Supreme Court Decodes “Dispute” under the Insolvency and Bankruptcy Code

[Guest post by R. Jawahar Lal and Sanjeev Jain, who are Partners, and Apoorva Agrawal, who is an Associate, all at PRA Law Offices, New Delhi.

Disclosure: PRA Law Offices represented Kirusa Software Private Limited (Operational Creditor) before the Supreme Court, the National Company Law Appellate Tribunal at New Delhi and the National Company Law Tribunal, Mumbai Bench.]

Introduction

The Insolvency and Bankruptcy Code, 2016 (the “I&B Code”) provides for insolvency resolution of corporate persons, partnership firms and individuals. Under the I&B Code, an application for the commencement of insolvency resolution process by an operational creditor can be rejected on a mere ground that a ‘notice of dispute’ has been received by the operational creditor from the corporate debtor.

The term ‘dispute’ under the I&B Code has been contentious since its inception, with considerable deliberations on decoding the meaning of the same by various benches of the National Company Law Tribunal (“NCLT”) and the National Company Law Appellate Tribunal (“NCLAT”). Ultimately, the Supreme Court on 21 September 2017 delivered a noteworthy judgment in the matter of Mobilox Innovations Private Limited v. Kirusa Software Private Limited, which is believed to have cleared the cobwebs from the interpretation of the I&B Code in relation to the treatment of operational debts. The main issue before the Supreme Court in the matter related to the interpretation of the words ‘dispute’ and ‘existence’ appearing under section 5(6) of the I&B Code.

Brief History of the Case

Kirusa filed a petition in the NCLT, Mumbai against Mobilox for commencement of insolvency resolution process of Mobilox. The NCLT, Mumbai on 27 January 2017 dismissed the application on the ground that section 9(5)(ii) of the I&B Code as it reads, inter alia, requires the adjudicating authority (being the NCLT) to reject an application by an operational creditor (Kirusa) on the mere ground that a ‘notice of dispute’ was sent by Mobilox upon receipt of the demand notice from Kirusa. The NCLT further held that the adjudicating authority has no option but to dismiss the application if a notice of dispute was received by the operational creditor and the NCLT has no discretion under I&B Code to consider whether the corporate debtor has raised a genuine dispute.

Kirusa filed an appeal, and by judgment dated 24 May 2017 the NCLAT held that the meaning of ‘dispute’ and ‘existence of dispute’ under sections 5(6), 8 and 9 of the I&B Code are relatable to the three conditions set out in section 5(6) of the I&B Code, i.e., the dispute including suit or arbitration should relate to the (a) existence of amount of debt, (b) quality of goods or service, or (c) breach of representation or warranty. Further, the NCLAT held that ‘dispute’ occurring in Part II of the I&B Code is an ‘inclusive’ definition and not ‘exhaustive’. The NCLAT further held the adjudicating authority is to consider the dispute and, if it is not a bona fide dispute, ought to proceed with the process of liquidation. Further, on the facts of the case, the NCLAT held that the dispute raised by Mobilox is not a bona fide dispute and remanded the application to the NCLT, Mumbai for consideration of the application of Kirusa, if the application is complete in all respects.

Mobilox had filed a statutory appeal under the I&B Code before the Supreme Court of India and the appeal was taken up for hearing before a bench of R.F. Nariman, J. and Sanjay Kishan Kaul, J.  The Supreme  Court allowed the appeal of the corporate debtor and set aside the order of the NCLAT. The Supreme Court felt that the law in relation to I&B Code has to be settled as the issue may occur repeatedly.

Judgment of the Supreme Court

The Supreme Court compared the current provisions of the I&B Code with the laws of the United Kingdom (“UK”) and Australia to adduce the true intent of the legislature regarding the use of the term ‘dispute’ in the I&B Code.

Meaning of ‘dispute’ under the I&B Code

The Supreme Court examined the evolution of the language of the definition of ‘dispute’ as contained in the draft of the Insolvency and Bankruptcy Code submitted by the Bankruptcy Law Reform Committee in November 2015 (the “BLRC Draft”). The BLRC Draft defines ‘dispute’ as follows:

‘dispute’ means a bona fide suit or arbitration proceeding regarding (a) the existence or the amount of a debt; (b) the quality of a good or service; or (c) the breach of a representation or warranty

Under the BLRC Draft, “dispute” was limited to mean a proceeding of bona fide ‘suit or arbitration’ which related to the existence or amount of debt, quality of goods supplied or services provided, or the breach of representation or warranty in connection to the above. However, the words ‘means’ and ‘bona fide’ did not find any mention in the definition of “dispute” at the time of promulgation of the I&B Code. The current definition of “dispute” is inclusive and does not limit itself to ‘suit or arbitration’ alone. The intention of the legislature, as illustrated by the paradigm shift from the recommendation of the BCLR Draft, was to include all kinds of pre-existing ‘disputes’ in relation to the debt and default. Importantly, it is to be noted that such a ‘dispute’ should be pre-existing or pending prior to issue of the notice of demand by the operational creditor under section 8 of the I&B Code. Therefore, the Supreme Court held the definition of ‘dispute’ to be ‘inclusive’ and not an ‘exhaustive’ one.

