Heydon’s Rule & The Mystery around Section 29 (A) of IBC

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22/07/2021

Key Words: Heydons Rule, Interpretation, IBC 2016, Section 29(A)

Introduction:

In this Blog, Heydon’s Rule is analyzed in the context of some[1] Insolvency& Bankruptcy, 2016 “IBC” provisions. Heydon’s rule is to be placed in context before; provisions regarding IBC & the concept are explained & enumerated upon.

Supreme Court in Eera V. State

The Hon’ble Supreme Court “SC” has recently in Eera v. State[2] (N.C.T Delhi) discussed the theory of “creative interpretation[3]” flowing from Heydon’s Rule itself and carved out a concept of creative interpretation to be balanced with not stepping outwards of a judicially demarcated “Lakshman Rekha”. In situations where statutes utilize specific words, which appear to be prima facie clear and unambiguous, it is a possibility that the plain/bare meaning of the words utilized do not convey and in certain situations may even defeat the intention of the legislature; in such cases, there is no reason why the true intention of the legislature, if it can be determined, clearly by other means, should not be given effect[4]. Individual words here are the key subject.

Constitutional Courts always make attempts at setting the boundaries within which interpretations are permissible, especially ones where creative interpretation is required. In such cases stepping out of the judicially demarcated “Lakshman Rekha” can sometimes raise questions as well.

It is argued in a lot of situations that, courts stepping out of their bounds while creatively interpreting the law, step into the shoes of un-elected leaders, whose primary role it is to legislate.

King N.O & Ors v. De Jager & Ors

A contentious issue in the South African Constitutional Court, regarding laws which involve freedom of testation & rights of female descendants was under review in King N.O & Ors v. De Jager & Ors[5] where it was observed “Transformative constitutionalism and the obligation to ensure substantive equality means that the first judgment should take this into account in its assessment of freedom of testation. While the argument that freedom of testation is closely related to several rights – such as dignity, privacy, and property – may have some merit, this approach de- contextualizes what freedom of testation really means in a grossly unequal society such as South Africa[6]”. In their conclusion the court made an attempt to set out, their conclusions without really overstepping their bounds as a court of law, keeping in mind the sensitive nature of the dispute.

Maunsell v. Olins

In Maunsell v. Olins[7], Lord Simon elaborated on this aspect; he held that the rule in Heydon’s case is available at two stages; (i) Before sustaining the plain and primary meaning of the statute; (ii) At this stage when the court reaches the conclusion that there is no such plain meaning. It was observed, “words are meant to serve and not to govern and we are not to add the tyranny of words to the other tyrannies of the world[8]”, which goes to show that Heydon’s Rule’s primary task is to deal with Legislative Intent in all contexts, whether actual or even imputed.

A few Indian case laws discussing the development of Heydon’s Rule have been elaborated upon: –

Sodra Devi v. C.I.T[9] 

(a) In this particular case, the word in question was an interpretation under Section 16 (3)[10], Income Tax “IT” Act, 1961 of the words “any individual” & “such individual” which according to the court required clarity in order to apply the correct definition. (Purported by the Legislature in its true context in the Income Tax Inquiry Report, 1936). There was in question, the computation of the Total Income of an individual for purposes of assessment, & whether the income of the wife & minor child would be included in the assessment. Terms/Clauses under Section 16(3) were being misused by people. They were interpreted in a manner, where it became commonplace for spouses to enter into nominal partnerships with one another & fathers admitting their children to the benefits of partnerships, of which they were members. A correction was made here, in order to prevent this law from being exploited, & it was made clear that the income derived by the wife or minor child of a male assesse was to be included in the computation of total income while making assessments.

Bengal Immunity Co. v. State of Bihar[11];

(b) Rules lay down that courts should adopt that construction, which shall suppress the mischief and advance the remedy. The appellant company was an incorporated Co. that was involved in the business of manufacturing and selling various sera, vaccines, biological products & medicines. Its registered office was also in Calcutta, WB & its manufacturing facilities were also in W.B. The co. was also registered as a dealer under the Bengal Finance (Sales Tax) Act, and sold goods all over India as well as abroad. In 1951, they received a notice from the Assistant Superintendent of Commercial Taxes, Bihar stating inter-alia that the company should take necessary action to get itself registered under the Bihar Sales Tax, Act 1947 and also deposit its pending dues under the act with the competent department, Bihar State. It is to be noted here that the company was already registered under the Bengal Finance (Sales Tax) Act and the main question became whether the tax to be levied on the sales of the appellant, was in fact leviable, under law. The conclusion as drawn in this case was done so by, analyzing the interpretation of Article 286 & its construction. The court held that the Bihar Sales Tax, Act 1947 qua taxing sales or purchases made, which took place during Inter-State trade or commerce are unconstitutional, illegal & void.

