Process for Issuing a Demand Notice under the Insolvency and Bankruptcy Code

[Guest post by Satish Rai, who is an advocate based in New Delhi.]

Introduction

While the Insolvency and Bankruptcy Code, 2016 (the ‘Code’) gains momentum with evolving jurisprudence and continual changing of contours of provisions of the Code, a two-fold procedural requirement prescribed for the initiation of insolvency resolution process by an operational creditor requires greater scrutiny. The two-tier process for an operational creditor involves, first, the sending of a demand notice under section 8 of the Code demanding payment of the operational debt owed by the corporate debtor. The second arises only after the first step fails at the end of the corporate debtor, i.e., if the corporate debtor fails to pay the operational debt or to dispute the notice as provided under section 8, then the operational creditor may initiate the insolvency resolution process against the corporate debtor under section 9 of the Code, in the manner prescribed.

As the second step is entirely dependent on the first, it is essential to focus on the demand notice under section 8, more particularly in light of the recent judgments of the tribunals, including that of the National Company Law Appellate Tribunal (the ‘NCLAT’) in Macquarie Bank Limited v. Uttam Galva Metallics Limited (decided on 17 July 2017). In this case, the NCLAT declared that a demand notice by an advocate on behalf of the operational creditor shall not be deemed to be a demand notice within section 8 of the Code. It also declared that the notice under section 8 can be sent only by the operational creditor or a person who holds a position in the company (i.e., the operational creditor).

In Uttam Galva Steels Limited v. DF Deutsche Forfait AG & Anr. (decided on 28 July 2017), the NCLAT laid down:

30. From bare perusal of Form-3 and Form-4, read with sub-rule (1) of Rule 5 and Section 8 of the I&B Code, it is clear that an Operational Creditor can apply himself or through a person authorised to act on behalf of Operational Creditor. The person who  is authorised to act on behalf of Operational Creditor is also  required to state “his position with or in relation to the  Operational Creditor”, meaning thereby the person authorised by Operational Creditor must hold position with or in relation to the Operational Creditor and only such person can apply.

The judgment reasons the verdict on the ground that only if the said notice is sent in Form 3 through a person holding a position with or in relation to the creditor the corporate debtor will understand the seriousness of the notice. The relevant part of the judgment is reproduced hereunder:

Only if such notice in Form-3 is served, the ‘Corporate Debtor’ will understand the serious consequences of non-payment of ‘Operational Debt’.

Based on the review of the relevant provisions, forms and rules, and reasons recorded as aforementioned, the NCLAT reached the conclusion that lawyers cannot send a demand notice under section 8, since they do not hold any position in the company. However, an alternative was also provided through the judgment, which is that if the lawyer is authorized by the Board of Directors, he may issue such demand notice.

Critical Analysis

The aforementioned judgment is strengthened by other judgments of the NCLAT on the subject matter, including M/s. Aruna Hotels Limited v. Mr. N. Krishnan (decided on 2 August 2017).

However, a close scrutiny of the verdicts, which as on date is the law on the subject, will reveal the hardships in the legality and in the practical aspects of application of the Code. A critique on the law so ascertained is enumerated below:

1. Seriousness attached to demand notice: The rationale for such ruling, that only when such demand notice is sent by the person holding any position with the creditor that the corporate debtor will take the said notice seriously, displays some level of prejudice. The very fact that the notice is sent by or on behalf of the operational creditor under section 8 of the Code in itself shows the gravity and seriousness of the notice. A section 8 notice does not lose its character merely because it is sent by an advocate in the manner prescribed under Form 3 or 4. In fact, an argument can be made to the contrary that a notice sent through an advocate may be taken more seriously by the debtor than one sent by the creditor itself, more so when there have been presumably several letters from the side of the operational creditor, which may possibly have been ignored by the corporate debtor prior to the demand notice under section 8. Furthermore, the ruling fails to recognize a situation where, in response to a demand notice sent by an advocate, a notice of dispute has been received from the corporate debtor. The law is unclear whether in such cases too, where the purpose of section 8 has been achieved, as evidenced by the notice of dispute, the demand notice sent by advocate shall be deemed to be no notice at all.

2. No obligation to attach board resolution: The ruling seems to be incomplete and vague, in so far as it does not oblige the operational creditor to attach or annex the board resolution in favour of the advocate with the demand notice so sent by the advocate. In such a scenario, in effect, though the ruling will be complied with by having a resolution in favour of the advocate, the notice (without such a resolution attached to it) will remain an ‘advocate notice’ for the corporate debtor and the rationale of ‘seriousness’ will get frustrated.

