India: NCLAT's Order On Dispute Under The Insolvency And Bankruptcy Code, 2016

Last Updated: 5 September 2017
Article by Pooja S. Mahajan

Under the Insolvency and Bankruptcy Code, 2016 ("Code"), an operational creditor can initiate a corporate insolvency resolution process ("CIRP") of the corporate debtor by filing an application before the relevant National Company Law Tribunal ("NCLT/ Adjudicating Authority") upon occurrence of a default in payment of its operational debt.

However, the operational creditor must first send a demand notice or invoice to the corporate debtor, demanding the payment of the defaulted debt. In case the corporate debtor issues a 'notice of dispute' to the operational creditor, the Adjudicating Authority is required to reject the application of the operational creditor.

Since the Code has been notified, one of key interpretational question that has arisen is the meaning of 'dispute' to constitute a valid notice of dispute that will defeat the application of the operational creditor. The term 'dispute' has been defined in Section 5 (6) of the Code as "dispute includes a suit or arbitration proceedings relating to: (a) the existence of the amount of debt; (b) quality of goods or service; or (c) the breach of a representation or warranty". On the other hand, Section 8 (2) provides that the debtor should bring to the notice of the operational creditor "existence of a dispute, if any, and record of suit or arbitration proceeding pending before receipt of the demand notice".

The question that has arisen before various NCLTs is whether a corporate debtor can raise all kinds of disputes in the notice of dispute or can the notice of dispute only refer to pendency of a suit or arbitration before receipt of the demand notice. In other words, is the application of an operational creditor liable to be rejected only if the notice of dispute refers to a pending suit or arbitration proceeding on the dispute before receipt of the demand notice? Very recently, in Kirusa Software Private Limited v. Mobilox Innovations Private Limited1, the National Company Law Appellate Tribunal ("NCLAT") discussed this issue and passed an order, interpreting the meaning of 'dispute' under the Code ("NCLAT Order"). This e-alert discusses some critical observations made by NCLAT on interpretation of 'dispute'.

FACTS OF THE CASE:

Kirusa Software Private Limited ("Kirusa") issued a demand notice on Mobilox Innovations Private Limited ("Mobilox") as an operational creditor, demanding payment of certain dues. Mobilox issued a reply to the demand notice inter alia stating that there exists serious and bona fide dispute between the parties and that Kirusa had breached the terms of an NDA between the parties and divulged Mobilox's confidential information.

Kirusa filed an application before the NCLT, Mumbai for initiation of CIRP of Mobilox which was dismissed by the NCLT, Mumbai on the grounds that a notice of dispute has been issued by Mobilox.

Kirusa filed an appeal before the Hon'ble NCLAT, claiming that Mobilox's reply does not constitute a notice of dispute in accordance with the Code.

ISSUE BEFORE THE NCLAT:

What does "dispute" and "existence of dispute" mean for the purpose of determining the petition of the operational creditor under Section 9 of the Code?

HELD:

  • Though the words 'prima facie' are missing in Sections 8 and 9 of the Code, yet the Adjudicating Authority would examine whether notice of dispute in fact raises the dispute and that too within the parameters of two definitions – 'debt' and 'default' and then it has to reject the application if it apparently finds that the notice of dispute does really raise a dispute and no other factual ascertainment is required. On the other hand, if the Adjudicating Authority finds that the notice of dispute lacks in particulars or does not raise a dispute, it may admit the application but in either case, there is neither an ascertainment of the dispute, nor satisfaction of the Adjudicating Authority.
  • The definition of "dispute" is "inclusive" and not "exhaustive". The same has to be given wide meaning provided it is relatable to the existence of the amount of the debt, quality of goods or service or breach of a representation or warranty.
  • The corporate debtor must raise a dispute with sufficient particulars. Further, the dispute under the Code must relate to the specified nature in Section 5 (6) (a)- (c), i.e. existence of amount of debt or quality of goods or service or breach of representation or warranty.
  • Mere illusory dispute, raised for the first time while replying to a demand notice cannot be a tool to reject the application under Section 9 if the operational creditor otherwise satisfies the Adjudicating Authority that there is a debt and a default.
  • Dispute as defined in Section 5 (6) cannot be limited to a pending proceeding or 'lis' within the limited ambit of suit or arbitration proceedings but includes proceedings initiated or pending before consumer court, tribunal, court or mediation, conciliation etc. If any action is taken by the corporate debtor under any Act or law, including while replying to a notice under Section 433 of the Companies Act or Section 59 of the Sale of Goods Act or regarding quality of goods or services provided by the operational creditor, the same will come within the ambit of dispute, raised and pending within the meaning of Section 5 (6) read with Section 8 (2) of the Code.

On facts of the case it was held that Mobilox's reply, when read in totality, does not raise any dispute within the meaning of Section 5 (6) or Section 8 (2), that Mobilox has disputed the payment merely on "some or other account" and that Mobilox's defence was "vague, got up and motivated to evade the liability". The NCLAT therefore set aside the order of NCLT, Mumbai and remitted the case to it for consideration of Kirusa's application for admission, if the application is otherwise complete.

IMPLICATIONS:

Rather than clarifying the meaning of the term 'dispute', the NCLAT Order raises more interpretational issues. On the one hand, Hon'ble NCLAT held that the definition of 'dispute' is inclusive and the term 'dispute' must be given a wide meaning and further that disputes raised in the notice sent by the corporate to the operational creditor would get covered within Section 8(2). On the other hand, Hon'ble NCLAT also said that the corporate debtor must have taken some action on the dispute under any Act or law before receipt of the demand notice. Therefore, while the Hon'ble NCLAT has extended the definition of dispute beyond suit or arbitration proceeding, it appears that it has still limited it to some action/ proceeding taken by the corporate debtor under any Act or law in respect of the dispute, before receipt of the demand notice.

The NCLAT Order will have wide implications for corporate debtors as the NCLAT Order puts an onus on the corporate debtors to take proactive action on the dispute before receipt of the demand notice. Therefore, if a corporate debtor has concerns or disputes regarding a payment to be made to its operational debtor, and if no proceedings (in the form of suit, arbitration, mediation etc.) is pending, it must proactively take steps in respect of the same (before the operational creditor issues a formal demand notice under the Code).

Footnote

1 Company Appeal (AT) (Insolvency) 6 of 2017, dated May 24, 2017

May 2017

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.

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