India: Invocation Of Bank Guarantees During Moratorium: A Situation Of Conflicting Decisions?

"Stare Decisis" has been defined under the Black's Law Dictionary as "to abide by, or adhere to, decided cases". Interpreting the same, the doctrine of 'Stare Decisis' lays down that that if a court of competent jurisdiction has laid down an interpretation of law, that applies to a set of facts and circumstances, then the principle as laid down will apply to all forthcoming cases on substantially similar cases and the concerned courts ought to follow the same.

However, the exceptions to this doctrine have been laid down in the doctrines of "Per-Incuriam" and "Sub-Silentio". Black's Law Dictionary defines "Per Incuriam" as "through inadvertence". The doctrine of a judgment being 'Per Incuriam' means that a decision of a court of law that is in advertence to the terms of a statute, rule of law having the force of law that renders the decisions as not a binding precedent. Further Black's Law Dictionary defines "Sub-Silentio" as "Under silence; without any notice being taken". Thus, a decision declared as 'Sub-Silentio' renders it as having been passed without consideration on a point of law or presented to or perceived or not consciously determined by the concerned court thereby rendering it as not a good law.

The doctrines of Stare Decisis, Sub-Silentio, Per Incuriam are an extended facet to enforce judicial discipline under the principles of administration of justice. The Supreme Court of India in the case of Sub-Inspector Rooplal v. Lt. Governor1 held that even tribunals are bound to follow judicial discipline and following precedents is one of the most important principles.

In view of the above principles, a critically important position has arisen under the principles of the Insolvency and Bankruptcy Code, 2016 ("Code"). Under Section 132 of the Code, the Adjudicating Authority i.e. the concerned bench of the National Company Law Tribunal ("NCLT"), once after admitting an application for initiation of Corporate Insolvency Resolution Process ("CIRP") under Section 7 i.e. Initiation of CIRP by financial creditor or Section 9 i.e. Application for initiation of CIRP by operational creditor or Section 10 i.e. Initiation of CIRP by corporate applicant of the Code, declares a moratorium under Section 143 of the Code upon the corporate debtor. However, there lies a conundrum over the inclusion and exclusion of certain security interests from the ambit of moratorium?

Under Section 14(1)(b) and (c) of the Code, the intent of the Legislature seems to be very clear that during the period of Moratorium qua the corporate debtor, there shall be no action whatsoever of foreclosure, recovery or enforcement of any 'security interest' which has been created by the corporate debtor vis-a-vis its property. Further, there shall be no transfer, encumbrance, alienation or disposal of the assets or any legal right or beneficial interests by the corporate debtor during the moratorium.

It is trite to refer to the definition of 'Security Interest' as under Section 3(31)4 of the Code at this juncture. Importantly vide a proviso clause, performance guarantee(s) is / are specifically excluded from the definition of Security Interest under the Code. Hence, on a con-joint reading of Section 14(1)(c) with Section 3(31) of the Code, performance guarantees have been specifically excluded from the ambit of Moratorium under the Code.

It is interesting to note that the definition clause under the Code provides that a security interest shall include an interest that has been created for a secured creditor by way of a transaction that 'secured performance of an obligation'. However, despite including performance obligations as security interest, the Legislature in its wisdom decided to exclude performance based guarantees from the definition. This leads to a situation, where if the intent of the Legislature was to carve out an exception for performance guarantees from the ambit of security interest, then the inclusion of performance obligations under the definition is bound to create a conundrum when the same would be put to test by the concerned NCLT. The dichotomy has now arisen through decision of various forums.

It started with a writ petition5 that was moved by a resolution professional of a corporate debtor before the High Court of Gujarat under Article 226 of the Constitution of India and IBC. The issue raised before the Hon'ble High Court of Gujarat was whether invocation of bank guarantees could be allowed pursuant to an order of admission of CIRP by the NCLT, Ahemdabad and during the period of Moratorium under the Code?

The Hon'ble High Court of Gujarat held that a separate yardstick is bound to be observed in matters pertaining to those covered under the Code, departing from the earlier set principle of law that Courts ought not interfere with invocation of bank guarantee matters. Accordingly, after referring to the Order of the NCLT, Ahemdabad and Section 14 of the Code, an ad-interim Order was passed by the High Court restraining the invocation of the bank guarantee in question.

Thereafter, the National Company Law Appellate Tribunal ("NCLAT") while deciding an appeal6 against the Order of NCLT, Principal Bench was dealing with a similar situation.

Vide the impugned Order passed by the NCLT, Principal Bench7, an application was moved by the resolution professional against a financial creditor for invoking security interests in violation of the Moratorium and sought for reversal of the same. The NCLT, Principal Bench held that during Moratorium, a financial creditor has to file its claims before the resolution professional in accordance with the provisions envisaged under the Code. Coming down heavily upon the concerned financial creditor therein, the NCLT, Principal Bench apart from other orders, directed the financial creditor to roll bank the amounts of the bank guarantee encashed after the moratorium for being in violation of Section 14(1)(c) of the Code.

