M/s Instyle Exports case: Dark side of Section 11 of IBC

Kahnav Mahajan writes about the dark side of Section 11 of the Insolvency and Bankruptcy Code, 2016.

Introduction

In the matter of M/s Mandhana Industries Limited v/s M/s Instyle Exports Private Limited¹, the Resolution Professional of Mandhana Industries, which was undergoing Corporate Insolvency Resolution Process (CIRP) under the Insolvency and Bankruptcy Code, 2016 (Code) filed an application under section 9 of the Code r/w Rule 6 of the Insolvency and Bankruptcy (Application to Adjudicating Authority) Rules, 2016, with a prayer to initiate CIRP against M/s Instyle Exports Private Limited.

The Hon’ble NCLT (ND-IV) (Adjudicating Authority) rejected the application on the grounds of the bar under Section 11 of the Code.

The decision of the Adjudicating Authority raises a very important question of law, that whether the Corporate Debtor, undergoing CIRP, in order to realise its assets, can file an application in the capacity of “Financial Creditor” under section 7 or “Operational Creditor” under section 9 of the Code, as the case may be, against its Corporate Debtor?

Analysis

The title of section 11 reads as “Persons not entitled to make an application” and it states that “The following persons shall not be entitled to make an application to initiate corporate insolvency resolution process under this Chapter, namely: -
(a) a corporate debtor undergoing a corporate insolvency resolution process;”²

A plain reading of clause (a) of Section 11 draws a clear picture that a corporate debtor undergoing CIRP cannot initiate CIRP. Not entirely wrong yet this cannot be held to be completely right. As it is evident from the language of the section that it is missing the object in the grammatical sense of the language used. In the rhetoric sense one may very well be inclined to ask the question “against whom?”. The question prima facie might seem naïve but in reality, is a very important question.

Clause (a) of section 11 of the Code puts a bar on the corporate debtor undergoing CIRP from initiating CIRP, but against whom? The law is silent on this aspect. To answer this question, it is pertinent to analyse section 11 in light of the objective and other relevant provisions of the Code.

What needs to be noted at this point is that the objective of the Code is maximisation of value assets and resolving the insolvency of debt-ridden entity. This raises the issue of status of the assets of the company which are being held by corporate debtor’s debtors. Surely, the law makers did not intend to sever the assets of the corporate debtor undergoing CIRP as it would defeat the very primary objective of the Code i.e. resolution of the corporate debtor while keeping the entity as a going concern. For the aforementioned purpose, the resolution professional is bestowed with the duty to take custody and control of all the assets of the corporate debtor³ and to represent and act on behalf of the corporate debtor with third parties, exercise rights for the benefit of the corporate debtor in judicial, quasi-judicial and arbitration proceedings⁴. In order to protect the assets of the corporate debtor which are in possession of the third party or any debt due from a third party shall be recovered by the resolution professional and if such third party fails to do so the resolution professional has a duty to initiate CIRP against such party.

If ratio of the decision, given by the Adjudicating Authority in the M/s Instyle Exports Case, is applied on clause (b) of Section 11 it raises grave concerns as it states that “(b) a corporate debtor having completed corporate insolvency resolution process twelve months preceding the date of making of the application;”⁵ which would mean that a corporate debtor who has completed an insolvency process 12 months preceding the date of making an application cannot initiate CIRP against any of its debtors. Not only this prohibits the corporate debtor from exercising its legal rights but also, is pushing the corporate debtor into a debt spiral with no chance of recovery. This would not only lead to failure of effective resolution of many corporate entities and in addition to that, it will also put the resolved entities back on to the insolvency path.

Further using the same ratio, the inclusion of section 238A⁶ to the Code i.e. the limitation clause, which states that “The provisions of the Limitation Act, 1963 (36 of 1963) shall, as far as may be, apply to the proceedings or appeals before the Adjudicating Authority, the National Company Law Appellate Tribunal, the Debt Recovery Tribunal or the Debt Recovery Appellate Tribunal, as the case may be”⁷,does not seem to help the corporate debtor in any manner and rather adds on to its troubles. As per clause (a) of section 11 of the Code, the corporate debtor cannot initiate insolvency proceedings while it is undergoing CIRP so it cannot realize its assets from its debtors during the pendency of the proceedings, but as per section 60(6) of the Code⁸ the time under moratorium is excluded from the limitation. However, as per clause (b) of section 11 of the Code, the corporate debtor cannot initiate CIRP 12 months after the conclusion of its CIRP and the same does not fall within the moratorium period and therefore, is not excluded under section 60(6) of the Code. The claims that a corporate debtor might have against its debtors has a 3 year limitation period⁹ out of which the corporate debtor is barred, under section 11(b) of the Code, from realizing its assets for a period of 1 year which leaves the corporate debtor with a mere 2 year time period. This not only reduces the limitation period for any claim that a corporate debtor might have against its debtors, viz. a clear violation of its rights, but also puts section 11(b) of the Code in conflict with section 238A of the Code and the provisions of Limitation Act, 1963.