(c) R.M.D.C v. Union of India[12];

The definition of “prize competition” under Section 2(d)[13], Prize Competition Act, 1955 was to be imputed meaning, while dealing with mischief occurring under the rule regarding the literal reading of the rule. In competitions where no substantive skill was required, these were the ones to be included under 2(d). Naturally here, competitions where some skills were required did not come under the ambit of this section. So to give meaning, to the words covered under “skill”, to make them more inclusive of situations, the Heydon’s rule was applied in this case.

(d) K.P Vargese v. I.T.O[14];

Here, the issue in contention was whether understatement of consideration in a transfer of property is a necessary stipulation to attract the applicability of Section 52(2)[15]. The revenue department had a contrary view regarding this issue wherein the fair market value of the property as on date would be considered. The judgment began by providing analysis “The task of interpretation of a statutory enactment is not a mechanical task. It is more than a mere reading of mathematical formulae because few words possess the precision of mathematical symbols. It is an attempt to discover the intent of the legislature from the language used by it and it must always be remembered that language is at best an imperfect instrument for the expression of human thought[16]”…………. thereby at the offset acknowledging the challenge posed by the language itself, while interpreting laws under the IT, Act 1961. The bench concluded in this case by observing “We must therefore eschew literalness in the interpretation of section 52 sub-section (2) and try to arrive at an interpretation which avoids this absurdity and mischief and makes the provision rational and sensible unless of course, our hands are tied and we cannot find any escape from the tyranny of the literal interpretation. It is now a well-settled rule of construction that where the plain literal interpretation of a statutory provision produces a manifestly absurd and unjust result which could never have been intended by the legislature, the court may modify the language used by the legislature or even ‘do some violence’ to it, so as to achieve the obvious intention of the legislature and produce a rational construction”. It was very clearly laid down here, the court can provide analysis and construct a provision in a manner that leads to its true legislative intent/objective and serves a logical end result. In this particular case, stating that the construction of Section 52(2) to be done in a fair and reasonable manner.

Before we can begin elaborating on Heydons Rule qua the IBC, 2016 it would be pertinent to analyze the approach of the judicial system towards economic legislation. In order to better understand the questions pertaining to stressed assets and their timely re-structuring, the newly enacted IBC is being utilized. In the current scheme, courts have adopted an approach and are being consistent in their observations while dealing with particular cases and questions. In most cases, economic legislation is challenged on the ground of it being violative of Article 14. J. Nariman in Swiss Ribbons v. Union of India[17] in paragraphs- 7 till 10 analyzed this position of the Indian Courts over time since 1981. The legislative intent behind economic legislation is subjective and done on a case-by-case basis using subject expertise & special knowledge while making use of favorable conditions, localized to the body making such decisions e.g Indian Government taking into account (all) local factors while deciding upon any economic policy. They take into account factors such as weather, fuel costs, and storage costs, etc. before determining the maximum retail price of any product.

Judicial Approach qua economic legislation:

The Supreme Court of India has developed its approach to dealing with economic legislation passed by either the Union Legislatures or even the States through a series of judgments starting in 1981 all the way till 2016 before this pertinent question was reiterated before the court in Swiss Ribbons (Supra).

Court has usually adopted a hands-off approach while deciding to intervene in cases where economic legislation is involved & has made it a point to intervene only when absolutely necessary.

This is further elicited in the case of R.K Garg v. Union of India[18] where the court holds in paragraph 8 “Every legislation, particularly in economic matters is essentially empiric and it is based on experimentation or what one may call trial and error method and therefore it cannot provide for all possible situations or anticipate all possible abuses. There may be crudities and inequities in complicated experimental economic legislation but on that account alone it cannot be struck down as invalid”. The court in this particular scenario was implicitly mindful of the transaction cost theory[19] while making adjudication as they truly believed that they would not be able to anticipate further trickle-down effects from their own pronouncement thereby stressing “all possible situations” while making their observation.

The transaction cost theory briefly states that the optimum organizational structure is one that achieves economic efficiency by minimizing the costs of exchange[20]. The theory states that each type of transaction produces coordination costs of monitoring, controlling, and managing transactions.

The court, implicitly took into account this theory while deciding not to interfere in such matters, keeping in mind the factor of efficiency while running the economic system of a firm. Costs (to transact) within this economic ecosystem rising in the interim (during re-structuring) is a major factor for non-interference in economic matters.

