India has long recognised the right of foreign creditors to participate in the winding up of Indian companies. As early as 1961, the Supreme Court of India, in Rajah of Vizianagaram (AIR 1962 SC 500), clarified that foreign creditors have the same right as Indian creditors in winding up proceedings under Indian law. Given the backlog of cases and resultant timelines for resolving disputes in the Indian judicial system, winding up has been the remedy of choice, albeit mostly as a pressure point, for unsecured creditors including foreign unsecured creditors of Indian companies. Such creditors have taken winding up actions despite the low return (an abysmal 28% as per one source) and pace of insolvency (almost 4.5 years) in the Indian market. At the same time, there have been instances where consensual restructuring of stressed Indian companies has been halted by such actions of unsecured creditors.

The Indian government from time to time provided a specific legal regime for Indian financial creditors to recover their money – for example, debt recovery tribunals (DRT) and the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI). But no additional measures were suggested for non-financial creditors.

In this context, the Insolvency and Bankruptcy Code, 2016 (IBC) introduced a paradigm shift in corporate insolvency resolution. It stipulates a payment default by a company to either financial creditors or trade creditors, as the trigger for initiating a time bound corporate insolvency resolution process (CIRP) of a company. At the same time, the IBC omits ‘inability to pay debts’ as a ground for winding up a company from the Companies Act. Therefore, if an Indian company defaults in payment to its trade creditors, the trade creditor can seek to wind up the debtor only under the IBC.

Equitable treatment of similarly situated creditors is a widely accepted objective of insolvency law. It is notable that under the IBC, the process for a trade creditor to trigger CIRP of a debtor is materially different from that for a financial creditor. The trade creditor is required to, among other documents required as per the IBC regulations, annex copies of its bank statements from ‘Financial Institutions’ to the petition to prove that no payment has been received in those bank accounts against the unpaid invoices. The National Company Law Appellate Tribunal (NCLAT) has since held that enclosing such bank statements is a mandatory requirement for a trade creditor to present a CIRP application under the IBC (Smart Timing Steel Limited vs. National Steel and Agro Industries, NCLAT Order dated May 19, 2017).

Now, this is where the IBC story in respect of trade creditors had taken a turn for the worse. In Uttam Galva Steels vs. DF Deutsche Forfait (NCLAT Order dated July 28, 2017) and Macquarie Bank Limited vs. Uttam Galva Metallics (NCLAT Order dated July 17, 2017), the NCLAT interpreted section 3 (14) of the IBC to conclude that for the purposes of the IBC, such bank statements can only be from an Indian bank or financial institutions and not from banks and financial institutions outside India.

Therefore, a trade creditor which does not have a bank account with an Indian bank or financial institution will not be able to satisfy this requirement. It is notable that holding of bank accounts by non-residents in India is highly regulated under the foreign exchange and tax regulations. The combined effect of such an interpretation of the IBC and the foreign exchange regulations is that a foreign creditor will not be able to initiate CIRP of its Indian debtors despite an undisputed default in payment having been occurred, if no statement from Indian bank or financial institution have been enclosed with the petition. Of course, for foreign law governed contracts, proceedings can be initiated outside India, but enforcement of any decrees under such proceedings in India is likely to be prohibited/restricted due to either the moratorium or the binding nature of the resolution plan.

As things stand, there are three ways to address this concern without legislative intervention:

  • Clarification by the Government Central: Government has the power to notify other institutions to be ‘financial institutions’ under section 3 (14) of the IBC. Therefore, the relevant ministry, being the Ministry of Corporate Affairs (MCA), will have to come out with a notification to specify all foreign banks and financial institutions to be covered within the definition of “financial institution”.
  • Review of the NCLAT decisions by the Supreme Court: Appeal against an order of the NCLAT can be filed before the Supreme Court on questions of law. As per the latest available information, none of the parties in the above decisions has filed an appeal against the above-mentioned orders of the NCLAT. In the background of above discussion, there is good reason for the Supreme Court to overturn this position.
  • Foreign trade creditors can open bank accounts with foreign branches of Indian banks: Branches of Indian banks are not separate legal entities and such branches have also been extended benefits of creditor specific legislations such as the DRT and the SARFAESI. Although untested, it is possible that bank statements of foreign branches of Indian banks will satisfy the requirements of section 9. However, this does not address the issues in relation to existing contracts and also forces foreign trade creditors to conduct their business in a manner different to that conducted hitherto.

IBC has been projected across the world as a landmark change towards ease of doing business in India. The uncertainty in respect of applications by foreign trade creditors has the potential to cast a shadow over those claims. The picture becomes grimmer if we consider the plight of discounting banks who may have already discounted the receivables of the foreign trade creditor (this was the factual background in the Uttam Galva cases). Urgent intervention from the Supreme Court or the MCA is required to resolve this.

* The author was assisted by Vardaan Ahluwalia, Principal Associate