SC upholds constitutional validity of sections 3, 4 and 10 of IBC (Amendment) Act, 2020

A three judge Bench of the Hon’ble Supreme Court comprising of Justices Rohington F. Nariman, Navin Sinha and K.M. Joseph in the case of Manish Kumar v. Union of India and Others, REED 2021 SC 01515, upheld the Constitutional validity of the amendments made to the Insolvency and Bankruptcy Code (IBC) in 2020. The amendments mandated a minimum of 100 home buyers from the same real estate project to come together to file an insolvency application in the National Company Law Tribunal (NCLT) to trigger the IBC against a defaulting property developer. 

 

Facts of the case

The petitioner approached the court under Article 32 of the constitution regarding sections 3, 4 and 10 of the Insolvency and Bankruptcy Code (Amendment) Act, 2020. The petitioners are mostly allottees under real estate projects. Some of these petitioners are money lenders who have financed real estate projects.

Procedural History 

The Insolvency and Bankruptcy Code was enacted in the year 2016 aimed at preventing insolvency and hence an important economic measure. The code is divided in five parts- first is the shortest out of them all, second and third part is the concern here. 

The second part deals with insolvency resolution and liquidation for corporate persons, the third part deals with Insolvency resolution and Bankruptcy Code for individuals and partnership firms. The third part is in regard to insolvency resolution and bankruptcy for other partnership firms.

  

Final Judgment and Reasoning

The counsel for the petitioners argued that the amendments fall foul of the mandate of Articles 14, 19(1)(g), 21 and 300A of the constitution. The amendment through S.3 introduced the section 7(1) of the code making hostile discrimination between financial creditors, the category to which the petitioners belong.

Secondly, he contended that the amendment imposing a threshold restriction is afflicted with the vice of palpable and hostile discrimination qua operational creditors. This led to the violation of freedom under Article 19(1)(g) and is an invasion of equality. 

He argued that there are leakages in the impugned provisions which would make it unworkable, and it manifests arbitrarily and creates a class within a class.

Under the code, the law provides a period of 14 days for adjudicating authority to decide whether under section 7 should be admitted. Section 12 declares an inflexible limit for insolvency resolution process to be terminated. He further pointed out the Supreme Court judgment in Pioneer Urban Land and Infrastructure Ltd. and another vs Union of India and Others, REED 2019 SC 08502, which dealt with the petitioner’s apprehension that there will be a misuse of provisions and allayed their unfounded fears. The legislature has however ventured to place clogs on rights of one category of financial creditors which is impermissible. There is no data to back the idea of misuse by home buyers i.e., the financial creditors. He points towards judgments of the NCLT where there had been a gross delay in justice as the debtor had genuinely become insolvent and the home buyers were well within their rights to go to the tribunal. He also pointed out the reports of the parliamentary committee and said that there were no reasons justifying this amendment.

He sought for a comparison between certain sections of the Companies Act and pointed out certain distinctions in requirements, first being that when the shareholders approach the tribunal under companies Act, they have all the details regarding shareholding, however this is not the case for home buyers as there is no system of obtaining an information of similar nature. Second being, under section 244 of the Companies Act there is a clarification regarding joint holding, however, no such provision is provided for under section 7 of the code. There are practical difficulties relating to this code as well. 

He also contended that as under the third proviso, the 14-day period for disposal is directory and not mandatory, and the retrospectivity renders this provision arbitrary.

The other counsel for the petitioners argued that the impugned amendment is arbitrary according to the principles laid down in Pioneer case. The ordinance deprives petitioner of rights under section 7 but violates Article 14 as well. The threshold limit is unreasonable. There already exists adequate shield against a single allottee misusing the code. It is only applicable to home buyers and hence discriminatory.

The third counsel for the petitioners stated that once the right to make an application is conferred, it cannot be conditioned according to threshold limit. There is also hostile discrimination qua other corporate debtors. The Builder in this case is given a more favorable treatment as compared to others. He brought the court’s attention towards the judgments under Chitra Sharma and Others Vs Union of India and others and Pioneer, the provisions are against the principles laid down in both these cases and renders the remedy illusory. He drew the attention towards Order 1 Rule 8 of the CPC under which the numerical stipulation in impinged proviso is not insisted upon, which is also captured by Section 12 of the Consumer Protection Act. As the real estate developers raise funds through allottees exclusively, the threshold limit is impermissible. He pointed out the Judgment under Motilal Padampat Sugar Mills Co. Ltd. v. State of U.P., (1979) 2 SCC 409  regarding the availability of principles of promissory estoppel. Also, RERA has not been constituted in all states and under Nagpur Investment trust and others v. Vithal Rao and Others, (1973) 1 SCC 500, where the principle of hostile discrimination is reiterated. He also pointed out that the definition of ‘Allottee’ under RERA is over inclusive. Since the date of home buyer’s agreements would be different for each so would the date of Default, and it is not possible for a home buyer to assemble one hundred or one-tenth the total number of allottees. 

