Title:

Evolution of the Insolvency and Bankruptcy Code 2016

Author:

Muktesh Swamy

Student, LLM

National Law Institute University, Bhopal

Address:

209 A Block, Katyayan Hostel, National Law Institute University, Kerwa

Dam Road, Bhopal, Madhya Pradesh 462044

1
 Abstract

Insolvency and Bankruptcy Code is a new code specifically legislated to provide a

thrust to the lagging business environment in India. In a way, it opened up a new
avenue within the corporate environment in India.

However, as is the case with any legislation, the code encountered a plethora of
lacunas after coming into operation. The adjudicating bodies were faced with
glorious omissions and ineffective provisions within the code while judging
various cases leading to the courts engaging in creative interpretation of the
provisions to meet the ends of justice. The amendments and changes in the
Insolvency and Bankruptcy code are a result of judicial pronouncements which
themselves are a result of the need to administer justice by way of creative
interpretation because of the complexity of facts and issues of the case.

This research paper has been written with a threefold objective: To trace the
development and evolution of Insolvency and Bankruptcy Code, to explain the
reasoning behind the four major changes made to the code and to analyze
landmark cases and judgments in the field of Insolvency and Bankruptcy.

Keywords: Insolvency and Bankruptcy Code, Resolution Applicant, Committee

of Creditors, Operational Creditor, Financial Creditor

2
 Introduction

The Insolvency and Bankruptcy Code, 2016 has been seen as a representative of a
major shift in the way Business is regulated in India. The code coming into force
took the mantle from the relatively new Companies Act in regards to handling the
issue of Insolvency and Liquidation of Corporate entities. As a result, the whole
of Chapter 19 of the Companies Act 2013 was omitted.
The Bankruptcy code heralded the beginning of new reforms aimed squarely at
reshaping the regulation of Business entities and attracting new players both
international and domestic to enter into the market.
However, the code was new and the authority to adjudicate upon it was also given
to a new class of tribunal called National Company Law Tribunal and National
Company Law Appellate Tribunal. So starting from scratch, jurisprudence was
destined to develop and changes were bound to follow. A new regulator was
appointed called the Insolvency and Bankruptcy Board of India and it set in place
a new breed of professionals called Insolvency Resolution Professional.
The tribunals, unburdened unlike traditional courts, immediately went to work
and not long before creative interpretations started shaping the code and
jurisprudence emerged. Likewise, the regulator spent no time in reacting to the
changes happening in the code due to interpretations of the courts as well as in the
society as a result of coming into force of the Code.
So with a proactive regulator and an adjudication body which was continuously
reading new things into the code as result of interpretation has seen the code
rapidly evolve. So much so that even the Legislature has been forced to make
amendments into the code to take into account the judicial pronouncements.

The 4 major changes made to the Code are:

3
 1. Insertion of Section 29A: Persons ineligible to be Resolution
Applicant.
2. Coming into force of Fast Track Resolution process.
3. Coming into Force of Voluntary Liquidation Process.
4. Promulgation of 2018 Ordinance.

The word insolvency has greatly been in use in the Indian legal arena for the past
couple of years. News continues to flood in of either Insolvency process initiated
against high profile names or a landmark decision being passed every other day.

Ever since the Code came into the picture in 2016, it has opened up the channel
for creditors to resolve their long-standing financial issues with their corporate
debtors. Although a channel was available to them under the Companies Act but
having a separate code provides a much-needed impetus.

The word Insolvency has really been making rounds on national as well as global
level. On Indian shore, big names like Monnet Ispat & Energy Ltd., Essar Steel
Ltd., Jaypee Infratech and Bhushan Steel Ltd. have gone under the hammer of
Insolvency and Bankruptcy code, hereinafter to be referred as IBC. Globally the
biggest news that concerns India is that of Vijay Mallaya's venture into the world
of Formula One by the name of Force India which has been placed in
administration under the British Insolvency laws.

Globally the Insolvency laws have started out as a channel allowing the creditors
of a company to shred the company to fulfill their debts. But then there was a
paradigm shift in the philosophy and credence was given to allow the Company to
continue as an “on-going concern” with the focus having shifted towards revival
failing which liquidation would be the only avenue left.

