India: Judicial Vagaries Of Insolvency & Bankruptcy Code, 2016 – An Analysis

Introduction

By way of background, the Insolvency and Bankruptcy Code, 2016 (Code) was enacted with the primary objective to consolidate and amend the laws relating to reorganisation and insolvency resolution of corporates, firms and individuals in a time bound manner to maximise the value of their assets. The genesis of the Code is rooted in the long-term vision of providing an effective legal framework for timely resolution of insolvency and bankruptcy, which would support development of credit markets and encourage entrepreneurship. As it exists, the Code has dovetailed judicial and commercial wisdom for the first time. On perusing the entire scheme of Code, while it is evident that time is of the essence for the entire insolvency resolution process, it is equally important that the Code be interpreted with its entire purpose and the mischief it sought to address in mind.

However, the Code is still at a nascent stage and recent judicial interpretations have raised more questions than it has answered with respect to its implementation. This is because the Principal Bench of the National Company Law Tribunal (NCLT PB), seems to have interpolated a wider meaning in certain provisions of the Code while interpreting them.

Factual Background

Recently, while disposing of two cases on 1 March 2017 against a common corporate debtor, Ambience Private Limited, (Corporate Debtor) filed by One Coat Plaster and Shivam Construction Company (being Company Application No. (I.B.) 07/PB/2017 and Company Application No. (I.B.) 08/PB/2017 respectively), the NCLT PB was required to interpret the word 'dispute', the phrase 'notice of dispute', and deal with the sanctity of the timeframe envisaged for filing a reply, if at all, to demand notice by an operational creditor, for the first time.

Briefly, the Corporate Debtor had issued certain work orders to One Coat Plaster and Shivam Construction Company (collectively, Operational Creditors), on various occasions. After some payments had been made to the Operational Creditors, they alleged that certain amounts were still due to them by the Corporate Debtor, i.e. INR 32,60,833 (Indian Rupees Thirty two lakh sixty thousand eight hundred thirty three) in so far as One Coat Plaster was concerned, and INR 8,95,900 (Indian Rupees Eight Lakh ninety five thousand nine hundred) in so far as Shivam Construction Company was concerned.

Accordingly, both the Operational Creditors served a notice of demand under Section 8 of the Code on 25 January 2017, at the registered office of the Corporate Debtor as well as via e-mail. The Operational Creditors inter alia claimed that they had not received any payment, much less any response to the demand notice, till the date of filing of the petition before NCLT PB.

Arguments before the NCLT

While the Operational Creditors demonstrated their case and supported it with the documents on record, the Corporate Debtor contended that it had in fact replied to the demand notice dated 4 February 2017 to both the Operational Creditors on 8 February 2017, stating, inter alia, that due to the poor quality of work on part of both the Operational Creditors, no further payment could have been made to them, and that in any event it completely denied the claim of both the Operational Creditors.

NCLT Order

For ease of reference and to appreciate the controversy at hand, the relevant extracts from the NCLT PB order are reproduced below, with emphasis added in bold where necessary:

  • "...However, in relation to the balance amount claimed by the petitioners as due from the Company, we are unable to agree in view of lack of materials submitted before us by the Petitioners and also taking into consideration the fact that the debt sought to be fastened on the company has been vehemently disputed as is evident from the reply to the notice sent by the Company, which is dated 04.02.2017 but dispatched on 08.02.2017 to the counsel for the petitioners."...
  • "Reference to the provisions of the Code, more particularly Section 9 thereof clearly discloses that this Tribunal has the power, inter alia also to reject the Application of the Operational Creditor under Section 9(5)(d) in case of notice of dispute has been received by the operational creditors or there is record of dispute with the information utility. In the absence of information utility, we are perforce to rely on the notice of dispute as sent by the Company to the petitioners denying the liability based on which the entire edifice of the petitioner's claim crumbles which constitutes basis of the present application. It is pertinent to note that the expression 'dispute' has been defined and it seems to be an inclusive definition as seen from Section 5(6) of the Code..."
  • "A bare perusal of Section 5(6) of the Code shows that a dispute could be proved by showing that a suit has been filed or arbitration are pending. It further elaborates that suit or arbitration should be in respect of the existence of the amount of debt, quality of goods or services; or a breach of a representation or a warranty. It is not an exhaustive definition but an illustrative one. It becomes evident from the expression 'includes' which immediately succeeds the word 'dispute'. Moreover, under Section 8(1) of the Code adequate room has been provided for the 'NCLT' to ascertain the existence of a dispute...Section 8 (2) further clarifies that the corporate debtor is obliged to bring to the notice of the 'Operational Creditor' within 10 days of the receipt of notice, the existence of a dispute and record of the pendency of the suit or arbitration proceeding filed before the receipt of such notice or invoice in relation to such dispute. The other option is to pay the demanded amount. In the instant case the Petitioner sent a demand notice which was duly received by the 'company' but the reply was also filed which has been delayed by four days where dispute has been raised...Hence we are inclined to reject the above petitions."

Judicial Vagaries – An Analysis

By passing the above directions, which, in our view seem to be tad glib, the NCLT PB seemed to have opened a Pandora's box with respect to the implementation of the Code. Given the clear mandate, object and purpose of the Code, certain relevant questions are itemised below:

Whether definition of 'dispute' under the Code can be said to inclusive?

