The moratorium prescribed by the Insolvency and Bankruptcy Code, 2016 (IBC) stands as a crucial element in the resolution process for financially distressed corporate entities. It delineates a period during which legal actions, such as recovery proceedings, security enforcement, asset sale, or the termination of essential contracts, are temporarily halted against the Corporate Debtor. This article delves into the intricacies of Section 14 of the IBC, exploring its impact on parallel legal proceedings and the nuanced issue of the enforceability of contractual agreements, particularly focusing on ipso facto clauses.
Understanding the Moratorium under IBC
Section 14(1)(a) of the IBC plays a pivotal role in implementing the moratorium. This provision prohibits the initiation or continuation of suits, pending suits, or proceedings against the corporate debtor, including the execution of judgments, decrees, or orders in any court, tribunal, or arbitration panel, once a moratorium is declared. The primary objective is to provide a ‘calm period,’ enabling the financially distressed corporate debtor to optimize asset realization and achieve a successful resolution without the distraction of parallel legal actions.
The intention of the legislation is present in the preamble; IBC provides an effective and time-bound system for sick corporate entities with respect to the optimization of the corporate debtor assets during insolvency and the promotion of all credit and balance of all stakeholders in the company. The moratorium’s only aim is to protect corporate debtor assets through all assets, and section 14 clearly mentions, “no judicial proceedings for recovery, enforcement of security interest, sale or transfer of assets, or termination of essential contracts can be instituted or carried on against the corporate debtor.”
Judicial Interpretation and Clarifications
The interpretation of Section 14 has been subject to judicial scrutiny, as seen in the case of Power Grid Corporation of India Limited v. Jyoti Structures Limited (REED 2017 Del 12676). The Delhi High Court emphasized that the applicability of Section 14 hinges on whether the proceedings are detrimental or beneficial to the corporate debtor. In alignment with the moratorium’s objective, the court clarified that the section does not apply to proceedings favoring the corporate debtor.
The Hon’ble Supreme Court, referring to the Insolvency Law Committee’s February 2020 Report, highlighted the moratorium’s purpose as shielding the corporate debtor from financial attacks during the moratorium. This breathing space allows the corporate debtor to continue as a going concern, facilitating eventual rehabilitation. Legislative intent also seeks to prevent the termination or suspension of essential grants by government authorities, safeguarding the company’s operational foundation and maximizing its value during insolvency.
In the legal matter of SSMP Industries Ltd Vs. Perkan Food Processors Pvt. Ltd, the Delhi High Court addressed the complexity of Section 14(1)(a) of the Insolvency and Bankruptcy Code (IBC). This section imposes a moratorium, halting suits or proceedings against a corporate debtor undergoing insolvency. The court observed that while the corporate debtor can pursue its claims during insolvency, any counter claim against it is barred.
In the case of Mr. Anand Rao Korada, Resolution Professional vs. M/s Varsh Fabrics (P) Ltd. and Ors., the Supreme Court ruled against the High Court’s auction of the corporate debtor, Respondent No. 4, after the initiation of a moratorium by the National Company Law Tribunal (NCLT). The High Court’s orders, dated August 14, 2019, and September 5, 2019, were deemed inappropriate during the ongoing Corporate Insolvency Resolution Process (CIRP). The Supreme Court underscored that any disposal of assets belonging to Respondent No. 4 amid IBC proceedings would significantly endanger the interests of all stakeholders, emphasizing the importance of respecting the moratorium period.
In the case of SBI vs. V. Ramakrishnan & Anr, the Supreme Court clarified that Section 14 of the Insolvency and Bankruptcy Code (IBC) is not applicable to the personal guarantor but exclusively to the corporate debtor (CD). The court emphasized that in a guarantee contract, the liability of the surety and the principal debtor is coextensive. Therefore, the creditor has the discretion to pursue assets of either the principal debtor or the surety, or both, without any specific sequence. This ruling affirms the distinct treatment of personal guarantors under the IBC, reinforcing the creditor’s flexibility in seeking recovery from relevant assets.
Arbitral proceedings are also affected by Section 14(1)(a), which bars the execution of arbitral awards. However, the Delhi High Court, in Power Grid Corporation of India Limited v. Jyoti Structures Limited, demonstrated a nuanced approach, excluding proceedings beneficial to the corporate debtor from the moratorium.
