Supply of Essential Goods or Services under the IBC: Unresolved Issues

[Job Michael Mathew is a IV year student at NALSAR University of Law, Hyderabad]                                                                                                               

Under section 13(1)(a) of the Insolvency and Bankruptcy Code, 2016 (“Code”), the adjudicating authority is required to impose a moratorium for matters referred to in section 14.  Section 14(2) of the Code states that the supply of essential goods or services shall not be terminated or suspended or interrupted during the moratorium period. According to Section 14(4) of the Code, the moratorium shall operate from the insolvency commencement date till the completion of the Corporate Insolvency Resolution Process (“CIRP”). Section 12 imposes a maximum time limit of 270 days within which CIRP has to be completed.  The Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations, 2016 (“IBBI Regulations”) state that water, electricity, telecommunications services and information technology services are essential services[1] under 14(2).

In Uttarakhand Power Corporation Limited v. ANG Industries Limited, the National Company Law Appellate Tribunal (“NCLAT”) had the opportunity to answer some questions in relation to section 14(2). The Uttarakhand Power Corporation Limited (“UPCL”) disconnected electricity to the corporate debtor for non-payment of dues. Subsequently, an application for CIRP was moved under section 10 of the Code and the same was admitted. The Insolvency Resolution Professional (“IRP”) then filed an application for restoration of electricity under section 14(2) and the same was allowed by the National Company Law Tribunal (“NCLT”). The question before the NCLAT was whether corporate debtor is required to clear the dues pending at the stage of admission of CIRP before moving under section 14(2). The NCLAT held that the corporate debtor need not clear pending dues but is required to pay at regular intervals for electricity consumed subsequent to the order passed pursuant to section 14(2). As regards pending dues, the NCLAT held that it will be open for UPCL to submit the claim before the IRP.

Two questions come to mind from the reading of the law and the facts of this case. The first question: is the NCLAT right in holding that the suppliers have to submit their previous claims before the IRP? Secondly, is it right to hold that any default in making payment subsequent to restoration of supply under section 14(2) will entitle the supplier to terminate the supply?

A supplier of essential services or goods would be an operational creditor under the Code.[2] For a resolution plan to be approved, the only requirement vis-à-vis debt owed to operational creditors is that they receive at least as much as they would in the event of liquidation of the company.[3] Operational creditors do not enjoy an enviable position at the time of liquidation of the company, ranking just above preferential shareholders[4]. Thus, it is possible that an IRP and committee of creditors can approve a resolution plan that earmarks just the statutory minimum amount for operational creditors even as the financial creditors make handsome returns on the loans they are owed. The scope for the adjudicating authority to interfere in such a situation is minimal since section 31 states that the adjudicating authority shall approve a plan that satisfies the conditions in section 30(2). Thus, according to the NCLAT, an essential supplier’s freedom to terminate contracts on default by the corporate debtor is taken away and it is forced to continue supplying to the debtor at probably the same terms as it was before the default occurred; after all, there is a high possibility that it may not recover the entirety of its debts. There is a high possibility that the terms of supply will not be changed, since the idea of ensuring uninterrupted supply is to preclude the possibility of such suppliers demanding ransom payments in light of the difficult situation the corporate debtor finds itself in.

In my view, the NCLAT erred in holding that the essential suppliers need to submit their claim to the IRP. Regulation 32 of the IBBI Regulations categorically states that amounts due to essential suppliers under section 14(2) are a component of Insolvency Resolution Process Cost (“IRPC”). Making a provision for IRPC is a precondition for a resolution plan to be accepted and is first in order of priority.[5] Thus, essential suppliers belong to a category of operational creditors who rank highest among all categories of creditors. The priority accorded to essential suppliers can be said to be consideration for not terminating the supply even after default and playing a role in the rescue of the company.  When certain supplies are essential for the business, its termination or demand for better terms on the onset of the insolvency process can hamper the rescue process and section 14(2) aims to prevent the same.

The NCLAT gave a timeline to the corporate debtor within which payments were to be made for electricity consumed after its restoration under section 14(2) and said that any default with respect to these timelines will entitle the supplier to terminate the supply.  The question I wish to pose is whether the corporate debtor is required to make these payments during the subsistence of the moratorium period. A strict reading of section 14(2) just indicates that the supplies shall continue and makes no reference to any timelines within which post-restoration payments are to be made.  It can be argued that allowing the essential supplier to terminate the supply for default within the moratorium period goes against the statutory rationale of section 14(2). Imagine a situation when a supplier of water cut supplies due to default and then subsequent to section 14(2) restored it. The NCLT then states that if payment is not made within 28 days, then the supply will be cut and the debtor makes a default at the first installment. Such an outcome can result in (a) an operational creditor upsetting the order in sections 30 and 53 without playing any meaningful role in rescue of the company; (b) the company having to find another supplier when it is in CIRP. The rationale for section 14(2) was the difficulty a company in CIRP would face in finding a supplier at commercially competitive terms; the moment the existing supplier is allowed to terminate the problem that section 14(2) is seeking to solve resurfaces again. According to me, the supplies shall continue unabated during the moratorium period of 270 days without having to make payments or without the right of the supplier to terminate if there is any default.  At the end of 270 days either a resolution plan will be approved, or the company will go into liquidation and, in either case, the essential supplier will have first priority and therefore its interests are sufficiently protected. To further protect the interests of essential suppliers the resolution professional can be required to personally guarantee the debts owed to them. Such an approach is followed in the United Kingdom[6] to ensure that the IRP exercises his mind before any request to restore essential supplies and such requests are made only when he is confident of a turn-around plan or when the company has enough assets to pay them off at liquidation.  

Interestingly, the NCLT Hyderabad bench in Canara Bank v Deccan Chronicle Holdings Limited accepted the prayer of the corporate debtor that for a newspaper company, printing ink, printing plates, printing blanker, solvents are essential supplies and therefore come under section 14(2) exemption.  The order was appealed to the NCLAT and the abovementioned part of the NCLT order was left untouched by the NCLAT. Further, the NCLT did not state that default on payment for essential supplies will entitle the supplier to cut supplies. Thus, the NCLT and the NCLAT orders in this case pave the way for a dynamic interpretation of the phrase ‘essential supplies’ depending upon the industry in question while giving the corporate debtor enough breathing space to repay debts.  According to the me, such an approach achieves a fine balance between corporate rescue and the interests of the supplier. 

– Job Michael Mathew

[1] Regulation 32, IBBI Regulations.

[2] See, definition of “operational creditors” and “operational debt” in sections 5(20) and 5(21) respectively of the Code.

[3] Section 30(2)(b) of the Code.

[4] See section 53 of the Code.

[5] Section 30(2)(a) of the Code.

[6] Section 233A(5), Insolvency Act, 1986.

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