Context

In the recent judgement the Supreme Court held that the National Company Law Tribunal (NCLT) cannot admit an insolvency application filed by a financial creditor merely because a financial debt exists and the corporate debtor has defaulted in its repayment.

Why the point of trigger is important in insolvency law

• A critical element for any corporate insolvency law is the point of trigger.
• The law must clearly provide the grounds on which an insolvency application against a corporate debtor should be admitted.
• If there is any confusion at this stage, precious time could be wasted in litigation.
• That would cause value destruction of the distressed business.
• On the other hand, if the law is clear and litigation can be minimised, the distressed business could be resolved faster.
• Its value could be preserved.
• And all stakeholders collectively would benefit.
• Evidently, objective legal criteria for admission are critical for an effective corporate insolvency law.

Determining insolvency and implications of the SC ruling

• The balance-sheet test is one method for determining insolvency at the point of trigger.
• This test, however, is vulnerable to the quality of accounting standards.
• That’s why the Bankruptcy Law Reforms Committee did not favour this test in the Indian context.
• Instead, it recommended that a filing creditor must only provide a record of the liability (debt), and evidence of default on payments by the corporate debtor.
• This twin-test was expected to provide a clear and objective trigger for insolvency resolution. 
• The Supreme Court’s latest ruling is likely to radically alter these expectations.

Implications of the Supreme Court ruling

• Resisting the admission by debtor: Now due to the Supreme Court ruling, even if the NCLT is satisfied that a financial debt exists and that the corporate debtor has defaulted, it may not admit the case for resolution if the corporate debtor resists admission on any other grounds.
• Corporate debtors are likely to use this precedent to the fullest to resist admission into IBC.
• Risk of value destruction due to delay: The likely outcome would be more litigation and delay at the admission stage, enhancing the risks of value destruction in the underlying distressed business.

Conclusion

In all fairness, the Supreme Court has been extremely pragmatic in its interpretation and application of the IBC. Even in the recent ruling, the court has rightly cautioned that the NCLT should not exercise its discretionary power in an arbitrary or capricious manner. Yet, this decision may have opened a Pandora’s box. Policymakers would be well-advised to take note before history starts repeating itself.

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