Supreme Court on the Validity of Ipso Facto Clauses during Insolvency

[Ridhi Arora is a III Year B.A., LL.B (Hons.) student at Gujarat National Law University and Varun Singh a III Year B.A., LL.B (Hons.) student at Rajiv Gandhi National University of Law]

On March 8, 2021, the Supreme Court of India in Gujarat Urja Vikas Nigam Limited v. Amit Gupta ruled that the provisions of the Insolvency and Bankruptcy Code, 2016 (‘IBC’) prevail over power purchase agreements (‘PPA’) entered into by a corporate debtor, and upheld the decision of the National Company Law Appellate Tribunal (‘NCLAT’) that stayed the termination of the PPA.  

In this post, the authors analyse the Supreme Court’s deliberation on issues pertaining to the validity of ipso facto clauses and the jurisdiction of the National Company Law Tribunal (‘NCLT’) and NCLAT over contractual disputes.

Facts of the case

On January 6, 2009, the Government of Gujarat notified the Solar Power Policy of 2009 to develop solar power projects in the state of Gujarat. On August 1, 2009 the Gujarat Urja Vikas Nigam Limited (‘GVNL’) allocated 25-megawatt capacity to Astonfield Solar Gujarat Pvt. Ltd (‘Astonfield’) for developing and setting up a solar photovoltaic based power project in Gujarat. GVNL signed a PPA with Astonfield to purchase all the power generated by the latter for 25 years with a higher tariff rate in first 12-15 years and a lower tariff rate for the remaining years. However, in the year 2015 there was heavy rainfall and floods in the State of Gujarat due to which the plant was shut down for two months. Consequently, it was severely damaged and its electricity production capacity had reduced. In the year 2017, Gujarat was again affected by floods and the plant could operate only at 10-15% of its capacity. Both these events forced Astonfield into a financial crunch, due to which it was not able to fully repay its dues to its creditors, who later proposed to declare Astonfield a non-performing asset (“NPA”).

Astonfield filed for insolvency under section 10 of the IBC, as a result of which the NCLT initiated a corporate insolvency resolution process (‘CIRP’) in respect of Astonfield and issued an order of moratorium. Subsequently, GNLV terminated the PPA with Astonfield on account of presence of an ipso facto clause. The resolution professional appointed by the NCLT challenged this move, and the NLCT stayed the termination of PPA. An appeal against the order of the NCLT was also rejected by the NCLAT. As a result, GNLV decided to move the Supreme Court.

The issues before the Court related to termination of agreements on the basis of ipso facto clauses and the jurisdiction of NCLT and NCLAT on contractual disputes under section 60 of the IBC.

Jurisdiction of the NCLT on adjudication of contractual disputes

An important question of law that the Supreme Court decided in the present case related to the scope of jurisdiction of the NCLT on matters relating to termination of contracts or agreement. Since GVNL was the sole purchaser of power generated by Astonfield, it sought to terminate the PPA relying on the clause which allowed GVNL to terminate the agreement in case Astonfield goes under insolvency. The resolution professional appointed for Astonfield filed an application under section 60(5) of the IBC before the NCLT, in order to challenge GVNL’s move to terminate the PPA on the ground that CIRP had been initiated against Astonfield. The counsel for Astonfield submitted that the termination of PPA by GVNL was against the scheme of IBC, as it would push Astonfield into insolvency and the continuation of PPA was necessary for the entire resolution process and in order to keep Astonfield as an ongoing concern. Based on the facts of the case, the Court observed that the PPA was terminated solely on the ground of CIRP being initiated against Astonfield, and it would not have been terminated had CIRP not been initiated. Hence, it could be stated that it was a matter directly related to IBC and the NCLT had jurisdiction under section 60(5)(c) of IBC to adjudicate the dispute.

The Supreme Court also held that, in accordance with section 238 of the IBC, which gives the IBC an overriding effect, the PPA would be considered as an instrument under section 238 of the IBC. The NCLT’s jurisdiction would be valid as the PPA was terminated solely on the ground of insolvency, i.e., the initiation of CIRP against Astonfield. However, the Supreme Court opined that the validity of the residuary power of the NCLT to adjudicate the matters relating to termination of the PPA would be tested on a case-to-case basis and the Court did not lay down general principles in this regard, as that would fall outside the legislative ambit of the IBC. The Court also observed that the NCLT and NCLAT must ensure that they do not supersede the original and legitimate jurisdiction of other courts or tribunals if the matter is not solely related to insolvency or bankruptcy of the corporate debtor.

Validity of ipso facto clauses

The Court delved into the discussion on validity of ipso facto clauses, and noted that multiple jurisdictions across the globe either validate or invalidate them. The need for validating ipso facto clauses arises from respecting commercial relationships between parties, and to prevent the debtor from selectively performing the contract. However, the Court also noted that in jurisdictions where insolvency law overrides ipso facto clauses, invoking an ipso facto clause when a debtor is under financial distress may result in hampering the restructuring plans of the debtor. This safeguard is provided in Article 7 of the EU Directives which states that a party will not be allowed to terminate a contract based on ipso facto clauses if the defaulting party is a corporate debtor undergoing restructuring. Likewise, section 365(E) of the US Bankruptcy Code does not allow for termination of a lease or a contract on ipso facto clauses although the United States allows swap agreements and securities agreements to be terminated based on ipso facto clauses.

The position in the United Kingdom (“UK”) on this aspect has been conclusively decided. In 2012, the UK Supreme Court in Belmont Park Investments Pty Ltd v BNY Corporate Trustee Services Ltd  held that ipso facto clauses could not help in validating contracts that did not fulfill a legitimate commercial intent, and were present only to evade an illegitimate bankruptcy or insolvency law. Furthermore, in 2020, amendments were introduced to the Insolvency Act, 1986 by the Corporate Insolvency & Governance Act 2020, which makes termination of a demand-supply contract unenforceable on the basis of ipso facto clauses. Even in Singapore, section 440 of the Insolvency, Restructuring and Dissolution Act, 2018 provides that ipso facto clauses cannot invalidate agreements in cases of insolvency.

In India, the Expert Committee on Company Law, headed by Mr. JJ Irani recommended the need to invalidate ipso facto clauses during insolvency proceedings so as to bring the corporate debtor and its assets out of severe financial adversity. The IBC does not contain a provision which directly declares ipso facto clauses invalid during insolvency proceedings, but section 14 provides that essential service agreements cannot be terminated during CIRP. The Court noted the dilemma between the corporate debtor’s liabilities in a commercial contract, as well as the hardship that the corporate debtor would have to face if the ipso facto clause is brought into effect during insolvency. However, the Court did not conclusively deal with the validity or invalidity of ipso facto clauses in an agreement, and left the same to be deliberated upon by the legislature.

Conclusion

The objective of IBC is to provide financial relief to a corporate debtor and to restructure its assets. For this objective to be met, the termination of agreements solely on the grounds of insolvency through the means of ipso facto clauses cannot be upheld. While the air surrounding the validity of ipso facto clauses is yet to be cleared in India by including the same in the IBC, multiple jurisdictions like the UK, United States and Singapore have incorporated the invalidity of ipso facto clauses in their insolvency legislations. It is probably time for the Parliament to incorporate the same in the IBC.

– Varun Singh & Ridhi Arora

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