NCLT order mandating filing default record under section 7 IBC: Ultra vires and untenable

The National Company Law Tribunal (NCLT) on May 12, 2020 by way of an ‘order’ directed that any new insolvency application filed by a financial creditor under section 7 of the Insolvency & Bankruptcy Code, 2016 (IBC) must be accompanied by a default record from an Information Utility.

Not only did it make such filing mandatory for new applications, it also directed that authorized representatives of financial creditors must file such default record in all pending insolvency applications.

Section 7 of the IBC provides for initiation of corporate insolvency resolution process (CIRP) by a financial creditor. It enables a financial creditor to file an appropriate application, either by itself or jointly with other financial creditors, for initiation of a CIRP against a corporate debtor. Section 7(3) specifies what is required to be furnished along with the application, which is extracted as under:

“7. Initiation of corporate insolvency resolution process by financial creditor

…

(3) The financial creditor shall, along with the application furnish –

(a) record of default recorded with the information utility or such other record or evidence of default as may be specified;

(b) the name of the resolution professional proposed to act as an interim resolution professional; and

(c) any other information as may be specified by the Board.”

(emphasis supplied)

An information utility is an entity which is a repository of financial information like loans, defaults and security interests etc. for corporations and firms. The utility procures, maintains and provides such undisputed financial information for initiation of CIRPs.

To accept, store and make readily available authenticated financial information submitted by creditors that helps establish defaults as well as verify claims under the IBC expeditiously and thereby facilitate completion of the insolvency resolution transactions under IBC in a time-bound manner.

National e-Governance Services Ltd. (NESL) is the only information utility in India authorized by the Insolvency and Bankruptcy Board of India (IBBI). Its objectives are:

To accept, store and make readily available authenticated financial information submitted by creditors that helps establish defaults as well as verify claims under the Insolvency and Bankruptcy Code, 2016 expeditiously and thereby facilitate completion of the insolvency resolution transactions under IBC in a time-bound manner.

The NCLT order dated May 12, 2020 effectively means that every insolvency application filed by a financial creditor must necessarily be accompanied by a default record obtained from NESL.

In my view, this direction is contrary to the provisions of section 7 of IBC, more specifically contrary to section 7(3)(a). The said section clearly provides that a financial creditor may either furnish record of default recorded with the information utility or such other record or evidence of default as may be specified. The choice has, therefore, been left up to the financial creditor under the IBC. The NCLT cannot, that too by way of an order, override the directory nature of the provision to make it mandatory.

The language of section 7(3) of IBC is important to note. It says that a financial creditor “shall” furnish the information specified under the sub-section along with the application. The Supreme Court in PT Rajan vs TPM Sahir [2003 (8) SCC 498] held that in a procedural provision the word “shall” may not make the same mandatory if otherwise no prejudice is caused. It may benefit us to also extract the ratio laid down by the Supreme Court in Rani Kusum vs Kanchan Devi [2005 (4) SCC 480]:

“10. All the rules of procedure are the handmaid of justice. The language employed by the draftsman of processual law may be liberal or stringent, but the fact remains that the object of prescribing procedure is to advance the cause of justice. In an adversarial system, no party should ordinarily be denied the opportunity of participating in the process of justice dispensation. Unless compelled by express and specific language of the Statute, the provisions of the CPC or any other procedural enactment ought not to be construed in a manner which would leave the court helpless to meet extraordinary situations in the ends of justice.”

Section 7(3)(a) requires that a financial creditor shall furnish either a default record from an information utility, or any other record or evidence to prove default by a corporate debtor. In light of the judgments in PT Rajan and Rani Kusum cases, the use of ‘shall’ in the provision cannot be construed to be mandatory as far as furnishing default record from an information utility is concerned because no prejudice would be caused to any person or adjudicating authority if default is proved by alternate means.

This position finds support in the Supreme Court’s judgment in Surendra Trading Company vs JK Jute Mills [2017 (16) SCC 143] where it held that provisions regarding time lines for the adjudication of insolvency applications under IBC are directory in nature and not mandatory. The Court relied on the judgments in PT Rajan and Rani Kusum cases to reach this conclusion. Relying on this judgment, the Supreme Court in Pioneer Urban Land & Infrastructure Ltd. vs Union of India [2019 (8) SCC 416] while dealing with various provisions of IBC held that absence of any consequences for infraction of a procedural provision implies that such provision must be interpreted as directory and not mandatory. Therefore, in light of both Surendra Trading Company and Pioneer Urban Land & Infrastructure Ltd., it is clear that as no adverse consequence would occur if a financial creditor opts to furnish any evidence of default other than default record from an information utility, the procedural provision under section 7(3)(a) of IBC can only be construed as directory and not mandatory.

