Classification between Operational and Financial Creditor not violative of Article 14 of the Constitution of India: Swiss Ribbon v. Union of India

The Insolvency and Bankruptcy Code, 2016 was enacted to provide a fixed solution to the creditors for resolving insolvencies and to aid them in recovering their dues from the defaulters. The prime objective of the code was to shield the interest of the small investors and provide the debtors with numerous instruments to rebuild and restore their business.[1] The Code since its inception has faced a lot of criticism and issues of its constitutionality have always been questioned by the Stakeholders.

In response to such criticism and constitutional challenges, the division bench of the Supreme Court in a landmark judgment comprising of Justice Rohinton F Nariman and. Justice Navin Sinha has upheld the constitutional validity of the various provisions of the Insolvency and Bankruptcy Code, 2016.[2] The court went on to say that the code is a beneficial legislation and its primary focus is to “ensure revival and continuation of the corporate debtor by protecting the corporate debtor from its management and a corporate death by liquidation.”

Supreme Court while adjudicating the matter made numerous observations concerning the issues raised by the petitioners. The major contention put forth by the petitioners was concerning the classification of financial and operational creditors. It was contended that the differentiation between the two types of creditors lacks any intelligible differentia as both operational as well as financial creditor assists the debtor either in terms of money or goods. Therefore, no genuine link could be established with the object sought to be achieved by the code as the objective behind the legislation was to promote resolution and not liquidation. As a result, it would be just to say that such a differentiation is violative of Article 14 of the Constitution of India which guarantees “equality before the law.”[3] Hence, relying upon the decision of Shayara Bano v. Union of India[4] , such differential treatment is wholly discriminatory and arbitrary.

However, the Supreme Court vehemently denied the contention put forth by the petitioner and upheld the classification and concluded that the “classification between financial creditor and operational creditor neither discriminatory, nor arbitrary, nor violative of Article 14 of the Constitution of India.”

Supreme Court on the issue of differential treatment held that there is a clear existence of intelligible differentia between operational and financial creditors and observed that unlike operational creditors, financial creditors belong to the category of secured creditors. Further, the nature of the agreements existing with the financial creditors is entirely different from the contract subsisting with the operational creditors and the amount of money owed to the operational creditors is comparatively less than the amount of money due to the financial creditors. The court also observed that in case of the financial creditors the repayment of the amount of money borrowed is substantially organized under various repayment schedules and in cases of defaults, the financial creditors are given liberty to recall upon the entire sum of money given as loan to the corporate debtors. Also, the dispute resolution forum existing for financial and operational creditors are entirely different from one another. The court further observed that the possibility of the existence of a genuine dispute is much higher in the case of operational debts as compared to the financial debts for the simple reason that the financial debts are well-documented with the banks and therefore are easily verifiable.

It is pertinent to mention that the financial creditors have been involved in “assessing the viability of the corporate debtor” and during the situation of financial strain, unlike operational creditor, they are committed to rebuilding and restoring the business of the corporate debtor. Thus, the classification between the two types of creditors is based upon an intelligible differentia having an immediate connection with the object sought to be achieved by the code. Hence, keeping in mind the underlying objective of the legislation which ensures the preservation of the corporate debtor while ensuring “maximum recovery for all creditors”, there exist substantial demarcation between them under the code.

The court to decide the issue of the differential treatment in case of Committee of Creditors, which encompasses only financial creditors, went on to study the role played by both sets of creditors in furtherance of the code and thereafter, relied upon the report of BLRC, which provides that the “operational creditors are neither able to decide on matters regarding the insolvency of the entity nor willing to take the risk of postponing payments for better prospects for the entity. The Committee concluded that, for the process to be rapid and efficient, the Code will provide that the creditors’ committee should be restricted to only the financial creditors.”

The court further noted that the financial creditors being involved in the process of providing financial support to the corporations are ‘best equipped to assess viability and feasibility of the business of the corporate debtor” and therefore are substantially at a good position to assess the viability of the resolution plan.  On the contrary, operational creditors play a role for a very small period and are just concerned in recovering the amount of the goods and services offered by them to the corporations. The court also mentioned that it is the duty of the tribunals (NCLT) to safeguard the interest of the operational creditors and therefore, the tribunals must make sure that operational creditors at least receive a minimum payment, which must not be less than the liquidation value. For the above reasons, the court found it unreasonable to hold that the operational creditors have been discriminated on the grounds of equality or there is a violation of Article 14 of the Constitution of India.

Another contention that was put forth by the petitioner was concerning the legitimacy of Section 12A that it provides for the approval of 90% of Committee of creditors to allow the withdrawal of a petition filed under Section 7 and section 9 of the Insolvency and bankruptcy code. The court to answer the question referred to the ILC reports which clearly explained the objective behind Section 12A. The court noted that the “financial creditors have to put their heads together to allow such withdrawal as, ordinarily, an omnibus settlement involving all creditors ought, ideally, to be entered into. This clarifies why 90%, which is substantial all the financial creditors, have to grant their approval to an individual withdrawal or settlement.” Further, the court also pointed out that under Section 60 of the Code, the CoC doesn’t have the final word regarding the matter. On the top of it, if the CoC arbitrarily rejects a fair settlement, as well as withdrawal claim, the NCLT and thereafter NCLAT, can generally set aside such choice under Section 60 of the Code. This indicates that the Committee of Creditors does not have that last say and therefore there exist no questions concerning the legitimacy of Section 12A of the Code.

While upholding the validity of the legislation, the Supreme Court adopted a more extensive way and considered the legislation as an experiment dealing with economic problems. The court relied upon the judgment of R.K. Garg v. Union of India[5] and noted that- “Every legislation, particularly in economic matters is essentially empiric and it is based on experimentation or what one may call trial and error method and therefore it cannot provide for all possible situations or anticipate all possible abuses. There may be crudities and inequities in complicated experimental economic legislation but on that account alone it cannot be struck down as invalid”.

Therefore, a complex economic matter based on experimentation and empirics cannot be tested on any straitjacket formula.[6] Even if legislation is unscientific or illogical these errors are not subject to judicial review, rather they can be declared void only on the arbitrary exercise of power.[7] The court while exercising the power of judicial review must not be oblivious of the practical needs of the Government and the door must be left open for experimentation because the Constitutional Law like other mortal contrivances needs to take few risks.[8] Moreover, with regards to the changed economic scenario, the ability of individuals dealing with the subject should not be lightly interfered with.[9] Once it is proved that the authority acted within their vires then the court must show some judicial restraint by upholding the applicability of legislation. The arrangement of governing rules must be used fairly with the essential goal of quickening economic development as opposed to suspending its development by questioning its sacred adequacy at the beginning itself.  Therefore, merely because there is a likelihood of certain contingencies, legislation based upon economic consideration cannot be struck down as unconstitutional.

[1] CPPR MEDIA, The Bankruptcy Code for India – A step to ease ‘Doing Business’? accessed on 03/03/2019

[2] Swiss Ribbons Pvt. Ltd. & Anr. v. Union of India, WRIT PETITION (CIVIL) NO. 99 OF 2018.

[3] Constitution of India, Art. 14

[4] Shayara Bano v. Union of India, 2017 SCC OnLine SC 963.

[5] R.K. Garg v. Union of India, (1981) 4 SCC 675

[6] Metropolis Theater Company v. City of Chicago, 228 US 61 (1913).

[7] Metropolis Theater Company v. City of Chicago, 228 US 61 (1913).

[8] Keshavananda Bharati v. State of Kerala, AIR 1973 SC 1461, 1535.

[9] Bhavesh D. Parish v. Union and India, (2000) 5 SCC 471.

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