It is to be noted that, as per section 6 of the Code following persons may initiate CIRP, “where any corporate debtor commits a default, a “Financial creditor”, an “Operational creditor” or the “Corporate debtor” itself may initiate corporate insolvency resolution process in respect of such corporate debtor in the manner provided under this chapter.”¹⁰ From a plain reading of section 6 of the Code it can be noted that a corporate debtor has the right to initiate CIRP against itself only. The same is also substantiated by the language of section 10 of the Code wherein the procedure to initiate insolvency process has been laid down and it specifically deals with the case where the corporate applicant is initiating the proceedings against corporate debtor. Under section 10 of the Code, a corporate applicant may file an application with the NCLT to initiate a CIRP against the corporate debtor as per the procedure laid down under section 10 of the Code. Section 5(5) of the Code defines a ‘corporate applicant’ as either (a) a corporate debtor; (b) a member or partner of the corporate debtor authorised to make the application under constitutional document of the corporate debtor; (c) an individual in charge of managing operations and resources of the corporate debtor; or (d) a person who has control and supervision over financial affairs of the corporate debtor. The explanation to section 11 states that “For the purposes of this section, a corporate debtor includes a corporate applicant in respect of such corporate debtor.”¹¹

Section 11 of the Code explicitly bars the corporate debtor, who is already undergoing insolvency process, from initiating CIRP under chapter II of the Code. However, the provision for a corporate debtor to initiate CIRP under chapter II is provided only under section 10 of the Code, 2016, which, as stated above, only lays down the process of initiating CIRP against the corporate debtor itself by the corporate applicant. It is pertinent to notice that no similar bar, neither explicit nor implicit, has been put upon either the financial creditors or the operational creditors under section 11 of the Code.

The Hon’ble NCLT (Mumbai Bench) observed in Jai Ambe Entreprise vs S.N. Plumbing Private Limited¹² that “The same has been substantiated by the Code under section 60(2), and allied provisions of the Code thatno two parallel insolvency proceedings must run against a Corporate debtor.” Section 11 of the Code aims as preventing the multiplicity of the proceedings against the corporate debtor, which might be initiated by the corporate debtor itself in order to impede the repayment process.

The Insolvency and Bankruptcy Bill (Bill), presented in the Parliament for approval, provides a clear intent of the legislature behind the enactment of section 11. The notes on clauses in the Bill states that “A corporate debtor which is undergoing a corporate insolvency resolution process (at the time of such application) or has completed a corporate insolvency resolution process in the preceding twelve months is not entitled to file an application for initiating the corporate insolvency resolution process. This ensures that corporate debtors cannot have repeated recourse to the corporate insolvency resolution process in order to delay repayment of debts due or to keep assets out of the reach of creditors.”¹³

It is clear from the Bill that the intent of the legislature was to prevent the repeated recourse to corporate insolvency which can unnecessarily impede the corporate insolvency resolution process and gives the officers of the corporate debtor a chance to delay the repayment of the debts, ultimately resulting in failure of the Code. However, restricting the corporate debtor from collecting and protecting its assets from third parties was not the intent of the legislature.

CONCLUSION

As per the principles of interpretation, the provisions of the statutes, which bear upon the same subject matter, must be read as a whole and in their entirety, each throwing light and illuminating the meaning of the other. To ascertain the intent of the legislature by directing attention not merely to the clause to be construed but to the entire statute; the clause must be compared with other parts of the statute and the setting in which the clause is to be interpreted.

It can be concluded from the aforementioned reasons that provisions of section 11 are only applicable in respect of the insolvency proceedings under section 10 of the Code and it does not bar the corporate debtor from initiating proceedings against its debtors in the capacity of a financial creditor or an operational creditor in order to protect its assets from third parties. Once an application is filed under section 7 or section 9 of the Code, by the corporate debtor in the capacity of financial creditor or operational creditor, as the case may be, the corporate debtor stops being the corporate debtor under section 10 of the Code for the purpose of section 11 and steps into the shoes of the financial creditor or operational creditor, as the case may be, and hence the bar under section 11 does not appear to be applicable on such corporate debtor.

The decision of Hon’ble NCLT in the matter of M/s Mandhana Industries Limited v/s M/s Instyle Exports Private Limited¹⁴ results in certain implications which may not satisfy the intended object of the Code. The Hon’ble NCLT should have realized the value of assets of the corporate debtor, which is due to it from third parties, as those assets are very imperative to the corporate debtor during the CIRP period. Setting a precedent like that could prove to be fatal to the economy as the Code is an economic legislation which has far reaching consequences as each and every entity under CIRP is not being operated by an individual rather it is a machinery which is being operated by a large number of people. Every single liquidation result in economic loss to the growing economy of the country and putting a dent on its growth. This is the reason why the NCLT and NCLAT both in their several decisions have reiterated it innumerable times that the object of the Code is not to liquidate the corporate entity but rather to resolve the debt-ridden entity as a going concern and liquidation is the last resort.

Therefore, for the aforesaid reasons it can be concluded that the corporate debtor has the right to initiate insolvency proceedings against its debtors. Further, it may initiate corporate insolvency resolution process against its corporate debtor in the capacity of operational creditor under section 9 or financial creditor under section 7 of the Code. Barring the corporate debtor from protecting its assets from third parties and using those assets in time of need is not only against its rights but also goes against the objectives of the Code.