Termination During Moratorium: An Alternative Perspective

[Kartik Adlakha is a 5th year B.B.A., LL.B. (Hons.) student at the Jindal Global Law School]

On 24 June 2020, the National Company Law Appellate Tribunal (‘NCLAT’) in the case of Tata Consultancy Services Limited v. Vishal Ghisulal Jain(‘TCS Case’)upheld the National Company Law Tribunal (‘NCLT’) Mumbai bench’s order of stay on termination of a Facilities Agreement (‘Agreement’). This was because the Agreement was terminated after the moratorium had kicked in and would go against the Insolvency & Bankruptcy Code’s (‘I&B Code’) spirit of protecting and preserving the value of the company undergoing resolution.

This post seeks to discuss and analyze the far reaching legal implications of this judgment and argue that the decision is questionable on multiple grounds. It also suggests how the issue of termination of contracts during moratorium deserves to be looked at from an alternative perspective. 

Factual Background

Tata Consultancy Services entered into a Facilities Agreement dated 1 December 2016 with S. K. Wheels Private Limited (‘Corporate Debtor’) to avail services in nature of facilities from the Corporate Debtor for conduct of examinations deploying National Technology Infrastructure for clients of Tata Consultancy Services.

Corporate Insolvency Resolution Process (‘CIRP’) of the Corporate Debtor was instituted and a moratorium was imposed on 29 March 2019. Tata Consultancy Services issued a termination notice on 10 June 2019 on account of the inability of the Corporate Debtor to remedy various contractual breaches.

Procedural History

Resolution Professional (‘RP’) approached the NCLT to seek stay of the termination notice. NCLT granted an interim stay by an order dated 18 December 2019. The order mentioned that the termination was stayed so that the Corporate Debtor could remain a going concern.

Tata Consultancy Services approached the NCLAT to get the order set side.

Main Issue

Along with arguing that the termination was against the object of the code, the Corporate Debtor had also argued that the termination was not contractually valid as breaches were remedied from time to time and there was neither a material breach nor a 30-day notice notifying the Corporate Debtor of the same, as required by the contract. Tata Consultancy Services had argued that the various breaches noted by them amounted to a material breach of contract, and they were not remedied by the Corporate Debtor.

However, the NCLAT refused to go into the factual aspects and framed the issue as being limited to, whether the termination notice tendered during moratorium was legal or not.

NCLAT Ruling

The NCLAT ruled that the termination had been rightly stayed. Rationale given by the bench focused primarily on the fact that the moratorium under section 14(1) had already kicked in and that the RP had approached the tribunal under duty imposed on him to preserve and protect the assets of the Corporate Debtor under section 25. The bench also noted that the termination went against the objective of the I&B Code which is to ensure that the company continues to function and its assets are protected. Due to all these reasons NCLAT upheld NCLT’s order of stay of termination.

Analysis

Far reaching legal ramifications of the judgment

The NCLAT has considered the issue of termination of contracts during moratorium in two previous cases. First being the 2019 judgment given inGujarat Urja Vikas Nigam Ltd. v Amit Guptaand second being the July 2020 decision in GRIDCO Limited v Surya Kanta Sathapathy.

It is important to note that both judgments were with respect to termination of a power purchase agreement (‘PPA) during moratorium and were vastly fact specific in nature.

In the Gujarat Urja case, the NCLAT had ruled that Gujarat Urja Vikas Nigam Ltd. was the only purchaser of the electricity generated by the Corporate Debtor, therefore, it was important that the PPA not be terminated, because if it were terminated, the company would no longer remain a going concern. Gujarat Urja case was a fact specific judgment that was limited to a PPA scenario where the termination was solely on the basis that insolvency proceedings had been commenced against the corporate debtor.

The GRIDCO case was factually similar to the Gujarat Urja case, because here too, there was a PPA in place but the factual dissimilarity was that the termination was not on ground of insolvency but because of various contractual breaches. The NCLAT while giving its judgment in the GRIDCO case went a step ahead to say that the termination was in violation of section 14(1) of the I&B Code, which lists actions that are prohibited during the moratorium. Whereas, in the Gujarat Urja case, the NCLAT had not pointed out any particular section being violated by the termination of the PPA. GRIDCO judgment was also mostly fact specific in nature as the NCLAT had highly relied upon the fact that the termination was not in conformity with the procedure set out in the termination clause of the PPA to prevent the PPA from being terminated.

These two cases were similarly placed factually and had similar straightforward decisions where the NCLAT upheld the spirit of the I&B Code by understanding that allowing termination would result in reducing the value of these companies to an absolute zero as the PPA agreements were the only major assets of these companies, and the CIRP process would also be rendered redundant.

When the TCS case got decided, it was different from the PPA cases (Gujarat Urja case and GRIDCO case) as here there was a facilities agreement and not a PPA in place, and the Corporate Debtor wasn’t solely created for the purpose of supplying facilities to Tata Consultancy Services but had different clients as well. Apart from these factual differences, the NCLAT in the TCS case, chose to ignore the issue of whether the termination in question had been effected as per the termination clause of the Agreement or not. The termination clause in the Agreement required a material breach notice to be given before termination and the Agreement could only be terminated if the material breach was not cured within 30 days. The Corporate Debtor had argued that the Agreement was terminated without any such notice being received by them. However, the NCLAT chose to ignore this question completely and decided to limit the issue to whether the termination during moratorium was legal or not. This delimiting of the issue made the judgment considerably law specific rather than a fact specific one, making the TCS case completely different from the PPA cases which were more fact specific judgments.