At the outset, Section 5(6) of the Code gives a very restrictive meaning to a 'dispute' by defining it to 'include a suit or arbitration proceedings relating to – (a) the existence of the amount of the debt; (b) the quality of the goods or service; or (c) the breach of a representation or warranty'. Upon perusal of this definition, the legislative intent is clear in limiting the scope of the term 'dispute', to only mean the pendency of a proceeding, be it either a suit or an arbitration, in the manner discussed above.

Having said the above, even if it is argued that the definition of 'dispute' under the Code can be said to be inclusive, it cannot extend to a situation of mere denial of the claim. By extending the settled principle of ejusdem generis, it appears to be clear that the word 'includes' can, at best, be extended only to any pending legal proceedings other than a pending suit or arbitration proceedings.

In this regard, the observation made by the Hon'ble Supreme Court in the case of Godfrey Phillips India Limited v State of UP [Ref: (2005) 2 SCC 515] is relevant. The constitutional bench of the Supreme Court observed that 'where two or more words susceptible of analogous meaning are clubbed together, they are understood to be used in their cognate sense. They take, as it were, their colour from and are qualified by each other, the meaning of the general word being restricted to a sense analogous to that of less general.'

Whether NCLT has the discretion to ascertain the veracity of a 'dispute' at the time of adjudicating an application under Section 9 of the Code?

Section 8 of the Code entitles an operational creditor, upon occurrence of a default (i.e., non-payment of debt, when it has become due and payable) to issue a demand notice in the manner prescribed therein, to a corporate debtor, which can be followed by filing an application before NCLT in terms of Section 9 of the Code. Once the said application is filed, NCLT, in terms of Section 9(5) of the Code, can exercise only one of the two options within a timebound period of 14 (fourteen) days of such filing, (i.e., either admit the application or reject the application by way of an order in the clearly prescribed manner provided in Section 9(5)(i) and Section 9(5)(ii) of the Code respectively).

Upon a perusal of the grounds (either for admission or rejection) under Section 9 of the Code, it is evident that the Code does not envisage any discretion upon NCLT to ascertain the veracity of a dispute (i.e., whether the dispute raised is genuine or not), since the Code has given a very clear and unambiguous meaning to the term 'dispute', thereby rendering the interpretation extremely objective and contextual.

Having said the above, the powers, scope and limit of adjudication under Section 9 are apparent from a perusal of Section 9(5) of the Code as the same uses the word 'shall', thereby indicating the legislative intent to require NCLT to (a) necessarily decide an application within 14 (Fourteen) days of it being filed by means of an order; (b) while deciding, either admit an application or reject an application on the limited five grounds available to NCLT under Section 9(5)(i) or Section 9(5)(ii) of the Code respectively.

It is relevant to state here that the Supreme Court in the case of Super Cassettes Industries Limited v Music Broadcast Private Limited [Ref: (2012) 5 SC 488], stated "...as has been held by this Court in innumerable cases, a tribunal is a creature of the statute and can exercise only such powers as are vested in it by the statute."

What is the meaning of 'notice of dispute'? Whether a reply under Section 8(2) of the Code simply denying a claim in a demand notice can be considered for rejecting an Application under Section 9 of the Code? What is the sanctity of the time frame envisaged in Section 8(2) of the Code?

Though 'notice of dispute' has not been defined in the Code, it cannot be extended to mean a mere notice, inter alia, denying the claim. Any denial to a demand notice must necessarily raise a 'dispute' in terms of Section 5(6) of the Code. Thus, a mere reply simply denying a claim made in the demand notice cannot be considered for rejecting an application under Section 9 of the Code.

Further, Section 8(2) of the Code provides that a notice of dispute, if any, to a demand notice must be within a period of 10 (ten) days from its receipt. The question which remains to be addressed and analysed is whether the period of 10 (ten) days, as provided for in Section 9, includes "non-working days" and "gazetted holidays".

Khaitan Comment

The context of the term 'dispute', as referred in the Code, ought to be given a plain and literal meaning, as envisaged in the Code. A failure to do so would give errant corporate debtor(s) an opportunity to bypass the purpose, object and scheme of the Code. Interestingly, post the passing of the order by NCLT PB on 1 March, 2017, two judgments with divergent views have been passed on this issue, (i) NCLT Mumbai Bench, on 6 March, 2017, in the case of Essar Projects India Ltd v MCL Global Steel Pvt Ltd., while interpreting the term 'dispute', held that merely denying a claim in reply to a demand notice, could not be treated as 'dispute in existence' for the purposes of rejecting an application under Section 9 of the Code; and (ii) NCLT PB, in its recent judgment on 24 March 2017 in the case of Annapurna Infrastructure Pvt. Ltd. & Ors. v Soril Infra Resources Ltd., has expanded the scope of term 'dispute' by holding that a corporate debtor is well within its right to reject a demand on any sustainable grounds, which is to be determined on a fact to fact basis.

Having said this, it is yet to be seen as to which of the interpretations would eventually prevail, if challenged. However, as of today, the Code seems to have already become a victim of judicial vagaries, given the fact that two different benches of NCLT have rendered divergent interpretations on the same issue.

The content of this document do not necessarily reflect the views/position of Khaitan & Co but remain solely those of the author(s). For any further queries or follow up please contact Khaitan & Co at legalalerts@khaitanco.com

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