FinTechResolution Professional Mechanism under IBC does not infringe upon the Principles of Natural Justice

The Supreme Court, in the case of Dilip B Jiwrajka Vs. Union Of India, 2023 SCC OnLine SC 1530 has resoundingly upheld the constitutionality of Sections 95, 96, 97, 99 and 100 (hereinafter referred to as “Impugned Provisions”) of the Insolvency and Bankruptcy Code, 2016 (hereinafter referred to as “IBC”) which had come to be challenged in a batch of 384 petitions before the Supreme Court.

The Supreme Court disagreed with the contentions of the Petitioners who primarily claimed that the Impugned Provisions, as much as they relate to the powers of the interim resolution professional and the resolution professional over the individual and partnership debtors, are violative of the principles of natural justice as well as the fundamental rights guaranteed under Article 14 and 21 of the Constitution of India (hereinafter referred to as “Constitution”).

FACTS

Compared to other nations where the laws on insolvency and bankruptcy are present, the Indian law on the same subject, i.e., the enactment of IBC was much more delayed. Prior to the introduction of IBC, India had numerous acts in place to penalize financial defaulters. Depending on the nature of the defaulter as well as the default, the following laws used to govern the financial defaulters and recovery of debts:

1. Indian Contract Act, 1872

2. Recovery of Debts Due to Banks and Financial Institutions Act of 1993,

3. Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act of 2002, and

4. Sick Industrial Companies (Special Provisions) Act of 1985.

However, due to the haphazard procedure, crossing and confusing jurisdictions as well as poor enforcement and relief under these schemes of laws, the Indian Government decided to replace the existing insolvency and bankruptcy laws with a brand-new Act with more stringent regulations which were aimed at addressing existing defaults in a time-bound manner.

Thus, the IBC was introduced in 2016, with a new vision in the Indian scheme of laws wherein ‘Resolution’ was introduced by virtue of the Code, which was precisely catered towards salvaging of such “sick” and suffering companies aiming to re-vitalize them and make them a part of the economy once again instead of pushing them towards liquidation.

Part I of the IBC deals with preliminary matters, such as its application and definitions. Part II deals with insolvency resolution and liquidation for corporate persons. Part III deals with insolvency resolution and bankruptcy for individuals and partnership firms. Part IV provides for the regulation of insolvency professionals agencies and information utilities. Part V contains miscellaneous provisions.

The aforesaid structure was contentious with many in the business and start-up industries criticizing the methodology of the corporate insolvency resolution process (hereinafter referred to as “Resolution Process”), thus resulting in the batch of petitions in the Supreme Court, challenging the constitutionality of the various provisions, which came to be clubbed and adjudicated together in the present case.

ISSUES BEFORE THE SUPREME COURT

1. Whether actions and conferred powers under the Impugned Provisions are violative of principles of natural justice?

2. Whether Sections 97 and 98 of the IBC grant powers to the resolution professional which are violative of the fundamental rights under the Constitution?

3. Whether the adjudicating authority receiving the report by the resolution professional prior to any opportunity for hearing for the debtor is violative of the principles of natural justice?

4. Whether the powers and effects of a resolution professional act as a punitive executive action without judicial determination?

5. Whether the Impugned provisions are arbitrary for not providing the debtors an opportunity of hearing before appointment of resolution professional?

CONTENTIONS OF THE PARTIES

The Petitioner’s emphasized the need for a judicial determination of debt existence at the very threshold of the CIRP process, similar to Sections 7 and 9 of the IBC.

The Petitioners termed the scheme of laws in the IBC as an invasive in rem (in general) proceeding that is highly prejudicial to the assessee. The Petitioners pointed out that the mechanical initiation of insolvency proceedings based on a complaint without any judicial intervention amounts to a contravention of Fundamental Rights and that there must be a determination by a judicial body of the existence of a debt before the resolution professional takes any action.

Furthermore, the Petitioner’s ended their contentions by drawing the effectual similarities between Sections 7 and 9 of the IBC, pointing out how the IBC follows the same model for the said provisions. Therefore, the Petitioners contended that there exists neither any reasonable distinction nor any qualification for denying the right to adjudicatory hearing to a guarantor in the same statute when confronted with the application under Section 95.

The Petitioners also pointed out how the wide powers provided to the CIRP such as the power to seek information from guarantors as well as third parties are untrammelled and are being routinely exercised causing unjustified loss of reputation and damages to the assessee.

The Petitioners also argued that before initiating insolvency proceedings or appointing a resolution professional, a judicial body must determine the existence of a debt to ensure fairness and natural justice. This is crucial because once the process starts, it becomes difficult to reverse and can have serious consequences for the guarantor (e.g., information gathering, creditworthiness impact). The Petitioners also focused on the jurisdictional aspect of establishing a creditor-debtor relationship before appointing a resolution professional.

