Awards no longer ‘debt’ under IBC? What financial creditors must know

March 17, 2020 4:24 PM

The Code has seen several amendments since its inception to address teething issues faced due to dissimilar interpretations or unwarranted application of the Code by different authorities and stakeholders.

The credible threat of IBC process that a company may change hands has changed the behaviour of debtors.Section 65 thus looks at the ‘purpose’ for which the application was filed and penalizes applicants where the purposes are for mere recovery of a specific debt.
  • By Charanya Lakshmikumaran, Partner & Puneeth Ganapathy

The Objectives of the Insolvency and Bankruptcy Code, 2016 (‘Code’) are well documented. The Code has seen several amendments since its inception to address teething issues faced due to dissimilar interpretations or unwarranted application of the Code by different authorities and stakeholders. While it has been stated time and again that the Code is not a mechanism for recovery, its practical application in various contexts continues to be in the nature of a recovery procedure.

Section 65 of the Code provides as follows:

“65. Fraudulent or Malicious Initiation Of Proceedings. – If, any person initiates the insolvency resolution process or liquidation proceedings fraudulently or with malicious intent for any purpose other than for the resolution of insolvency, or liquidation, as the case may be, the Adjudicating Authority may impose upon such person a penalty which shall not be less than one lakh rupees, but may extend to one crore rupees”

Section 65 thus looks at the ‘purpose’ for which the application was filed and penalizes applicants where the purposes are for mere recovery of a specific debt.

In its recent decision in C. Shivakumar Reddy v. Dena Bank & Anr, Judgment dtd. 18th December 2019 in Company Appeal (AT) (Insolvency) No. 407 of 2019, the NCLAT held that the relevant insolvency application was barred by limitation. However, since in this case the financial creditor had also approached the Debt Recovery Tribunal and obtained a decree.

Similarly, in International Asset Reconstruction Co. Pvt. Ltd. v. Jayant Vitamins Ltd., Judgement dtd. 17th December 2019 in Company Appeal (AT) (Insolvency) No. 1472 of 2019, the NCLAT passed a short order upholding the dismissal of an application by a Financial Creditor on the ground that an insolvency application while the execution of a decree was pending, was improper.

This trend follows from another decision in HDFC Bank Ltd. v. Bhagwan Das Auto Finance Ltd., Judgment dtd. 9th December 2019 in Company Appeal (AT) (Insolvency) No. 1329 of 2019, where a three-judge bench of the NCLAT clearly, and unequivocally dismissed an insolvency application solely on the ground that the Code could not be used to execute an arbitral award or decree.

The above decisions dismissed insolvency applications by financial creditors, where the financial creditor was effectively seeking expedited recovery of a decree or award in respect of the debt, instead of filing for or awaiting the result of, ordinary execution proceedings under the Code of Civil Procedure, 1908.

That where a financial creditor proceeds in respect of a debt by resorting to civil suit, arbitration, debt recovery tribunal, etc – instead of approaching the NCLT under the Code, in the first instance itself – it indicates that the creditor itself considered recovery to be possible against the debtor. This would usually then not be a situation of insolvency of the debtor – where recovery itself would be impossible, and the diligent creditor would accordingly not file for any other proceedings in respect of the debt as they would be fruitless.

The situation would however be different, where, the debt is itself generated by a decree – as opposed to a debt which has been the subject of a decree (i.e. the debt existed before the decree and was merely confirmed in the decree). Thus in some situations, judgment-debtors may be seen as genuine insolvency applicants as operational creditors.

This would explain the apparent divergence between other decisions on thus issue. For example, in one of NCLAT’s earliest decisions under the Code in Kirusa Software Private Ltd. v. Mobilox Innovations Private Ltd. Judgment dtd. 24th May 2017 Company Appeal (AT) (Insolvency) 6 of 2017 (at para. 32, otherwise reversed by the Supreme Court on a different point) and of the Supreme Court in K. Kishan v. Vijay Norman Company Pvt. Ltd. (2018) 17 SCC 662.

These judgments did not have occasion to consider the propriety of applications by financial creditors under Section 7 of the Code, where recovery proceedings under other fora had been initiated. In these cases, decree holders were considered as operational creditors under the Code. However, these were situations of operational debts that had arisen as a result of adjudication of disputes – in the form of relevant decrees.

This is explainable since, in such cases, the ‘inability to pay’ debts crystallized by the legal proceeding has (obviously) arisen after legal proceedings. This differs from situations where financial debts existed before the legal proceedings, and were merely confirmed by decrees, either issued by the DRT or an Arbitral Tribunal or a Civil Court. In the latter situation, the conduct of the financial creditor would show that by filing for proceedings in respect of the debt, the creditor clearly thought that the debt was recoverable.

These decisions essentially lead to the position that Financial Creditors who initiate recovery proceedings in respect of a debt in any manner other than under the Code, may then be faced with a dismissal of their Section 7 applications subsequently filed under the Code.

Charanya Lakshmikumaran, Partner & Puneeth Ganapathy, Principal Associate,
Lakshmikumaran & Sridharan Attorneys

Get live Stock Prices from BSE, NSE, US Market and latest NAV, portfolio of Mutual Funds, Check out latest IPO News, Best Performing IPOs, calculate your tax by Income Tax Calculator, know market’s Top Gainers, Top Losers & Best Equity Funds. Like us on Facebook and follow us on Twitter.

Financial Express is now on Telegram. Click here to join our channel and stay updated with the latest Biz news and updates.

Next Stories
1Data sharing, cybersecurity top concern areas for banks, customers: Deloitte
2IFSC codes of e-Andhra, e-Corporation Bank branches changed
3Reliance Home Finance defaults on Rs 40 cr loan repayment to Punjab & Sind Bank