The non-obstante clause in the Insolvency and Bankruptcy Code (IBC)

The Insolvency and Bankruptcy Code, 2016 (“IBC”) was enacted with the view to bringing a complete code of reorganisation and insolvency resolution of corporate persons, partnership firms and individuals in a time bound manner. Prior to the introduction of IBC, the law of insolvency and bankruptcy was spread across several statutes and fora, which rendered the process time consuming and largely ineffective due to dissipation of value of assets. The IBC consolidated the law related to insolvency by amending 11 laws, including the Companies Act, 2013, Recovery of Debts Due to Banks and Financial Institutions Act, 1993 (DRT Act), and Securitization and Reconstruction of the Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act). It further repealed the centuries-old laws of the Presidency Towns Insolvency Act, 1909 and Provincial Insolvency Act.

The legislative intent behind the enactment of the Code was replacing the existing framework for insolvency, which was visibly inadequate, ineffective and operated with delays. The Insolvency and Bankruptcy Code, 2016 is, therefore, a complete compilation of laws and rules relating to the bankruptcy laws in India.

OBJECTIVE

As stated in the opening para, it is “An act to consolidate and amend the law relating to reorganization and insolvency resolution of corporate persons, partnership firms and individuals in a time bound manner for maximization of value of assets of such persons, to promote entrepreneurship, availability of credit and balance the interests of all the shareholders including alteration in the order of priority of payment of Government dues and to establish an Insolvency and Bankruptcy Board of India, and for matters connected therewith and incidental thereto.”

The Code being at a nascent stage, has seen disputes emerging with regard to its interpretation vis-a-vis other statutes, particularly so in respect to the overriding clause provided as section 238 of the Code.

Section 238 of the Insolvency and Bankruptcy Code, 2016- Provisions to override other laws. -

“The provisions of this Code shall have effect, notwithstanding anything inconsistent therewith contained in any other law for the time being in force or any instrument having effect by virtue of any such law.”

‘Non-obstante’ is a Latin word which means ‘notwithstanding anything contained’. This means that the provisions of the Code shall override the effects of any other legal provisions contained in any other laws which are contrary to these provisions. Sections 245-255 of the IBC deal with Amendments to various other statutes to facilitate the afore-stated overriding effect. With various other statutes already having “overriding” clauses, the years of IBC coming in operation and the lacunas in the Code left a lot of room for judicial interpretation.

Furthermore, it is a settled position in law that in case of an inconsistency arising between two special legislations, the later enacted legislation will prevail over the previously enacted legislation Solidaire India Ltd. v. Fairgrowth Financial Services Ltd. & Ors, (2001) 3 SCC 71.

In light of the scheme of IBC and its overriding nature, this article will analyse the interplay of IBC with some selected statutes.

IBC and SARFAESI

The SARFAESI Act was enacted to identify and rectify the problem of NPA in financial institutions. Both the IBC and the SARFAESI Act largely deal with recovering bad debts by identifying and directing the assets of a debtor to fill the dent of bad debt. Encore Asset Reconstruction Company Pvt. Ltd Vs. Ms. Charu Sandeep Desai & Ors. has cleared the doubts regarding the two laws at loggerheads. The Code in this case has emerged as a clear winner with the deft reasoning of the National Company Law Appellate Tribunal. (NCLAT).

Facts of the case

In 2011 Calyx Chemicals and Pharmaceuticals Limited, the corporate debtor, secured a loan from Dena Bank by mortgaging its property. A charge was created in the favour of the bank against the property owned by the corporate debtor. There was default on repayment of the loan and, pursuant to this, Dena Bank initiated proceedings under the SARFAESI Act and took over the physical possession of the property in the year 2017.

Later, in October 2017, an application was filed under section 7 of the IBC against the corporate debtor by State Bank of India before the National Company Law Tribunal (NCLT). This application was admitted in February 2018 and an Interim Resolution Professional (IRP) was appointed. Moratorium was declared under Section 14 of the Code. Dena Bank then approached the NCLT seeking an interim order to stop the IRP from demanding custody of the property which was already in the possession of the bank as a result of the SARFAESI proceedings.

Judgement of the NCLT

The Bank argued that once the possession of a secured asset has been taken, then all rights to the property lie with the bank. The NCLT found that the rights in the asset can be claimed by the financial institution “as if” it is the owner of the asset and the words “as if” denote deemed ownership and not actual ownership of the property. Further, since the property continued to reflect as an asset in the balance sheet of the corporate debtor, the IRP was bound under section 18 of the Code to take control and custody of such property. It was also held that any further action by Dena Bank to enforce its security interest would be restrained by the moratorium. As a result, all the propertiesof a corporate debtor should be taken together for further consideration under IBC.

