2018 (5) TMI 79 - HC - Insolvency and Bankruptcy

Insolvency resolution Process - financial creditor versus operational creditor - whether undue preference has been given to a financial creditor - It is submitted that, a financial creditor has a right to be in the Committee of Creditors (COC) of a corporate debtor in an insolvency proceeding. An operational creditor, although such creditor may have a claim far in excess than that of the financial creditor, will have no say in the Committee of Creditors. Held that - Classification amongst similarly situated persons is permissible if the classification is based on reasonable differentia. If the classification is on reasonable differentia it does not offend the principle of equality. Consequently, creditors of a company can be classified, provided the classification is on reasonable differentia. An operational creditor is not ousted in its entirety from coming into the committee of creditors. An operational creditor does not have a voting right in the event it is in the committee of creditors. The Bankruptcy Committee gives a rationale to the financial creditors being treated in a particular way vis- -vis an operational creditor in an insolvency proceeding with regard to a company. The rationale is a plausible view taken for an expeditious resolution of an insolvency issue of a company. Courts are not required to adjudge a legislation on the basis of possible misuse or the crudities or inequalities that may be perceived to be embedded in a legislation. The rationale of giving a particular treatment to a financial creditor in the process of insolvency of a company under the Code of 2016 cannot be said to offend any provisions of the Constitution of India. Nothing is placed on record that, a different view should be taken on the ground of breach of principles of natural justice in a proceeding under the Code of 2016.

Issues Involved:
1. Vires of Sections 7, 8, and 9 of the Insolvency and Bankruptcy Code, 2016.
2. Distinction between financial and operational creditors.
3. Preference given to financial creditors in the Committee of Creditors (COC).
4. Adjudicating authority's power to scrutinize claims.
5. Principles of natural justice in insolvency proceedings.
6. Constitutionality and economic rationale of the Code.

Issue-wise Detailed Analysis:

1. Vires of Sections 7, 8, and 9 of the Insolvency and Bankruptcy Code, 2016:
The petitioners challenged the constitutionality of Sections 7, 8, and 9 of the Insolvency and Bankruptcy Code, 2016 (IBC), arguing that the differentiation between financial creditors and operational creditors lacks a rational basis. They contended that this differentiation is unjust, unfair, and irrational, and thus, these sections should be struck down. The court, however, upheld the constitutionality of these sections, stating that the classification between financial and operational creditors is based on reasonable differentia and does not offend the principle of equality under the Constitution.

2. Distinction between Financial and Operational Creditors:
The petitioners argued that the IBC's distinction between financial and operational creditors is irrational and lacks an intelligible basis. They highlighted that financial creditors have a right to be in the COC, whereas operational creditors, even if they have larger claims, do not. The court noted that the classification is based on the nature of the debt and the capability of creditors to assess viability and modify terms of existing liabilities. The court found this classification to be reasonable and necessary for the rapid and efficient resolution of insolvency issues.

3. Preference Given to Financial Creditors in the Committee of Creditors (COC):
The petitioners contended that financial creditors are given undue preference in the COC, which is unjust as operational creditors may have larger claims. The court referred to the Bankruptcy Committee's rationale, which stated that financial creditors are better positioned to assess the viability of the debtor and are more willing to modify terms for the entity's future prospects. The court held that this preference is justified and does not violate the Constitution.

4. Adjudicating Authority's Power to Scrutinize Claims:
The petitioners argued that the IBC does not empower the adjudicating authority to scrutinize the validity and sufficiency of claims by financial creditors, whereas operational creditors face stricter scrutiny. The court observed that the IBC provides a framework for resolving insolvency issues expeditiously and that the differentiation in scrutiny is based on the nature of the debt and the likelihood of disputes. The court found no violation of principles of natural justice or constitutional provisions in this differentiation.

5. Principles of Natural Justice in Insolvency Proceedings:
The petitioners claimed that the IBC violates principles of natural justice by not providing adequate opportunities for corporate debtors to challenge claims. The court noted that the IBC includes provisions for notice and response, ensuring that corporate debtors have an opportunity to address claims before insolvency proceedings are initiated. The court found that the principles of natural justice are adequately protected under the IBC.

6. Constitutionality and Economic Rationale of the Code:
The respondents argued that the IBC represents a paradigm shift in insolvency and bankruptcy proceedings, aimed at resolving issues expeditiously and keeping legal entities viable. The court emphasized that economic legislation is given greater latitude and should be presumed constitutional unless there is a flagrant violation of the Constitution. The court upheld the IBC, stating that it is a valid economic measure designed to address insolvency issues efficiently.

Conclusion:
The court dismissed the petition, upholding the constitutionality of Sections 7, 8, and 9 of the IBC. The differentiation between financial and operational creditors was found to be based on reasonable differentia, and the preference given to financial creditors in the COC was justified. The court also found that the principles of natural justice are adequately protected under the IBC and that the economic rationale behind the Code is valid and constitutional.

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