The Supreme Court's IBC Judgment And The Continuing Problems With "Manifest Arbitrariness"

Structure of the Code

The Code was enacted by Parliament to provide a consolidated scheme for the resolution of insolvency of corporate persons, partnerships and individuals (See: Statement of Objects & Reasons).

Under the Code, an application for the initiation of proceedings of insolvency resolution can be filed by a financial creditor (Section 7), an operational creditor (Section 9) or by the indebted company itself (Section 10). Once the Adjudicating Authority satisfies itself that a debt is owed by the corporate entity; the Adjudicating Authority admits the application and declares a moratorium on the 'Corporate Debtor'. Thereafter, a Resolution Professional ("RP") is appointed who takes over the management of Corporate Debtor and keep it as a going concern. The RP also constitutes a Committee of Creditors ("COC"), made up of the financial creditors of the Corporate Debtor.

Subsequently, the RP invites resolution plans ("plans") from interested resolution applicants who may want to revive, restructure or simply take over the Corporate Debtor. In view of the fact that creditors now have debts to the tune of hundreds of crores lined up and that resolution applicants would want the process to be efficacious for it to make commercial sense, the Code and the appended Regulations provide detailed timelines for each step of the process.

On the receipt of various plans, the COC votes on each one of them and the plan receiving more than 66% of the votes of the financial creditors is accepted. The accepted plan is then placed by the RP before the Adjudicating Authority ("AA"), which is tasked with a confined mandate of ensuring that no provision of the Code has been breached and that the plan is not motivated by extraneous or mala fide considerations. In absence of any breach, the AA approves the resolution plan and lifts the moratorium, allowing the successful resolution applicant to revive the corporate debtor. As per the Code, the CIRP) is to be completed within a period of 180 days with an outer limit of 330 days. It is this timeline that has been held by Nariman J. to be manifestly arbitrary.

However, in our view, there was no need though for him to take recourse to this constitutional doctrine at all. The concerns about the strictness of the timeline could have been addressed by the ordinary tools of statutory interpretation.

Directory v Mandatory

Section 12 of the Code that speaks about the timeline of the CIRP says,

"(1) Subject to sub-section (2), the corporate insolvency resolution process shall be completed within a period of one hundred and eighty days from the date of admission of the application to initiate such process.

(2) The resolution professional shall file an application to the Adjudicating Authority to extend the period of the corporate insolvency resolution process beyond one hundred and eighty days, if instructed to do so by a resolution passed at a meeting of the committee of creditors by a vote of [sixty-six] per cent. of the voting shares.

(3) On receipt of an application under sub-section (2), if the Adjudicating Authority is satisfied that the subject matter of the case is such that corporate insolvency resolution process cannot be completed within one hundred and eighty days, it may by order extend the duration of such process beyond one hundred and eighty days by such further period as it thinks fit, but not exceeding ninety days:

Provided that any extension of the period of corporate insolvency resolution process under this section shall not be granted more than once:

Provided further that the corporate insolvency resolution process shall mandatorily be completed within a period of three hundred and thirty days from the insolvency commencement date, including any extension of the period of corporate insolvency resolution process granted under this section and the time taken in legal proceedings in relation to such resolution process of the corporate debtor:"

While there is no definition of CIRP, the structure of the Code makes it seem that the process logically comes to an end on the approval of the successful plan by the AA. However, nowhere in the Code do we find any mention of the consequences of the non-approval of the Resolution Plan by the Adjudicating Authority within the time-frame of 330 days. In the absence of any consequences for the violation of a mandatory clause, the Supreme Court could have simply read the clause to be directory in nature. It is now a well settled proposition of law that a clause which is mandatorily worded is in fact mandatory only if there are certain consequences listed for the breach of that clause. Therefore, this issue could have been resolved simply by resorting to a rule of statutory interpretation.

