IBC passes another test of constitutionality as SC upholds IBC Amendments Act 2020
By Megha Mittal and Ishika Basu
In view of the rising need to fill critical gaps in the corporate insolvency framework like last-mile funding and safeguarding the interests of resolution applicants, certain amendments were introduced by way of the Ordinance dated 28 December 2019, which were later on incorporated in the Insolvency Bankruptcy Code (Amendment) Act, 2020 (Amendment Act). The IBC amendments related to introduction of threshold for filing of application by homebuyers and section 32A for ablution of past offences of the corporate debtor, were made effective from 28 December 2019, that is, the date of Ordinance.
While the Ordinance introduced several amendments, clarificatory as well as in principles, apprehensions were raised against proviso to section 7 (1), that is, threshold for filing of application by homebuyers, the ablution provision introduced by way of section 32A, and clarification under section 11 dealing with the rights of a corporate debtor against another company. As such, various writ petitions were filed under Article 32 of the Constitution, alleging that the aforesaid IBC amendments were in contravention of the fundamental rights like Article 14 which deals with the equality before law and equal protection of law; Article 19(1)(g) deals with fundamental right to trade, occupation, and business; and Article 21 deals with the right to life and personal liberty.
Now, after a year of its effect, the Supreme Court in its 19 January 2021 order, in Manish Kumar V/s Union of India, upheld the constitutional validity of the third proviso to section 7(1) and section 32A, setting aside all apprehensions against their insertion.
In this article, the authors analyses the order of the Supreme Court, with respect to the threshold on filing of application by homebuyers, and section 32A.
Issues under Consideration
The third proviso to section 7(1) provides that the financial creditors mentioned under clause (a) and clause (b) of subsection (6A) of Section 21 (i.e. debenture holders and other security holders)and the allottees of real-estate projects can make application for initiation of CIRP against the corporate debtor only if 1) the application has been made jointly by not less than 100 allottees of a particular project; or 2) 1/10th of the total number of allottees of the particular project, whichever is lower.
Further, section 32A provided that all the liability of corporate debtor, committed prior to commencement of corporate insolvency resolution process (CIRP) should be discharged post-CIRP provided that there is a change in the management and control of the corporate debtor, and the person who shall have the control and right over management of corporate debtor as per resolution plan should not be in any manner involve in the default or abetted in the default.
Challenging the Constitutional Validity
Third Proviso to section 7
More than a lion’s share of the petitions were filed by homebuyers, who alleged that the impugned amendment is contravening the provision of Article 14 (Equality before law, Equal protection of law),19(1) (g), 21 and 300A of the Constitution and is discriminatory towards the homebuyers vis-à-vis other financial creditor.
It was alleged that by imposing the thresholds for real-estate creditors, the object of the law stands defeated and the Ordinance not only deprives the real-estate creditorsfrom their right u/s 7 but also violates the provision of Article 14. It was contended that despite the aim of the Legislature to improve the ease of doing business in India, the Amendment Act is restrictive in nature, obstructing the allottees from recovering their claim. Drawing reference to the landmark case of Pioneer Urban Land and Infrastructure Ltd. and Anrv. Union of India and Ors, where the Hon’ble SC upheld the right of real-estate creditors to file an application against the insolvent debtor, the Petitioners submitted that the Legislature was now estopped from enacting the said Amendment which imposed additional conditions for application by real-estate creditors.
Further, the other arguments raised by the petitioners were based on impracticalities by virtue of disparity in ‘date of default’ for different home-buyers, confirmation of the numerical strength on the date of filing or till admission, treatment of joint-allottees, as well as the non-workability of the threshold in view of limited availability of information about the fellow creditors, home-buyers, power of the CG to impose additional restrictions etc.
The principal argument was based on the fact that there is already a threshold limit of amount of default of INR 1 crore, and any further threshold limit would be discriminatory for the real-estate creditors, without any intelligible differentia.
Ablution u/s 32A
It was argued by the Petitioners that the immunity granted to the corporate debtor and its assets acquired from the proceeds of crimes and any criminal liability arising from the offences of the erstwhile management for the offences committed prior to initiation of CIRP further jeopardizes the interest of the allottees/creditors. It was contended that such ablution would cause huge losses which is sought to be prevented under the provisions of the Prevention of Money Laundering Act, 2002. Hence, section 32A was argued to be arbitrary, ultra-vires and violative of Article 300-A and Articles 14, 19 and 21.
Observation of the Court- the Final Verdict
While observing that there is nothing like a perfect law and as with all human institutions, there are bound to be imperfections, the Hon’ble Supreme Court appreciated that what is significant is that for the court ruling on constitutionality, the law must present a clear departure from constitutional limits. The issues in consideration, being economic reforms the wider latitude given to the law giver is based on sound principle and tested logic over time. That being said, the Apex Court upheld the amendments introduced vide the Amendment Act as constitutional, and gave certain filing relaxations to the real-estate creditors based on the clarified position of law.
Below, we discuss and analyse the observations on the Apex Court:
Analysis
Third Proviso to section 7
The third proviso to section 7 of the Code, imposing additional thresholds for initiation of insolvency proceedings by real-estate creditors was introduced in the backdrop of multiple individual applications by creditors, the need for safeguarding the interest of hundreds or even thousands of allottees who may oppose the application of single home buyer, and to ensure a smoother and cost effective process.
