[Ragini Agarwal and Mayank Udhwani are graduate students at the National Law University, Jodhpur]
As per any standard commercial contract, initiation of insolvency against a party is considered as a material breach of the contract. Such a material breach often gives the non-defaulting party a right to terminate the contract. However, owing to section 14(1)(b) of the Insolvency and Bankruptcy Code, 2016 [“IBC”], such clauses have been rendered unenforceable.[i]
The justification behind such a stance seems to be that if termination of the contract is allowed, then the cash flows of the corporate debtor will be affected, which in turn shall make it difficult for the corporate debtor to remain a going concern. While the authors support this justification, there have been at least two instances wherein the adjudicating authority prohibited the termination of the contract despite there being a non-insolvency related default committed by the corporate debtor in the performance of a contract after the initiation of the corporate insolvency resolution process [“CIRP”]. The authors argue that such a position is flawed and that the corporate debtor should not be allowed to wriggle out of its contractual obligations by hiding behind the protection of section 14 of the IBC.
In this article, the authors will first discuss the cases where the adjudicating authority did not allow termination of the contract despite the commission of non-insolvency related default by the corporate debtor. The authors will then proceed to propose solutions to the emergence of a problematic jurisprudence under the IBC.
Cases Disallowing Termination of Contract During CIRP
In Tata Consultancy Services Limited v. Vishal Ghisulal Jain, the National Company Law Appellate Tribunal [“NCLAT”] held that the stay on the termination of the agreement was valid. In this case, the corporate debtor and the appellant [“TCS”] had entered into a facilities agreement whereby TCS availed services from the corporate debtor. These services were in the nature of facilities such as premises, computers, internet, broadband connection, staff for invigilation, etc., required for the conduct of examinations by TCS for its clients. The corporate debtor was a service provider with the obligation to, inter alia, fit the premises with materials as per the specifications in the facilities agreement. When it failed to remedy certain contractual breaches, a notice of termination of the facilities agreement was issued by TCS. This notice of termination was stayed by the adjudicating authority by an order dated 18 December 2019.
The issue before the NCLAT, thus, was whether the termination of the facilities agreement was valid. Clause 11(b) of the facilities agreement reads:
“11(b): Termination for material breach:- Either party may terminate this agreement immediately by a written notice to the other party in the event of a material breach which is not cured within 30 days of the receipt of the said notice period.”
In order to determine this issue, the NCLAT was required to see: (1) whether a notice of termination was issued by TCS; and (2) whether the material breach was cured within 30 days of receipt of notice of termination. The parties to the dispute took opposite stances in their response to this issue. TCS contended that the corporate debtor had failed to remedy the contractual breaches (¶9); whereas, the corporate debtor argued that contractual breaches had been remedied by it.
Upholding the contentions of the corporate debtor, the NCLAT observed:
“As on the date of the imposition of moratorium the business and activities of the ‘Corporate Debtor’ will have to be carried out for smooth functioning of the company and the company shall remain as a going concern.” (¶10) Further, since “it is the main objective of the Code to keep the Corporate Debtor as a going concern” (¶11), the stay was held to be legal.
Instead of weighing the contentions of the parties against evidence, the NCLAT accepted the stance taken by the corporate debtor on an a priori basis (¶9). Thus, the NCLAT assumed that the contractual breaches had indeed been remedied by the corporate debtor. Not only this, the NCLAT further ordered the parties to “adhere to the terms of the contract without fail” (¶11).
The authors contend that if we reject the a priori assumption of NCLAT about the remedy of contractual breaches, then the position which will emerge is that TCS is being coerced into contract despite there being multiple defaults committed by the corporate debtor. Such a situation cannot be said to be in line with the objectives of the IBC. While arriving at this conclusion, the authors would provide a caveat that given the NCLAT’s failure to deal with the contentions of the parties on cure of contractual breaches, the authors remain uncertain whether such breaches had indeed been cured by the corporate debtor or not.