3. Position with or in relation to the operational creditor: The rulings have laid down that only a person holding a position in the company can send a notice under section 8. While doing so, the NCLAT has not dealt with the differentiation and distinction of the phrases used in Form 3, namely, ‘Position with Operational Creditor’ and ‘Relation to the Operational Creditor’. While the former may mean and include a person holding a position with the operational creditor, the latter can very well be construed to include an advocate for the operational creditor, as the same can be covered under a professional relationship with the creditor. The very fact that two phrases have been used in alternative to each other reflects the intent of the legislature to include a person with whom any relationship can be reposed by the operational creditor, which may include an advocate.

4. “A demand notice by the operational creditor”: Although the phrase used in the provision is “a demand notice by the operational creditor”, yet the same cannot be construed narrowly to mean only the operational creditor by itself, as Forms 3 and 4 themselves widen the phrase to include any person having position with or in relation to the operational creditor. In such a case, the construction of the same shall be as per the preceding paragraph. Further, based on the same rationale of the ruling, even the notice of dispute shall be ‘by the corporate debtor’ and not through an advocate, which is not the case. Therefore, if a notice of dispute by the corporate debtor can be construed to be an advocate notice, so can a demand notice under section 8.

5. Analogous provisions under other laws: Even in the absence of the Form 3 or 4, it has been the settled law under many other statues (one such being the Negotiable Instruments Act, 1882 (the ‘NI Act’)), that the demand notice, although worded to be sent by the party, includes a notice through the advocate. The same analogy and principle can be applied in relation to the notice under section 8 too. It is important to note the nature of the notices under section 8 of the Code and section 138 of the NI Act for a better comparison. Under section 138 of the NI Act as well as section 8 of the Code, notices are sent with an aim to provide a final opportunity to the party in default to pay the debt or liability owed. Also, the notices in themselves do not give any cause of action, but it is the expiration of the notice period that gives rise to the cause of action, be it for a complaint under the NI Act or application under section 9 of the Code, since there is no prejudice until the expiration of the notice period against the party in default in both the proceedings. It is only after the expiration of the period of the notice that such presumption against the defaulting party arises under both the laws. Therefore, the nature of the demand notices being the same, until and unless any rationale is attached for any differentiation, they shall be construed in the same manner.

6. Board resolution and effects: On the one hand, the rationale behind not allowing an advocate’s notice is that an advocate does not hold any position with or in the company. On the other hand, the same advocate is allowed to send the demand notice if there is a board resolution in his favour. Such an arrangement lead to a rather incongruous situation that once there is a resolution in the favour of an advocate, the criterion of holding any position in the company is satisfied. Such a construction may even prove to be contrary to the ethics which clearly lays down that the advocate shall not hold any position in the establishment whom he or she is representing. Further, the advocate shall be acting in dual capacity firstly, as an authorized representative of the company and secondly, as an officer of the court, which are contradictory roles and should be allowed.

7. Absurd consequences under section 76: The ruling, following which an advocate is authorised to send a demand notice based on a board resolution and also to initiate the insolvency resolution process under section 9, may lead to absurd consequences. For example, in the capacity as an authorized representative of the operational creditor, the advocate, although might be acting effectively under a client-attorney relationship, may be implicated under section 76 of the Code which provides for imprisonment for one year to five years apart from fine. Alternatively, the advocate could be liable for wilful or knowing concealment of notice of dispute, since the affidavit that no such dispute has been received required under section 9 shall be sworn in by the advocate acting as an authorized representative.

Conclusion

The law on demand notice under section 8 and its nuances seem to be settled for the time being. But, it may require intervention as the time passes by in view of the difficulties that may come up and be recognized judicially. Being a legislation in its embryonic phase, the Code can be fairly expected to overcome the strict formula-based approach followed thus far. It indeed is a novel piece of legislation, but care should be taken to ensure that procedural impediments may not override the substantial issues. The ruling in Uttam Galva needs a review in the time to come. It also does not indicate whether the ruling is a clarification to the prevailing law inherent in the Code or whether it has to be applied prospectively, and further as to how will the matters already initiated under the Code, but pending decision on other grounds.

– Satish Rai