It was also pointed out that none of the steps mentioned hereinabove are reversible under Section 100 which begins 2 crucial stages:

(a) the first time at which a judicial body adjudicates; and

(b) the first stage at which the guarantor is furnished with a hearing by the adjudicating authority;

The Petitioners thus sought that the provisions ought to be amended such that the debtor or personal guarantor are provided an opportunity to be heard the very threshold of the process.

Thus, the Petitioners claimed that for all the aforesaid reasons the Impugned Provisions are violative of Article 14 of the Constitution and that as such, the lack of judicial intervention and automatic actions are discriminatory and violate Article 14 of the Constitution, which guarantees equality before the law.

Overall, the petitioners raised valid concerns about the potential lack of fairness and due process under the current provisions of Section 95 of the IBC. They advocated for a more judicialized process with early determination of debt existence, greater control over information gathering, and stronger safeguards for the guarantor’s rights.

The Respondents on the other hand emphasized the importance of timely insolvency resolution as the core objective of the IBC. Therefore, needless and excessive judicial interventions would delay this process which would undermine this goal.

While addressing the contentions of violation of natural justice due to lack of an opportunity to be heard, the Respondents asserted that, on the contrary, the present scheme under the IBC prevents serious consequences by having the adjudicating authority not be involved in the initial investigations. They expounded that in Sections 7 and 9, which deals with an application for initiation of corporate insolvency resolution process by a financial creditor and the operational creditor respectively, the admission of the application itself triggers the CIRP.

That the moratorium under Section 96 of IBC differs in its purpose and impact compared to the one under Section 14 of the IBC. It protects the guarantor/debtor without significantly restricting their financial activities.

Another grave argument of the Respondents was that when the process of selection of a resolution professional under Section 97 (5) of the IBC is done by the adjudicating authority, the adjudicating authority must be required to decide the jurisdictional questions on the basis of which the provisions of Part III are implicated, i.e., the adjudicating authority must establish whether

• a debt subsists; and
• the relationship of creditor and debtor subsists.

The Respondents further argued that the resolution professional under Section 99 of IBC is no judge – they gather facts, not make decisions. It is non-adjudicatory and debtors can still engage by clarifying their financial status and ensuring completeness of information. The professional acts as an information filter, preparing the case for the real decision-maker, i.e., the adjudicating authority.

Early judicial intervention disrupts the IBC timeline. Introducing judicial hearings before Section 100 of the IBC would significantly prolong the process and contradict the IBC’s focus on swift resolution.

That the resolution professional’s work under Section 99 of IBC culminates in a non-binding recommendation (accept/reject) for the adjudicating authority. Natural justice kicks in only at the crucial Section 100 stage, where the authority makes the final decision and adverse consequences (acceptance/rejection) can occur. Essentially, a hearing and full due process await at the moment of truth.

The legislative intent during the enactment of the IBC was brought into attention by the Respondents that the Parliament has, in a calibrated manner, interposed a resolution professional before the adjudicatory stage under Section 100 of the IBC, bearing in mind the limited role of the resolution professional which is to gather information, examine the application submitted under Sections 94 or 95 of IBC and determine as to whether it meets the requirements of the statute.

The Respondents further added that the provisions of Part III of Chapter III eventually lead to the creation of a repayment plan and, only if that fails, to a bankruptcy. The adjudicatory role of the interim resolution professional under Section 18 of the IBC is sought to be distinguished from the role of the liquidator who discharges certain adjudicatory functions if an order of liquidation is passed in view of the provisions of Sections 40 and 42 of IBC. The Respondents concluded its arguments by stating that it has been urged that an alleged ground of misuse of a provision in a particular case cannot be utilized to challenge the constitutional validity of a statute that the Parliament is competent to enact.

The Respondents also highlighted the different types of moratoriums under Section 14 of IBC on one hand, and an interim-moratorium under Section 96 of the IBC, and highlighted how the latter operates on the debt and not on the debtor.

FINDINGS OF THE COURT

After hearing the above arguments in detail, the Supreme Court made a detailed and verbose analysis of the scheme of the IBC based on the arguments of both the parties as well as by employing its own independent reasoning. The Supreme Court decided to break down its reasoning and verdict into the following 3 parts:

A. Comparative Analysis of Part II and Part III of the IBC

1. Stages under Part II and III

The Supreme Court began by analysing the process of initiation of corporate and insolvency proceedings under Sections 6-10 of the IBC. The Supreme Court explained the initiation of corporate and insolvency proceedings by a financial creditor or an operational creditor or the debtor itself in respect of a debtor who commits a default.

Subsequently, the Supreme Court pointed out that the fundamental aspect to be noticed is that on one hand- Part II of the IBC deals with the resolution of insolvencies of corporate entities, whereas on the other hand, Part III deals with the resolution of insolvencies of individuals and partnership firms.