Harmonious Construction of Provisions

It could also have been resolved by a harmonious construction of Section 12 with Section 33 of the Code. Section 33 lists out the instances when the liquidation of a corporate entity may be initiated. It says,

"(1) Where the Adjudicating Authority, –

(a) before the expiry of the insolvency resolution process period or the maximum period permitted for completion of the corporate insolvency resolution process under section 12 or the fast track corporate insolvency resolution process under section 56, as the case may be, does not receive a resolution plan under sub-section (6) of section 30; or

(b) rejects the resolution plan under section 31 for the non-compliance of the requirements specified therein, it shall –

(i) pass an order requiring the corporate debtor to be liquidated in the manner as laid down in this Chapter;

(ii) issue a public announcement stating that the corporate debtor is in liquidation; and

(iii) require such order to be sent to the authority with which the corporate debtor is registered." (emphasis supplied)

A worry with the non-approval of a Resolution Plan within 330 days has been that the corporate entity is then sent into liquidation, a consequence that may not lead to a maximisation of the assets of that entity and may even truncate what the financial creditors and workers would receive. It is definitely a consequence that the AA would want to avoid unless absolutely necessary. However, Section 33 makes it clear that liquidation would not automatically ensue on a mere non-approval of the plan within the 330 days' time period. Liquidation is the outcome only when either (i) no plan whatsoever is received by the Adjudicating Authority or (ii) the plan received is rejected.

In fact, the joint reading of the second proviso of Section 12 and Section 33(1)(a) suggests that it is only mandatory for the RP to submit a Resolution Plan to the Adjudicating Authority within 330 days. It is not mandatory for the AA to also approve the plan within 330 days.

While the pendency of a plan before the AA could have its own set of commercial consequences, the Legislature seems to have made it quite clear what the scheme ought to be. Based on this construction of Sections 12 and 33 too then, Nariman J. could have resolved the issue. There seems to have been little need to resort to Article 14 of the Constitution.

Little Basis to Say 'Manifestly Arbitrary'

Leaving aside the fact that this issue could have otherwise been addressed, the use of the doctrine of 'manifest arbitrariness' itself is worrisome. To say that the word 'mandatorily' in Section 12 shall be read down, Nariman J says (Para 79),

"Given the fact that the time taken in legal proceedings cannot possibly harm a litigant if the Tribunal itself cannot take up the litigant's case within the requisite period for no fault of the litigant, a provision which mandatorily requires the CIRP to end by a certain date – without any exception thereto – may well be an excessive interference with a litigant's fundamental right to non-arbitrary treatment under Article 14 and an excessive, arbitrary and therefore unreasonable restriction on a litigant's fundamental right to carry onbusiness under Article 19(1)(g) of the Constitution of India. This being the case, we would ordinarily have struck down the provision in its entirety. However, that would then throw the baby out with the bathwater, inasmuch as the time taken in legal proceedings is certainly an important factor which causes delay, and which has made previous statutory experiments fail as we have seen from Madras Petrochem (supra). Thus, while leaving the provision otherwise intact, we strike down the word "mandatorily" as being manifestly arbitrary under Article 14 of the Constitution of India and as being an excessive and unreasonable restriction on the litigant's right to carry on business under Article 19(1)(g) of the Constitution." (emphasis supplied)

What this means is that in the one-off case where the AA is unable to either approve or reject the resolution plan within the stipulated time period, the corporate debtor shall head into insolvency and this will adversely affect the rights of the litigants and stakeholders. As has already been spelled out, the statutory scheme does not say that a corporate debtor must head into liquidation and therefore, it was unwarranted to use a constitutional doctrine to account for a mechanism not contemplated by statute..

Even if we were to assume for a moment that liquidation did ensue, the use of this doctrine does not meet the very standards prescribed for it either. When enunciating the doctrine in Sharaya Bano v Union of India ("Sharaya Bano"), Nariman J. said that a provision of law would be manifestly arbitrary if it lacked a clear determinative principle or encapsulated a capricious or irrational measure (Para 55). It was this very standard that was followed in Navtej Johar v Union of India ("Navtej") as well by him (Para 82), by Misra and Khanwilkar JJ.(Paras 238-39) and by Malhotra J (Para 14.9).

On this metric, it can hardly be said that Section 12 of the Code is manifestly arbitrary. A strict time-period was prescribed precisely to avoid the unpleasant situation that creditors found themselves in under previous statutes such as the Sick Industrial Companies (Special Provisions) Act, 1985. Those systems were found to be inefficient and tardy and were hardly of any assistance in pulling the economy out of quagmire of non-performing and stressed assets that it found itself in.