4
India, being late to the party in terms of having a dedicated code for Insolvency,
benefitted in terms of having a robust set of laws it could take inspiration from,
namely the US Bankruptcy Code and UK’s Insolvency Act of 1986. Our code
resembles the above two very closely, but since it’s passing has evolved into
something unique.

In this paper, the emphasis is on 4 major changes or evolution to the code and will
be dealt with in detail in the upcoming chapters.

 Section 29A

Within just 1 year of the working of the Code, a big loophole was discovered in
the code. Under the scheme of the code, any person could present a resolution
plan and become a resolution applicant. There were no qualifying criteria as to
who can be a resolution applicant. This allowed the previous promoters who had
run the company into dire straits, to gain a backdoor entry into the management.

To address this loophole, two changes were made. First Section 29A was inserted
which disqualified various categories of people from becoming a resolution
applicant.

Secondly, section 5(25) was amended to read that a resolution applicant is one
who submits a resolution plan to the resolution professional upon an invitation
made under section 25(2)(h). Section 25(2)(h) was amended to the effect that the
resolution professional invite resolution plans from such applicants who fulfill the
criteria laid down by the resolution professional with the approval of the
committee of creditors keeping in consideration the complexity and the scale of
business of the corporate debtor. Therefore, a prospective resolution applicant in
order to be eligible to submit a resolution plan shall not only meet the criteria laid

5
down by the resolution professional under section 25(2)(h) but shall also not fall
under any of the categories laid down by section 29A for disqualification.

A cursory glance of 29A reveals that there are 4 tiers of ineligibility. They are:

1. the person itself is ineligible.

2. A connected person is ineligible
3. being a “related party” of connected persons.
4. a person acting jointly/in concert with a person suffering from first
tier/second tier/third tier ineligibility becomes ineligible.

The Code was designed to find the best possible way out for an ailing entity- it
was meant to be more inclusive in approach and there was definitely no intention
to avoid promoters from submitting resolution plans. However, the reach of
Section 29A extends to four tiers (as explained above), and may lead to exactly
opposite results. It is quintessential to ensure that the citadel of insolvency
resolution does not have holes into it but at the same time, it is also important to
ensure that the citadel is not inaccessible, with no steps, doors or windows. The
intent of Section 29A will be counterproductive if it results into a whole lot of
intending resolution applicants being disentitled, because the recursive definitions
of related party, connected persons etc are cast wide enough, intertwining all the
entities promoted by an entity.1

 Fast Track Resolution Process

As a matter of prudence, the code prescribes a limit of 180 days and a 90-day
extension, in which the whole process of resolution must be completed or else the

1
Richa Saraf & Sikha Bansal, Ineligibility criteria under section 29A: A net too wide!, LIVE
LAW, (Feb. 18, 2018) http://www.livelaw.in/ineligibility-criteria-u-s-29a-ibc-net-wide/

6
company faces liquidation. In an Insolvency process though, time is really of the
essence, so much so that depending upon a situation, this 180-day limit may even
prove to be too much. Therefore a shorter, in terms of procedures and time frame,
process within the code is prescribed. Called the Fast Track process, this process
was already present but came into effect only on 14 June 2017 and provided that
an Application for Fast track corporate insolvency resolution process may be
made in respect of the following corporate debtors:

1. a small company as defined under clause (85) of section 2 of Companies

Act, 2013
2. a Startup (other than the partnership firm) as defined in the notification of
the Government of India in the Ministry of Commerce and Industry dated
the 23rd May, 2017; or
3. an unlisted company with total assets, as reported in the financial
statement of the immediately preceding financial year, not exceeding
rupees one crore.

Now the major question to be asked is why a fast track process was specified in
the first place? Well, there are several reasons. One is that India had a dismal rank
in terms of Insolvency process as per World Bank estimates 2, which ranked it at
137 out of 189 nations. The same World Bank estimate showed that on an
average, it takes 4 years to wind up a company in India which is not a good
number. The estimate showed that India recovers only 25.7 cents on a dollar,
which is among the worst in the emerging economies.

There were other reasons as well such as the fact that it made no sense for small
and non-complex companies to spend so much time in resolution despite the fact
that the insolvency process for them ends earlier.
2
World Bank 2014. Doing Business 2015: Going Beyond Efficiency. Washington, DC: World
Bank.

