Recent Developments in Insolvency Tests under Indian Law

On the 12th of July 2022, a division bench of the Supreme Court of India delivered its judgment in Vidarbha Industries Power Ltd v Axis Bank (‘Vidarbha’). Prior to this case, the settled position of law was that a creditor had to demonstrate the existence of debt and default to initiate insolvency proceedings—a standard widely perceived as objective and consistent. This test is similar to the ‘cash flow test’ under English law, wherein a company is deemed insolvent if it is unable to pay its debts as and when they fall due. In Vidarbha, the Court departed from existing precedent and held that even if debt and default were proved, the National Company Law Tribunal (‘NCLT’) may consider other ‘relevant factors’ in deciding whether to admit the debtor into insolvency proceedings.

The judgment was deeply polarizing and prompted strong objections from various stakeholders, including lawyers, bankers and insolvency professionals. The crux of their objections was that a grant of discretionary power would further elongate the process for insolvency resolution, leading to value erosion and lower recovery for creditors. A review petition was filed before the Supreme Court against Vidarbha, which was dismissed in September 2022. In this post, I present a brief analysis of Vidarbha and how it may impact the trajectory of insolvency law in India.

The facts of the case are relatively straightforward. The debtor, Vidarbha Industries, was an electricity generating company that had entered into a power purchase agreement with Reliance Industries Limited. Under India’s electricity regime, the tariff payable to electricity generation companies is determined by the state regulator, along with a specialized appellate procedure for resolution of disputes. In relation to its agreement with Reliance, the debtor objected to the tariff determined by the regulator and successfully challenged it before the appellate tribunal. As per the terms of the appellate tribunal’s award, the debtor was entitled to INR 1730 Crores (approximately 211 million USD) as compensation. The regulator appealed the appellate tribunal’s award before the Supreme Court.

During the pendency of the appeal before the Supreme Court, Axis Bank Ltd, a financial creditor of the debtor, filed an application for initiation of insolvency proceedings against the debtor. Axis Bank argued that the debtor had defaulted on its debt obligations of approximately INR 550 Crores (approximately 67 million USD). In response, the debtor argued that insolvency proceedings should not be initiated before the disposal of the Supreme Court appeal, given that the amount due under the award would comfortably allow it to service all its existing debt obligations. The Supreme Court upheld the debtor’s claim and remanded the matter to the NCLT, with the observation that it may consider factors beyond the occurrence of debt and default, such as the overall financial health of the debtor under its existing management, before initiating insolvency proceedings.

Despite its nascency, the influence of Vidarbha can already be seen in lower court insolvency adjudication. In Anita Jindal, the National Company Law Appellate Tribunal (‘NCLAT’) held that even if debt and default had been proved, the creditor’s intention would also be relevant in determining whether to admit a debtor into insolvency. If a creditor was merely seeking debt recovery—as opposed to reorganization of the debtor—the NCLAT held that the application was liable to be dismissed. Similarly, in Reliance Commercial Finance, the NCLAT granted the debtor a 45-day period to pay off all outstanding dues, failing which the insolvency process would commence. In other cases, courts have had to distinguish Vidarbha before admitting a debtor under Section 7. The short-term impact of this judgment is that courts are not restricting their threshold inquiry to default on debt and are considering subjective factors, such as short-term liquidity issues and overall financial health of the firm. 

This post does not take a position on the merits of the judgment. Instead, at a broader level, I suggest that the discourse surrounding Vidarbha reflects the tensions embedded in Indian insolvency law and the competing directions it may take in the future. On the one hand, as many have argued, Vidarbha exacerbates the difficulties faced by creditors in acting against defaulters. A creditor will not only have to prove debt and default but may also have to demonstrate their bona fides and rebut any defences raised by the debtor. Through this, pre-admission processes are elongated, and the creditor’s recovery may be harmed. A discussion paper by the Insolvency and Bankruptcy Board of India, India’s insolvency regulator, has calculated that the average time period for admission of an application by an operational creditor under Section 9 is 650 days—far beyond the statutory time period of 14 days. A similar delay in admission of applications by a financial creditor under Section 7 may severely impact any attempt at debt resolution. As per this view, the purpose of insolvency law is to establish a swift, efficient and consistent mechanism for creditors to resolve debt owed to them.  

On the other hand, it can also be argued that Vidarbha offers some protection to incumbent management and shareholders of the debtor. On the commencement of insolvency, the management is replaced by a resolution professional, who runs the debtor as a going concern till resolution or liquidation. In the event of liquidation, shareholders are last in the waterfall mechanism, which means that they rarely receive any payouts. It appears undesirable to penalize shareholders and managers when a firm is facing short-term liquidity issues due to any number of external factors, ranging from geopolitical conflict (eg Russia’s invasion of Ukraine and resultant rise in energy prices) to unfair state regulatory action (as was the case in Vidarbha). A more flexible approach may be appropriate in addressing such circumstances. Under this approach, the purpose of insolvency law is to protect multiple stakeholders, including the debtor, its creditors, its shareholders, its workers and the public interest.

In Vidarbha, the court adopted the latter approach. The fact that the debtor was entitled to compensation from the state was sufficient to temporarily thwart the creditor’s attempt at initiating insolvency proceedings. Another example of the shift towards a pluralistic conception of insolvency law can be seen in the judicial treatment of homebuyers in real estate insolvencies. Under the statutory insolvency procedure, most real estate firms were being liquidated rather than reorganized, leading to low recovery rates for real estate allottees. In Umang Realtech, the NCLAT devised a special mechanism for resolution of real estate firms—described as ‘reverse CIRP’—which ensured homebuyers received possession of apartments, even if a senior creditor held security interest over the construction. This dichotomy is also arising in various other contexts, such as environmental liabilities of bankrupt firms. As India’s insolvency law evolves, its future trajectory will increasingly be shaped by our understanding of its purpose and limitations.

In conclusion, it appears that Vidarbha has significantly altered India’s insolvency landscape for the time being. Debtors now have an additional ground of defence before being admitted into insolvency. In the long term, it remains to be seen whether this judgment marks an inflexion point in our understanding of the purpose and nature of insolvency law in India.

Satyajit Bose is an Associate at the Insolvency and Bankruptcy Practice of Shardul Amarchand Mangaldas and Co, New Delhi.