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Corporate Insolvency Resolution Process: A New Recovery Mechanism for Operational Creditors

Corporate Insolvency Resolution Process:

A New Recovery Mechanism for Operational Creditors

 Background

The Insolvency and Bankruptcy Code, 2016 (the Code) provides for a specialized forum to oversee insolvency and liquidation proceedings for individuals, firms and corporates.  The code also recognizes National Company Law Tribunal (NCLT) as the Adjudicating Authority for the purpose of Insolvency and Liquidation of Corporate Persons.

Insolvency Resolution and Liquidation of Corporate Persons

As per Sec 4 read with Sec 6 of the Code, where any corporate debtor commits a default, a financial creditor, an operational creditor or the corporate debtor itself may initiate corporate insolvency resolution process in respect of such corporate debtor, where the minimum amount of such default is Rs. 1 Lacs.

To understand the above, it is important to examine few key definitions:

Corporate Debtor

Sec 3(8) “corporate debtor” means a corporate person who owes a debt to any person;

Sec (7) “corporate person” means a company as defined in clause (20) of section 2 of the Companies Act, 2013, a limited liability partnership, as defined in clause (n) of sub-section (1) of section 2 of the Limited Liability Partnership Act, 2008, or any other person incorporated with limited liability under any law for the time being in force but shall not include any financial service provider;

Sec 3 (11) “debt” means a liability or obligation in respect of a claim which is due from any person and includes a financial debt and operational debt;

Financial and Operational Creditors

Sec 3(10) “creditor” means any person to whom a debt is owed and includes a financial creditor, an operational creditor, a secured creditor, an unsecured creditor and a decree- holder;

Sec 5(7) “financial creditor” means any person to whom a financial debt is owed and includes a person to whom such debt has been legally assigned or transferred to;

Sec 5(8) “financial debt” means a debt along with interest, if any, which is disbursed against the consideration for the time value of money;

Sec 5 (20) “operational creditor” means a person to whom an operational debt is owed and includes any person to whom such debt has been legally assigned or transferred;

Sec 5(21) “operational debt” means a claim in respect of the provision of goods or services including employment or a debt in respect of the repayment of dues arising under any law for the time being in force and payable to the Central Government, any State Government or any local authority;

Demand Notice for Initiation of Insolvency Resolution by an Operational Creditor

As per Sec 8 of the Code read with Rule 5 of the the Insolvency and Bankruptcy (Application to Adjudicating Authority) Rules, 2016, in case a default of any payment occurs for an amount equal to or more than Rs. 1 Lacs, the operational creditor may, on the occurrence of a default, deliver a demand notice of unpaid operational debtor in Form 3 along with copy of an invoice in Form 4 demanding payment of the amount involved in the default to the corporate debtor.

Sec 3 (12) defines “default” as non-payment of debt when whole or any part or instalment of the amount of debt has become due and payable and is not repaid by the debtor or the corporate debtor, as the case may be.

The demand notice or the copy of the invoice demanding payment shall be filed with an information utility and may be delivered to the corporate debtor:

(a) at the registered office by hand, registered post or speed post with acknowledgement due; or

(b) by electronic mail service to a whole time director or designated partner or key managerial personnel, if any, of the corporate debtor.

It may be noted that there is no timeline prescribed for sending this demand notice and copy of the invoice.  In Neelkanth Township & Construction Pvt. Ltd. v. Urban Infrastructure Trustees Ltd. (Company Appeal (AT) (Insolvency) No. 44 of 2017) the National Company Law Appellate Tribunal (“NCLAT”) has recently ruled that the Limitation Act, 1963 is not applicable to the Insolvency & Bankruptcy Code, 2016 (“IBC”).

The NCLAT held that in the absence of any provision in IBC, the Limitation Act, 1963 would not be applicable to initiation of Corporate Insolvency Resolution Process. The NCLAT further observed “If there is a debt which includes interest and there is default of debt and having continuous course of action, the argument that the claim of money by Respondent is barred by Limitation cannot be accepted.”

Therefore, NCLAT has treated the cause of action arising from non-payment of debt which includes interest, as a continuing cause of action, thereby holding that limitation period cannot be said to have expired.

The NCLT has not referred to Section 433 of the Companies Act, 2013 in its judgment which makes the Tribunals subject to the Limitation Act. It is still recommended to file insolvency proceedings within the limitation period, specially for operational debt to avoid any ambiguities.

Dispute by Corporate Debtor

As per Sec 8(2) of IBC, the corporate debtor shall, within a period of ten days of the receipt of the demand notice or copy of the invoice bring to the notice of the operational creditor—

(a) existence of a dispute, if any, and record of the pendency of the suit or arbitration proceedings filed before the receipt of such notice or invoice in relation to such dispute; or

(b) the repayment of unpaid operational debt by sending an attested copy of the record of electronic transfer or cheque of the unpaid amount received from the corporate debtor

It may be noted that the term “dispute” is defined in Section 5(6) of the IBC 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”

The question that emerges from the above is whether pendency of a suit or arbitration is a must in order for the Corporate Debtor to satisfy the condition of existence of a dispute.