The argument pertaining to state intervention is well summed up by J. Frankfurter of the US Supreme Court who in Morey v. Doud[21] opined that  “In the utilities, tax and economic regulation cases, there are good reasons for judicial self-restraint if not judicial deference to legislative judgment. The legislature after all has the affirmative responsibility. The courts have only the power to destroy, not to reconstruct”.

The Indian Courts have taken a cue from this idea that judicial power is not well equipped to deal with such questions that the legislature is itself struggling to deal with due to the ambiguous nature of the problem itself i.e economic uncertainty & their related concerns.

While parting in the case of R.K Garg (Supra) the court made an interesting observation regarding human behavior, which explains the perilous position of the court while deciding such complex questions of economic significance. “It is true that one or the other of the immunities or exemptions granted under the provisions of the Act may be taken advantage of by resourceful persons by adopting ingenious methods and devices with a view to avoiding or saving tax. But that cannot be helped because human ingenuity is so great when it comes to tax avoidance that it would be almost impossible to frame tax legislation that cannot be abused”. Moreover, as already pointed out above, the trial and error method is inherent in every legislative effort to deal with an obstinate social or economic issue and if it is found that any immunity or exemption granted under the Act is being utilized for tax evasion or avoidance not intended by the legislature, the Act can always be amended and the abuse terminated. We are accordingly of the view that none of the provisions of the Act is violative of Article 14[22] and its constitutional validity must be upheld[23].

This reticent behavior of the court can be further understood when a case concerning questions pertaining to the informal sector of the economy came before it. It concerned a policy decision of the State where the court went on to observe in[24]  “The services rendered by certain informal sectors of the Indian economy could not be belittled. However, in the path of economic progress, if the informal system was sought to be replaced by a more organized system, capable of better regulation and discipline, then this was an economic philosophy reflected by the legislation in question. Such a philosophy might have its merits and demerits. But these were matters of economic policy. They are best left to the wisdom of the legislature and in policy matters, the accepted principle is that the courts should not interfere[25]”.

It stated in clear words that “subject expertise” in economic policy should not be lightly interfered with. A parting observation in this present case is a clear indicator of a broad principle of the court and its attitude towards economic progress. They state that “The system of checks and balances has to be utilized in a balanced manner with the primary objective of accelerating economic growth rather than suspending its growth by doubting its constitutional efficacy at the threshold itself“ making it clear that mere technical constitutional grounds would not suffice in convincing the court to intervene in matters concerning economic policy.

Further, in the case of DG of Foreign Trade v. Kanak Exports[26] the court highlighted the importance of empirical analysis while deciding on economic policy thereby acknowledging that rigidity cannot be utilized while making such decisions with widespread uncertain consequences. It stated, “Therefore, it cannot be denied that the Government has a right to amend, modify or even rescind a particular scheme. It is well settled that in complex economic matters every decision is necessarily empiric and it is based on experimentation or what one may call a trial and error method and therefore, its validity cannot be tested on any rigid prior considerations or on the application of any straitjacket formula ……That the legislature should be allowed some play in the joints because it has to deal with complex problems which do not admit of solution through any doctrine or straitjacket formula and this is particularly true in case of legislation dealing with economic matters, where having regard to the nature of the problems greater latitude require to be allowed to the legislature……”.

More recently, while analyzing sections of the newly enacted IBC & their relevant influence the Supreme Court in Swiss Ribbons (Supra) held that ”It is with this background, factual and legal, that the constitutional validity of the Insolvency and Bankruptcy Code, 2016 has to be viewed”. While making a note of all of the above and various policy implications the Supreme Court tested the constitutional validity of various provisions of the IBC making a note of these cases, terming it as a judicial “Hands off” approach to economic legislation.

Pure Economic Loss & Section 29 (A), IBC 2016:

Keeping in mind the above, it is argued that this judicial hands-off approach in certain cases leads to pure economic loss.

Pure Economic loss: Financial loss suffered by someone, while being involved in a web of an economic ecosystem. Eg: How our economy is interdependent on one another, whereby if the price of crude oil increases so does the price of petrol and consequently due to transport costs, all other products as well.

The object of the IBC can be best defined by the equation between Quick resolution (restructuring within 270 days[27]) v. maximization of assets (extracting maximum value via the process).