2. Role of the Resolution Professional in Corporate as opposed to Individual Insolvency

The Supreme Court found it pertinent to examine and elaborate on the role of the corporate insolvency and resolution professional itself.

The Supreme Court highlighted that although the term is used in both Part II and Part III of the IBC, the functions of the resolution professional in both Parts are different. Section 5(27) of IBC provides that a resolution professional, for the purposes of Part II of the Code, means an insolvency professional appointed to conduct the CIRP or the pre-packaged insolvency resolution process, as the case may be, further Part II requires that an interim resolution professional be included in the process.

Subsequently, the bench went into detail about the roles and tasks of the interim insolvency resolution professional and highlighted that a vital role is entrusted to the interim resolution professional initially and later to the resolution professional in cases involving corporate insolvencies. The Supreme Court emphasized how this role has to be contra-distinguished from the role which is ascribed to a resolution professional in Part III of the Code, who is appointed to resolve insolvencies and bankruptcies for individuals and partnership firms.

In contrast, the role of a resolution professional under Part III, is firstly, to examine the application within ten days of appointment which further involves two steps:

• that the application satisfies the requirement of Section 94 or Section 95 of the IBC, and;
• that the applicant has provided the information and furnished the explanation which is sought under sub-section (4)

After this, the resolution professional must recommend the acceptance or rejection of the application by submission of the Report. Thus, the Supreme Court clarified how the roles of the resolution professional appointed under Part II and the ones appointed under Part III are completely distinct. It opined that the reason why the legislature had chosen it fit to interpose the function of the resolution professional even before the adjudicating authority under Section 100 of IBC comes into operation, would be that the application under Section 94 or Section 95 of IBC is sought to be moved principally against an individual or a partnership.

3. The impact of a moratorium under Section 14 of Part II vis-a-vis interim moratorium under Section 96 of Chapter III of Part III of IBC

The Supreme Court then found it pertinent to distinguish between Moratorium and Interim Moratorium. The bench explained how Section 96’s “interim moratorium” offers targeted protection to debtors/guarantors facing debt recovery actions, whereas the Moratorium offers relief from the broader corporate insolvency restrictions in Part II.

This temporary shield is triggered immediately upon application filing under Section 94 or 95 of the IBC and stays any existing legal proceedings related to “any debt,” not the debtor. This key phrase highlights the moratorium’s purpose: to halt debt collection efforts, not impose general restrictions on the debtor’s activities.

By restraining legal action against the “debt” rather than the debtor, Section 96 of IBC prioritizes a breathing space for potential financial resolution before judicial review in Section 100 that determines the application’s fate. This narrower focus contrasts with the wider asset and business control granted to the resolution professional in Part II under Section 14’s moratorium, underscoring the distinct needs and considerations in individual/partnership insolvency under Part III of the Code.

4. The Role of the Adjudicating Authority

The Supreme Court emphasized that the resolution professional and the adjudicating authority are separate and the real decision-making powers lie with the adjudicating authority.

Therefore, the function of the adjudicating authority commences, under Part III, after the submission of a recommendatory report by the resolution professional. Due to the differences between the resolution process under Part II and the resolution process for individuals and partnership under Part III, the legislature has carefully calibrated:

1. The role of the resolution professional;
2. The imposition of the moratorium; and

• The stage at which the adjudicating authority steps in under Part II, on one hand, and III, on the other.

The Supreme Court stated that this is based on an intelligible differentia between the nature of the insolvency resolution process in the case of a debtor, on one hand, and individuals or partnerships, on the other.

5. Applicability of the Principles of Natural Justice

The Supreme Court then addressed the main argument of the Petitioners which was that the principles of natural justice of audi alterum partem i.e. an opportunity of being heard before an investigation or inquiry were being violated as the resolution process would rob the opportunity from the alleged debtors to present their defenses.

6. Role of the Resolution Professional as a facilitator is to collate facts

The Supreme Court initially described how, over the passage of time, precedents have expanded the application of the principles of natural justice, which was originally only a tenet of law to be applied to the judicial proceedings, to all sorts of administrative, quasi-judicial actions as well.

However, with this broad application, it also explained how the standard of the opportunity of being heard also varies according to the type of action and forum by whom the action is taken. Before a tribunal, it may mean the active opportunity to present arguments whereas on the other hand, a bare minimum opportunity may be given to an individual who is liable to be affected by an action.

The Supreme Court drew attention to Section 95 of IBC, which states that the resolution professional may require the debtor to prove the repayment of the debt according to sub-clauses (a), (b) and (c). Evidently, the expression “may require the debtor to prove repayment of the debt” implicates the role of the debtor in explaining, whether, as a matter of fact, the debt remains unpaid or has been paid.

