Introduction

The Hon’ble Supreme Court of India in Dilip B. Jiwrajka v. Union of India & Ors.[1] has upheld the constitutional validity of the provisions contained in Sections 95 to 100 of the Insolvency and Bankruptcy Code, 2016 (as amended) (“Code”) which deals with insolvency resolution and bankruptcy for individuals and partnership firms. The provisions of the Code in so far as it is applicable to insolvency of personal guarantors of corporate debtors were brought into force on 15th November 2019[2]. Subsequent to this, the Insolvency and Bankruptcy (Application to Adjudicating Authority for Insolvency Resolution Process for Personal Guarantors to Corporate Debtors) Rules, 2019 (“Rules’) were also notified. In the present matter, the provisions were challenged on the ground that without ascertaining the existence of debt and affording an opportunity to the debtor, the automatic imposition of moratorium was arbitrary and violative of Article 14 of the Constitution of India.

Time-Lapse of Legal Process

When an application is filed by a creditor seeking initiation of insolvency of a personal guarantor of the corporate debtor[3], an interim moratorium operates from the date of filing of the application and a resolution professional (“RP”) is appointed by the Adjudicating Authority. The RP is required to examine the application and submit a report to the Adjudicating Authority recommending approval or rejection of the application. The RP is also empowered to seek further information and explanation from the debtor or the creditor or any other person. Thereafter, the Adjudicating Authority is required to either admit or reject the application within 14 (fourteen) days of submission of the report.

Grounds of challenge

The primary contentions raised by the petitioners in the batch of appeals were as follows:

1. the existence of debt owed to be claimed by a creditor under Section 95 of the Code is a jurisdictional fact which ought to be determined by the Adjudicating Authority at the very threshold of filing of the application, rather than an automatic imposition of an interim moratorium and appointment of the RP;
2. appointment of the RP, without affording the debtor an opportunity to be heard renders the provisions of Sections 95 to 100 of the Code arbitrary and unconstitutional; and
3. the power vested in the RP to seek information not only from the guarantor but also from a third party is being routinely exercised in an unrestricted manner and therefore, adjudication of an application filed under Section 95 of the Code should be akin to the process of deciding an application filed under Section 7 or 9 of the Code.

Grounds of Opposition

In contrast to the submissions made by the petitioners, it was argued by the
respondents that:

1. the consequences of moratorium under Section 14 of the Code are far more serious whereby there is a statutory embargo on the corporate debtor from alienating, encumbering, or dealing with its assets in any manner. Therefore, the legislature has mandated the involvement of the Adjudicating Authority at the threshold;
2. the interim moratorium under Section 96 of the Code does not prejudice the debtor and there is no embargo on alienation of its assets, legal rights, or beneficial interest;
3. the role of the RP under Section 99 of the Code is not adjudicatory in nature and is limited to collation of facts to assist the Adjudicating Authority in admitting or rejecting an application filed under Section 94 or 95 of the Code;
4. sufficient opportunity is afforded to the debtor in the process of formulating the recommendation of the RP in its report, which is not binding on the Adjudicating Authority; and
5. the requirement of observing principles of natural justice arises at the adjudicatory stage under Section 100 of the Code and to add an intermittent stage to decide a ‘jurisdictional question’ would dislocate the entire scheme of the Code.

Decision of the Supreme Court

In arriving at its conclusion to uphold the constitutional validity of the provisions of Sections 95 to 100 of the Code, the Supreme Court broadly analysed the stages under Parts II and III of the Code, the role of the RP, the impact of moratorium, and the role of the Adjudicating Authority thereto. The key observations made by the Supreme Court were as under:

1. The role of the RP appointed under Part II[4] of the Code is materially different from the role of the RP appointed under Part III[5] of the Code. Under Part II, the role of the RP is to conduct the insolvency process, whereas under Part III, the role of the RP is limited to examination, ascertainment and filing a report recommending approval or rejection of the application. The RP is not empowered to take over the assets or the business of the debtor.
2. The use of the expressions “examine the application”, “ascertain” and “satisfies the requirements” and “recommend” the acceptance or rejection of an application under Sections 94 or 95 of the Code clarifies that the RP is not to perform any adjudicatory function or arrive at a binding conclusion.
3. The report of the RP is purely recommendatory in nature and does not bind the Adjudicating Authority and the Adjudicating Authority has the power to further direct the debtor and creditor to enter into negotiations of it admits the application.
4. There is an intelligible differentia in the nature of the insolvency process conducted under Part II and Part III of the Code.
5. The principles of natural justice are not to be construed as straitjacket and is liable to vary with the exigencies of the situation. At the stage of admitting or rejecting the application, the Adjudicating Authority is duty bound to hear the person against whom the application has been filed.
6. The RP does not collate information and prepare the report under Section 99 of the Code without affording an opportunity to the debtor to furnish an explanation and produce material evidencing the payment of the debt.
7. The RP is only entitled to seek information purely relevant to the examination of the application and as per Regulation 7(2)(h) of the Insolvency and Bankruptcy Board of India (Insolvency Professionals) Regulations, 2016, there is an obligation on the RP to ensure confidentiality of all information relating to the insolvency process.
8. The Adjudicating Authority does not mechanically accept or reject applications based on the report of the RP and conducts an independent assessment. Such adjudicatory role commences after submission of the report and involves deciding a mixed question of law and fact.
9. While Section 100 of the Code does not explicitly mention a hearing for the debtor, the lack of an explicit mention therein does not automatically make it unconstitutional, and the courts may imply or read in such a requirement.
10. Section 95(2) of the Code provides for a situation where a creditor has applied under Section 95(1) of the Code in relation to a partnership debt and does not control the ambit of Section 95(1) of the Code so as to limit it to a partnership debt.

Takeaways and way forward

The decision of the Supreme Court has brought in much needed clarity for the Adjudicating Authority as well as for the RP in performing their respective roles. Further, applications which were pending before the Adjudicating Authority due to pendency of the appeals before the Supreme Court would now be revived and a debtor can no longer delay adjudication on this ground.

While promoters may be reluctant in providing personal guarantees to creditors to avoid the consequences of insolvency under the Code, creditors, on the other hand, may emphasize on the need to obtain such promoter guarantees as credit enhancement against debt financings.

What remains to be seen is how successful is the insolvency process in case of personal guarantors.

Authors: Ankit Sinha, Partner, Juris Corp

Aditi Sinha, Associate, Juris Corp

Footnotes

[1] Writ Petition (C) No. 1281 of 2021; decided on 9th November 2023

[2] Notification S.O. 4126(E) dated 15th November 2023 issued by the Ministry of Corporate Affairs

[3] Section 95 of the Insolvency and Bankruptcy Code, 2016

[4] Insolvency Resolution and Liquidation for Corporate Persons

[5] Insolvency Resolution and Bankruptcy for Individuals and Partnership Firms