The decision of the NCLAT

The NCLAT observed that section 18 of the Code stipulates that it is the duty of the IRP to take control and custody of the assets of the corporate debtor in which he has “ownership rights” as stated in the balance sheet of the corporate debtor, including the assets that may or may not be in possession of the ‘corporate debtor’. It is clear from reading of clauses (f) and (f)(i) which stipulate that the IRP can “take control and custody of any asset over which the corporate debtor has ownership rights.”

Thus, the NCLAT rejected the appeal, holding that although the asset was not in the possession of the corporate debtor, Encore was bound to transfer the property to the IRP because the title still remained with the corporate debtor. It was not the case as if the title of the property was transferred or that the asset had been sold in terms of section 13(4) of the SARFAESI, which allows for the secured creditor to take recourse to selling a secured asset in case a borrower fails to discharge his liability. The NCLAT order was also upheld by the Supreme Court in November, 2019.

Conclusion

The Encore case offers us clear and deft reasons for the Code to prevail over SARFAESI Act. The IRP must be allowed to pool all the necessary assets of the corporate debtor in order to satisfy the claims of the creditors. A financial institution having a security over an asset cannot make claims with regard to the ownership, as the title still lies with the corporate debtor and, in so far as it lies with the corporate debtor, the asset should be managed according to the IBC.

IBC and Taxation Statutes

Most of the taxation statues provide for attachment of property as a mode of recovery, which may turn the revenue department into a ‘secured creditor’ position in some sense. However, under IBC, the government dues are lower in hierarchy in the waterfall mechanism. In Leo Edibles & Fats Ltd. Vs. The Tax Recovery Officer, Income Tax Department, before Andhra Pradesh High Court, the issue whether in an event an attachment order for recovery of dues under a taxation statute is made prior to initiation of liquidation under IBC, whether the property subject to attachment forms part of liquidation estate or not was discussed. The court observed that an attachment itself creates no interest in a property and the tax department does not enjoy the status of a “secured creditor”, who can avail benefits of provisions of Section 52 of IBC.

In Pr. Commissioner of Income Tax Vs. Monnet Ispat and Energy Ltd. (SLP(C) No. 6483 of 2018), the Supreme Court while dealing with the interplay between Income Tax Act, 1961 and the IBC held that the incorporation of Section 238 in the Code makes its obvious that the Code will override anything inconsistent contained in any other enactment.

IBC and Tea Act, 1953

The question before the Court in the matter of Duncans Industries Limited. Vs. A. J. Agrochem, (2019) 9 SCC 725 was whether consent of the Central Government under the Tea Act is required before initiation of proceedings under section 9 of the Code.

Held: The Hon’ble Supreme Court held that the provisions of the IBC will override the provisions of the Tea Act, 1963 (“the Tea Act”). Section 16 (G) of the Tea Act requires the consent of the Central government to initiate winding up proceedings or for appointment of receiver against a Company owing tea estates in cases where the management of the tea estate owned by such a Company has been taken over by the Central Government.

The entire exercise of obtaining the consent of the Central Government, as envisaged by the Tea Act, is a time-consuming process, and was therefore unnecessary. Furthermore, a contrary approach, if taken, would result in putting the creditors at the mercy of the Central Government before initiating the CIRP and, therefore, making it troublesome for certain creditors. The Court has also emphasised on the objectives of the IBC and liquidation, being an option of the last resort, that shall only be resorted to upon the failure of the CIRP.

Unresolved Conflicts:

Two matters having wide effect over the interpretation of non-obstante provisions of Insolvency & Bankruptcy Code (IBC) have reached the Hon’ble Supreme Court.

IBC and SEBI

The conflict with the Securities and Exchange Board of India Act, 1992 (SEBI Act) is presently pending before the Supreme Court in SEBI Vs. Rohit Sehgal. In the year 2015 SEBI directed attachment of properties belonging to HBN Dairies and Allied Ltd. (HBN Dairies) which was allegedly running an unauthorized Collective Investment Scheme (CIS). HBN Dairies had collected approx. Rs. 1136 Crores under the said scheme from lakhs of investors. Thereafter, SEBI directed attachment of properties of HBN Dairies in order to return dues to the depositors.