The bare provision of Section 29 (A): A person shall not be eligible to submit a resolution plan if such person, or any other person acting jointly or in concert with such person: (a) is an un-discharged insolvent or (b) is a wilful defaulter in accordance with the guidelines of the Reserve Bank of India issued under the Banking Regulation Act, 1949 and (c) Shall apply to a resolution applicant where such applicant is a financial entity and is not a related party to the corporate debtor. Clause (j) places a blanket ban on ex-promoters (against whom/ whose Co. insolvency proceedings have been filed) to bid for their entities as it was understood that in most cases, the persons who were making these bids were not doing so with clean hands.

In a lot of cases, noting’s were made qua ex-promoters who simply utilized the restructuring process under bankruptcy laws to circumvent the law and escape their debts. They then at a fraction of the cost, bid and regain control of their entity at a much lower price, thereby escaping discharge of their existing debts, and start on a fresh slate (w/o any previous debts carrying over). Once these facts came to light, in order to prevent debts from being left unpaid in the hope that the restructuring process would aid in the future, Section 29 (A) was introduced. However in certain cases, even when the provision is to be construed very strictly, a similar issue regarding pure economic loss does crop up.

Essar Steel v. Satish Kumar Gupta

The concept of pure economic loss becomes apparent in the current IBC, 2016 scheme of restructuring when the bidding process in Essar Steel v. Satish Kumar Gupta[28] was put under scrutiny. Essar Steel’s erstwhile promoters also attempted at running to submit a resolution plan to the Committee of Creditors “CoC” for approval. They did so by floating a Special Purpose Vehicle “SPV” by the name of Numetal with one of the relatives of the promoters also involved, in order to circumvent the hurdles created under Section 29 (A).

Along with Arcelor Mittal, they too submitted a bid in order to take back their own assets & also in the process come out of the resolution process. It is pertinent to state here that the bid submitted by Numetal (SPV) was of higher value than that of Arcelor Mittal to the tune of Rs. 54,389 crores, which was a significant difference.

However in this particular case, even though the amount was significantly higher & would have resulted in value maximization, it was disallowed [29], on the ground that it was offered as a settlement amount & during the period of the insolvency process (once the process is initiated), only bids from resolution applicants could be heard. In this case the bid of Arcelor Mittal amounting to about Rs. 42,000 cr was finally accepted.

It was argued in Swiss Ribbons (Supra) that the provision of Section 29 (A) is absolutely contrary to the objects laid down by the act itself i.e value maximization derived from the entity undergoing the restructuring process.

Furthermore, it was stated that some intelligible differentia must be observed while categorizing the old management of the firm, separating the efficient managers & promoters and the bad ones, allowing certain members to not be affected under Section 29 (A).

It was argued that not all connected persons should be categorized under “related parties[30], & the doctrine of nexus must be applied. Interestingly dismissing these arguments the court held that “All the categories in Section 29A(j) deal with persons, natural as well as artificial, who are connected with the business activity of the resolution applicant. The expression ―related party‖, therefore, and ―relative‖ contained in the definition Sections must be read noscitur a sociis[31] with the categories of persons mentioned in Explanation I, and so read, would include only persons who are connected with the business activity of the resolution applicant[32].

In this particular case, it was stated that the legitimate settlement process between debtors, being settled by way of the increased bid by Numetal (SPV), was being derailed. It would be pertinent to state that the parties concerned (stakeholders) with the insolvency process would have suffered Pure Economic Loss from the technical hurdle created under Section 29 (A) to the tune of about Rs 12,000 cr, the difference between both bids.

However in the court’s wisdom, while pronouncing adjudication in the Swiss Ribbons (Supra) case they stated, matters of Commercial wisdom regarding the resolution applicants and their bids would be wholly under the ambit of the CoC. The reason given was due to the criteria of “financial expertise” that lay with this group (CoC) who have the necessary skill.

The courts could in view of the above make a purposeful construction of Section 29(A), considering in so many situations it has been capable of yielding both +ve & -ve results.

Conclusion

If we take a look at the figures it can be seen that the debt amounts are really high compared to the finally paid amounts, for which the entity underwent the resolution process. In the interest of presenting a balanced view, it is also argued that if not for the reduced price, the entity would still be a non-performing asset & reflect poorly on balance sheets. In the interest of ensuring this timely resolution the “most appropriate amount/highest eligible bidder” is selected, thereby resulting consequently in pure economic loss for the involved stakeholders. The balance to be achieved is done by keeping in mind that timeliness needs to be balanced with value maximization. In view of the objects (IBC) also analyzed above, the courts should step in, in certain scenarios where an unreasonable construction of any Section is being purported by either of the parties to the dispute, coloring its true legislative intent.