The NCLAT, upheld the decision of the NCLT, Principal Bench and referred to its earlier Order8, wherein a prima facie observation was made that, during Moratorium debiting of any amount from the accounts of a corporate debtor resulted in recovery which was impermissible under Section 14 of the Code.

However, dealing with issue herein, a departure from the above was made by the NCLT, Ahemdabad9. Upon an Application moved by the interim resolution professional, a question of law came up for consideration before the NCLT, Ahemdabad that whether during Moratorium a coercive action such as to stay invocation of bank guarantees, in the nature of performance and security, could be granted?

NCLT, Ahmedabad held that Section 3(31) of the Code clearly excluded performance guarantees from the ambit of Section 14(1)(c) of the Code, and hence moratorium would not extend to the performance guarantees given by the corporate debtor. Further, NCLT, Ahmedabad granted liberty to the concerned bankers to allow encashment of such performance based guarantees. However, a clarification was laid down that any other bank guarantee that was sought to be encashed apart from being a performance based guarantee, cannot be carried out for being covered under the ambit of Moratorium under the Code. Whether this issue can be considered as a case of priority in payments, which is strictly barred under the Code? On the first blush seems to have been overlooked by the Legislature.

The conundrum that now arises is that whether the judgment of the NCLT, Ahemdabad is per-incuriam or sub-silentio for being contrary to the precedent as laid down by the Hon'ble High Court of Gujarat and the NCLAT, both having supervisory and appellate jurisdiction over the NCLT, Ahemdabad and for not observing the doctrine of Stare Decisis.

At the very same time, the issue yet unanswered is that whether the orders passed by the High Court of Gujarat and the NCLAT, were per incuriam for not being in line with the carved out exception under Section 3(31) read with Section 14 of the Code?

The list of judgments on this issue does not end here. Thereafter, NCLT, Mumbai in two separate applications qua the same corporate debtor, vide orders dated 26.04.201810 and 12.06.201811 passed its ruling on this issue. The NCLT, Mumbai, while dealing with one of the applications moved by the resolution professional, passed an ad-interim order wherein the invocation and encashment of the performance bank guarantee in question was restrained on the ground that after declaration of Moratorium under the Code, such an action would cause prejudice to the stakeholders of the corporate debtor.

In the later application that was also moved by the resolution professional of the corporate debtor, the NCLT, Mumbai relying on its earlier order injuncted the encashment of the performance bank guarantee by applying the provisions of Moratorium and held that the encashment would be squarely covered under the ambit of alienation / recovery of property of the corporate debtor and thus invocation of such bank guarantees was against the provisions of Moratorium under the Code. Per-Incuriam?

The decision of NCLT, Mumbai seems to be in line with the true underlying intent of the Code, that is to maintain a calm over the assets of the corporate debtor during the CIRP.

This decision of NCLT, Mumbai was challenged by the concerned beneficiary of the performance bank guarantee before the NCLAT12. The NCLAT held that Section 3(31) read with Section 14(1)(c) of the Code excluded performance bank guarantees from the ambit of Moratorium under the Code and thus the beneficiary was allowed to invoke and encash the bank guarantee.

Though, NCLAT applied the provisions of law strictly, however its impact seems to be in clear violation to the intent of the Code, as this allows a beneficiary of a performance bank guarantee to seek priority in payments over all other persons having claims against the corporate debtor. This aspect ought to be looked into by the concerned authorities by applying Section 60(5)(c) of the Code, which begins with a non-obstante clause, that the NCLT has wide powers under its inherent jurisdiction to adjudicate upon issues that touch upon priority during the CIRP.

The decision of NCLAT appears to be per incuriam for not having followed its earlier decision of rolling back the amounts encashed through a bank guarantee, wherein it was held that debiting any amount from the accounts of a corporate debtor during CIRP would amount to a recovery action which is forbidden under Section 14 of the Code.

It is imperative to consider that a threat of invocation / encashment of bank guarantee during the CIRP has a direct impact on the assets of a corporate debtor. The intent of the Legislature behind imposing Moratorium under the Code is very clear i.e. to maintain calm on the assets and liabilities of corporate debtor, till there being a resolution plan or liquidation. As a result, it flows as a statutory duty under the Code for the interim resolution professional / resolution professional to take necessary action to protect the assets of a corporate debtor till completion of CIRP i.e. to take all legal steps to protect such invocation / encashment of bank guarantees.

It is also important to keep in mind that as a matter of commercial routine, companies in order to secure on-going projects issue performance bank guarantees or other kind of bank guarantees having a different nomenclature but serve the same purpose i.e. secure performance obligations. If a company that undergoes CIRP, performance bank guarantee holders have now been given a green signal, by the NCLAT ruling, to invoke and encash the same. Following suit, nothing bars every holder of such performance bank guarantees to take the same recourse and in result, a situation is bound to arise where there shall be no resolution applicant during the CIRP, for there being no possible viability in a company, leading to the ultimate scenario of liquidation under the Code. It is our understanding that revival of a corporate debtor is the main intent of the Code, rather than liquidation, as the case was during winding up proceedings under the erstwhile Companies Act, 1956.