However, delay in the recovery of invested money prompted a few investors to approach NCLT and initiate proceedings under IBC against HBN Dairies. On 14th August 2018, NCLT admitted the Application and directed de-attachment of HBN Dairies’s properties. The said order was challenged before NCLAT. In the meantime, RP wrote to SEBI for de-attachment of properties. NCLT held that in view of Section 238 of IBC, provisions of IBC will override provisions of SEBI Act and as such directed SEBI to handover title deeds of properties of HBN Dairies to RP. Subsequently, the appeal filed against NCLT’s order of admission has been rejected by NCLAT taking the same view that IBC will have an overriding effect over provisions of SEBI Act.

Orders passed by NCLT and NCLAT have been challenged by SEBI before Supreme Court. The issue which now arises before Hon’ble Supreme Court is whether depositors of a CIS can be treated as Financial Creditors under IBC, and whether provisions of IBC can be invoked in case of CIS which is regulated by the SEBI Act, 1992 and its Regulations. The Supreme Court during the first hearing of the appeal, stayed the order of NCLT and directed maintaining status quo, to the extent that neither SEBI is required to return the title certificates of the assets of HBN Dairies nor SEBI will create any encumbrance over the properties.. RP can continue with his proceedings under IBC.

IBC and PMLA

The Prevention of Money Laundering Act, 2002 (PMLA) empowers the Enforcement Directorate (ED) to provisionally attach properties which are the proceeds of crime. It becomes a problem for a Resolution Applicant who has bid on the basis of those assets, with the hope of using them once it takes over the CD. Given the contentious nature of this issue, it was not long before it found its way at the centre of disputes before the Courts. Two decisions of the NCLT, Mumbai and Delhi High Court, at variance with another, hold the ground on this.

The NCLT, Mumbai in SREI Infrastructure Finance Limited Vs. Sterling SEZ and Infrastructure Limited has held that the IBC prevails over PMLA in view of Section 238 of the IBC and, therefore, no attachment under PMLA can be allowed in derogation of the moratorium. The Delhi High Court, on the other hand, in The Deputy Director Directorate of Enforcement Delhi v. Axis Bank has taken a different view. It has held that there is no inconsistency between the PMLA and the IBC since both have distinct purposes, text and context which militates against the application of Section 238. In fact, with this judgment, the Delhi High Court has cleared a major misconception surrounding the application of a non-obstante clause. This is because a view seemed to have developed that once Section 238 kicks-in, each and every time another legislation had to be applied, IBC completely barred the application of a co-existent legislation. However, a cardinal principle of interpreting a non-obstante clause is that it only applies in case of an inconsistency with another legislation and this even finds a mention in the provision itself. This is what the Delhi High Court has considered in its judgment while ruling that the laws operate in different spheres.

Meanwhile, to address this, Insolvency and Bankruptcy Code (Amendment) Act, 2020 was enacted adding Section 32A to the IBC. This provides the CD complete immunity from prosecution for any offence committed prior to the CIRP, once the Resolution Plan is approved. This amendment will certainly affect attempts to attach properties by the ED under legislations like the PMLA and has impliedly given the IBC an overriding effect over the PMLA, in that sense.

The amendment can be traced back to the decision of the NCLAT in JSW Steel Ltd v. Mahender Kumar Khandelwal & Ors., where the NCLAT had to decide whether attachment of assets of Bhushan Power & Steel Ltd. (“BPSL”) (the corporate debtor) by the Enforcement Directorate would be permissible, given that the resolution plan submitted by JSW (successful resolution applicant) had already been approved by the NCLT.

The NCLAT concluded that while stakeholders have the opportunity to voice their objections prior to the NCLT approving a resolution plan for a corporate debtor, once a resolution plan is passed, that opportunity ceases to exist and no stakeholder, including a government agency is permitted subsequently, to raise an objection. All stakeholders are to be bound by the resolution plan approved by the NCLT. The order went on to state that an incoming investor cannot be held responsible for misdoings of the corporate debtor in the past. Subsequent to this order of the NCLAT, the Amendment Act was promulgated.

However, the NCLAT’s decision, based on the new Section 32A, to disallow the ED from attaching the assets of Bhushan Steel and Power Limited (CD) for which JSW Steel had bid (RA), has been appealed to the Supreme Court. This means that the IBC-PMLA conundrum, in spite of the legislative amendment, is here to stay, at least till the Supreme Court endorses the NCLAT’s view on this.

Conclusion

The cases where the appeals have been made in the Supreme Court are expected to bring more clarity on the overriding provision contained in section 238 of the IBC. Ultimately, the object of the IBC of being complete code of reorganisation and insolvency resolution is required to be met.