Bibliography

List of Cases:

  1. Eera v. State (N.C.T Delhi)- [(2017) 15 SCC 133]
  2. King N.O & Ors v. De Jager & Ors- [CCT No. 315 of 2018]
  3. Maunsell v. Olins- [(1975) 1 All ER 16 (HL)]
  4. Sodra Devi v. C.I.T- 1957 AIR 832
  5. Bengal Immunity Co. v. State of Bihar- AIR 1955 SC 661
  6. M.D.C v. Union of India- AIR 1957 SC 628
  7. P Vargese v. I.T.O- (1981) 131 ITR 597/24 CTR 358/7 Taxman 13 (SC)
  8. Swiss Ribbons v. Union of India- Writ Petition (Civil) No. 99 of 2018)
  9. K Garg v. Union of India- (1981) 4 SCC 675 (Paragraph 8)
  10. Morey v. Doud- [351 US 457: 1 L Ed 2d 1485 (1957)] pg 457
  11. DG of Foreign Trade v. Kanak Exports- (2016) 2 SCC 226- Paragraph 109
  12. Essar Steel v. Satish Kumar Gupta- CIVIL APPEAL NO. 8766-67 OF 2019
  13. Bhavesh D. Parish v. Union of India- (2000) 5 SCC 471
  14. Girdhari Lal v. Balbir Nath Mathur- {A.I.R 1986 C 1499}
  15. A No. 430 of 2019 NCLT Ahmedabad, By Essar Steel Holdings Ltd

List of Bare Acts & Books:

  1. Insolvency & Bankruptcy Code, 2016
  2. Income Tax Act
  3. Blacks Law Dictionary
  4. Prize Competition Act, 1955
  5. Constitution of India

List of Articles:

  1. Williamson, O. (1979). Transaction-cost economics: The governance of contractual relations. Journal of Law and Economics, 22, 233–261.
  2. Coase, R. H. (1986). The nature of the firm (1937)

End Notes And Citations

[1] Section 29(A)- {See Page 10}- Bare Provision Reproduced

[2] [(2017) 15 SCC 133]

[3] Eera v. State- Paragraph {110}

[4] Girdhari Lal v. Balbir Nath Mathur {A.I.R 1986  S.C 1499}{Paragraph-6}

[5] [CCT No. 315 of 2018]

[6] Paragraph {244}

[7] [(1975) 1 All ER 16 (HL)]

[8] Girdhari Lal (Supra) -{Paragraph 6}

[9] 1957 AIR 832

[10] Section 16(3):  the profession tax paid by an employee is allowed as a deduction from his/her gross salary income.

[11] AIR 1955 SC 661

[12] AIR 1957 SC 628

[13] Section 2(d):  prize competition” means any competition (whether called a cross-word prize competition, a missing- word prize competition, a picture prize competition or by any other name) in which prizes are offered for the solution of any puzzle based upon the building up, arrangement, combination or permutation, of letters, words, or figures.

[14] (1981) 131 ITR 597/24 CTR 358/7 Taxman 13 (SC)

[15] Section 52(2): (1) Income of every kind which is not to be excluded from the total income under this Act shall be chargeable to income-tax under the head “Income from other sources”, if it is not chargeable to income-tax under any of the heads specified in section 14, items A to E. (2) In particular, and without prejudice to the generality of the provisions of sub-section (1), the following incomes, shall be chargeable to income-tax under the head “Income from other sources”, namely : Clauses: (i) to (x)

[16] Paragraph (2)

[17] Writ Petition (Civil) No. 99 of 2018)

[18] (1981) 4 SCC 675 (Paragraph 8)- Supreme Court Case

[19] Coase, R. H. (1986). The nature of the firm (1937)

[20] Williamson, O. (1979). Transaction-cost economics: The governance of contractual relations. Journal of Law and Economics, 22, 233–261.

[21] [351 US 457 : 1 L Ed 2d 1485 (1957)] pg 457

[22] Constitution of India- Art 14: Right to Equality

[23] Paragraph 19

[24] Bhavesh D. Parish v. Union of India, (2000) 5 SCC 471

[25] Paragraph {26}

[26] (2016) 2 SCC 226- Paragraph 109

[27] Regulation 40: The committee may instruct the resolution professional to make an application to the Adjudicating Authority under section 12 to extend the insolvency resolution process period.

[28] CIVIL APPEAL NO. 8766-67 OF 2019

[29] I.A No. 430 of 2019 NCLT Ahmedabad, By Essar Steel Holdings Ltd

[30] Section 5(24)- Clauses (a) to (m) & 5(24)(A)- Clauses (a) to (i)

[31] Blacks law Dictionary: Noscitur a sociis: It is known from its associates

[32] Paragraph 75

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