Moratorium under the Bankruptcy and Insolvency Code: Impact on Proceedings for Cheque Dishonour

[Guest post by Aayush Mitruka, a lawyer based in Delhi.

An earlier version of this post was published in the newsletter of ICSI – Pune chapter.]

The Insolvency and Bankruptcy Code, 2016 (the “Code”) is an all-encompassing legislation which is, inter alia, aimed at a structured and time-bound process for insolvency resolution and liquidation.

Chapter II (Part II) of the Code contains detailed provisions for corporate insolvency resolution process. When an Adjudicating Authority admits an insolvency resolution application, the Authority, inter alia, declares a moratorium under section 14 of the Code which continues until the approval of a resolution plan under Section 31 of the said Code. The rationale behind this moratorium is to provide a “calm period” for the debtor and creditors to assess the situation and deliberate their future course of action, without having to deal with individual enforcement actions by creditors, which could lead to asset-stripping and chaos.

The said provision has not been subjected to judicial scrutiny yet and therefore, in the absence of any authoritative judicial pronouncement, the scope and extent of the same is uncertain. This post aims to examine whether ongoing proceedings under section 138[1] of the Negotiable Instruments Act, 1881 (the “NI Act”) against the corporate debtor would ipso facto get stalled as soon as a moratorium under section 14 of the Code kicks in.

In order for a better appreciation of the question, it will be beneficial to reproduce the relevant provision of the Code herein below:

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 judgment, decree or order in any court of law, tribunal, arbitration panel or other authority;

(b) transferring, encumbering, alienating or disposing of 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;

(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 such transactions as may be notified by the Central Government in consultation with any financial sector regulator.

(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.

[Emphasis supplied]

Let us turn to the legislative intent behind incorporating the above quoted provision. The intent can be gathered from the Bankruptcy Law Reforms Committee Report:

The motivation behind the moratorium is that it is value maximising for the entity to continue operations even as viability is being assessed during the IRP. There should be no additional stress on the business after the public announcement of the IRP. The order for the moratorium during the IRP imposes a stay not just on debt recovery actions, but also any claims or expected claims from old lawsuits, or on new lawsuits, for any manner of recovery from the entity.

One of the goals of having an insolvency law is to ensure the suspension of debt collection actions by the creditors, and provide time for the debtors and creditors to re-negotiate their contract. This requires a moratorium period in which there is no collection or other action by creditors against debtors.

The Supreme Court in Innoventive Industries Ltd v. ICICI Bank Ltd (2017) observed that the intent behind the moratorium was “to provide the debtors a breathing spell in which he is to seek to reorganize his business.” In other words, during the moratorium period, no claim for recovery of debt (existing or new) can be pursued. Evidently, the “calm period” is essentially provided so that the debtors can negotiate with the creditors to forego a part of the debt or to restructure the payment schedule of the debt. During this “calm period”, no judicial proceedings for recovery, enforcement of security interest, sale or transfer of assets, or termination of essential contracts can take place against the corporate debtor. Section 14 imposes serious restrictions on the rights of the third party against filing of suits or proceedings or taking coercive action against the corporate debtor for recovery of debt. In view of the same, such restrictions ought to be strictly interpreted as they affect valuable rights, even the rights finalised by judgment and decrees of the competent courts.[2]   

Section 14 employs the expression “pending suits or proceedings” and the question which needs to be addressed is how one construes the word “proceedings”. In my view, the word “proceedings” ought to be read ejusdem generis with the word “suits” therein; and so read, they mean proceedings for recovery of debt. It must take within its ambit any proceedings which are pending before a civil court and also other miscellaneous applications which are pending in the suit or other proceedings. Pertinently, section 22 of The Sick Industrial Companies (Special Provisions) Act, 1985 had a similar provision for moratorium and the case law under the said provision suggests that the courts were not inclined to include criminal proceedings within its preview. Absent words like “criminal” or “prosecution” in the definition (i.e., clauses (a) to (d) of sub-section 1 of section 14), it can hardly be argued that the Legislature also intended to stall criminal proceedings. 

Now, it is vital to understand if a proceeding under section 138 of the NI Act be designated as a recovery proceeding.  That provision creates a penal offence for dishonour of cheques on certain grounds. The Supreme Court delved into the question of the object and intent behind section 138 of the NI Act in the case of M/s. Electronics Trade and Technology Development Corpn. Ltd., Secunderabad v. M/s Indian Technologists & Engineers (Electronics) Pvt. Ltd. and another.[3] The Court observed:

The object of bringing section 138 on statute appears to be to inculcate faith in the efficacy of banking operations and credibility in transacting business on negotiable instruments. Despite civil remedy, Section 138 intended to prevent dishonesty on the part of the drawer of negotiable instrument to draw a cheque without sufficient funds in his account mainly attained by him in a bank and induce the payee or holder in due course to act upon it. Section 138 draws presumption that one commits the offence if he issues the cheque dishonestly.

Pertinently, in another case, the Supreme Court observed:[4]

So far as the criminal complaint is concerned, once the offence is committed, any payment made subsequent thereto will not absolve the accused of the liability of criminal offence, though in the matter of awarding of sentence, it may have some effect on the Court trying the offence. But by no stretch of imagination, a criminal proceeding could be quashed on account of deposit of money in the Court or that the order of quashing of criminal proceeding, which is otherwise unsustainable in law, could be sustained because of the deposit of money in this Court. In this view of the matter, the so called deposit of money by the respondent in this Court is of no consequence. 

In view of the aforesaid, it can hardly be argued that the proceedings under section 138 of the NI Act should be stalled if the Adjudicating authority admits an insolvency application against the corporate debtor. An order imposing a moratorium cannot have the effect of terminating or stalling criminal proceedings. If that is allowed it will amount to compounding an offence, which cannot be achieved indirectly by the effect of section 14 of the Code.  However, since this provision has not been tested by the courts, it remains to be seen how the same will be interpreted when the opportunity arises.

– Aayush Mitruka

[1] Dishonour of cheque for insufficiency, etc., of funds in the account.

[2] Madalsa International Ltd. & Others v. Central Bank of India, AIR 1998 Bom 247.

[3] AIR 1996 SC 2339.

[4] Rajneesh Agarwal v. Amit J Bhalla, AIR 2012 SC 518.