Based on the arguments placed by the Petitioner-Creditors and the Respondent (UoI), the Hon’ble SC made the following observations-
No discrimination against the homebuyers
The Constitution of India guarantees an equitable treatment of law for all. It must be noted that the term “equitable” does not connote “equal”; rather, it means that the principles applied on one shall be same as that applied to another. Hence, where there exists an intelligible differentia for applying tweaked principles on a certain class, on the basis of the nature of contract and other related factors, the same cannot be said to an unequitable treatment.
The Apex Court observed that what distinguishes the real-estate creditors from other financial creditors is numerosity, heterogeneity and individuality in decision making. Thus, acknowledging the possibility of individual allottees crowding the Adjudicating Authority, and hence becoming a peril for the law, the amendment was thought fit in view of the numerosity. Further, given that the homebuyers are not completely denied the right to recourse under the Code, the additional threshold could not be considered as being discriminatory.
Centre not subject to Estoppel
Another interesting argument raised by the homebuyers was the applicability of ‘principle of estoppel’ on the legislature, in view of the order of the SC in Pioneer Urban Land (supra) wherein the rights of homebuyers as FCs were upheld.
The Apex Court clarified that “A supreme legislature cannot be cribbed, cabined, or confined by the doctrine of promissory estoppel or estoppel. It is incontestable that promissory estoppel serves as an effective deterrent to prevent injustice from a Government or its agencies which seek to resile from a representation made by them, without just cause.
While in Union Of India &Ors vs Godfrey Philips India Ltd. Etc, the SC held that “the doctrine of promissory estoppel is applicable against the Government in the exercise of its governmental, public or executive functions at the doctrine of executive necessity or freedom of future executive action cannot be invoked to defeat the applicability of the doctrine of promissory estoppel”, in the instant case, the action of the Legislature was not against an explicit directive of its own, or in the nature of a complete denial of rights of the homebuyers.
Hence, in view of the fact that homebuyers, who may not satisfy the additional conditions imposed by the Amendment Act, they would still have recourse under other statues like RERA. Thus, where the amendment has been introduced to avoid the misuse of law by individual creditors, the principle of estoppel would not apply.
Mere difficulties not a reason to strike down a law
As regards several arguments raised on account on practical difficulties, the SC held that “the mere difficulties in given cases to comply with a law can hardly furnish a ground to strike it down,” and as such, upheld the introduction of the proviso to section 7 (1) of the Code.
Ablution u/s 32A
As discussed above, as per section 32A no action shall be taken against the properties of the corporate debtor provided that there is a change in the control and management of the corporate debtor who are not involved in default in any manner.
The statutory basis of this section has already been established in the case of Essar Steel, and can be tracked down to the order of NCLAT in JSW Steel Ltd v. Mahender Kumar Khandelwal&Ors, where the question of attachment of assets of Bhushan Power & Steel Limited was considered. Reference may also be drawn to report of the Insolvency Law Committee.
The main purpose of this section is to give a fresh start to the corporate debtor after the resolution applicant has taken over the management of the corporate debtor pursuant to the resolution plan. However, in order to mitigate the risk of misuse of such ablution, this section does not discharge the liability of the persons who have committed or abetted in commission of offence — section 29A disqualifies certain person who cannot be Resolution Applicant which also include the erstwhile promoters who have committed default or involved in the offence. Hence, the resolution applicant generally shall not be involved in the offence in any manner who deserves a fresh start.
Also See: Key takeaways from Supreme Court judgement upholding amendments in Section 7, 11 and 32A
As regards the arguments raised regarding the unconstitutionality of section 32A, the Apex Court observed that “the extinguishment of the criminal liability of the CD is apparently important to the new management to make a clean break with the past and start on a clean slate”. It further held that “Attaining public welfare very often needs delicate balancing of conflicting interests. As to what priority must be accorded to which interest must remain a legislative value judgement and if seemingly the legislature in its pursuit of the greater good appears to jettison the interests of some, it cannot, unless it strikingly ill squares with some constitutional mandate, suffer invalidation”
As such, in view of the fact that the ablution was warranted to motivate resolution applicants, and hence achieve the objective of the Code, section 32A cannot be held as unconstitutional, as all necessary checks and balances have been provided for to avoid misuse.
While the Apex Court did not find any substance in the contentions raised against section 32A, there are several loose threads, which may be considered by the law-makers like the scope of ‘offences’ that shall stand absolved upon a successful resolution plan, absence of any exemptions for MSMEs. In absence of any defined ‘scope’ as mentioned above, SEBI, in its Report on the Measures for Strengthening the Enforcement Mechanism of the Board and Incidental Issue recognized that by virtue of the fact that the meaning of ‘offence’ is not limited to criminal offences only (Held by the SC in Standard Chartered Bank v. Directorate of Enforcement), the scope of section 32A becomes wide indeed. SEBI also pointed out that the immunity under section 32A of the IBC would also include a violation committed by the corporate debtor under securities laws, and as such debar actions provided for under SEBI. As such, SEBI in its Report made several proposals by way of exceptions to section 32A.
Thus, the authors are of the view that the SC, by way of the instant order has upheld the constitutional validity as well as commercial importance of section 32A, thus putting to rest all apprehensions against its introduction.
Megha Mittal is an Associate and Ishika Basu is an executive with Kolkata-based Company Secretary and corporate law firm Vinod Kothari & Company. The article first appeared in http://vinodkothari.com/2021/01/ibc-passes-another-test-of-constitutionality/