The Hon’ble Supreme Court in Mobilox Innovations Private Limited v Kirusa Software Private Limited (CIVIL APPEAL NO. 9405 OF 2017) has finally settled the widely debated question of what constitutes “existence of a dispute” in the context of applications filed by operational creditors for initiation of corporate insolvency resolution process (CIRP) of corporate debtors under the Insolvency and Bankruptcy Code, 2016 (IBC). The  Court has held as follows:

  1. The word “and” occurring in Section 8(2)(a) of the IBC must be read as “or”
    The word “and” in Section 8 (2)(a) of IBC suggests that a dispute between the operational creditor and the corporate debtor will be in existence only if a suit or an arbitration proceeding on the dispute is pending before receipt of Demand Notice. The Supreme Court held that such an interpretation would lead to a great hardship and anomalous situations as the corporate debtor would then be able to stave off the bankruptcy process only if a dispute is already pending in a suit or arbitration proceedings and not otherwise. The Supreme Court cited an example that in case of a dispute that arises a few days before triggering of the CIRP, there would be no time to approach either an arbitral tribunal or a court even though a dispute may exist.
  1. Dispute must be “pre-existing”

The existence of the dispute and/or the suit or arbitration proceeding must be “pre-existing” i.e. it must exist before the receipt of the Demand Notice.

  1. Formulation of a new “plausible contention” test

The test for “existence of a dispute” would be if without going into the merits of the dispute, a plausible contention is raised requiring further investigation which is not a patently feeble legal argument or an assertion of facts unsupported by evidence. The dispute must not be spurious, mere bluster, plainly frivolous or vexatious. A dispute should truly exist in fact between the parties, which may or may not ultimately succeed and must not be vague and motivated to evade liability.

Therefore, a dispute in the payments, existing before the receipt of demand notice, even if the same is not a part of any suit or arbitration proceeding, would disqualify the debt from being adjudicated under CIRP.

Application for initiation of corporate insolvency resolution process by operational creditor

As per Sec 9 of IBC, after the expiry of the period of ten days from the date of delivery of the notice or invoice demanding payment under section 8(1), if the operational creditor does not receive payment from the corporate debtor or notice of the dispute under section 8(2), the operational creditor may file an application before the NCLT for initiating a corporate insolvency resolution process (CIRP) in Form 5 along with requisite documents.

The operational creditor shall, along with the application furnish—
(a) a copy of the invoice demanding payment or demand notice delivered by the operational creditor to the corporate debtor;

(b) an affidavit to the effect that there is no notice given by the corporate debtor relating to a dispute of the unpaid operational debt;

(c) a copy of the certificate from the financial institutions maintaining accounts of the operational creditor confirming that there is no payment of an unpaid operational debt by the corporate debtor; and

(d) such other information as may be specified.

Appointment of Interim Resolution Professional

An operational creditor initiating a corporate insolvency resolution process under this section, may propose a resolution professional to act as an interim resolution professional.

The Adjudicating Authority shall, within fourteen days of the receipt of the application, by an order—
(i) admit the application and communicate such decision to the operational creditor and the corporate debtor if,—

(a) the application is complete;

(b) there is no repayment of the unpaid operational debt;

(c) the invoice or notice for payment to the corporate debtor has been delivered by the operational creditor;

(d) no notice of dispute has been received by the operational creditor or there is no record of dispute in the information utility; and

(e) there is no disciplinary proceeding pending against any resolution professional proposed.

As per Sec 17 of the code, from the date of appointment of the interim resolution professional the management of the affairs of the corporate debtor shall vest in the interim resolution professional and the powers of the board of directors or the partners of the corporate debtor, as the case may be, shall stand suspended and be exercised by the interim resolution professional. the officers and managers of the corporate debtor shall report to the interim resolution professional and provide access to such documents and records of the corporate debtor as may be required by the interim resolution professional. This gives wide sweeping powers to the Interim Resolution Professionals.

Time-limit for completion of insolvency resolution process.

As per Section 12 of IBC, the corporate insolvency resolution process is to be completed within a period of one hundred and eighty days from the date of admission of the application to initiate such process unless extended by NCLT on the application of the Insolvency Professional.

Conclusion

It may be noted that in case of operational creditors, there is a very thin line difference between civil suits for recovery of money vis a vis the Corporate Insolvency Resolution Process (CIRP). It may be said that subject to the satisfaction of other conditions as provided in the Code, the admissibility or non-admissibility of the petition by the operational creditor would primarily hinge on the fact whether there is a pre-existing dispute or not. In case of petitions by Operational Creditors under IBC, if the petitions are admitted and the interim resolution professional appointed, it has been observed that the corporate debtors (specially the ones who are solvent and where the operational debt is very small compared to the size of the Company)  choose in favour of settling the matter rather than giving reins of their Company to a Resolution Professional who will sit above the Board of Directors and call the shots. In view of the above, the Corporate Insolvency Resolution Process (CIRP) may practically be said to be an alternative recovery mechanism with a much more effective and speedy recovery, despite denial by the Tribunals time and again that it is not a recovery forum.

Tags: Corporate Insolvency Resolution ProcessIBCInsolvency and Bankruptcy Code

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About Sumit Pahwa

Sumit Pahwa | Partner

A Corporate Lawyer & Company Secretary, Sumit has over 17 years of experience in dealing with the Corporate Legal and Compliance issues of small, medium and large corporates and is the founder partner of the law firm “eMinds Legal”, a Corporate Law Firm based in Gurgaon specialising in Corporate Secretarial, Corporate Legal and Compliances.

Sumit is an expert in Corporate Laws, Governance, Risk & Compliance and has independently led investigations related to Sexual Harassment, Fraud, Cybercrime and whistle blower cases.

Sumit is also the Lead Author of “Corporate Law Referencer” - a leading book on Companies Act, 2013 and LLP Regulations and published by Lexis Nexis.

Sumit is a regular speaker at the Institute of Company Secretaries of India, various management colleges and several small and large corporates on Corporate Laws, Sexual Harassment Laws and Compliances.

Sumit leads the Corporate Legal vertical at eMinds Legal and is supported by a strong team of Corporate Lawyers at eMinds Legal who advise corporates for their routine corporate legal requirements.

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