In tax proceedings, a distinction is made between assessment proceedings and recovery proceedings. While assessment proceedings are considered outside the moratorium’s scope, recovery proceedings fall within it. This distinction, though seemingly inequitable, aligns with the legislative goal of centralizing the handling of a company’s assets during liquidation.
Initiation of CIRP against a Subsidiary
Addressing the initiation of Corporate Insolvency Resolution Process (CIRP) against a subsidiary, the Axis Bank Limited v. Alok Infrastructure Limited case provided clarity. It affirmed that the initiation of CIRP against a subsidiary of a Corporate Debtor is not hindered by the Section 14(1)(a) moratorium. The court reasoned that a subsidiary company is a distinct entity, and initiation of CIRP against it does not fall within the scope of the moratorium affecting the holding company.
Section 138 of the Negotiable Instruments Act, 1881, deals with proceedings related to dishonor of cheques. The P. Mohanraj and Others v. Shah Brothers Ispat Private Limited (REED 2021 SC 03526) judgment clarified that the moratorium applies to suspend parallel proceedings under Section 138 during insolvency. The Supreme Court emphasized the legislative intent behind the moratorium, aligning it with the suspension of quasi-criminal proceedings contained in Chapter XVII of the Negotiable Instruments Act.
Enforceability of Contractual Agreements and Ipso Facto Clauses
The issue of enforcing contractual agreements during insolvency poses a significant challenge, especially concerning ipso facto clauses. These clauses permit a party to terminate a contract on the occurrence of predefined insolvency-related events of the counterparty. The enforceability of such clauses varies across jurisdictions, and the IBC, while largely silent on this matter, has been subject to judicial consideration.
Gujarat Urja Vikas Case
The Supreme Court, in Gujarat Urja Vikas Nigam Limited v. Mr. Amit Gupta & Ors., addressed the issue of termination of a power purchase agreement (PPA) during the Corporate Insolvency Resolution Process (CIRP) of Astonfield Solar Gujarat Private Limited. The Court held that the National Company Law Tribunal (NCLT) had jurisdiction to adjudicate on contractual disputes related to the insolvency proceeding under Section 60(5) of the IBC. However, the Court did not provide a general ruling on the validity of ipso facto clauses, leaving it for the legislature to decide.
Balancing Competing Interests
The enforceability of ipso facto clauses underscores the tension between respecting contractual commitments and facilitating a successful resolution process. Various jurisdictions have enacted restrictions on the enforcement of ipso facto clauses, considering the competing interests at stake. The United States Bankruptcy Code, for instance, prohibits the enforcement of ipso facto clauses in certain contexts, while the United Kingdom upholds them if part of a bona fide commercial transaction.
Legislative Clarity and Considerations
The absence of legislative clarity on ipso facto clauses in the IBC necessitates a careful balance between facilitating a successful resolution and protecting the interests of contractual counterparties. Any potential restriction on the enforcement of ipso facto clauses should explicitly allow counterparties to terminate contracts during the CIRP for reasons other than insolvency. The duration of such restrictions needs careful consideration, with different considerations during the CIRP and liquidation processes.
The type of contract involved and its centrality to the corporate debtor’s business are crucial factors. Companies undertaking infrastructure projects, heavily reliant on specific contracts, may face challenges if counterparties can terminate contracts during insolvency. The IBC, as a resolution tool, may need sector-specific provisions to address these business structures effectively.
In conclusion, while the moratorium under IBC aims to provide a breathing space for financially distressed corporate debtors, certain ambiguities persist, necessitating ongoing examination and legislative clarification. The enforceability of contractual agreements, particularly ipso facto clauses, remains a challenging aspect. The Gujarat Urja Vikas case highlights the need for legislative clarity on ipso facto clauses, balancing the interests of contractual parties with the imperative of facilitating successful resolution processes. Until such clarity is provided, courts must consider the unique circumstances of each case when assessing the impact of termination on the corporate debtor during insolvency proceedings. The ongoing evolution of insolvency laws and judicial interpretations will continue to shape the landscape of corporate resolution in India.
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This article has been authored by Umang Mehta, Partner (left) & Aamir Attari, Associate (right) at Dhruve Liladhar & Co., Advocates, Solicitors & Notary.