7
Hence a separate chapter called Chapter IV is dedicated to Fast Track Resolution
Process. While section 56 prescribes a period of 90 days, with an extension of 45
days, section 57 is of main importance here.

So the notification of Fast Track Resolution process was another evolutionary

step as it paved a faster way for certain companies to sort out their Insolvency
issues in a shorter time frame. Mind you the chapter IV was already a part of the
code in 2016 but was notified only in 2017 after it was clear that there indeed was
a scope for a faster process. Also the fact that it was not determined on which
companies the process would be applicable and only after gauging the reaction
and needs of Companies, the government notified the list of eligible companies
who are allowed to initiate the process.

 Voluntary Liquidation Process

Chapter V of the Code is completely dedicated to Voluntary Liquidation process.

The scheme of the code is that any company that defaults in paying its dues can
be made to undergo Corporate Insolvency Resolution process by either its
creditors or by its own volition. If the process fails, then mandatorily it is
liquidated i.e. dissolved. With respect to dissolution of a company, previously the
governing law was The Companies Act 2013, but with Insolvency and
Bankruptcy Code coming into effect in 2016, the requisite chapter in the
Companies Act 2013 was repealed.

So now the process was that a Company which wanted to get dissolved
voluntarily had no other choice but go through the Insolvency process which
made no sense. Hence Chapter V of the code was bought into force on 1 April
2017.

8
As per Section 59 of the Code read with the Regulations, any corporate entity
may initiate a voluntary liquidation proceeding if it satisfies all the following
conditions:

1. It has not committed any default;

2. If the majority of the directors or designated partners of the corporate
person make a declaration verified by an affidavit to the effect that :
i) the corporate person has no debt or it will be able to pay its debts in
full out of the sale proceeds of its assets under the proposed
liquidation; and
ii) liquidation is not initiated to defraud any person;
3. Such declaration is accompanied by the audited financial statements and
valuation report of the corporate person;
4. Within 4 (four) weeks of such declaration, a special resolution (an
ordinary resolution would suffice in cases of voluntary liquidation by
reason of expiry of its duration or occurrence of any dissolution event) is
passed by the contributors* requiring the corporate person to be liquidated
and appointing an insolvency professional as a liquidator (Contributories'
Resolution); and
5. Creditor(s) representing two thirds in value of the total debt owed by the
corporate person, approve the Contributories’ Resolution within 7 (seven)
days of its passage (Creditors’ Approval).

Voluntary winding up, therefore, was an important step as it finally assumed all
the steps related to Insolvency and Bankruptcy. Dissolution is one of a natural
outcome of the two process name earlier, with the provisions in the Companies
Act 2013 not in force, the subject matter was governed by the archaic 1956 law
which was a major bottleneck on the corporate world. A new law was needed and
the delay with enforcing 2013 Act’s provision meant the problem persisted. With

9
the legislature working behind the scene to get the Code out and the rationale
being that a code is a complete system of law on a particular ground, it was
natural that dissolution of companies be governed by the Code rather than having
to refer to the Companies Act.

 2018 Ordinance

The biggest evolutionary change in the IBC is that represented by the 2018
Ordinance. This ordinance introduced a raft of changes into the Code to bring it in
tune with judicial pronouncements. This Chapter deals, in brief, all the changes
made to the Code.

The headline-grabbing change was the fact that Homebuyers who had advanced a
certain sum of money to the builder for the construction and later possession of
the house were deemed as financial creditors of the builder. This meant that in
case the builder is a company and it defaults in delivering the possession of the
house to the homebuyer, then, in that case, the homebuyer could initiate the
Insolvency resolution process against the builder. This was a major move as it
strengthens the position of not only the homebuyer but also adds to the credibility
of the Code.

It was a position of great joy for the Homebuyers as after the RERA Act this was
a major fillip to their position against the recalcitrant Builders. The Real Estate
sector before RERA was driven completely by the Builders and Homebuyers
were at their mercy as various articles had referred to the real estate sector as a
landmine for potential homebuyers.

Another change was to the Section 29A discussed in Chapter I which relates to
the disability of certain persons from becoming resolution applicant. The section,

10
as it stood then had run into some trouble and sprouted certain complexities that
needed to be addressed. The 2018 Ordinance did exactly that.

