Ensure corporate accountability

The new bankruptcy law is a progressive piece of legislation that will help create a transparent, predictable, efficient and swift legal regime for doing business

The question of unpaid bills/unpaid debt and ensuing litigation keep the courts busy everywhere. Every legal system provides some or the other mechanism to settle assets of the debtor under bankruptcy/insolvency laws. These laws have a twin purpose ie, to address the debtor’s financial difficulty as quickly and efficiently as possible and to protect the interests of various parties directly concerned with financial difficulty, principally creditors and other parties with a stake in the debtor’s business.

The Insolvency and Bankruptcy Code, 2016, (IBC) seeks to achieve this very objective and is a landmark legislation in several ways. It brought an end to multiple overlapping legislations covering the arena of bankruptcy and insolvency of corporate and individuals in various parts of the country by providing a time-bound, step-wise action plan. The code is derived from the  ‘Legislative Guide on Insolvency Law of the United Nations Commission on International Trade’ adopted by Resolution of the UN General Assembly, Resolution No.59/40, passed on December 2, 2004. It is viewed as a step in the direction of creating transparent, predictable, efficient and swift legal regime for doing ease of business.   

This code is at the nascent stage and there are several aspects of the code which is being clarified through judicial interpretation in the course of its implementation. The code distinguishes between financial creditors and operational creditors. The insolvency process can be triggered against the company by the financial creditor, the operational creditor or the company itself. Financial creditors are dealt under Section 7 of the code. These are banks or financial institutions who have advanced loan and  credit facility to the company and the company has defaulted the payment. There is no scope for the debtor to raise any dispute whatsoever when a proceeding is initiated under scheme of Section-7 which is a complete in itself.

Sections 8 and 9 of the code deal with operational creditors.  ‘Operational creditor’ means a person to whom an operational debt is owed and includes any person to whom such debt has been legally assigned or transferred. ‘Operational debt’ is defined under the code to mean a claim in respect of the provision of goods or services, including employment or a debt in respect of repayment of dues arising under any law for the time being in force and payable to the Union Government, any State Government or any local authority.

Operational creditors may, on the occurrence of a default ie, on non-payment of a debt or any part of the debt, which has become due and is payable but has not been paid, deliver a demand notice of such unpaid operational debt or deliver the copy of an invoice, demanding payment of such amount to the operational debtor. Within a period of 10 days of the receipt of such demand notice or copy of invoice, the debtor must submit the proof of the payment of such debt or must bring to notice of the operational creditor, the existence of a dispute and the record of the pendency of a suit orarbitration proceeding filed before the receipt of such notice orinvoice in relation to such dispute (Section 8(2)(a)).

One of the issues which came up repeatedly in last one year before various National Company Law Tribunal (NCLT) benches was the question of  a debtor ‘disputing’ the debt. Conflicting orders were passed by various benches of the NCLT, while interpreting the provisions of Section 8 (2)(a), which lays down the following:

“The corporate debtor shall, within a period of 10 days of the receipt of the demand notice or copy of the invoice mentioned in sub-section (1) bring to the notice of the operational creditor — (a) existence of a dispute, if any, and record of the pendency of the suit or arbitration proceedings filed before the receipt of such notice or invoice in relation to such dispute.

It must be noted that the expression “dispute” under Section 5(6) of the code covers only three things, namely, existence of the amount of debt, quality of goods or services or breach of a representation or warranty. Therefore, any dispute has to be confined to only this and no other aspect of the commercial dealings.

What vexed legal minds, is the use of the word “and” in Section 8(2)(a), which on a plain reading, appears that the debtor had to furnish proof that it has filed a suit or arbitration if its disputing the debt. Merely disputing the debt is not enough, unless the said dispute has been raised either by filing a suit or an arbitration. This also called for a pro-active approach on behalf of the debtor and, instead of waiting for the demand notice under this code to be raised for the creditor. This interpretation was adopted by the Mumbai bench of NCLT, who in the matter of DF Deutsche Forfait AG and Another vs Uttam Galva Steel Limited, held that the “existence of a dispute” means that a suit or arbitration proceedings must be pending before an operational creditor serves a demand notice. Thus, raising a dispute in reply to the demand notice does not amount to notice of an existing dispute or for that matter filing a suit or initiating arbitration proceedings subsequent to receipt of demand notice shall not amount to an existing dispute.

The Delhi bench of NCLT, in the matter of One Coat Plaster, Shivam Construction Company vs Ambience Private Limited held that the term “dispute” needs to have a broad and inclusive definition. The Delhi bench further held that it is not mandatory on part of the debtor to have initiated a suit or arbitration proceeding prior to the receipt of demand notice to assert the existence of a dispute. Mere response to the demand notice showcasing existence of a bona fide dispute shall suffice. The National Company Law Appellate Tribunal (NCLAT) affirmed these views in Kirusa Software Private Limited vs Mobilox Innovations Private Limited.

This was finally decided in the authoritative decision by the Supreme Court, passed in the same matter of Mobilox Innovations Private Limited Kirusa Software Private Limited (Civil appeal no: 9405 of 2017)

The apex court held that “What is important is that the existence of the dispute and/or the suit orarbitration proceeding must be pre-existing — ie, it must existbefore the receipt of the demand notice or invoice, as the case may be. Once this is done, the adjudicating authority may either admit the application or reject it.”

The top court read “and” as “or” and held that “Even otherwise, the word “and” occurring in Section 8(2)(a) must be read as “or”, keeping in mind the legislative intent and the fact that an anomalous situation would arise if it is not read as “or”. If read as “and”, disputes would only stave off the bankruptcy process if they are already pending in a suit or arbitration proceedings and not otherwise. This would lead to great hardship; in that a dispute may arise a few days before triggering of the insolvency process, in which case, though a dispute may exist, there is no time to approach either an arbitral tribunal or a court. Further, given the fact that long limitation periods are allowed, where disputes may arise and do not reach an arbitral tribunal or a court for up to three years, such persons would be outside the purview of Section 8(2), leading to bankruptcy proceedings commencing against them. Such an anomaly could not possibly have been intended by the legislature nor has it so been intended. We have also seen that one of the objects of the code qua operational debts is to ensure that the amount of such debts, which is usually smaller than that of financial debts, does not enable operational creditors to put the corporate debtor into the insolvency resolution process prematurely orinitiate the process for extraneous considerations. It is for this reason that it is enough that a dispute exists between the parties.”

With this judgement of the Supreme Court, the law on the point of “dispute” has been clarified to a great extent. It has provided definite breather to the operational debtors who may have some genuine dispute with respect a pending debt or are holding on the payment on account or some or the other claim but no formal suit or arbitration proceeding has commenced. They stand a chance before the NCLT and can successfully contest an application for insolvency launched by a disgruntled creditor upon showing the existence of dispute. Operational creditors, on the other hand, are required to be more mindful and should make an attempt to resolve the disputes with respect to the pending dues rather than using the insolvency mode as a quick fix formula to recover the debt. That has never been the purport or the intent of the law on insolvency. It is not a debt recovery mechanism as been held in plethora of judgments.

The pronouncement of the apex court is binding on all the NCLTs and NCALTs. However, the one question that they will still have to ponder upon and decide, on a case-to-case basis, is whether the dispute raised by the operational debtor is a  genuine dispute or a sham? Like always, the tasks before the courts is not an easy one.

(The writers are Partners at TRS Law Offices)