Insights
August 2, 2017

INDIA - INSOLVENCY LAW UPDATE - ACTION AGAINST ESSAR STEEL UPHELD

Introduction

The Indian government enacted the Insolvency and Bankruptcy Code, 2016 (the “ Code”) to consolidate the law on insolvency in India, and provide an effective and timebound mechanism for recovering debts due to both, financial as well as operational creditors. The provisions of the Code are being tested in Indian courts, and an important ruling has been passed by India’s Supreme Court (the “Court”) on out-of-court settlements between parties following the commencement of insolvency proceedings.

Background

Nisus Finance & Investment Manager LLP (“Nisus”), a financial creditor acting as a facility agent under a debenture trust deed (the “Trust Deed”), initiated insolvency proceedings against Lokhandwala Kataria Construction Pvt. Ltd. (the “ Company”), a guarantor under the Trust Deed for repayment of the borrowings (against debentures) by Vistas Homes Pvt. Ltd., a group company. By an order dated June 15, 2017, the National Company Law Tribunal, Mumbai Bench, Mumbai (the “NCLT”) admitted the insolvency application against the Company observing that the Company was under an obligation to repay the debenture holders, which was not done, and the corporate insolvency resolution process could, therefore, be initiated.

Being aggrieved, the Company filed an appeal before the National Company Law Appellate Tribunal (the “NCLAT”) against the admission order of the NCLT. However, during the pendency of the appeal, a settlement was arrived at between Nisus and the Company, and the Company made a part payment to Nisus. Following this, the lawyers of Nisus and the Company sought to withdraw the appeal filed before the NCLAT. However, the NCLAT rejected this request under Rule 8 of the Insolvency and Bankruptcy (Application to Adjudicating Authority) Rules, 2016, which stipulates that an application may be permitted to be withdrawn only before its admission. Once the application is admitted, the process as prescribed under the Code has to be followed.

The Company’s lawyer requested the NCLAT to exercise its inherent powers under Rule 11 of the National Company Law Appellate Tribunal Rules, 2016 (the “NCLAT Rules”) and permit the withdrawal of the appeal. However, by its order dated July 13, 2017, the NCLAT rejected this request on the ground that no merits existed. It dismissed the appeal filed by the Company and directed the NCLT to continue the corporate insolvency resolution process.

Appeal before India’s Supreme Court and its Ruling

Being aggrieved by the NCLAT’s order dated July 13, 2017, the Company approached the Court, especially challenging the NCLAT’s refusal to exercise its inherent powers under Rule 11 of the NCLAT Rules.

Interestingly, the Court opined that the NCLAT was “prima facie” correct in its interpretation of Rule 11 of the NCLAT Rules and that the inherent powers of the NCLAT could not be utilized in such a situation. However, in the exercise of its inherent powers under Article 142 of the Constitution of India (which allows the Court to pass such decree or order as is necessary in the interest of justice), the Court allowed the parties to file Consent Terms (recording terms of settlement) along with an undertaking from the Company to abide by the Consent Terms. In so doing, by its order dated July 24, 2017 (the “Ruling”), the Court set aside the orders of the NCLT and the NCLAT, and disposed of the appeal.

Our Comments

In our view, the Ruling will open the door for use of the Code as a pressure tactic to arrive at bipartite settlements. This will go contrary to the intention behind the Code, which is to ensure speedy insolvency and winding up for the benefit of all creditors.

Although the Court upheld that the NCLAT’s interpretation of the NCLAT Rules (disallowing Nisus to withdraw the insolvency application under the Code after its admission), effectively, it permitted a disposal of an insolvency proceeding on the basis of an inter se settlement between the parties. The Ruling will, therefore, embolden many other creditors to approach the Court after admission of an application under the Code to file settlement Consent Terms with a debtor, and thereby, frustrate and prevent other creditors from continuing the insolvency resolution process against that debtor. The Indian government will have to quickly address this issue and amend the Code in this regard.

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