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More than a debt recovery tool

Does the Insolvency and Bankruptcy Code fix debt or fuel the economy, asks Debarshi Chakraborty

More than a debt recovery tool

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Ludwig Wittgenstein, the 20th-century Austrian philosopher, observed that words do more than communicate; they shape the way we see the world. This idea finds striking relevance in the context of the Insolvency and Bankruptcy Code (IBC). Consider the word ‘resolution,’ which suggests images of experts working to save a struggling business. Replace it with recovery, and the tone shifts entirely. Now, it feels less like a rescue mission and more like creditors gathering at the debtor’s door, demanding their dues. This is not just a semantic nuance – it reveals a deeper tension within the IBC.

IBC’s Dual Role

When Finance Minister Nirmala Sitaraman praised the IBC for resolving over 1,000 companies in her budget speech, swiftly followed by the mention of Rs. 3.3 lac crore  recovered, it was more than just a celebratory footnote – it encapsulated the duality at the heart of IBC. The IBC, as introduced by the late Arun Jaitley in 2015, was designed not only as a corporate lifeline but also as a mechanism for creditors to recover dues. From the outset, the IBC has been clear about this balance between rescue and recovery.

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Whenever a creditor – whether a financial lender owed a loan or an operational supplier awaiting payment – files an insolvency petition, the corporate debtor is immediately thrust into a precarious position, beneath the proverbial Damocles’ sword. Each tick of the clock weakens the thread holding it in place, amplifying the pressure. For the creditor, the expectation is simple – the mere presence of this threat should push the debtor towards a swift settlement to avert commercial collapse. The debtor, however, clings to a different hope – that the sword’s blade might be dulled by time, or that a legal defence could deflect it before it strikes.

From Private to Public

Once the corporate debtor is admitted into insolvency, the nature of the process transforms dramatically from private negotiation to a collective, public endeavour. The Supreme Court’s ruling in Swiss Ribbons v. UOI (2019) and subsequent cases highlights that pre-admission, the petitioning creditor’s claims and the debtor’s obligations are a private affair. However, post-admission, the process evolves into an ‘in rem’ procedure, engaging all stakeholders – creditors, suppliers, and employees. This transition is vital keeping in mind the IBC’s goal of comprehensive resolution of financial distress, while maximising value for all involved.

The rules governing insolvency underscore a clear distinction between pre-admission and post-admission scenarios. Rule 8 of the Insolvency and Bankruptcy (Application to Adjudicating Authority) Rules, 2016, grants the National Company Law Tribunals (NCLT) the discretion to permit withdrawal of an insolvency petition if requested by the creditor or debtor before it is admitted. However, the process becomes significantly more rigorous after admission. Section 12A of the IBC mandates that withdrawal of an admitted petition requires the approval of 90 per cent of the Committee of Creditors (CoC). In practice, this often leads to suspended management challenging the insolvency admission order before the National Company Law Appellate Tribunal (NCLAT), seeking a stay on the formation of the CoC, while negotiating settlement with the petitioning creditor to bypass CoC scrutiny and regain control.

In typical settlement scenarios, parties often strike agreements where the management undertakes to initiate steps under the IBC to withdraw insolvency proceedings before the CoC is even formed. This tactic effectively bypasses the rigorous requirements of  Section 12A, allowing the debtor to sidestep CoC approval entirely. While this manoeuvre might appear effective when dealing with a single creditor, the situation becomes considerably more complex when the debtor owes multiple creditors. Settling solely with the petitioning creditor while neglecting others amounts to a  ‘robbing Peter to pay Paul’ approach, leading to superficial resolutions that unfairly disadvantage other creditors.

For operational creditors, early settlements offer a pragmatic advantage, given their subordinate position in the payout hierarchy. If the debtor enters liquidation, these creditors often receive a mere fraction – or nothing – of their dues.  Opting to settle early ensures at least partial recovery, avoiding the uncertainty and meagre returns that liquidation offers. However, this approach, though beneficial to the immediate parties, exposes a deeper flaw in the insolvency framework. It bypasses the collective resolution intent of the IBC, allowing individual settlements to undermine the integrity of the process.

Byju’s Case

The ongoing Byju case, before the Supreme Court, highlights this tension. By swiftly settling a Rs. 158 crore debt with the Board of Cricket Control for India (BCCI) – petitioning (operational) creditor – before the CoC could be formed, Byju’s management skirted the safeguards meant to ensure fair distribution of resources. This strategic prioritisation of one creditor – potentially to secure control or avoid deeper scrutiny – sparked sharp objections from GLAS, a financial creditor.

The crux of GLAS’s grievance lies in the misuse of pre-CoC dynamics, whereby Byju’s management allegedly diverted resources that should have been equitably allocated to all creditors. The Supreme Court’s stay on the NCLAT’s order in Byju’s case has brought the spotlight back on a foundational tenet of IBC – sanctity of collective creditor resolution. The Court’s intervention, though succinct, underscored that insolvency is not a pick-and-choose process; every creditor’s claim, big or small, must be accounted for within the collective framework.

Setting Sail for Stability

The Byju’s case is a textbook illustration of Mancur Olson’s ‘Collective Action’ theory, where individual creditors manipulate insolvency proceedings to settle personal debts, thus jeopardising the collective interests of all creditors. This highlights the need for insolvency petitions to represent a broader financial community rather than just the petitioner. Section 7(1) of the IBC already contemplates this by allowing financial creditors to initiate insolvency proceedings even in cases where the default belongs to another creditor. Once a default is identified by the adjudicating authority, the process should focus on addressing the distress of the debtor as a whole, not merely the claims of the petitioner. In the same vein, Section 12A, which permits withdrawal from insolvency, should only apply where a comprehensive settlement with all creditors is achieved.

This reminds that IBC is more than just a debt recovery tool – it is a safeguard for the economy. Debt recovery is crucial, but as Olson warns, unchecked self-interest can upend the system. Wittgenstein’s language theory drives it home – by prioritising ‘resolution’ over ‘recovery,’ the IBC ensures businesses not only clear their debts but thrive. It is a fine balance, but like a well-steered ship, it propels the economy forward, with creditors and stakeholders reaping the rewards. In the end, it is not just about staying afloat – it is about setting sail.

The writer is an Advocate at the Delhi High Court

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