Therefore, the NCLT cannot make furnishing default record mandatory as such a direction is ultra vires the framework of section 7 of IBC. Of course, the question remains whether the NCLT even has any power to issue such orders?

The NCLT is the adjudicating authority under the IBC, and not a regulatory authority like the IBBI. Section 196 of the IBC provides the powers and functions of the IBBI. Section 196(1)(u), empowers the IBBI to make regulations and guidelines on matters relating to insolvency and bankruptcy as may be required under the IBC. Various provisions in the IBC empower the IBBI to prescribe the requirements under such provisions. There is no such corresponding power vested in the NCLT under the IBC. In fact, the order dated 12.05.2020 does not specify the source of the enabling provision through which the order mandating filing of default record has been issued. An argument may be made that NCLT has inherent powers under Rule 11 of the National Company Law Tribunal Rules, 2016. Rule 11 provides that:

“11. Inherent Powers.- Nothing in these rules shall be deemed to limit or otherwise affect the inherent powers of the Tribunal to make such orders as may be necessary for meeting the ends of justice or to prevent abuse of the process of the Tribunal.”

The NCLT has invoked this power to pass ad interim orders during the pendency of an insolvency application which was upheld by the National Company Law Appellate Tribunal (NCLAT) in NUI Pulp and Paper Industries Pvt. Ltd. Vs. Ms. Roxcel Trading GMBH bearing Company Appeal (AT) (Insolvency) No. 664 of 2019. However, these powers cannot be exercised to pass an order on the administrative side which would have an effect of restricting the scope of a provision contained in the IBC.

Even assuming that NCLT had rule making powers, or if IBBI had issued such an order, even then the order would have been ultra vires section 7 of IBC.

It is settled law that rule making powers given to an authority to support a legislation cannot be used to restrict the provisions of the enabling act. In St. Johns Teachers Training Institute vs. Regional Director, National Council for Teacher Education and Ors. [(2003) 3 SCC 321] the Supreme Court held that:

“10. A Regulation is a rule or order prescribed by a superior for the management of some business and implies a rule for general course of action. Rules and Regulations are all comprised in delegated legislations. The power to make subordinate legislation is derived from the enabling Act and it is fundamental that the delegate on whom such a power is conferred has to act within the limits of authority conferred by the Act. Rules cannot be made to supplant the provisions of the enabling Act but to supplement it. What is permitted is delegation of ancillary or subordinate legislative functions, or, what is fictionally called, a power to fill up details.”

Similarly, the Supreme Court in Indian Young Lawyers Association and Ors. vs. The State of Kerala and Ors. [(2019) 11 SCC 1] held that:

“266. When the rule-making power is conferred by legislation on a delegate, the latter cannot make a Rule contrary to the provisions of the parent legislation. The rule-making authority does not have the power to make a Rule beyond the scope of the enabling law or inconsistent with the law. Whether delegated legislation is in excess of the power conferred on the delegate is determined with reference to the specific provisions of the statute conferring the power and the object of the Act as gathered from its provisions.”

Therefore, no form of delegated legislation under the IBC can restrict the scope of section 7(3)(a) to make furnishing of default record from an information utility mandatory. The order dated 12.05.2020 issued by the NCLT also provides that default records must also be furnished in cases where insolvency applications filed by financial creditors are pending admission. This has an effect of making the direction retrospective with regard to applications which are already filed and accepted for adjudication. This is again ultra vires the IBC as there is no provision to make any delegated legislation retrospective. The Supreme Court in Director General of Foreign Trade and Ors. vs. Kanak Exports and Ors. [(2016) 2 SCC 226] held that delegated legislation can be retrospective only when the enabling act empowers the authority to do so. It said:

“108. We may, in the first instance, make this legal position clear that a delegated or subordinate legislation can only be prospective and not retrospective, unless rule making authority has been vested with power under a statute to make rules with retrospective effect. …”

Therefore, the order dated May 12, 2020 does not appear to be tenable in the eyes of law even on this account.

Author is a Partner at Dua Associates, Advocates & Solicitors.