The definition of ‘related party’ in the context of an individual person has been
introduced which was earlier missing, providing clarity to the scope of connected
persons of a resolution applicant who have to be tested for disqualifications set
out in paragraphs (a) through (i) of Section 29A. The definition of an individual's
related party is extensive and will cast a wide net. In addition, where the
individual whose connected persons need to be determined is married, the relative
of the individual's spouse will also be included within the scope of ‘connected
persons'. This, on the face of it, is excessive and could have been handled better
by limiting the definition of relatives as used in the Companies Act, 2013. The
wider definition under the 2018 Ordinance will increase the burden on the
resolution professional and the Committee of Creditors.

One of the major concerns highlighted by market participants is that financial

investors should not be barred from bidding for companies under the IBC on
account of Section 29A. This was and to a certain degree continues to be the case,
given the broad ambit of the Disqualification Criteria, the principal amongst them
being Section 29A(c), which disqualifies a person who is the promoter or in
control of a company whose account has been a non-performing account (NPA)
whether in India or abroad for more than one year.

The 2018 Ordinance identifies certain ‘financial entities’ – though NBFCs are
conspicuously absent from this list – which have been exempt from the NPA
Disqualification provided that such financial entities are not related to the
corporate debtor (in the manner as prescribed under the 2018 Ordinance). Also, it
is worth noting that

11
 (i) Such an exemption is available only where the resolution applicant
is a ‘financial entity’ and not to connected persons of the resolution
applicant.
(ii) For an entity to qualify as a ‘financial entity’, it would also have to
comply with additional criteria to be prescribed by the Government in
consultation with the relevant financial sector regulator.

The 2018 Ordinance also exempts the NPA Disqualification for a resolution
applicant that has acquired a company (whose account is an NPA) pursuant to a
resolution plan approved by the NCLT under the IBC. This exemption is available
to the relevant resolution applicant for a period of three years following the
approval of the plan.

The 2018 Ordinance provides further relief to ‘micro’, ‘small’ and ‘medium’
enterprises by exempting them from the Disqualification Criteria under
paragraphs (c) and (h) of Section 29A and also allows the Government to exempt
the other Disqualification Criteria for MSMEs as well.3

Previously, all decisions of the Committee of Creditors needed to be approved by

75% of the voting share of the Committee of Creditors members. This threshold
has now been lowered to 51% except for the following requirements:

1. 90% approval for withdrawal of an insolvency application post admission

by the NCLT.
2. 66% approval for resolutions: (i) proving extension of the corporate
insolvency process beyond 180 days; (ii) relating to matters listed out
under Section 28 of the IBC; (iii) approving a resolution plan; and (iv)
replacing a resolution professional.
3
L. Viswanathan & Abhijeet Das, 2018 IBC Ordinance: Impact of Changes, INDIA
CORPORATE LAW (Jul. 16, 2018), https://corporate.cyrilamarchandblogs.com/2018/07/2018-
ibc-ordinance-impact-changes/

12
 Important Cases

The whole jurisprudence and major evolution of the Code have been a product of
some creative interpretation on the part of National Company Law Tribunal,
National Company Law Appellate Tribunal and Supreme Court. Name any major
change and there's a high chance that it has been the result of a judgment by any
of the adjudicating body named above. In this chapter, we deal with the important
cases, basically judgments that heralded a major change in the understanding of
the Code.

1. Macquarie Bank Limited v. Shilpi Cable Technologies Limited (Supreme

Court)4

The said appeal raised two imperative questions:

A. Whether in relation to an operational debt, the provision contained in Section

9(3)(c) of the Code is mandatory?

— The Court held that a fair construction of Section 9(3)(c), in consonance with
the object sought to be achieved by the Code, would lead to the conclusion that it
cannot be construed as a threshold bar or a condition precedent.

B. Whether a demand notice of an unpaid operational debt can be issued by a

lawyer on behalf of the operational creditor?

