India: Supreme Court: Applicability Of A Right To Claim Set-Off During A Cirp Under IBC

Applicability of set-off during a corporate insolvency resolution process ("CIRP") had been a vexed question. For instance, whilst the National Company Law Appellate Tribunal in Simbhaoli Sugars Limited v. Pramod Kumar Sharma [Company Appeal (AT) (Insolvency) No. 776 of 2023], had noted the non-applicability of set-off recognised under Regulation 29 of IBBI (Liquidation Process) Regulations, 2016 ("Liquidation Regulations") to CIRP, the Chandigarh bench of National Company Law Tribunal in Pramod Kumar Sharma v. ED&F Man Sugar Limited, London, UK [CA No. 235/2018 & 236/2018 in CP (IB) No.120/ALD/2017], had recognised the application of such principles during the CIRP.

The uncertainty surrounding the application of the principles has hopefully now been settled by the Supreme Court in the case of Bharti Airtel Limited v. Vijaykumar V. Iyer [Civil Appeal Nos. 3088-3089 of 2020, decided on January 3, 2024], wherein it had the opportunity to discuss the applicability of a right to claim set-off during a CIRP under the Insolvency and Bankruptcy Code, 2016 ("IBC/the Code").

Observations of the Supreme Court

Meaning and types of set-off

The Court observed that set-off is a right of a debtor to adjust the small claim owed to him against the larger claim payable to his creditor and is supported by principles of economics and natural equity. It was observed that a set-off can have the following meanings –

Set-off during liquidation

Set-off during liquidation falls under the category of statutory set off, as Regulation 29 of the Liquidation Regulations expressly provides that where there are 'mutual dealings' between the corporate debtor and another party, the sums due from one party shall be set off against the sums due from the other to arrive at the net amount payable to the corporate debtor or to the other party.

What amounts to 'mutual dealings' was explained to be more concerned with the relationship between the parties, rather than the nature of claims, such that it would be unfair to allow the claim of one to be enforced without regard to the other. It was observed that 'mutual dealings' for the purpose of Regulation 29, which distinguishes insolvency set-off from other meanings of set-off mentioned above, is wider than the statutory set-off postulated under Order VIII Rule 6 of the CPC and the equitable set-off under common law

Set-off during CIRP

In so far as applicability of set off during CIRP is concerned, the Court observed that insolvency set-off mitigates against the doctrine of pari passu (aimed at ensuring that all creditors get their proportional dues by preventing any one creditor from getting more than their deserved share and imbibed under Section 53 read with Section 52 of the Code) because when the cross demands are set-off, the assets available for distribution amongst the general body of creditor, would be depleted in favour of a single creditor with the set-off entitlement. Such set-off would result in deduction of dividend payable and grant priority to a single creditor. Since a set-off can mitigate against the pari passu principle, it can only be allowed when mandated or can be justified under law. The Court also relied on the anti-deprivation principle which encapsulates that a person cannot contract to obtain a more beneficial position, in the event of bankruptcy.

The Court then referred to the provisions of the Code, especially Section 238 of the Code (overriding effect of the Code) to come to the conclusion that in view of the specific legislative mandate as incorporated and reflected in Chapter II Part II of the IBC, the provisions of the Code relating to CIRP do not recognise the principle of insolvency set-off, nor can a statutory set-off in terms of Order VIII Rule 6 of CPC or insolvency set-off in terms of Regulation 29 of the Liquidation Regulation be applied to CIRP. The Court went on to observe that the legislation or even the legislative intent permits neither statutory set-off, nor insolvency set-off.

Whilst arriving at the conclusion, the Court also took note of the provision contained in clause (ii) to subsection (2)(b) of Section 30 (amount to be payable to be not less than entitlement in accordance with priority specified under Section 53 of the Code), which was relied upon to urge that if the provision does not support insolvency set off, it would result in certain anomalies. For instance, in the event the corporate debtor undergoes liquidation, Section 36(4)(e) and Regulation 29 would apply. However, if the Resolution Professional proceeds in terms of Section 25 and secures the assets from the creditors, the creditors would not be entitled to claim set-off during the course of the CIRP, which is earlier in the point of time.

The aforementioned submission was rejected by inter alia observing that clause (ii) to subsection (2)(b) of Section 30, which deals with the amounts to be paid to the creditors and not the amount payable by the creditors to the corporate debtor, does not make Chapter III Part II, that is, Section 36(4)(e) or Regulation 29, applicable to the CIRP under Chapter II Part II of the Code.

Exceptions to non-applicability of set-off during CIRP

Despite observing that right to claim set-off is not available during the course of the CIRP, the Court noted the following two exceptions to the aforementioned principle of law.

First, where a party is entitled to contractual set-off which is put into motion prior to commencement of CIRP. This is because during the moratorium period, the terms of the contract between the corporate debtor and the creditor remain binding and are not altered or modified, therefore, the contractual set-off can still be implemented.

Second, in the case of transactional set off (a subset of 'equitable set-off'), where a claim and set-off are closely linked in such a manner that it would be inequitable and unfair that claim of one is allowed. However, the claim in such equitable set-off ought to be quantifiable and unquestionable monetary claim and which does not require adjudication of disputed questions of law and facts. The Court observed that such transactional set-off will not eclipse a moratorium under Section 14 of the Code because in such cases the transactions will be treated as singular and one.

Author`s View:

The judgement of the Supreme Court provides helpful clarity on the law on set-off of claims at the initial stage of CIRP, by specifying the non-applicability of the principle subject to certain identified exceptions. Whilst the principles laid down is not a novel proposition, it certainly would help in ensuring that there is clarity in terms of judicial application of the principles.

Please find attached a copy of the judgement.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.