In a judgment in the matter of Brand Realty Services Ltd. v. Sir John Bakeries India Pvt. Ltd.1 the NCLT Delhi ("NCLT") clarified that unpaid dues under a settlement agreement cannot be considered as an 'Operational Debt' under Section 5(21) of the Insolvency and Bankruptcy Code, 2016 ("IBC"), as the NCLT "is not a recovery court".
Brand Realty Services Ltd., the Operational Creditor ("Petitioner") filed an application under Section 9 of the IBC against Sir John Bakeries India Pvt. Ltd. ("Corporate Debtor") for initiating a Corporate Insolvency Resolution Process ("CIRP"), in view of the pending dues under an Account Settlement Agreement entered into between the parties on 15 June 2018 ("Settlement Agreement").
The Petitioner was an investor cum consultant to the Corporate Debtor under a previous agreement dated 28 November 2014, in respect of setting up of a new retail outlet. The Petitioner had raised several invoices under this agreement which were unpaid. Subsequently the parties entered into a Settlement Agreement under which the Corporate Debtor agreed to pay the unpaid fixed commission due to the Petitioner, by Post Dated Cheques ("PDCs"), in 66 monthly installments. The default occurred when some of the PDCs were returned due to the reason of stop payment instructions issued by the Corporate Debtor, without taking any subsequent steps towards payment of unpaid dues under the Settlement Agreement. The Petitioner thus sent a legal notice in April 2019 calling upon the Corporate Debtor to comply with the terms of the Settlement Agreement. However, not having received a reply from the Corporate Debtor, the Petitioner served a demand notice under Section 8 of the IBC.
Corporate Debtor's contentions:
The Corporate Debtor replied to the demand notice stating that since no documents were enclosed with the demand notice, the Corporate Debtor was not liable to pay any amount to the Petitioner. The Corporate Debtor further submitted that the account of the Petitioner stood settled by another 'Settlement Letter' of December 2017 and therefore nothing remained due and payable to the Petitioner. The Corporate Debtor submitted that there was a pre-existing dispute between the parties in respect of personal debt, which remained unsettled due to the uncleared cheques issued earlier by a representative of the Corporate Debtor.
After considering the facts, the NCLT held that the present dispute was in relation to the breach of the terms and conditions of the Settlement Agreement, and not in relation to the invoices raised under the previous agreement. The NCLT further held that though it was clear that the reply to the demand notice was not sent by the Corporate Debtor within the time of 10 days prescribed under Section 8(2) of the IBC, the question to be considered was "Whether the terms and conditions of the Settlement Agreement would come under the definition of 'Operational Debt' under the IBC?"
Upon a combined reading of Sections 5(21) (definition of Operational Debt), Section 3(11) (definition of Debt) and Section 3(12) (definition of Default), it was held that 'Debt' under the IBC includes both operational and financial debt, as well as liability or obligation in respect of a claim which is due from any person. However, to trigger Section 9 of the IBC, the operational creditor is required to establish a 'Default' for non-payment of an 'Operational Debt' under Section 5(21), "which means a claim in respect of the provisions of goods or services including employment or a debt in respect of the payment of dues arising under any law for the time being in force and if a person fails to establish that, then they cannot initiate CIRP under Section 9 of the IBC."
The NCLT relied upon the earlier judgment of NCLT Allahabad regarding a similar issue in the matter of Delhi Control Devices (P) Limited v. Fedders Electric and Engineering Limited2, in which it was held that "unpaid instalment as per the settlement agreement cannot be treated as operational debt under Section 5(21) of IBC. The failure or breach of a settlement agreement can't be a ground to trigger CIRP against the Corporate Debtor under the provisions of IBC 2016 and remedy may lie elsewhere and not necessarily before the Adjudicating Authority".
In light of the above, the NCLT held "that the default of installment of a settlement agreement does not come within the definition of operational debt" and consequentially dismissed the Petition.
Considering the NCLT is not a forum for recovery and has a summary jurisdiction for determining ingredients of a 'Default' under the IBC, one may say that this judgment is in line with the settled principles previously laid down by the Supreme Court in Mobilox Innovations (P) Ltd. v. Kirusa Software (P) Ltd.3 and Innoventive Industries Ltd. v. ICICI Bank4 for determination of an operational debt.
However, the judgment under discussion of the NCLT leaves out bonafide creditors entering into settlement agreements for unpaid operational debts and may thus deter entities from entering into such agreements in the future. To that extent, there remains a lacuna in the IBC provisions and the courts must take a broader interpretation of 'operational debt'.
Legislators and courts/tribunals must also ensure that a similar interpretation as has been given to 'operational debt' by the NCLT, must not be extended to 'financial debt', so as to not jeopardize the large number of financial restructuring prevalent in the country.
If a narrow interpretation of 'operational debt' is upheld by the courts in India, those entering into settlement agreements in good faith, having taken haircuts towards their original operational debt, will then lose the right to trigger CIRP as an operational creditor under the IBC, against the defaulting party.
1 (IB) 1677 (ND) / 2019
2 Company Petition (IB) No. 343/ALD/2018
3 (2018) 1 SCC 353
4 (2018) 1 SCC 407
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