Supreme Court Upholds Constitutional Validity of Insolvency and Bankruptcy Code, 2016, Affirming Differentiation Between Financial and Operational Creditors

Landmark Judgment Validates Provisions on Committee of Creditors, Resolution Applicants’ Eligibility, and Role of Information Utilities, Emphasizing Economic Policy and Legislative Experimentation

In a significant judgment delivered on January 25, 2019, the Supreme Court of India upheld the constitutional validity of various crucial provisions of the Insolvency and Bankruptcy Code, 2016 (IBC), reinforcing the legislative framework for insolvency resolution and liquidation in the country. The judgment, pronounced by a bench comprising Justices R.F. Nariman and Navin Sinha, meticulously addressed challenges to the distinctions drawn by the Code between financial creditors and operational creditors, the eligibility criteria for resolution applicants, the functioning of the National Company Law Tribunal (NCLT) and its appellate body (NCLAT), and the establishment and role of information utilities.

The Court emphasized that the Insolvency Code represents a paradigm shift from the erstwhile fragmented and inefficient insolvency regime to a consolidated, time-bound legal framework aimed at maximizing the value of assets of corporate debtors and promoting entrepreneurship and credit availability. Recognizing the Code’s primary objective as the reorganization and revival of corporate entities rather than mere recovery for creditors, the Court upheld the classification of creditors into financial and operational categories, holding that such differentiation is neither arbitrary nor discriminatory but is rooted in the distinct nature of their contracts and roles. Financial creditors, typically banks and financial institutions, are engaged in assessing the viability of corporate debtors and restructuring loans, whereas operational creditors primarily supply goods and services and are usually unsecured.

The Court clarified that under Section 7 of the Code, a financial creditor may trigger the insolvency resolution process upon default, which is ascertained based on records maintained by information utilities and other documentary evidence. The corporate debtor is provided an opportunity for hearing before the Adjudicating Authority admits or rejects such an application. Operational creditors, on the other hand, follow a separate procedure involving notice and dispute resolution under Sections 8 and 9, with the right to raise disputes at the initial stage. The Court found that the Code adequately safeguards the rights of both types of creditors, with operational creditors guaranteed priority in payments and representation at committee meetings if their dues aggregate to 10% or more of the total debt, albeit without voting rights.

Addressing challenges to Section 29A, which bars certain persons including wilful defaulters and those with non-performing assets (NPAs) beyond a stipulated period from submitting resolution plans, the Court ruled that no vested right is infringed by this provision. The Court underscored the legislative intent to exclude unscrupulous persons from the resolution process to ensure effective corporate governance and maximize asset value. The one-year period for NPA classification, as per Reserve Bank of India guidelines, was upheld as a reasonable and non-arbitrary policy measure. The Court also upheld the restriction on relatives and connected persons of ineligible applicants from participating, interpreting the term “connected person” to mean those with genuine business connections.

The Court further directed the establishment of Circuit Benches of the NCLAT across the country to ensure convenience and accessibility of appellate remedies, as mandated by its earlier judgments. It also addressed the administrative anomaly of tribunals functioning under the Ministry of Corporate Affairs instead of the Ministry of Law and Justice, urging compliance with the Supreme Court’s directions and the constitutional scheme.

On the role of information utilities, the Court recognized that their certificates constitute prima facie evidence of default, subject to verification and rebuttal by the corporate debtor, thereby expediting the resolution process while safeguarding fairness. The resolution professional’s role was clarified as administrative and facilitative, without adjudicatory powers, with oversight by the committee of creditors and the Adjudicating Authority.

The judgment highlighted the successful impact of the Code since its inception, noting substantial improvements in credit flow to the commercial sector and enhanced recovery rates, thereby dispelling the notion of a “defaulter’s paradise.” The Court concluded that the Code’s provisions, viewed as a legislative experiment in economic regulation, must be accorded judicial deference unless manifest arbitrariness or constitutional infirmity is demonstrated, which was not found in this case.

This landmark ruling consolidates the legal foundation of the IBC, providing clarity and assurance to stakeholders and reinforcing India’s commitment to a robust insolvency regime that balances creditor interests, protects corporate debtors, and fosters economic growth.

Statutory provisions

Insolvency and Bankruptcy Code, 2016 Sections 5, 7, 8, 9, 12A, 14, 18, 21, 24, 28, 29A, 30, 31, 38, 40, 41, 42, 53, 65, 75, 210; Companies Act, 2013 Sections 164, 412, 420; Insolvency and Bankruptcy (Application to Adjudicating Authority) Rules, 2016 Rules 4, 11, 34, 37; Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations, 2016 Regulations 16A, 16B, 30A, 35A, 38; Insolvency and Bankruptcy Board of India (Information Utilities) Regulations, 2017 Regulations 20, 21; Micro, Small and Medium Enterprises Development Act, 2006 Section 7; Reserve Bank of India Master Circular on Prudential Norms on Income Recognition, Asset Classification and Provisioning pertaining to Advances (2015).

Swiss Ribbons Pvt. Ltd. v. Union of India (SC) : Law Finder Doc Id # 1347340