International Financial Law Review: Indian Insolvency Code*

Fastest fingers first

Recent legislation may have unified the country’s insolvency and bankruptcy
proceedings, but issues surrounding the threshold for commencing the
process could be a problem

There have been a few rumblings in the Indian business world since the introduction of the Insolvency and Bankruptcy Code of 2016. The Code has sought to produce a single forum for the recovery or restructuring of debts – processes that were previously strewn across different laws interpreted by different bodies. It is intended to jumpstart the credit environment in India where there has been an impasse between debt laden businesses and banks hesitant to lend without security. With prevailing liquidation practices taking years and producing a low recovery rate, the Code could not come at a better time for creditors and has been lauded as a game changer. However, with its low threshold for commencing the insolvency resolution process, the Code has become a battleground for creditors and debtors to gain leverage with each party being in a race to press the right buttons first – to trigger or derail the insolvency resolution process.


The Code empowers any creditor (whether secured or unsecured) to trigger the corporate insolvency resolution process by filing an application with the National Company Law Tribunal (NCLT), which has 11 different benches across India including a principal bench in Delhi. Decisions of the NCLT can be appealed to the National Company Law Appellate Tribunal (NCLAT). The NCLT and NCLAT are the gatekeepers of the Code and of the insolvency process: it is to assess whether the threshold to commence the insolvency process has been satisfied, that is, whether there has been a payment default by the debtor. There is no balance sheet equivalent test for triggering the insolvency process which means that even a viable business may face the insolvency process due to cashflow issues rather than having its liabilities exceed the value of its assets.

A financial creditor or operational creditor may file an application with the NCLT subject to fulfilling certain conditions. Once this is done, the Code sets an ambitious timeline of 14 days for which the NCLT has to decide whether to admit the application and commence the insolvency resolution process or reject the application. If the application is admitted, an insolvency professional (IP) takes over the running of the debtor with the powers of the board being suspended and has 180 days (with a possibility of an extension of a further 90 days) to have relevant creditors approve a resolution plan to restructure the company’s debts. Where no agreement is reached, the debtor is then placed into liquidation. The restructuring mechanism is not too different from the regimes in Singapore and the UK but with the Code at its early stages, creditors and debtors have been quick to test a variety of provisions in the Code dealing with commencing the process. With ambiguity in the Code’s wording and a lack of jurisprudence in its interpretation, conflicting decisions across the different benches of the NCLT have been produced. We raise some of the more practical concerns for parties looking to engage the Code below.

Who can apply?

The Code draws a distinction between financial creditors and operational creditors. Broadly speaking operational creditors includes those in respect of the provision of goods and services while financial creditors stand in relation to debts disbursed against the time value of money. The distinction is critical because a financial creditor can apply to the NCLT immediately upon default while an operational creditor must issue a demand notice to the debtor and only after 10 days have lapsed without the debtor responding with a notice of a valid dispute under the Code, is the creditor then allowed to apply to the NCLT to commence the insolvency process. Operational creditors in particular should be alive to some potential pitfalls in their position. Banks may take on the role of
operational creditors by exercising assignment rights, and step into the shoes of their borrowers to demand payments of debts from the corporate debtors. An assignment of common form of security for a bank as it would allow it to pursue debts owed to its borrower. Foreign banks will typically use English law governed facility and assignment agreements. However legal assignment under English law requires certain formalities including a written notice of the assignment to be given by the assignor (the borrower/creditor) to his contracting party (the debtor). Without a valid assignment, a bank may find that it is not legally entitled to be the operational creditor for the purposes of commencing proceedings under the Code. A less obvious concern relates to whether an operational creditor is in the position to fulfil certain requirements for instituting the insolvency process. After the expiry of 10 days from the notice of demand, section 9(3) of the Code empowers the operational creditor to file an application to initiate the insolvency resolution process which must be accompanied by ‘a copy of the certificate from financial institutions maintaining accounts of the operational creditor confirming that there is no payment of an unpaid operational debt by the corporate debtor’. The rationale behind the clause seems clear enough – it requires the creditors’ financial institution, for example its bank, to confirm that the debt remains unpaid particularly after issuing the demand notice. The difficulty is that as a result of the definition of financial institution, foreign companies with no office or bank account in India may find themselves excluded from the Code. This seems incongruous with the intent of the Code and the point was raised in Smart Timing Steel Ltd v National Steel & Agro Industries Ltd before the NCLAT. It was argued before the NCLAT that section 9(3) of the Code could not have been intended to exclude foreign companies unable to comply and hence these requirements should be viewed as directory and not mandatory. In a striking judgment in May 2017, the NCLAT upheld that section 9(3) of the Code was mandatory and was unmoved by the suggestion that foreign companies without Indian bank accounts or offices would be prejudiced. The operational creditor in that case was thus precluded from applying to commence the insolvency process and the case serves as a cautionary tale of a potential pitfall for foreign creditors.

Disputed debt – how and when?