By ruling that it was illegal and violative of the I&B Code, the NCLAT has set a precedent that contractual termination of agreements during moratorium is illegal under the I&B Code. This will have far reaching consequences as now the circle disallowing termination of contracts has extended from PPA agreements with the companies created solely to carry out those PPA agreements to general commercial agreements such as a facilities agreement in the TCS case.

Corporate Debtors will use this judgment to prevent termination of any contract without considering whether it really affects the value of the corporate debtor or not, while third parties would be forced to stay in contracts despite glaring contractual breaches.

Unreasoned Judgment

The NCLAT applied section 14 in the TCS case, however the order merely reiterates section 14 but has failed to show how termination of one contract would substantially deter the company from functioning and continuing its activities as a going concern. Similarly, it has failed to show how the termination of one contract would erode the assets of the company; the company still has other contracts and clients as assets.

It’s important to note that the NCLAT did not go into the valuation of the contract or how important it is for the company, therefore, the judgment fails to convince that the termination should be stayed because of the reasons mentioned in the order.

Amended section 14

Section 14(1) was amended by ordinance number 16 of 2019 on 28 December 2019 and an explanation was added after section 14(1) that clarified that the grants or rights given by any authority constituted under law shall not be suspended or terminated on grounds of insolvency. Therefore, the textual interpretation of the explanation to section 14(1) clearly clarifies that the scope and purpose of section 14(1) is to prevent such grants or rights from being terminated. It could have been said that the pre-amendment section 14(1) was to prevent any kind of contract from being terminated during moratorium however the explanation added by the amendment clearly defines the limits of section 14.

However, the NCLAT did not even mention the explanation added to section 14 in its judgment. The amendment was an ‘explanation’ thus the nature of the amendment was clarificatory in nature. It is well established that clarificatory amendments are interpreted to be retrospective in nature, additionally this was also reiterated by Supreme Court in context of the same section 14 of I&B Code, although, on a different issue in State Bank of India vs V. Ramakrishnan. Therefore, the NCLAT should have also considered the amended section 14 while deciding this case.

Additionally, section 14(2) was also amended, but that is for supply of essential goods and services and is not applicable to this case and neither was it mentioned by the NCLAT.

Proposed Solution: Nature Based Classification of Contracts

All the cases discussed above portray that the NCLAT wants all commercial contracts of the company to remain as it is after the CIRP has commenced so that the value of a company can be preserved. However to restrain all types of contracts from being terminated is excessive and unnecessary.

The object of the I&B Code is to protect and preserve the value of the Corporate Debtor however it is quite likely that the Corporate Debtor entered into such contracts, which if terminated, would have little to no effect on the Corporate Debtor’s value, while some other contracts would have a substantial effect on the value of the Corporate Debtor. Therefore, contracts can be classified into two categories, ones that substantially do not affect the value if terminated and others that do. 

The NCLAT has been right to classify PPAs to be belonging to the latter category and has rightly ruled in both the Gujarat Urja case and the GRIDCO case. However, the NCLAT seems to be ignoring the former category of contracts. 

As per the Economic Survey 2019-20 Vol IIput up on the IBBI website, resolution under the I&B Code takes on an average about 340 days, and now after the 2019 amendment to section 12, resolutions have to be completed within 330 days. Taking the average time taken into consideration, it takes about 340 days before parties to the contract know what will happen to their contractual agreements and these parties have to abide by their contractual obligations for this duration.

In commercial contracts where performance of the contract is remaining on both sides, and remaining performance is of such an extreme nature that if left unperformed it would excuse the performance of the other party, such contracts should be allowed to be terminated. An example would be commercial contracts that were signed just before the CIRP commenced and there has been no substantial performance by either party to the contract. There could also be commercial contracts where a material breach has occurred that excuses the performance of the other party.

It is not commercially viable to force the parties in such contracts to continue abiding by them by disallowing termination of all contracts in an attempt to protect the value of the Corporate Debtor because more often than not such contracts would not substantially affect the value of the Corporate Debtor.

Conclusion

The judgment given in the TCS case has far reaching legal ramifications. However, the judgment is not a well-reasoned one because as pointed out above, there are various questions and issues that the bench left unaddressed and certain amendments that the bench did not take into account.

The judgment is under challenge before the Supreme Court where the counsel of Tata Consultancy Services has argued that the NCLAT and the NCLT have misread provisions of section 14 and that section 14 relates to provision of essential goods or services to the corporate debtor but here Tata Consultancy Services was availing facilities provided by the Corporate Debtor. Therefore section 14 has no application in their case. As on date, the Supreme Court has rightly ordered an ad-interim stay on the operation of the judgment of the NCLAT. 

It is hoped that the Supreme Court considers whether the Agreement in question substantially affects the value of the Corporate Debtor or not before giving its final decision on the matter. 

– Kartik Adlakha

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