IBC’s section on protecting creditors from fraudulent applications is anomalous

The objective of the code will be taken up further if the Parliament steps in to rectify the error.

By Akshat Mehta and Nitish Raj

Recently, the Supreme Court rendered its judgment in the case of Dilip Jiwarika v. Union of India. In this case, three hundred and eighty-four petitions were filed, inter alia, challenging the constitutionality of Section 95 to Section 100 of the Insolvency and Bankruptcy Code (“The Code”).

SC disposed these petitions to uphold the constitutionality of these impugned provisions. While the questions of constitutionality were being contested, an ambiguity in one of the provisions has gone unnoticed. This provision is Section 100 of the Code.

Role of Section 100

Section 100 is a part of Chapter III, Part III of the Code. Part III of the Code deals with the insolvency resolution and bankruptcy for Individuals and Partnership Firms. A brief overview of the relevant provisions is necessary to further the analysis. Section 94 of the Code empowers the debtor, either personally or through resolution professional to file an application initiating the insolvency resolution process.

Similarly, Section 95 of the Code empowers the creditor either by himself, or jointly with other creditors or through resolution professional to file an application initiating the insolvency resolution process.

Once an application is filed u/s 94 or Section 95, the resolution professional submits a report recommending approval or rejection of the said application u/s 99.

Thereafter, the Adjudicating Authority (“AA”) passes an order u/s 100 either admitting or rejecting the application. The Court has held that the report submitted by the resolution professional is only recommendatory in nature and it is not binding on the AA.

Ambiguity in the wording

The ambiguity, however, lies in the sub-section (4) of the Section 100. The said sub-section can be interpreted in three parts.

# The first part empowers the AA to reject the application referred to in Section 94 or 95.

# The second part stipulates that this application can be rejected on the basis of the report filed by the resolution application that the application made with the intention to defraud his creditors or the resolution professional.

# The third part enumerates the consequences of such fraudulent application whereby the AA, in an order passed u/s 100(1), shall record that creditor is entitled to file for bankruptcy under Chapter IV of Part III.

The ambiguity in the said provision arises from the reference to Section 95 in sub-section (4) of the Section 100. The Section 100, on prime facie reading, intends to prevent the fraudulent applications filed by the debtor only. Therefore, the reference to Section 95 creates an anomaly for following reasons.

Can a creditor try to defraud his creditor?

As already mentioned, Section 95 envisages an application filed by creditor himself, or jointly with other creditors or through resolution professional. The second part of the sub-section (4) of Section 100 provides that the application can be rejected if the application was made to defraud his creditor or resolution professional.

Therefore, reading these two provisions together would mean that these provisions envisage a situation where a creditor files an application to defraud his creditor. In other words, if the reference to Section 95 is retained, it would mean that Section 100(4) then operates to prevent a fraudulent application made by creditor to defraud his creditor. Such a “creditor’s creditor” situation is not envisaged either in the Code or in Chapter III of Part III. Therefore, reference to Section 95 read with words “his creditor” in the second part of the Section 100(4) entails an anomalous situation which does not seem to be the intention of the legislature.

An argument can be made that the legislature actually intended to prevent a fraudulent application filed by a creditor to defraud other creditors. However, even if this were to be the legislative intent, the issue emanating from the words “his creditor” will still persist.

Furthermore, the third part of the provision empowers the AA to pass an order recording that the creditor is entitled to file for bankruptcy. Now, if it is conceded that the intention of legislature was actually to prevent a fraudulent application filed by one creditor, it is unclear from the provision that how AA will decide “the creditor” who will file an application for bankruptcy.

SC in the case of Afcons Infrastructure Limited and Another v. Cherian Varkey Construction Company Private Limited and Another, has made it abundantly clear that in normal course a court would not substitute its own views for that of legislature. The Court, however, carved out an exception to this rule. When there is any draftsperson error, the Court can lay down the correct interpretation till the legislature steps in to rectify the error. However, even for this to happen, this provision needs to be questioned before the Court and possibility of it happening is very thin at the present moment. Therefore, it is submitted that it will further the objective of the code if the Parliament steps in to rectify the error which persists in the provision.

Conclusion and suggestion

The interpretational solution to this legal conundrum can be two-fold. If the Parliament only intended to prevent the debtor from filing the fraudulent applications, then reference to Section 95 is to be omitted altogether from the Section 100(4). On the other hand, if the Parliament actually intended to prevent one creditor from filing an application with an intent to defraud other creditors, then new sub-section has to be added which clearly stipulates the consequences of such an application. Whatever may be the intention of the Parliament, it is clear that the buck now has stopped at the doorstep of Parliament.

(Akshat Mehta is an LL.M. Candidate at the National Law School of India University, Bengaluru. Nitish Raj is a practicing Advocate before the Supreme Court.)

Views are personal and do not represent the stand of this publication.