Emphasising the importance of the term ‘existence’ occurring before the word ‘dispute’ under sections 8(2)(a) and 9(5)(ii)(d) of the I&B Code, the Supreme Court laid down a checklist for the adjudicating authority to consider admission or rejection of application under section 9 of the I&B Code for initiation of the insolvency resolution process. The Court stated that if any one of the following conditions is lacking, the application would have to be rejected:

“(i) Whether there is an “operational debt” as defined exceeding Rs.1 lakh?  (See Section 4 of the Act)

(ii) Whether the documentary evidence furnished with the application shows that the aforesaid debt is due and payable and has not yet been paid? and

(iii) Whether there is existence of a dispute between the parties or the record of the pendency of a suit or arbitration proceeding filed before the receipt of the demand notice of the unpaid operational debt in relation to such dispute?”

Disjunctive reading of the terms ‘existence of dispute’, ‘record of the pendency of the suit or arbitration proceedings’

The Supreme Court, in light of the meaning of the term ‘dispute’ and the intention of the legislature, observed that under section 8(2) of the I&B Code the corporate debtor can bring to the notice of the operational creditor the existence of a dispute or the record of the pendency of a suit or arbitration proceedings. Thus, it went on to say that the word ‘and’ in section 8(2) of the Code is to be read as an ‘or’, i.e., disjunctively. The Court observed: “if read as ‘and’, disputes would only stave off the bankruptcy process if they are already pending in a suit or arbitration proceedings and not otherwise. This would lead to great hardship; in that a dispute may arise a few days before triggering of the insolvency process, in which case, though a dispute may exist, there is no time to approach either an arbitral tribunal or a court”.

A ‘Bona Fide’ Dispute

Furthermore, in relation to the determination of a ‘dispute’ as ‘bona fide’ or not, the Supreme Court, after taking into consideration the erstwhile insolvency regime under the Companies Act, 1956 and the intention of the legislature while drafting of the I&B Code, held that the import of the expression ‘bona fide’ into section 8(2)(a) of the I&B Code to judge whether a dispute exists or not does not hold ground.

The Supreme Court, taking note of the legislative history of I&B Code, held that for the purpose of I&B Code the dispute need not be a  bona fide dispute. therefore the principles laid down in Madhusudan Gordhandas v. Madhu Woollen Industries Pvt. Ltd [(1972) 2 SCR 201] are inapplicable to the I&B Code.

‘Dispute’ – Real v. Illusory

Contrasting the old regime with the present one, the Supreme Court has held that the adjudicating authority is required to go into whether a dispute does or does not exist. Additionally, the Supreme Court also dealt with the meaning of the term ‘existence’ occurring before the word ‘dispute’ under sections 8(2)(a) and 9(5)(ii)(d) of the I&B Code. The Court also relied on the dictionary meaning of ‘existence’ meaning ‘reality as opposed to appearance’

In this regard, the Supreme Court relied on insolvency laws of the UK and Australia to arrive at a coherent conclusion that complements the current insolvency and bankruptcy regime in India. The Supreme Court, therefore, held that a ‘notice of dispute’ under sections 8 and 9 of the I&B Code must bring to the notice of the operational creditor the ‘existence’ of a dispute or the fact that a suit or arbitration relating to a dispute is pending between parties. The main points regarding the test of ‘existence of dispute’ to be kept in mind by the adjudicating authority while admitting or rejecting an application under Section 9 of the I&B Code, as laid down by the Supreme Court, are as follows:

i. the adjudicating authority is only required to see whether there is a plausible contention which requires further investigation;

ii. the adjudicating authority is only required to see that a dispute truly exists in fact and is not spurious, hypothetical, illusory, mere bluster, plainly frivolous or vexatious;

iii. the adjudicating authority is not required to be satisfied that the defence is likely to succeed or not;

iv. the adjudicating authority is not required to examine the merits of the dispute except to the extent of it being patently feeble legal argument or an assertion of fact unsupported by evidence.

The Supreme Court observed that a ‘dispute’ raised by the corporate debtor should be ‘in existence’, i.e., real as opposed to frivolous and/or illusory.

The Court compared the current provisions of the I&B Code with the laws of UK and Australia to adduce the true intent of the legislature regarding the use of the term ‘dispute’ in the I&B Code.

Timelines under the I&B Code – Mandatory v. Directory

The Supreme Court held that the timelines fixed under the I&B Code were inherent to the scheme of the legislation and are imperative to its effectiveness. The Court yet again examined the legislative chain of events leading up to enactment of the I&B Code. It pointed out that the timelines mentioned in Insolvency and Bankruptcy Bill as introduced in the Lok Sabha in 2015 underwent many changes before the final I&B Code came into existence. The Court emphasized that this change clearly reflects the intention of the legislature.

The Supreme Court, similar to its judgment delivered in Innoventive Industries Ltd. v. ICICI Bank & Anr, has clearly laid down that strict adherence of the timelines is of essence to both the triggering process and the insolvency resolution itself. It also stated that one of the principal reasons why the I&B Code was enacted was because liquidation proceedings went on interminably, thereby damaging the interests of all stakeholders, except a recalcitrant management which would continue to hold on to the company without paying its debts. Therefore, Court directed both the NCLT and the NCLAT to keep in mind this principal objective sought to be achieved by the I&B Code and to strictly adhere to the time frame within which they are to decide matters thereunder. 

Conclusion

With the Supreme Court intervening, it is hoped that the uncertainties and ambiguities in I&B Code, would get settled. However, the wide meaning that has been accorded to the term ‘dispute’ may become an albatross around the necks of operational creditors. Possibly, if greater care was taken at the stage of drafting the I&B Code, the litigants and lawyers would have lesser trouble grappling with the ambiguities.

– R. Jawahar Lal, Sanjeev Jain and Apoorva Agrawal

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