Likewise, Section 99 (4) empowers the resolution professional, in the course of carrying out an examination of an application to seek further information or explanation in connection with the application from the debtor or the creditor.

The provisions of Section 99 of the IBC thus leave no manner of doubt that the process which takes place before the resolution professional is not an ex parte process in the absence of a debtor against whom the insolvency resolution process is sought to be initiated.

In response to the argument of the Petitioners that the resolution professional is empowered to direct the personal guarantor and others to disclose sensitive personal information without a prior hearing which is violative of the right to privacy of the debtors, the bench responded by pointing out that the resolution professional is only entitled to seek information which is strictly relevant to the examination of the application for CIRP; and secondly, regulation 7(2)(h) of the Insolvency and Bankruptcy Board of India (Insolvency Professionals) Regulations, 2016 (hereinafter referred to as “IP Regulations”)read with para 21 of the First Schedule of the IP Regulations, casts an obligation on the resolution professional to ensure confidentiality of all information relating to the insolvency process.

Therefore, the bench concluded that not only is the resolution professional empowered to seek information under Section 99 of the IBC, but is also bound by practices and policies to ensure confidentiality.

7. Role of the Adjudicatory Authority

The Supreme Court then went on to examine the role and operations of the adjudicating authority. The bench observed that the adjudicating authority does not mechanically accept or reject applications based solely on the resolution professional’s report. Instead, it actively engages in a fair process, affording the debtor a fair opportunity to present their case.

The adjudicating authority arrives at its determination by considering arguments supported by relevant material particulars. In essence, the adjudicating authority conducts an independent assessment, not solely relying on the resolution professional’s report, to decide the fate of applications under Section 94 or 95 of the IBC.

The bench further observed that the entire scheme of Sections 99 and 100 of IBC lays emphasis on timelines that have been laid down by Parliament. Thus any adjudicatory intervention into the provisions of Section 97(5) of IBC would render the entire process of implementing these timelines nugatory.

The final reason which would militate against accepting the submission is that the provisions of Section 55 of the IBC do not as such implicate any adverse civil consequences particularly if those provisions are read in the manner in which we now propose to elucidate.

8. A right of representation has been provided under Section 99(2)

The Supreme Court found it pertinent to separately deal with the allegations of the Petitioners under Section 99 (2) of IBC where they argued that the resolution professionals have been empowered to make wide ranging enquiries for the purpose of eliciting information under sub-section (4) of Section 99.

The bench clarified that the ambit of sub-section (4) of Section 99 of the IBC  is prefaced by the words “for the purposes of examining an application”. Therefore, the information that the resolution professional is empowered to seek or the explanation which the resolution professional can require to be furnished is for only the aforementioned purposes of examining the application in question.

Further, it was also pointed out that Section 99 (4) of the IBC specifies that the information or explanation which may be sought for such examination. Thus, only that information may be sought which has a nexus with the application.

Therefore, if properly read, the power to seek information or, for that matter, to seek an explanation is related to the nature of the application which has been submitted under Section 94 or Section 95 of the IBC. Therefore, the Supreme Court took the view that the aforesaid conditions sufficiently comply with the requirements of audi alteram partem.

9. Challenge to the constitutional validity

Finally, the Supreme Court dealt with the sustainability of the constitutional challenge to the impugned provisions itself. Despite Section 100 of the IBC not explicitly mentioning a hearing for a debtor, the Supreme Court inferred that the requirement of a hearing should be read into the provision.

This argument is based on the principle of statutory interpretations, which states that when a statute is silent on a specific aspect, and there is no explicit prohibition, therefore the courts may imply or read in such a requirement. The conclusion asserts that the lack of explicit mention of a hearing does not automatically render a provision unconstitutional, as such a requirement can be reasonably inferred or read into the statute.

The Supreme Court took the view that an adjudicatory decision-making process as envisioned in the arguments of the Petitioners cannot not be implicated under Section 97(5) of the IBC. Further, an attempt to accept such a procedure would render the provisions of Sections 99 and 100 of IBC otiose.

AMLEGALS REMARKS

The passing of the verdict in the present case came as a disappointment to the Petitioner’s but it provided surety to debtors and all potential loan takers on the scheme of laws under the IBC.

Furthermore, although the verdict was adverse towards the relief claimed for by the side of the debtors, the views of the court in regards to the report of the resolution professional having merely evidentiary value can be used in future proceedings before the adjudicating authority by aggrieved debtors to persuade the adjudicating authorities to not solely rely upon the said reports.

The provisions of Part III of the IBC, as they currently stand, are only applicable to personal guarantors of a debtor. The clarification on the cloud of potential unconstitutionality of such major provisions of the IBC will surely have a net positive effect on the business industry, creditors as well as the overall financial sector in India.

-Team AMLEGALS

For any query or feedback, please feel free to get in touch with tanmay.banthia@amlegals.com or jason.james@amlegals.com