In GRIDCO Limited v. Surya Kanta Satapathy and Others, the corporate debtor, after the initiation of the CIRP, had failed to supply electricity to the appellant [“GRIDCO”] due to the damage caused to the solar power plant by a storm. Consequently, GRIDCO terminated the PPA. When the corporate debtor approached the adjudicating authority to contest GRIDCO’s decision of termination of PPA, the adjudicating authority held that termination of the PPA was in violation of the moratorium declared under section 14(1) of the IBC. GRIDCO appealed against this direction. However, the NCLAT upheld the order and concurred with the reasoning adopted by the adjudicating authority (¶15). Again, it is pertinent to note that the NCLAT prohibited GRIDCO to terminate the PPA, despite there being a non-insolvency related default being committed by the corporate debtor during the CIRP.
These two cases seem to hint towards a broad fiat of the NCLAT, whereby even when the grounds for terminating the agreement are deficiency or failure to supply services, the NCLAT will keep the agreement alive in the interest of ensuring that the corporate debtor is a going concern. This emphasis on keeping the corporate debtor as a going concern during CIRP comes at the cost of legitimate expectations of parties which enter into contracts with the assumption that the contract will be honored. Such a position also falls foul of the fundamental principle of pacta sunt servanda which forms the foundation of any contract.
Further, as a previous post on this blog had pointed out, the context of the TCS agreement, dealing with a facilities agreement is different from the agreement in question in the GRIDCO case, which only dealt with PPAs.
The Way Forward
The intent of the moratorium under section 14 of the IBC is to keep the corporate debtor’s assets together during the CIRP and to ensure that the company may continue as a going concern while creditors take a view on resolution of default.[ii] It is intended as a breathing space for the corporate debtor, not as a carte blanche to default on contractual arrangements. When parties agree in a contract that default entails certain consequences, those consequences must be followed through or commercial contracts will lose their value.
In the context of there being a moratorium on suspension or termination of grants given by the Government to a corporate debtor during CIRP, the Insolvency Law Committee [“ILC”] in its Report dated 20 February 2020 noted that such a moratorium was to prevent suspension or termination ipso facto on the grounds of insolvency. To avoid ambiguity and prevent expansive application of the above principle, the ILC saw it fit to recommend that a clarificatory amendment be introduced in the IBC which made the intent of the provision clear. Accordingly, explanation to section 14(1) was introduced which stated that the grants would not be suspended or terminated subject to there being no default in current dues. The authors believe that such an amendment is also warranted for permitting termination of agreements during CIRP on breach of contractual provisions.
Another solution to the problem highlighted above could be that the adjudicating authority follow its decisions made in light of supply of essential services and a subsequent default by the corporate debtor in making payments for such supply. In context of supply of essential goods and services during moratorium, the tribunals have consistently held that the supplier cannot terminate the supply of essential goods and services to the corporate debtor on account of initiation of the CIRP.[iii] Such a supplier can only terminate the supply if the corporate debtor fails to make payments for such supplies.
The authors contend that such a position should be extended to all the contracts entered into by the corporate debtor. Meaning, if the corporate debtor defaults on its obligations under a contract during the CIRP, then the counterparty must be allowed to terminate the contract or seek relief in accordance with the provisions of the contract. Such a position, the authors contend, will ensure that the scope of the order in these two cases discussed herein remain narrow and are not broadened to give a license to the corporate debtor to default on obligations.
– Ragini Agarwal & Mayank Udhwani
[i] See Gujarat Urja Vikas Nigam Ltd. v. Mr. Amit Gupta (NCLAT, 2020); Gujarat Urja Vikas Nigam Ltd. v. Yes Bank (NCLAT, 2020).
[ii] Notes on Clauses, Insolvency and Bankruptcy Code Bill, 2015, p. 118.
[iii] ABG Shipyard Ltd v. ICICI Bank Ltd. & Ors (NCLT, 2017); Super Multicolor Printers Private Limited. v. Senior Executive Engineer Himachal Pradesh Electricity Board, CA (NCLT, 2017); Uttarakhand Power Corporation Ltd. v. M/s. ANG Industries Ltd. (NCLAT, 2018).