The fourth counsel for the petitioners argued that it would be difficult to cull out investors if a corporate body has different projects. Insolvency cannot be applied with respect to only a single project, it will be applied to all. There is no platform for exchange of details of allottees. 

The fifth counsel argued that the Section 6 of the General clauses act would protect all pending applications.

The sixth counsel complained against the retrospectivity of the provisions. He argued that the law can only be prospective.

The seventh counsel drew the court’s attention towards Sections 2(u) and 20 of prevention of Money laundering Act, 2002. Section 14 and Section 32A are being violated and the remedies are being taken away.

The eighth counsel argued that a substantive right to invoke section 7 cannot be taken away through a procedural requirement. He contended that procedure cannot take away a right, law on date of initiation should prevail and not through subsequent amendment, and against the 3rd proviso of Section 7(1), a proviso cannot override the main provision and supported these through judgments under Garikapati Veeraya v. N. Subbiah Choudhry, AIR 1957 SC 540  Thirumalai Chemicals Ltd. v. Union of India and Others, (2011) 6 SCC 739  and Delhi Metro Rail Corporation Ltd. v. Tarun Pal Singh and Others, (2018) 14 SCC 161.

The Ninth Counsel complained that an amendment has been drafted without removing the premise on which the Pioneer Decision (REED 2019 SC 08502) was made. 

The tenth counsel pointed out that there is no intelligible differentia to distinguish home buyers from other creditors. The default is in rem and the allottees are spread across the globe. 

The twelfth counsel pointed out that home buyers would continue being financial creditors. The code itself does not provide for a mechanism for a home buyer to glean information about other allottees. The provision is vague with respect to the date of default, court fee payable for multiple applicants, the threshold amount and also the retrospectivity involved. 

The thirteenth counsel represents the cause of money lenders, he pointed that the proviso of applicants being of same class and at least 100 is unachievable and no information regarding the 10% requirement of the same. He drew the attention towards rule 8A.

Contrary to these contentions, the stand projected by the counsel for the Union is that the amendments are perfectly valid and based on the reports of an expert committee. It is modelled on the Companies Act and there are other statutory examples of threshold requirements. There is no discrimination but reasonable classification. The amendments are an extension of section 21(6A) and section 25A of the code, where debenture holders and security holders are treated differently. The constitutional validity of both were upheld in the pioneer judgment. In the same judgment, the court identified home buyers are not a homogeneous group. These provisions were introduced to iron out the procedural complications. The statement of objects and reasons under this code recognizes the heterogeneity within the class and aim at streamlining the same. The statement for the of objects for the second amendment stated that it is a necessity to prevent misuse of the code by certain classes of creditors. It supplements the protection under sections 65 and 75 of the Code. The intelligible differentia between the two groups is based on Numerosity, Heterogeneity, Lack of special expertise, individuality in decision making, Typicality in determination of default etc. 

There is a rational basis in this case of forming a sub-class within a class. Differential treatment in also contemplated under UNCITRAL Legislative guide and guidelines. 

There is no basis to argue that principles under the pioneer case are violated as the question involved in both the cases is different. Also, the legislature is free to make laws to deal with problems that manifest with experience which was felt in this case. Also, the argument based on estoppel under the legislature is untenable, as there can be no estoppel against the legislature and so is the principle of transferred malice. The right to file an application under section 7 is a statutory right and it can be conditioned. There is no absolute or inherent right under the same. 

Further, the third proviso in Section 7(1) does not affect any vested rights of the creditor. Mere right to take advantage of a statute is no right. The aim of third proviso is to protect the collective interests of others in class of creditors. The amendment does not have a retrospective application as no right accrues in favor of allottees over admission of application of insolvency. It also avoids needless multiplicity by putting the threshold of 100 allottees. 

In Garikapati Veeraya, it is contended that even a vested right can be taken away by legislature and a minimum threshold requirement is present in most class action law suits. A minimum threshold will add authenticity and weight to the claim under class action. The joint filing under section 7 was contemplated even under original enactment. At triggering stage, the application becomes an Application in rem rather than in personam. 