— The Hon’ble Supreme Court, keeping the objective of the Act in mind at all
times, engaged in a liberal interpretation of the provisions of the Act. Section 8 of
the Code speaks of an operational creditor delivering a demand notice. The Court
reasoned that had the legislature wished to restrict such demand notice being sent
by the operational creditor himself, the expression used would perhaps have been

4
Macquarie Bank Limited v. Shilpi Cable Technologies Limited, A.I.R. 2018 SC 498.

13
“issued” and not “delivered”. Delivery, therefore, would postulate that such notice
could be made by an authorized agent.

“It is clear, therefore, that both the expression “authorized to act” and “position in
relation to the operational creditor” go to show that an authorized agent or a
lawyer acting on behalf of his client is included within the aforesaid expression.”

2. Mobilox Innovations Private Limited v. Kirusa Software Private Limited

(Supreme Court)5

In this case, the Court finally settled the widely debated question of what
constitutes "the existence of a dispute" in the context of applications filed by
operational creditors for initiation of corporate insolvency resolution process
(CIRP) of corporate debtors under the Code.

First and foremost, the Court decided that the word "and" in section 8(2)(a) must
be read as “or”. This interpretation overcame the hardship that came with the
previous interpretation which had the effect that a dispute would only be said to
exist if a suit or arbitration proceeding on the dispute was pending.

Secondly, the Court came up with a new “plausible contention” test whereby all
that the NCLT is to see is whether there is “a plausible contention which requires
further investigation and that the “dispute” is not a patently feeble legal argument
or an assertion of fact unsupported by evidence.” So long as a dispute truly exists
in fact and is not spurious, hypothetical or illusory, the application of an
operational creditor must be rejected by the NCLT.

3. Innoventive Industries Ltd. v. ICICI Bank & Anr. (Supreme Court)6

The difference between Section 7 and Section 8 of the Code:

5
Mobilox Innovations Private Limited v. Kirusa Software Private Limited, A.I.R. 2017 SC 4532.
6
Innoventive Industries Ltd. v. ICICI Bank, A.I.R. 2017 SC 4084.

14
Supreme Court held that for triggering Section 7 (1) of the IBC, a default could be
in respect of default of financial debt owed to any financial creditor of the
corporate debtor – it need not be a debt owed to the applicable financial creditor.

The Supreme Court contrasted the IBC provisions relating to applications by

financial and operational creditors. It held that under Section 8(1), an operational
creditor is required to deliver a demand notice on the occurrence of a default and
under Section 8(2), the corporate debtor can bring to the notice of the creditor,
existence of a dispute or the record of pendency of a suit or arbitration
proceedings, which is pre-existing. The existence of such a dispute will make the
application of operational creditor inadmissible.

4. Surendra Trading Company v. Juggilal Kamlapat Jute Mills Company Limited

and Others (Supreme Court)7

In this case, the question of law framed by the NCLAT for its decision was
whether the time limit prescribed for admitting or rejecting a petition for initiation
of the insolvency resolution process is mandatory. The precise question was
whether, under the proviso to Section 9(5), the rectification of defects in an
application within 7 days of the date of receipt of notice from the adjudicating
authority was a hard and fast time limit which could never be altered. The
NCLAT had held that the 7 day period was sacrosanct and could not be extended,
whereas, insofar as the adjudicating authority is concerned, the decision to either
admit or reject the application within the period of 14 days was held to be
directory.

However, the Supreme Court differed in its perspective and held as follows:
7
Surendra Trading Company v. Juggilal Kamlapat Jute Mills Company Limited,
MANU/SC/1294/2017.

15
This judgment also lends support to the argument for the appellant in that it is
well settled that procedure is the handmaid of justice and a procedural provision
cannot be stretched and considered as mandatory, when it causes serious general
inconvenience.

5. Alchemist Asset Reconstruction Company Limited v. M/s Hotel Gaudavan

Private Limited & Ors.8

An arbitration proceeding cannot be started after imposition of moratorium and

that that the effect of Section 14(1)(a) is that the arbitration that has been
instituted after the aforesaid moratorium is non-est in law.

6. Black Pearl Hotels Pvt. Ltd. v. Planet M. Retail Ltd. (Supreme Court)9

The duty of determination of an instrument or, to explicate, to determine when

there is a contest a particular document to be of specific nature, the adjudication
has to be done by the judge after hearing the counsel for the parties. It is a part of
judicial function and hence, the same cannot be delegated.

