section 7 of the Code against ESSAR. SBI also filed a similar application against ESSAR on behalf of the Joint Lenders Forum (JLF).

It is should be noted here that financial creditors, that is, SCB and SBI have filed an application for initiating insolvency proceeding against the guarantor and not the principal debtor. The provision for the same is provided in the Code. Section 3(8) of the Code defines "corporate debtor" as "a corporate person who owes a debt to any person". "Debt" has been defined under Section 3(11) to include financial debt. Section 5(8) read with its sub-clause (i) defines "financial debt" as "a debt along with interest, if any, which is disbursed against the consideration for the time value of money and includes - (i) the amount of any liability in respect of any of the guarantee or indemnity for any of the items referred to in sub-clauses (a) to (h) of this clause." Thus, the Code specifically includes liability with respect to a guarantee under 'financial debt' and empowers a financial creditor to initiated Corporate Insolvency Resolution Process against the guarantor as well.

At the outset, ESSAR has contended that it is not a willful defaulter and that there is no diversion of funds, fraud or malfeasance on its part. ESSAR also argued that CIRP before the Adjudicating Authority poses risks- firstly, the process of formulation of Debt Resolution Process will have be reinitiated and further time will be lost due to a fresh start; and secondly, the functioning of ESSAR is complex and that it would be difficult for an individual interim resolution professional to oversee such complex operations.

ISSUES INVOLVED

1. Whether the Adjudicating Authority has discretion to admit or reject an application under Section 7 of the Code?

SCB has argued that although Section 7(5)(a) uses the term "may" but in the context of initiating a CIRP, it should be read as "shall". SCB contended that in order to find out whether the words "may" or "shall" are used in a directory or mandatory sense, the intent of the legislature needs to be looked at in the given circumstance. ESSAR on the other hand, argued that the legislature deliberately used the term "may" in Section 7(5)(a) which is evident from the fact that the word "shall" is used in Sections 9(5) and 10(4) with respect to the admission of applications by operational creditors and corporate applicants.

2. Whether the Adjudicating Authority was bound to take into consideration the Debt Restructuring Scheme submitted by ESSAR?

It was argued by ESSAR that insolvency resolution process should not be commenced when a Debt Restructuring Process is ongoing as it will affect the proper functioning of the company and that the suspension of the Board of Directors may cause prejudice to the interest of the company.

3. Whether the Adjudicating Authority can appoint an interim resolution professional on the date of admission of application under Section 7, 9 or 10 of the Code?

ESSAR argued that there is no need to appoint an interim resolution professional on the same day on which admission order is passed and it can be passed within 14 days of the admission of application. It relied on Section 14 of the Code to state that it is only moratorium which has to be declared on the date of commencement of Insolvency Resolution Process but the appointment of interim resolution professional can be deferred.

4. In light of the fact that SCB filed the application for initiating CIRP prior in time than SBI, whose proposed name for appointment as interim resolution professional should be considered?

SCB argued that Section 5(11) of the Code defines "initiation date" as "the date on which a financial creditor, corporate applicant or operational creditor, as the case may be, makes an application to the Adjudicating Authority for initiating corporate insolvency resolution process" and that it had initiated the proceedings before SBI filed its application under Section 7; hence, its recommended name should be appointed as the interim resolution professional. SBI on the other hand contended that it has proposed a name for interim resolution professional after analysis of various profiles on the basis of experience and presentations by JLF. SBI also argued that the value of debt of JLF is more than that of SCB and therefore it is appropriate to appoint interim resolution professional as recommended by JLF.

DECISION

  1. The Adjudicating Authority held that in order to give appropriate meaning to the words "may" and "shall", the intention of the legislature behind a particular enactment along with the circumstances needs to be looked into. The order of admission of CIRP application is a judicial order which should be according to principles of natural justice, legal provisions and in light of the consequences it entails. Hence, it was held that the Adjudicating Authority has discretion under Section 7(5)(a) to either admit or reject an application and it need not be mechanically admitted.
  2. The Debt Restructuring Process was in progress for two years and was not finalised. On these facts, the Adjudicating Authority held that Debt Restructuring Process cannot be a factor to not commence CIRP and that even in the CIRP, the Restructuring Plan can be taken into consideration by the Committee of Creditors. Further, it was held that suspension of Board of Directors does not suspend the entire machinery of the company; instead it will be under the control of the interim resolution professional. The Hon'ble Gujarat High Court in Essar Steel India Ltd. v. Reserve Bank of India and Ors., Special Civil Application No. 12434/2017 observed that the Adjudicating Authority shall consider factual circumstances including the process of Debt Restructuring Process. Hence, the Adjudicating Authority opined that the Debt Restructuring Process may be taken into consideration during CIRP.
  3. The Adjudicating Authority held that there is no provision which bars the appointment of interim resolution professional on the same day as the admission order. It was observed that the Code enjoins upon the Adjudicating Authority to declare moratorium, to make public announcement of initiation of CIRP and to appoint interim resolution professional on the date of commencement of Insolvency Resolution Process, that is, the date of admission of the application for initiating CIRP.
  4. It was held that the date of initiation of Insolvency Resolution Process cannot be taken as a yardstick or as a guideline for appointing interim resolution professional. The Adjudicating Authority observed that the debts of JLF were more in value than the debt due to SCB and hence, it was just to appoint the SBI's proposed name as interim resolution professional.

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