“Hardly six years old, the Insolvency and Bankruptcy Code continues to be a fertile ground to spawn litigation.” The Supreme Court’s new judgment in NOIDA v. Anand Sonbhadra begins with this understatement. The truth is that the IBC is structured in an adversarial manner that can only lead to litigation. Competing bidders try to have each other disqualified, the old, deposed management wants to get back in the saddle, and the NCLT, which is supposed to apply minimal scrutiny to bids, is too understaffed to accomplish even this.
NOIDA exposes yet another faultline: the perverse incentive to be labelled a ‘financial creditor’. As per the IBC, creditors are divided into clubs, with financial creditors lording it over the other creditors.
Financial creditors have two advantages: firstly, they are given a summary route to initiate the corporate insolvency resolution process, and need not concern themselves with the rigmarole of giving a notice of default, and waiting for a reply, and secondly, the Committee of Creditors, which decides upon the fate of an insolvent entity, including voting upon the resolution plan, is comprised solely of financial creditors. This voting power translates into plans that are tailored specifically to ensure that financial creditors keep the largest chunk of the bid for themselves.
In the NOIDA case, the petitioner, a local authority, leased land to the corporate debtor for a period of 90 years to construct residential buildings and sell flats to third parties. This was in pursuance of NOIDA’s mission of planned development. When the corporate debtor was declared insolvent, NOIDA initially (correctly) presented its claim as an operational creditor. It then appears to have had a rethink and reworked its claim, deciding that it was a financial creditor. After this to justify its shift, it attempted to slot its claim into various sub-clauses of Section 5(8), which defines what constitutes a financial debt under the IBC. It failed before the NCLT, and failed again in appeal before the NCLAT. Before the Supreme Court, it engaged the top government counsel, including the Solicitor General.
NOIDA’s strongest argument was that the lease was actually a ‘finance lease’ under Section 5(8)(d). A ‘finance lease’ is the transfer of substantially all the risks and rewards incidental to ownership of an underlying asset. In the case before the Court, it was clear that the transaction did not involve the complete divestment of rights that characterises a financial lease. NOIDA retained extensive powers over the land leased by it, including the power of re-entry and re-allotment.
The Supreme Court had to dedicate a 58-page judgment to dismissing the appeal.
The IBC, it is clear, is by its very nature an unending source of litigation. Unless Parliament steps in to retrieve the situation, insolvency resolution will remain an expensive and unrewarding process, driving away investment rather than attracting it.