In fact, the Supreme Court itself in various judgements including Arcelor Mittal (India) (P) Ltd. v. Satish Kumar Gupta, Innoventive Industries Ltd. v. ICICI Bank, and Swiss Ribbons (P) Ltd. v. Union of India ("Swiss Ribbons"), has noted the importance of a time bound resolution of corporate debtors to maximize the assets for the stakeholders. In Swiss Ribbons, the court observed,

"27. As is discernible, the Preamble gives an insight into what is sought to be achieved by the Code. The Code is first and foremost, a Code for reorganisation and insolvency resolution of corporate debtors. Unless such reorganisation is effected in a time-bound manner, the value of the assets of such persons will deplete.Therefore, maximisation of value of the assets of such persons so that they are efficiently run as going concerns is another very important objective of the Code.

….

Timely resolution of a corporate debtor who is in the red, by an effective legal framework, would go a long way to support the development of credit markets. Since more investment can be made with funds that have come back into the economy, business then eases up, which leads, overall, to higher economic growth and development of the Indian economy. What is interesting to note is that the Preamble does not, in any manner, refer to liquidation, which is only availed of as a last resort if there is either no resolution plan or the resolution plans submitted are not up to the mark. Even in liquidation, the liquidator can sell the business of the corporate debtor as a going concern.

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28.

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The timelines within which the resolution process is to take place again protects the corporate debtor's assets from further dilution, and also protects all its creditors and workers by seeing that the resolution process goes through as fast as possible so that another management can, through its entrepreneurial skills, resuscitate the corporate debtor to achieve all these ends." (emphasis supplied)

Therefore, even without looking at the legislative history or parliamentary debates surrounding the Code and its amendments, the very observations of the Supreme Court suffice to suggest that a clear and determinative principle undercuts Section 12 of the Code. Section 12 can hardly be said to be lacking a determinative principle the way Section 377 of the Indian Penal Code did. It is not capricious or irrational by any means either.

Just because the application of a principle leads to some hardship in a one-off situation, it does not make the entire section manifestly arbitrary. The hardship could well have been accounted for by the Legislature and in some cases, could have been the only feasible option available to it. To cure such hardships that follow from statutory structures using the doctrine of arbitrariness only opens a gateway to substitute legislative choices with judicial wisdom.

In Sharaya Bano, Nariman J. sidelined this criticism by simply saying that our jurisprudence is replete with instances where courts have sat in decision over legislative wisdom {Para 44(3)}. However, this case for one is a good example to show how this criticism could have more depth than what Sharaya Bano attributed to it. The threat of liquidation and the associated minimization in the assets of the corporate debtor could have specifically been devised by Parliament to compel the AA to approve the plan in a time-bound manner.

While he substitution of judicial wisdom for legislative wisdom may be warranted and even welcome in some scenarios where say, fundamental rights, are at stake, doing so without a degree of circumspection may definitely dent the legitimacy of the doctrine in times to come. In fact, this may happen in the present instance itself. Even before the decision in Essar, there have been case where the AA has not approved a plan even after a year of its submission. While Nariman J. says that the time period should only be extended beyond 330 days where the AA has not been able to approve the plan because of its own failings, there is no outer cap on how long this extension can be or what counts as a justifiable basis for the AA. In fact, the Supreme Court would not be able prescribe this either because doing so would effectively add a third proviso to Section 12.

The outcome of Essar has only been that the AAs now have a precedent to fall back on when taking their own sweet time to approve resolution plans. Financial creditors continue to struggle to recover their dues and there are now instances where resolution applicants even want to withdraw their plans because of the tardiness of the system. There is also plenty of data being now emerging which suggests that the Code has not led to the revival of stressed assets in the manner envisaged. In these circumstances, there is plenty to say for the decision of Nariman J. and not the Code resulting in manifestly arbitrary outcomes. 'Manifest arbitrariness' is a powerful tool and one that may lead the Judiciary into unchartered territory. Circumspection in its use thus is better exercised sooner rather than later.

Views are personal only.

(Dhruva Gandhi and Sahil Raveen, advocates at the Bombay and Delhi High Courts respectively)

This Article was originally published in theIndian Constitutional Law and Philosophy. Read the original Article here