In this case a debenture-holder and other security holder, there is a debenture trustee to protect their interest from the inception under SEBI. Necessary information regarding Debenture holders is present in the public domain, under sections 88(1)(b) and 88(1)(c) of the Companies Act, 2013 which obliges every company to maintain a record of its debenture and security holders, and there is a penalty under section 88(5) of the same. 

The counsel who appeared for respondent No. 4 who is a builder supported the Union, he contended that the second proviso is logical and makes the code workable. The main aim of the proviso is to prevent misuse of the code and the information is readily available in the public domain under section 11 of RERA and gave an illustration of Haryana Real Estate Regulatory Authority.

The laws for challenging of plenary laws are well established and there are three grounds that make a legislation vulnerable. There is a view that be it a plenary law, if it is arbitrarily manifested it becomes vulnerable, the legislature cannot be held accountable under the principle of promissory estoppel.

The court went through the relevant sections and codes mentioned by the counsels and also took into consideration The Real Estate Regulation and Development Bill, 2013, RERA and noted that the Section 88 of the RERA stated that RERA will prevail over any other inconsistent law and others not inconsistent with RERA are allowed to operate in their own sphere. They also considered the Delhi Apartment Ownership Act, 1986 and found that Section 15 declares that there will be an association of apartment owners. 

The court decided to address the contentions one by one, the first being regarding the definition ‘Allottees’ and found that it is impossible for buyers to obtain the information of the same as there is no published data available of allotted units, no builder shares such information. There is vagueness surrounding the determination of allottees in a sense, is it for a tower or a colonization or a SPV. The court on further contemplation found that under the Act, the term real estate project meant a building, plot or apartment’s development and is quite comprehensive. 

The term apartment is also defined under the Delhi Apartment Ownership Act, 1986. For the purpose of the code, the meaning of the word allottee is considered under sections 2(d) and 2(zn) of the RERA and section 5(8)(f) of the Code. The same provision has been upheld in the pioneer case. The court also considered the definition of the term ‘promoter’ under RERA to better understand allottee. It was found that the allottee will depend on what is being offered by the promoter and the type of project. The term allottee is categorized under—plot, apartment, building. The one tenth of the total will depend on this categorization, which will be quarterly update under a list as under Section 11. The transferee of an apartment will also be treated as an allottee. It is contended by the petitioners that the threshold limit is arbitrary and unworkable. It is found under section 6 that when any corporate debtor commits default, a financial or operational creditor or he himself may initiate CIRP on that matter. 

The court found that even if Section 238A was inserted after original amendment, the Limitation Act, 1963 with regards to limitation would still apply right from the inception of the Code.

It was found that to successfully move an application under section 7, a default of 1 Crore must be made, and not necessarily against the applicant and according to the rules, irrespective of the number of applicants, the court fee would remain 25,000/- and hence is not vague. 

Prior to the amendment, a single allottee could set the ball in motion and all he had to satisfy is default to him or another financial creditor. The only change now is that apart from establishing the factum of default, he must present the application endorsed by the requisite number introduced by the proviso. The action is understood to be in rem and would bind all the stakeholders, including the allottees, the court found no merit in the contention based on the theory of default, rendering the provision unworkable and arbitrary. Also, a joint application is permissible in respect of all classes of financial creditors. 

The rationale behind confining all the allottees to the same project is to prevent the misuse of code. The connection is important to determine critical mass in order to streamline the working of the Code.

The next contention was the alleged lack of clarity about the point of time. The requirement of the threshold must be fulfilled on the date of filing of application as under section 7. The court in this matter looked at section 153C of the Companies Act, 1913. After thorough examination of both it was found that this contention was untenable. 

Another contention raised was pertaining to the application of threshold test to family members to join in application under sections 397 and 398, where shares are held by two or more persons, they are to be taken only as one member. However, section 7 does not provide any indication as to how the number of allottees are to be reckoned with in case of more than one person, but for the purpose of section 7(1), while the allottees can be of any category under section 2(d) of the RERA, joint allottees of a single apartment will be treated as one, any other view will lead to clear abuse of the law.

It is contended that the provisions render the threshold requirement in section 399(1) a fair one, as it allows any member or members to apply under section 397 or section 398, even though the numerical strength required was not fulfilled. The objectives of this code are different from the Companies Act. If the legislature felt that threshold requirement representing a critical mass of allottees, alone would satisfy the requirement of a valid institution of application under section 7, it cannot be dubbed as discriminatory or arbitrary.

The petitioner argued that under Order I Rule 8 of the CPC, where there are numerous people in a suit, one or more person with the permission of the court, sue or be sued or may defend such suit for benefit of all. The procedure contemplated under Order I is suitable, appropriate and fair, and entirely within the realm of legislative choice and policy. This contention is hence rejected.