As gatekeeper of the insolvency process, one of the most critical issues that the NCLT has to decide is whether a debt is in dispute which would thereby disable the insolvency process under the Code. Section 8(2) of the Code is clear that the only defence a corporate debtor can bring in response to a demand for payment of the debt is ‘to bring to the notice of the operational creditor existence of a dispute, if any, and record of the pendency of the suit or arbitration proceeding filed before the receipt of such notice or invoice in relation to the dispute’. A dispute is defined to include a suit or arbitration proceedings relating to (a) the existence of the amount of debt; (b) the quality of goods or services or (c) the breach of a representation or warranty. Two questions immediately arise: what constitutes a dispute and when must it be raised? These are important practical issues because on the wording of the Code, there is a suggestion that the only way to defeat an application to commence insolvency proceedings would be to point to ongoing proceedings filed before the demand notice by the operational creditor. While it is not uncommon for a knee-jerk response by a debtor to dispute the debt as a response to threatened insolvency, it would be remarkable for the debtor to be the one to commence legal proceedings before the demand notice. This provision appears to be drafted to tackle the mischief of debtors engineering defences as an afterthought to threatened insolvency but the ambiguity lay in whether a dispute can only be evidenced through court or arbitration proceedings. The confusion on the issue was compounded by conflicting decisions of the different benches of the NCLT. In Essar Projects India Ltd v MCL Global Steel Pvt Ltd, the Mumbai bench in March 2017 took a literal reading of the Code stating that a dispute means a dispute in court or before an arbitration tribunal before the receipt of a demand notice under the Code. The same view was taken in Deutsche Forfait vs Uttam Galva Steel. As no such proceedings were instituted prior to the demand notice in both cases, the operational creditors’ applications were permitted against the debtors’ subsequent protests of a dispute.

Around the same time in March 2017, the Principal Bench in Delhi took a different view in Coat Plaster v Ambience Private Limited and Shivam Construction Company v Ambience Private Limited. The Principal Bench took the view that the definition of dispute under the Code was illustrative and was hence not just confined to court suits or arbitrations. The view of the Principal Bench even seems to suggest that disputes raised even after the demand notice can be valid to reject the insolvency process.

In May 2017, the NCLAT was presented with an opportunity in Kirusa Software Pvt Ltd vs Mobilox Innovations to reconcile the conflicting decisions in the different lower benches on the scope of the terms of dispute and existence of dispute. Kirusa, as operational creditor issued a demand notice to Mobilox as a corporate debtor for payment of a debt. Mobilox issued a reply to the demand notice disputing the debt with a bare denial together with an allegation of a breach committed by Kirusa of the terms of a nondisclosure agreement between the parties that appear unrelated to the debt. This reply did not point to existing arbitration or litigation proceedings on the alleged dispute but was held sufficient at first instance to constitute a notice of dispute thereby disabling the application of the insolvency process. On appeal, the NCLAT held that the term dispute is broader than just court or arbitration proceedings, and extends to any pending or initiated proceedings before every judicial authority – for example, labour courts – and includes actions taken by the corporate debtor in exercise of its legal rights. If for example, the debtor raises a quality claim before the demand notice, ‘one can say that a dispute is pending about the debt’. On the other end of spectrum, contrived, unrelated or bad faith defences designed to create the appearance of a dispute to stall the insolvency process, should not be countenanced. The Kirusa case was indeed an example of such an attempt with a bare denial of the debt raised by the debtor for a first time in response to the demand notice together with an unrelated alleged breach of confidential information that was ultimately viewed as ‘vague, got up and motivated to evade the liability’. The application to commence the insolvency process was therefore allowed.

The decision in Kirusa is welcomed but there are still some pockets of uncertainty in the Code. The NCLT as the adjudicating body is placed in an unenviable position of examining whether a dispute is pending without verifying the adequacy of the dispute. In doing this, it needs to sieve out ‘mere a dispute giving a colour of genuine dispute or illusory, raised for the first time while replying to the notice under Section 8…’. The distinction between a genuine and illusory dispute is often difficult to tell – it is not free from doubt whether a debtor with a genuine dispute should be precluded solely because it was raised for the first time in response to a demand notice. Similarly, a debtor who informally complains about goods or services but does not take any further action before it receives a demand notice from an operational creditor, may find itself not being able to prove a ‘dispute in existence’ before the NCLT. There are grey areas in interpreting the Code and novel situations and arguments will continue to test the application of the Code. At present, the system lends itself to those with the fastest fingers to steal a march on their counterparties. Creditors who commence the insolvency process sooner rather than later limit the potential of contrived defences by debtors. Debtors on the other hand may seek to side-step the insolvency process by pre-emptively raising disputes or commencing legal actions on frivolous grounds to frustrate creditors. Arbitrations in particular may become subject of abuse due to the general unwillingness of arbitrators to summarily dismiss such claims. To that end, perhaps the Singapore International Arbitration Centre’s new rules on summary dismissal of claims will be tested by operational creditors faced with frivolous arbitrations designed to stall the insolvency process.

With the stakes being high, there is a real likelihood of multiple legal proceedings with more showdowns expected at the NCLT.

Contributed by:

baldev-bhinder Baldev Bhinder
Head of energy, resources & infrastructure
T:6220 9388
This article is not intended nor does it purport to advise on Indian law but instead draws on the lessons learnt from insolvency regimes in the UK, US and Singapore.

*This article was first published in the September 2017 edition of the International Financial Law Review.