Revisiting Insolvency Proceedings in India: The Clean Slate Theory and Judicial Oversight

In the intricate landscape of insolvency and bankruptcy proceedings in India, the Clean Slate Theory (CST) and the role of the Committee of Creditors (CoC) have emerged as pivotal elements ensuring the efficacy and fairness of the process. This article provides an in-depth analysis of a recent case involving The National Sewing Thread Co. Ltd., focusing on the application of CST, the primacy of the CoC's commercial wisdom, the equitable treatment of creditors, and judicial oversight. Recent Madras High Court Judgment

The Madras High Court's recent judgment in the case of The National Sewing Thread Co. Ltd. underscored these principles, providing a contemporary application of the Clean Slate Theory and emphasizing the necessity of transparency and equitable treatment of creditors within the framework of the IBC.

Facts of the Case

The National Sewing Thread Co. Ltd., a public limited company registered under the MSME Act, 2006, availed financial assistance from Indian Overseas Bank (IOB). Due to significant business losses, the loan was classified as a Non-Performing Asset (NPA). IOB assigned the debt to Alchemist Asset Reconstruction Company Ltd. (Financial Creditor), which initiated a Corporate Insolvency Resolution Process (CIRP) under Section 7 of the Insolvency and Revisiting Insolvency Proceedings in India: The Clean Slate Theory and Judicial Oversight Code (IBC).

An Interim Resolution Professional (IRP) was appointed, and the Committee of Creditors (CoC), comprising IOB, approved the resolution plan, which was subsequently approved by the NCLT on December 6, 2021. The resolution plan provided minimal benefits to operational creditors, with a directive to pay them pro rata at 1% of the value of their claims. TANGEDCO issued a demand notice on January 19, 2022, for unpaid electricity charges amounting to Rs. 32,86,061/-, which the petitioner contested, citing the resolution plan.

Timeline of Events

March 24, 2017: IOB assigned the debt to Alchemist Asset Reconstruction Company Ltd.

December 6, 2021: NCLT approved the resolution plan.

January 19, 2022: TANGEDCO issued the demand notice for unpaid electricity charges.

September 15, 2023: Case reserved for judgment.

June 7, 2024: Judgment pronounced.

Issues Addressed

Validity of TANGEDCO’s Claim for Unpaid Electricity Charges

The central issue was whether TANGEDCO’s claim for unpaid electricity charges remained valid despite the approved resolution plan under the IBC. The petitioner argued that the claim was extinguished by the resolution plan, while TANGEDCO contended that their statutory dues were not addressed in the plan.

Adherence to Section 30(2) of the IBC

Another crucial issue was whether the resolution plan adhered to the requirements of Section 30(2) of the IBC concerning the treatment of operational creditors. This section mandates that the plan should ensure that operational creditors receive at least the liquidation value of their claims.

Extent of Judicial Review Over CoC’s Decisions

The extent to which judicial review is available over the commercial decisions made by the CoC was also scrutinized. The debate centered on the balance between respecting the CoC's commercial wisdom and ensuring compliance with statutory requirements.

Application and Interpretation of the Clean Slate Theory (CST)

The applicability and interpretation of the Clean Slate Theory in this context were examined. CST posits that once a resolution plan is approved, all previous claims and liabilities are extinguished, allowing the resolution applicant to start afresh.

Equitable Treatment of All Creditors

Finally, the court assessed whether the approved resolution plan provided equitable treatment to all creditors, including operational creditors like TANGEDCO, who are often disadvantaged compared to financial creditors.

Key Legal Precedents and Their Integration

K. Sashidhar v. Indian Overseas Bank [(2019) 12 SCC 150]

In K. Sashidhar v. Indian Overseas Bank, the Supreme Court held that the CoC's decisions on the resolution plan are not subject to judicial review concerning their commercial merits. This principle underscores the expertise of financial creditors in assessing the viability and feasibility of resolution plans. The ruling emphasizes that the CoC's commercial wisdom has paramount status without judicial intervention, highlighting the intrinsic assumption that financial creditors are fully informed about the viability of the corporate debtor and the feasibility of the proposed resolution plan.

Essar Steel India Ltd. v. Satish Kumar Gupta [(2020) 8 SCC 531]

In Essar Steel India Ltd. v. Satish Kumar Gupta, the Supreme Court emphasized that once a resolution plan is approved, all previous claims and liabilities are extinguished, ensuring the resolution applicant can take over the business free from past encumbrances. This promotes finality and certainty in the resolution process. The ruling reinforced the Clean Slate Theory, which asserts that a successful resolution applicant should not be faced with undecided claims after the resolution plan has been accepted. This principle ensures that the resolution applicant can take over the business on a fresh slate.

