“I gave a talk once where I said they ought to pass out to all federal judges a stamp, and the stamp says—Whack! [Pounds his fist.]—STUPID BUT ­CONSTITUTIONAL. Whack! [Pounds again.] STUPID BUT ­CONSTITUTIONAL! Whack! ­STUPID BUT CONSTITUTIONAL … [Laughs.]”

– Justice Antonin Scalia of the US Supreme Court

The point that the late Justice Scalia was making, that judicial deference to legislation passed by elected bodies ought to be the norm, seems to have been reaffirmed by our Supreme Court in its recent judgment (bearing the rather euphonious name Swiss Ribbons v. Union of India) by which it declared the Insolvency and Bankruptcy Code to be constitutional. Given that the IBC does not restrict free speech, or abridge religious rights, or otherwise trample on any constitutional danger zone, the petitioners challenging its provisions always had an uphill challenge, and deservedly failed.

And yet…and yet. The Supreme Court (helmed, yet again, by Justice Nariman, who seems to be the Court’s designated IBC judge) could have made its judgment an expanded version of that Scalia quote. It could have merely rebuffed the constitutional challenge by bowing to the carte blanche that the Court has historically allowed legislatures in cases involving economic legislation. I might then have had nothing to say about this judgment. But it did not. It made numerous observations about financial creditors, operational creditors and the IBC itself, that I seriously disagree with. This piece contains some of my concerns.

Operational and financial creditors and the myth of bank expertise

One of the issues for the Court to decide was whether the very different treatment given by the Code to operational and financial creditors was violative of the Constitution. The discrimination is stark. For example, operational creditors are not given a place on the elite committee of creditors that approves bids for the company – seats on the committee are reserved for financial creditors only. In a constitutional challenge, such discriminatory treatment does not matter if it can be shown that there is a rational basis for it, or, to put it in the Anglo-Latin of legalese, “intelligible differentia”.

The heart of the Court’s analysis on the issue of discrimination is contained in paragraph 28, which contains its logic for allowing the “financial creditors only” rule for the committee of creditors. With no empirical backing, it declaims:

“Most importantly, financial creditors are, from the very beginning, involved with assessing the viability of the corporate debtor. They can, and therefore do, engage in restructuring of the loan as well as reorganization of the corporate debtor’s business when there is financial stress, which are things operational creditors do not and cannot do. Thus, preserving the corporate debtor as a going concern, while ensuring maximum recovery for all creditors being the objective of the Code, financial creditors are clearly different from operational creditors and therefore, there is obviously an intelligible differentia between the two which has a direct relation to the objects sought to be achieved by the Code.” (emphasis supplied)

The idea that financial creditors are diligently and continuously analysing the business of the corporate debtor is a pleasant one. It is also directly contrary to the report of the Bankruptcy Law Reforms Committee, which gave us the Code. In a section titled “Misplaced emphasis on secured credit”, the Committee excoriated lenders for failing to analyse businesses, and looking only to the value of the collateral that a company could offer. The Committee lamented, “The concept of looking at the cash flows of a company and giving loans against that is largely absent.” Further, the fact that operational creditors could be equally adept at assessing the company’s viability does not even enter the Court’s analysis. Would a bank know more about the business of a shoe manufacturer than a shoe retailer? My point is that if the Court wanted to justify rather than merely uphold the provisions of the IBC, then it ought to have had its facts and statistics down pat.

In a different part of the judgement, Justice Nariman quotes Jesus from Luke 6:39 to say “if the blind lead the blind, both shall fall into the ditch.” Operational creditors might have wished that His Lordship’s finger would have moved one line higher to Luke 6:38: “Give, and it will be given to you.” Under the present regime, they give, and rarely get anything back.

A good ground for review?

A stranger piece of analysis ensues. The Court somehow assumes that the Code gives operational creditors the right to initiate the insolvency resolution process without having to prove the occurrence of a default. Note here that the very opening words of Section 8, which governs the triggering of the insolvency resolution process at the instance of an operational creditor, are, “An operational creditor may, on the occurrence of a default…” Without noticing these words, the Court observes:

“Whereas a claim gives rise to a debt only when it becomes due, a default occurs only when a debt becomes due and payable and is not paid by the debtor. It is for this reason that a financial creditor has to prove default as opposed to an operational creditor who merely claims a right to payment of a liability or obligation in respect of a debt which may be due. When this aspect is borne in mind, the differentiation in the triggering of insolvency resolution process by financial creditors under Section 7 and by operational creditors under Sections 8 and 9 of the Code becomes clear.”

I respectfully disagree.

A company, by any other name…

In considering the challenge to Section 29A, which disqualifies bidders from submitting bids for all sorts of reasons, the Court did not consider one argument: if a person is qualified to run any other company under Indian law, why should that person be disqualified from managing an insolvent company? In other words, what is the rationale for allowing convicts and wilful defaulters to own other companies but prohibiting them from owning insolvent ones? Perhaps no one argued this.

That unnecessary last paragraph

Judicial deference to legislation I can understand, judicial endorsement I cannot. In the last paragraph of Swiss Ribbons, based on figures that show a rise in credit to the commercial sector, the Court concludes:

“These figures show that the experiment conducted in enacting the Code is proving to be largely successful. The defaulter’s paradise is lost. In its place, the economy’s rightful position has been regained. The result is that all the petitions will now be disposed of in terms of this judgment.”

Is it the Court’s province to make such sweeping statements about the efficacy of an enactment? How does a rise in credit affect the constitutionality of the IBC? Are we to assume that the Court would have held the Code to be unconstitutional if the figures pointed down rather than up? And surely whether or not the Code has been “largely successful” and whether “the economy’s rightful position has been regained” are matters of public debate and not judicial proclamation?

In sum, I agree with the Court’s conclusion, but I don’t agree with how it got there.