The next question was whether the amendments are violative of the pioneer judgment, the provisions challenged included Section 5(8)(f) and the court made few observations regarding the code and its nature and found that the provisions in question are not violative of the principles under the pioneer judgment and this includes section 5(8)(f) and its explanation.

The next contention was that provisos are unworkable in terms of debenture holders and security holders. These contentions were unfounded as there is a statutory mechanism under section 88 in the Companies Act, 2013 whose violation is punished under section 88(3) and a provision under section 19 of the RERA on whose basis this decision is reached. The burden to peruse the availability of information contained in the registers in correct is on petitioners and they cannot be discharged of the same.

As regards to the classification under Article 14 , during consideration they included the principles of heterogeneity, numerosity and individuality in decision making and found that in this case, the rights of the allottees are not completely taken away, although there position is somewhere halfway , the point of distinction as contained in Sections 7, 8 and 9 pertaining to financial creditor and operational creditor is made and the operational creditor still has to cross the threshold of not being shut off from the application. The requirement is merely one tenth of the allottees and is a matter of policy and lies exclusively within the wisdom of the legislature. The contention in this regard is repelled.

The court in response to the contention that the target of the legislature was individual allottees and that some of the clients are debenture holders and other security holders to whom the corporate debtor owes debt and hence there is no rational basis for imposing threshold on security holders, said that the aim of the Code is to set apart the creditors involved in this case from generality of creditors, challenge here is an economic measure and thus the principle of absurdity as contended above is wholly inapposite. There is no scope of identification regarding para-49 of the pioneer judgement and the matter is further cleared from Section 21(6A)(a) read with Section 25(A).

The explanation II of Section 11 of the Code was challenged, in response to this the court noticed that these petitions were filed under Article 32 essentially around violation of Article 14 of the constitution regarding the explanation, it is contended that an explanation cannot widen or whittle the scope. The explanation that an explanation trespassing its limits would widen the scope of main provisions was found to be baseless and held that this was not arbitrary, the Sections 11(a) and 11(d) do not help in achieving the result of a repeal. The ground of violation of Article 14 was found not to merit acceptance.

The next contention was that Section 32A is unconstitutional, that the immunity granted to the corporate debtors and its assets acquired from the proceeds of criminal liability arising out of offences prior to initiation of CIRP will jeopardize the interest of the allottees and also violates Articles 14, 19, 21 and 300A. The court found that the immunity granted under this section was subject to various conditions, there must be an approved resolution plan and a change in control of corporate debtor, new management must not be a related party of the debtor and cannot be subject matter to the investigation. Every related person to debtor is liable to be prosecuted and punished. It was found that there was no basis to say that the section was violative of Article 19, 21 or 300A.

The next contention was over the retrospectivity and the 3rd proviso in Section 7, the third proviso is not found to be retrospective. The imposition of threshold requirement under the 3rd proviso is not a matter of mere procedure but impairs the vested rights of the individual creditor. It was found that all the applicants shared common characteristics and were not discriminated against on the basis of pendency at different stages, the court will not further enquire into this as it would go against the principle that the court does not look to mathematical nicety or perfection in the law.

Pertaining to the aspect of statutory withdrawal of application, and the period of retrospective operation is set for a period of one year mostly, though it appears to spread over two years. The withdrawal under third proviso will not stand in the way of the applicant. The court may have a different view about the period of time, which is allowed to the applicant.

In the question of court fees, it is found to be true that there is a compelled withdrawal of applications in this case, the court under powers vested in it under Article 142 directs that in case applications are moved by applicants, in regards to same corporate debtor, in the same project, they will be exempted to pay court fee, this would only be a one time affair, and will subsequently remain the same, for joint applicants, payment would be made once, to single applicants pertaining to subject matter and when more than one applicants combine in pending applications, they will stand exempted.

The court upheld the amendments, However, made them subject to certain directions through its power under Article 124:

Applicants will be exempted from court fee, if they make an application within the period of two months from default and compliant with first or second proviso of Section 7(1) in the manner detailed above.

If applications are moved under section 7 by the petitioners, within a period of 2 months from that day, in compliance of either proviso, and the application would be barred under Article 137 of the Limitation Act, and if applicant files it under section 5 of Limitations Act, 1963, the adjudicating authority shall allow the applicants and the period of delay will be condoned, during which an application filed under proviso 3 was pending before the authority

The time limit of two months is only fixed for exemption of court fee and condonation of delay caused by applications pending before adjudicating authority.

The writ petitions and transferred case was dismissed subject to aforesaid directions and observations contained in the judgment.

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