7. Nikhil Mehta & Sons (HUF) & Ors. v. M/s AMR Infrastructures Ltd. (NCLT
Delhi)10

The NCLAT has ruled that a purchaser of real estate, under an ‘Assured-return’
plan, would be considered as a ‘Financial Creditor’ for the purposes of IBC and
is, therefore, entitled to initiate corporate insolvency process against the builder,
in case of non-payment of such ‘Assured/Committed return’ and non-delivery of
unit.

8
Alchemist Asset Reconstruction Company Limited v. M/s Hotel Gaudavan Private Limited,
MANU/DE/0696/2016.
9
Black Pearl Hotels Pvt. Ltd. v. Planet M. Retail Ltd, A.I.R. 2017 SC 1974.
10
Nikhil Mehta & Sons (HUF) & Ors. v. M/s AMR Infrastructures Ltd, MANU/NC/5731/2018

16
The Appellant had booked a residential unit, office space and a shop in a project
being developed by AMR. The unit never came to be delivered to the Appellant.
The Appellant had a MoU with AMR, whereby AMR had assured
‘Assured/Committed returns’ to him, from the date of execution of the MoU till
the handing over of the physical possession of the unit(s). This was ostensibly
done in view of the substantial down payment made by the Appellant. The
Assured returns were paid for some time, however, the payments dwindled and
then stopped altogether. Despite various demands, no further payments were
made by the Builder. This constrained the Flat buyer to initiate Insolvency
process against the Builder.

The NCLT dismissed the Application on the singular premise that the agreement
in question was clearly a ‘pure and simple agreement of sale and purchase of a
piece of property and has not acquired the status of a financial debt as the
transaction does not have consideration for the time value of money. The NCLT
held that disbursal of monies ‘against the consideration for the time value of
money’ was an essential precondition for the debt to qualify as a ‘financial debt’.

At the NCLAT, it was argued that through this mechanism of ‘Assured returns’, a
huge amount of money was mobilized by AMR to ensure the development of the
project, without any collateral or security. In absence of this scheme, AMR would
have been constrained to procure this amount from financial institutions at
extremely high interest rates. Instead, this amount was secured from unsuspecting
buyers on the guarantee and under the garb of ‘Assured/Committed returns’.

The NCLAT, reversing the decision of the NCLT, ruled in favor of the Flat Buyer
and held it to be a ‘Financial Creditor'. The operative part of the decision reads:
"It is clear that Appellants are ‘investors' and has chosen ‘committed return plan.

17
The Respondent in their turn agreed upon to pay monthly committed return to
investors.”

NCLAT further went on to rule that the ‘debt’ in this case was disbursed against
the consideration for the ‘time value of money’ which is the primary ingredient
that is required to be satisfied in order for an arrangement to qualify as ‘Financial
Debt’ and for the lender to qualify as a ‘Financial Creditor’, under the scheme of
IBC.

18
 Conclusion

The Insolvency and Bankruptcy code is a piece of legislation that’s still evolving
as this project is being written. Because of the fact it’s so new, has an adjudication
body that’s unburdened and the fact that it is such an important piece of
legislation for the corporate world that the change is happening at a rapid pace.

A thorough look at the changes will reveal the fact that the majority of changes
are a result of judicial pronouncements. Some very big changes made to the code
for example like the amendment made to section 29A, conferring the status of
financial creditors on homebuyers, clarifying the difference between the status of
operational and financial creditors etc have all been done by the adjudicating body
in pursuance of resolution of a dispute. Majority of amendments that have been
made to the Act have been done to give the statutory status to these judicial
pronouncements.

19
 References

1. Batra Sumant, (2017), Corporate Insolvency: Law and Practice, First

edition, EBC

2. http://www.ibbi.gov.in/

3. https://www.ey.com/Publication/vwLUAssets/ey-interpreting-the-
insolvency-and-bankruptcy-code/$FILE/ey-interpreting-the-insolvency-
and-bankruptcy-code.pdf

4. https://taxguru.in/corporate-law/easy-understanding-insolvency-
bankruptcy-code-2016.html

5. https://www.bloombergquint.com/insolvency/2017/11/25/the-insolvency-
and-bankruptcy-code-amendments-everything-you-need-to-know

20