It is our considered opinion that the carved-out exception of excluding performance bank guarantees ought to be tested, by the highest court or be reconsidered by the Legislature, for overriding the interests of other stakeholders during CIRP. In a given situation where a beneficiary is said to be holding a normal bank guarantee not being in the nature of performance bank guarantee, is barred from enforcing the same due to Moratorium however the same bar does not apply to the other beneficiary for holding a performance bank guarantee. However, there may be a situation that both serve the same purpose i.e. security of a performance obligation which is clearly covered under the definition of a security interest and thus falling within the ambit of Moratorium.

In this situation it seems that the Legislature has not taken into account that mere nomenclature of a security interest ought not have been given a special exclusion by way of a proviso that excludes it from the ambit of Moratorium thereby leading to a situation of priority in payment during CIRP.

However, the divergent decisions of various judicial forums has stirred another round controversy under the Code. The question that which of the judgments on this issue will be declared as per-incuriam or sub-silentio cannot be ascertained till a higher court ruling is laid down or an amendment to the Code is passed by the Legislature that brings to rest this present conundrum under the Code that is currently affecting several CIRP's. Interesting times lie ahead.

The authors of this article, Sanjeev Kumar is a Partner and Anshul Sehgal is a Senior Associate in the Litigation and Dispute Resolution Group at L&L Partners Law Offices, New Delhi, India.

Footnotes

1. (2000) 1 SCC 644

2. Section 13 - Declaration of moratorium and public announcement.

(1) The Adjudicating Authority, after admission of the application under section 7 or section 9 or section 10, shall, by an order—

(a) declare a moratorium for the purposes referred to in section 14;

(b) cause a public announcement of the initiation of corporate insolvency resolution process and call for the submission of claims under section 15; and

(c) appoint an interim resolution professional in the manner as laid down in section 16.

(2) The public announcement referred to in clause (b) of sub-section (1) shall be made immediately after the appointment of the interim resolution professional.

3. Section 14. - Moratorium.

(1) Subject to provisions of sub-sections (2) and (3), on the insolvency commencement date, the Adjudicating Authority shall by order declare moratorium for prohibiting all of the following, namely: -

(a) the institution of suits or continuation of pending suits or proceedings against the corporate debtor including execution of any judgement, decree or order in any court of law, tribunal, arbitration panel or other authority;

(b) transferring, encumbering, alienating or disposing off by the corporate debtor any of its assets or any legal right or beneficial interest therein;

(c) any action to foreclose, recover or enforce any security interest created by the corporate debtor in respect of its property including any action under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (54 of 2002);

(d) the recovery of any property by an owner or lessor where such property is occupied by or in the possession of the corporate debtor.

(2) The supply of essential goods or services to the corporate debtor as may be specified shall not be terminated or suspended or interrupted during moratorium period.

(3) The provisions of sub-section (1) shall not apply to — (a) such transaction as may be notified by the Central Government in consultation with any financial regulator; (b) a surety in a contract of guarantee to a corporate debtor. (4) The order of moratorium shall have effect from the date of such order till the completion of the corporate insolvency resolution process.

Provided that where at any time during the corporate insolvency resolution process period, if the Adjudicating Authority approves the resolution plan under sub-section (1) of section 31 or passes an order for liquidation of corporate debtor under section 33, the moratorium shall cease to have effect from the date of such approval or liquidation order, as the case may be.

4. Section 3. Definitions. – In this Code, unless the context otherwise requires, -

...

(31) "security interest" means right, title or interest or a claim to property, created in favour of, or provided for a secured creditor by a transaction which secures payment or performance of an obligation and includes mortgage, charge, hypothecation, assignment and encumbrance or any other agreement or arrangement securing payment or performance of any obligation of any person:

Provided that security interest shall not include a performance guarantee.

5. ABG Shipyard Ltd. v. Govt. Of India & Ors. SCA 17666/2017 Order dated 25.09.2017. Please note that the Writ Petition was thereafter withdrawn.

6. State Bank of India v. Debashish Nanda, Company Appeal (AT) (Insolvency) No. 49/2018, Order dated 27.04.2018.

7. Debashish Nanda, RP v. State Bank of India, Order dated 25.01.2018. NCLT, Principal Bench, New Delhi

8. State Bank of India v. Debashish Nanda, Company Appeal (AT) (Insolvency) No. 49/2018, Order dated 21.03.2018.

9. Nitin H. Parikh IRP v. Madhya Gujarat Vij Co. Ltd. & Ors. IA 340/17 in CP 28/10/NCLT/AHM/2017. Order dated 09.02.2018

10. Re: Kohinoor Crane Services, through Resolution Professional. MA 384/2018 in CP 1374/I&BC/MB/MAH/2017.

11. Kohinoor Crane Services, through Resolution Professional v. Petron Engineering Construction Ltd. MA 521/2018 in CP 1374/I&BC/MB/MAH/2017.

12. GAIL (India) Ltd. v. Rajeev Manaadiar & Ors. Company Appeal (AT) (Insolvency) No. 319/2018, judgment dated 24.07.2018

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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