VALIDITY OF SECTION 7 OF INSOLVENCY AND BANKRUPTCY CODE, 2016

[Mr. M. GOVINDARAJAN]

Initiation of insolvency resolution process

Section 7 of the Insolvency and Bankruptcy Code, 2016 (‘Code’ for short) provides the procedure for initiation of insolvency resolution process by a financial creditor.

Section 7(1) provides that a financial creditor either by itself or jointly with other financial creditors may file an application for initiating corporate insolvency resolution process against a corporate debtor before the Adjudicating Authority when a default has occurred. 

Section 7(2) provides that the financial creditor shall make an application in Form 1 and accompanied by a fee of ₹ 25,000/-  Where the applicant is an assignee or transferee of a financial contract, the application shall be accompanied with a copy of the assignment or transfer agreement and other relevant documentation to demonstrate the assignment or transfer.   In case the application is made jointly by financial creditors, they may nominate one amongst them to act on their behalf.

Section 7(3) provides that the  financial creditor, along with the application furnish-

• record of the default recorded with the information utility or such other record or evidence of default as may be specified;
• the name of the resolution professional proposed to act as an interim resolution professional; and
• any other information as may be specified by the Board.

The applicant shall dispatch forthwith, a copy of the application filed with the Adjudicating Authority, by registered post or speed post to the registered office of the corporate debtor.

Section 7(4) provides that the Adjudicating Authority shall, within fourteen days of the receipt of the application, ascertain the existence of a default from the records of an information utility or on the basis of other evidences furnished by the financial creditor.

Section 7(5) provides where the Adjudicating Authority is satisfied that-

• a default has occurred and the application is complete and there is no disciplinary proceedings pending against the proposed resolution professional, it may, by order, admit such application; or
• default has not occurred or the application is incomplete or any disciplinary proceeding is pending against the proposed resolution professional, it may, by order, reject such application.

The Adjudicating Authority shall, before the rejection of the application give a notice to the applicant to rectify the defect in his application within seven days of receipt of such notice from the Adjudicating Authority. 

Section 7(7) provides that the Adjudicating Authority shall communicate-

• the order of admitting the application to the financial creditor;
• the order rejecting the application to the financial creditor

within seven days of admission or rejection of such application.

Issue

The issue to be discussed in this article whether section 7 of the Code is valid with reference to the decided case law.

Case law

In ‘Sree Metaliks Limited and another V. Union of India and another’ 2017 (4) TMI 1248 - CALCUTTA HIGH COURT – WP 7144 of 2017 of Kolkata High Court, decided on 07.04.2017, the petitioner assails the vires of section of the Code and the relevant rules under the Insolvency and Bankruptcy (Application to the Adjudicating Authority) Rules, 2016.  The challenge is on the ground that the Code does not afford any opportunity of hearing to a corporate debtor in a petition filed under section 7 of the Code.

The petitioner submitted the following before the High Court-

• The petitioner received a notice from a firm of Company Secretaries dated 21.01.2017 intimating that, an application under section 7 of the Code read with Rule 4had been filed before the National Company Law Tribunal, Kolkata Bench;
• The letter does not inform the petitioners about the date when such application would be taken up for consideration by the Tribunal;
• The Tribunal had registered the application;
• An order was passed on 30.01.2017;
• The said order was passed exparte;
• The petitioner was not informed of the date of hearing;
• The petitioner was not afforded an opportunity of hearing by the Tribunal prior to the passing of such order of administration of the petitioner and appointment of interim resolution professional;
• The petitioner preferred an appeal against such order;
• The Appellate Tribunal disposed the appeal upholding the order of the Adjudicating Authority;
• Pursuant to the disposal of the appeal, proceeding have taken place in the company petition;
• The petitioner is entitled to a right of hearing under the principles of natural justice;
• The Code is silent as to the grant of hearing by the Adjudicating Authority;

The respondent submitted the following before the High Court-

• The respondent no. 2 is an award holder and the award remains unsatisfied;
• The respondent was advised to invoke the provisions of the Code;
• In the appeal filed by the petitioner he informed that he had no objection to the admission of the insolvency petition but objects to the appointment of interim resolution professional;
• Therefore he cannot urge the violation of principles of natural justice;
• Section 424 of the Companies Act, 2013 provides that the Tribunal is required to follow the principles of natural justice in deciding an application;
• Therefore the challenge to the vires must fail;
• The petitioner did not attend the hearing before the Tribunal;
• The petitioner did not press for the objections raised in the petition, in the appeal;

The Additional Solicitor General refers to Rule 4 which provides a service of notice of the application by the financial creditor on the financial debtor.  Rule 10 contemplates that the provisions of Rules 20 to 24 and 26 of Part III of the National Company Law Tribunal Rules, 2016 will be applicable.  Rule 24 of the National Company Law Tribunal Rules, 2016 contemplates service of notice of the application upon the respondent.  The proceedings before the Tribunal are to be conducted under section 424 of the Companies Act, 2013.

He further submitted that the Tribunal is not bound by the Code of Civil Procedure, 1908 and that it can regulate its own procedure subject to the provisions of the Act, 2013 and the Code.  The Code does not debar the applicability of the principles of natural justice in proceedings under consideration by the Tribunal when it is considering an application under section 7 of the Code.

The High Court considered the submissions made by all parties.  The High Court analyzed the provisions of section 7 of the Code and section 61 of the Code which deals with the procedure of filing appeal before the Appellate Tribunal.  The High Court observed that any person aggrieved by an order passed by the authority under the Code in respect of an application under section 7 of the Code is entitled to prefer an appeal to the Appellate Tribunal.  The High Court also analyzed the provisions of Section 424 of the Companies Act, 2013.

The High Court observed that the Code read with Rules is silent on the procedure to be adopted at the hearing of the application under section 7 before the NCLT, that is to say, it is silent whether a party respondent has a right of hearing before the Adjudicating Authority or not. 

The High Court held that a proceeding for declaration of insolvency of a company has drastic consequences for a company.  Such proceeding may end up in its liquidation.  A person cannot be condemned unheard.  Where a Statute is silent on the right of hearing and it does not in express terms, oust the principles of natural justice, the same can and should be read into in.  When the NCLT receives an application under section 7 of the Code it must affora reasonable opportunity of hearing to the corporate debtor as section 424 of the Companies Act, 2013 mandates it to ascertain the existence of default as claimed by the financial credit in the application.  Therefore the NCLT is obliged to afford a reasonable opportunity to the financial debtor to contest such claim of default by filing a written objection or any other written document as the NCLT may direct and provide a reasonable opportunity of hearing to the corporate debtor prior to admitting the petition.  Section 7(4) of the Code requires the NCLT to ascertain the default of the corporate debtor.  Such ascertainment of default must necessarily involve the consideration of the documentary claim of the financial creditor.  This brings within its wake the extension of a reasonable opportunity to the corporate debtor to substantiate by document or otherwise, that there does not exist a default as claimed against it.  The proceedings before the NCLT are adversarial in nature.    Rule 4(3) requires such financial creditor to dispatch a copy of the application filed with the Adjudicating Authority by registered post or speed post to the registered office of the corporate debtor. 

The High Court held that it would be open to the parties to agitate their respective grievances with regard to any order of NCLT or NCLAT as the case may be, in accordance with law.  It is also open to the parties to point out that the NCLT and NCLAT are bound to follow the principles of natural justice while disposing of proceedings before them.

In such circumstances, the challenge to the vires to Section 7 of the Code fails.