India: National Company Law Tribunal Refusal To Admit CMRS Projects Into Insolvency – Should Lenders Be Forced To Settle?

Introduction

The world economy has been confronted by unprecedented challenges due to Covid-19. RBI and Central Government of India have announced a slew of measures to minimise the impact of Covid-19 on financial markets so as to provide liquidity to borrowers. These measures include moratorium on loan repayments and suspension of insolvency proceedings under the Insolvency and Bankruptcy Code, 2016 ("IBC") for 6 months or more¹ where the default has occurred in the lockdown. A balance, however needs to be struck so that these temporary measures adopted in extraordinary times, do not permanently weaken the credit culture of India. A robust economy requires a vibrant credit culture where borrowers are incentivised to repay their debts on time. The recovery of debts is a crucial component to credit flows in an economy and ultimately the banks who lend are the guardian of depositors/and taxpayers' money.

The recent judgment of the NCLT (Bengaluru bench) ("NCLT") in India Asset Growth Fund & ors. v. CMRS Projects Private Limited² (decided 23 June 2020) in overlooking an admitted default of a debtor and forcing the financial creditor to accept a unilateral settlement proposal due to the current stressed economic environment, in our view damages the country's credit culture and sends a wrong signal to borrowers. This is particularly acute in times where there are multiple large scale corporate frauds, siphoning of monies, enforcement directorate enquires which have occurred in corporates that were considered "blue chip" in their respective sectors a few years ago.

Facts

CMRS Projects Private Limited ("Corporate Debtor") issued non-convertible debentures that were subscribed to by India Asset Growth Fund and India Asset Growth Fund-II ("Financial Creditors"). Vistra ITCL was appointed as debenture trustee. The Corporate Debtor defaulted in repayment of debt in August 2018 and the parties tried to negotiate and arrive at a settlement, which also failed. Consequently, the Financial Creditors filed an application under Section 7 of the IBC for initiation of insolvency proceedings against the Corporate Debtor for a default amount aggregating to Rs. 18.0 crore.

Judgment

The Corporate Debtor proposed making a settlement payment of Rs. 12 crore (arguably a 65% recovery rate compared to some other assets may be viewed as a good recovery rate for certain creditors). NCLT ignored the existence of default (which is the fundamental requirement for an application under Section 7 of the IBC) and relied on a unilateral settlement offer of the Corporate Debtor (such settlement offer being rejected by the Financial Creditors) to direct the Financial Creditors to consider settlement offer of the Corporate Debtor. Interestingly, the NCLT relied on its powers under Rule 11 of the NCLT Rules, 2016 (rather than its duty as an adjudicating authority under the IBC) using the current economic situation to justify its decision. It held that the lockdown affected the timeline for the Corporate Debtor implementing its proposal and which was outside its control. It fell back on the objects of the IBC, which states it is "an Act to consolidate and amend all laws relating to reorganisation and insolvency resolution of corporate persons, partnership firms and individuals in a time bound manner and for maximisation of value of assets of such persons, to promoter entrepreneurship, availability of credit and balance of interests of all the stakeholders including alteration in the order of priority of payment of Government dues etc.". The order held that initiation of the corporate insolvency resolution process would be "civil death" for the Corporate Debtor and takes into account the effect on the all stakeholders and the public at large since the Corporate Debtor had contract labour workers, homebuyers and other vendors. The NCLT did agree this case is not covered by the IBC Ordinance 2020, as the default occurred prior to March 25, 2020. However, what it concludes is that the Corporate Debtor and the Financial Creditors must come to a settlement taking into account the current situation in India.

Comment

The Supreme Court in multiple cases has ruled that under Section 7 of the IBC the adjudicating authority is only required to be satisfied that a default has occurred.³ The moment the adjudicating authority is satisfied that a default has occurred the application must be admitted. NCLT has entirely disregarded and ignored the Supreme Court's rulings and its powers under the IBC.
Further, NCLT has relied on Rule 11 of the NCLT Rules, 2016 which refer to the inherent powers of the NCLT. However, such powers are to be used by the NCLT sparingly and only in the absence of express provisions of the IBC. The Supreme Court in Swiss Ribbons Private Limited v. Union of India⁴ allowed the NCLTs to invoke its inherent powers under Rule 11 of the NCLT Rules, 2016 for withdrawal of an application under Section 12A of the IBC, due to the lack of clear guidance under the IBC. Needless to say, the powers of the adjudicating authority are clearly demarcated under Section 7 of the IBC and Rule 11 cannot be invoked for rejecting an application when default is clearly established.

We also find the holding that the public at large/stakeholders will be affected since the Corporate Debtor had contract labour workers, homebuyers and other vendors untenable and taking the purpose of the IBC out of context, since all companies have customers, suppliers and employees. This would mean no company would ever be admitted under the IBC.

It is difficult to argue that NCLT acting as the adjudicating authority under Section 7 of the IBC has powers to force a creditor to settle with a debtor. As stated above, IBC has clearly laid down powers and authority of adjudicating authority. Except under Section 12A of the IBC, wherein the applicant creditor settles with the debtor, the adjudicating authority has no power to allow withdrawal of an application filed under the IBC. Even in that case, the adjudicating authority cannot force a unilateral settlement offer on creditors and creditors must be allowed to use their commercial wisdom to accept or reject a settlement offer, which was completely disregarded by the NCLT in this case.

A more fundamental point is ultimately, the Corporate Debtor "borrowed" monies. That is to say this is a loan and not equity, where if the terms of loans are freely entered and contracted into, are subsequently breached and amounts are not repaid (even one year after a default notice has been issued), fundamentally creditors need to have options. It is well established that the IBC is not a recovery mechanism but one of rehabilitation and the control of the Corporate Debtor must in our view then be in the hands of the creditors as a "creditor in possession model". The judiciary must not lose sight of the fact that recovery and resolution of bad debts are fundamental to maintaining smooth credit flow in the financial system. Consequently, stressed economic conditions on account of Covid-19 cannot and should not be a ground to reject bona fide applications under the IBC, where defaults clearly pre-date any lockdown. Ultimately most creditors seeking to utilise the IBC, whether banks, non-banking financial companies, mutual funds or investment funds, ultimately have depositors' monies which also need to be protected. It is hoped that the National Company Law Appellate Tribunal will set this error right.

Footnotes