Ghanashyam Mishra & Sons Private Limited v. Edelweiss Asset Reconstruction Company Limited [(2021) 9 SCC 657]

In Ghanashyam Mishra & Sons Private Limited v. Edelweiss Asset Reconstruction Company Limited, the Supreme Court affirmed that all dues, including statutory ones, are extinguished upon approval of the resolution plan, reinforcing the Clean Slate Theory. This protects the resolution applicant from subsequent claims arising from past liabilities. The Court held that even before the amendment of Section 31(1) of the IBC, the statutory intent favored the extinguishment of those dues owed to statutory authorities that were not specifically included in the resolution plan.

State Tax Officer v. Rainbow Papers Ltd. [(2023) 9 SCC 545]

In State Tax Officer v. Rainbow Papers Ltd., the Supreme Court held that the resolution plan must address statutory dues and ensure compliance with Section 30(2) of the IBC. Statutory authorities need not file claims separately if such dues are recorded in the debtor’s books. The ruling highlighted that the Adjudicating Authority is not a mere rubber stamp for approving whatever resolution plan is placed before it, ensuring that all operational creditors are paid in terms of Section 30(2) of the IBC.

Paschimanchal Vidyut Vitran Nigam Ltd. v. Raman Ispat Pvt. Ltd. [(2023) 10 SCC 60]

In Paschimanchal Vidyut Vitran Nigam Ltd. v. Raman Ispat Pvt. Ltd., the Supreme Court clarified that electricity dues are not statutory dues entitled to priority under the IBC’s waterfall mechanism, distinguishing them from statutory dues transferred to the state’s consolidated fund. The Court rejected the contention that electricity dues are secured statutory dues, emphasizing that the provisions of IBC will prevail over the Electricity Act.

M.K. Rajagopalan v. Dr. Periasamy Palani Gounder [(2024) 1 SCC 42]

In M.K. Rajagopalan v. Dr. Periasamy Palani Gounder, the Supreme Court emphasized that the CoC’s commercial decisions must be based on complete and transparent information and must ensure equitable treatment of operational creditors. The ruling highlighted that commercial wisdom of the CoC means a considered decision taken with reference to the commercial interests and the interest of revival of the corporate debtor and maximization of the value of its assets. This decision has introduced a much-needed responsibility to the thought process of the CoC, ensuring that their decisions are made with all relevant information.

Detailed Reasoning of the Court

Commercial Wisdom and Judicial Oversight

The Supreme Court reiterated the paramountcy of the CoC's commercial wisdom in deciding on resolution plans, provided these decisions comply with Section 30(2) of the IBC. The CoC, comprising financial creditors, has the requisite expertise to evaluate the viability and feasibility of the resolution plans. However, the Court highlighted that the Adjudicating Authority (NCLT) and the Appellate Authority (NCLAT) have a limited but crucial role in ensuring that the resolution plan adheres to statutory requirements and treats all creditors equitably.

Equitable Treatment of Creditors

The Court underscored the necessity for equitable treatment of operational creditors, such as TANGEDCO, who often find themselves at a disadvantage compared to financial creditors. The resolution plan must ensure that operational creditors receive at least the liquidation value of their claims or more if feasible. The Court found that the minimal payout to operational creditors in the case of The National Sewing Thread Co. Ltd. was inadequate and not in compliance with Section 30(2)(b) of the IBC.

Clean Slate Theory

The Clean Slate Theory, as affirmed in Essar Steel and Ghanashyam Mishra, provides that all claims against the corporate debtor are extinguished upon the approval of the resolution plan, allowing the resolution applicant to start afresh. However, this protection is conditional upon the resolution plan’s compliance with statutory requirements and the equitable treatment of all creditors. The Court stressed that the Clean Slate Theory does not absolve the resolution applicant from addressing the claims of operational creditors.

Full Disclosure and Transparency

The Court highlighted the importance of full disclosure and transparency in the CIRP. The Interim Resolution Professional (IRP) and the Resolution Professional (RP) must ensure that all claims, including those of operational creditors, are accurately presented and considered in the resolution plan. The Court noted that the failure to disclose all liabilities and claims could lead to personal liability for the promoters and directors of the corporate debtor.

Conclusion

The Supreme Court's detailed reasoning and reliance on key legal precedents underscore the importance of balancing the interests of financial and operational creditors within the framework of the Insolvency and Bankruptcy Code. The Court affirmed the primacy of the CoC's commercial wisdom while ensuring that the resolution plan complies with statutory requirements and provides equitable treatment to all creditors. The Clean Slate Theory, while crucial for attracting investors, must be applied in conjunction with full disclosure and transparency to protect the rights of all stakeholders. This comprehensive approach ensures the integrity and efficacy of the insolvency resolution process in India, promoting a fair and balanced outcome for all parties involved.