Terminating Contracts with the Corporate Debtor during CIRP: Revisiting the Position

[Vaishali Movva is an associate at a law firm and a practicing advocate in Bengaluru]

The provisions of the Insolvency and Bankruptcy Code 2018 (‘IBC’) and the regulations thereunder mandate that a moratorium be imposed on the assets of the corporate debtor during the corporate insolvency resolution process (‘CIRP’). While the moratorium does not explicitly prohibit a third party from terminating contracts with the corporate debtor during the CIRP, courts and tribunals in India have set aside such termination of agreements by third parties due to either an explicit bar under the IBC or on the grounds that the termination would have an adverse effect on the assets of the corporate debtor, and thereby breaching the very object of the moratorium. The question therefore remains whether there are any grounds – however limited – on which a third party may terminate a contract with a corporate debtor.

The Past: Interpretation of Section 14

In the past, the courts and tribunals have favoured a strict interpretation of section 14 of the IBC and have refused to uphold the termination of contracts by third parties with the corporate debtor. The first and most direct approach taken by courts and tribunals is by referring to the explicit bars under the IBC prohibiting termination of agreements during the moratorium. This is seen in contracts concerning essential goods and services under section 14(2) of the IBC read with the Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations 2016 (‘CIRP Regulations’), where courts and tribunals have refused to terminate such contracts, as that would result in a standstill in the operations of the corporate debtor. The term “essential goods and services” includes four supplies namely, electricity, water (only for drinking and sanitation), telecommunication services and information technology services (see regulation 32 of the CIRP Regulations). These supplies are considered essential to the extent that they are not a direct input to the output produced or supplied by the corporate debtor. Hence, while the intention of the legislature was to ensure that these are basic supplies that are necessary for “ensuring orderly completion of the proceedings” (see Insolvency and Bankruptcy Code Bill, 2015, Notes on Clauses, p. 118), tribunals have interpreted this provision broadly to include services which are essential for the running of the business (see Canara Bank v. Deccan Chronicle Holdings Limited CP No IB/41/7/HDB/2017 (NCLT Hyderabad, 19 July 2017)). In the recent Report of the Insolvency Law Committee, the broad view taken by courts and tribunals was encouraged, where it was stated that the resolution professional should identify critical supplies for the corporate debtor to run as a going concern, and that these supplies should not be terminated, suspended or interrupted, except in certain specific circumstances.

This strict interpretation adopted by the courts and tribunals is also seen in contracts which would fall under section 14(1)(d) of the IBC – see Navbharat Castings LLP v. Moser Baer India Ltd Company Appeal (AT) (Insolvency) No 323 of 2018 (NCLAT, 30 July 2018); Raj Builders v. Raj Oil Mills Limited Company Appeal (AT) (Insolvency) No 304 of 2018 (NCLAT, 8 August 2018); Srei Infrastructure Finance Ltd v. Sundresh Bhatt Company Appeal (AT) (Insolvency) No 781 of 2018 (NCLAT, 31 July 2019). While section 14(1)(d) prohibits the “recovery of any property by an owner or lessor where such property is occupied by or in the possession of the corporate debtor”, courts have also barred the termination of agreements granting licenses to the corporate debtor to develop certain immoveable property – see Rajendra K Bhutta v. Maharashtra Housing and Area Development Authority Civil Appeal No 12248 of 2018 (Supreme Court, 19 February 2020). In fact, tribunals have gone so far to hold that section 14(1)(d) also prohibits third parties from terminating licenses or contracts where usage rights are granted in relation to the property of the corporate debtor – see Vijaykumar V Iyer v. Union of India CP (IB)-298/(MB)/2018 (NCLT Mumbai, 27 November 2019), which was reaffirmed by the NCLAT in Pepsico India Holdings Pvt Ltd v. V Nagarajan, Resolution Professional of Oceanic Tropical Fruits Pvt. Ltd. Company Appeal (AT) Insolvency No. 686 of 2019 (NCLAT, 13 November 2019).

Evidently, courts and tribunals first analyse the nature of contract being terminated and, if these contracts squarely fall within the express bars of section 14 of the IBC, they proceed to determine the impact on the corporate debtor if these contracts are terminated. If the first criterion is satisfied – wherein based on the nature of the contract, the termination is hit by the express bars under section 14 of the IBC – it is unlikely that a court or tribunal would terminate the contract as it would certainly lead to the “corporate death” of the corporate debtor.

While analysing the second criterion, i.e., the impact of terminating the contract, courts have adopted a more liberal approach and have restrained third parties from terminating contracts on the ground that such a termination would have an adverse effect on the assets of the corporate debtor – see Vasudevan v. State of Karnataka CP/39/2018 (NCLT Chennai, 3 May 2019); Vijaykumar V Iyer v. Union of India CP (IB)-298/(MB)/2018 (NCLT Mumbai, 27 November 2019).  This is largely based on the principle that the main objective of the IBC is to keep the corporate debtor as a going concern and to maximise the value of its assets – see e.g. Tata Consultancy Services Limited v Vishal Ghisulal Jain, 2020 SCC OnLine NCLAT 484 (presently pending before the Supreme Court). The presumption is that if these contracts are terminated the corporate debtor would be unable to conduct its business activities, and would therefore lose its value. As discussed below, this approach has been narrowed down by the Supreme Court of India, wherein third parties can terminate contracts with the corporate debtor even if the value of the corporate debtors assets are reduced due to such a termination. 

Scope of Termination

In a few cases, courts and tribunals have permitted third parties to terminate contracts with the corporate debtor on alleged breaches of the contract, for example when outstanding dues are to be paid by the corporate debtor – see Orbit Lifesciences Private Limited v. Raj Ralhan, PwC Professional Services LLP Company Appeal (AT) (Insolvency) No 846 of 2019 (NCLAT, 4 February 2020); Embassy Property Developments Pvt Ltd v. State of Karnataka Civil Appeal No 9170 of 2019 (Supreme Court, 3 December 2019). Specifically, the recent decision of the Supreme Court of India in Gujarat Urja Vikas Nigam Ltd v Amit Gupta (2021 SCC OnLine SC 194) briefly considered this issue when dealing with the question of whether a contract can be terminated under an “ipso facto clause” during CIRP, i.e., termination based solely on an ‘insolvency event’. In this case, the Court had observed that the National Company Law Tribunal was empowered to restrain the appellant from terminating the power purchase agreement on the basis that (i) the termination took place solely on the ground of insolvency, and (ii) the said agreement was the “centrality to the success of the CIRP” as it was the “sole contract for the sale of electricity which was entered into by the Corporate Debtor”. This is line with a strict construction of section 14 of the IBC which was previously adopted by the courts and tribunals.

However, the Supreme Court had also observed that the jurisdiction of the tribunal cannot be invoked “where a termination may take place on grounds unrelated to the insolvency of the corporate debtor”. More importantly, the Court distinguished the termination of a contract which “dilutes” the value of a corporate debtor from the termination of a contract which would lead to its “corporate death”, wherein the former was allowed during the moratorium.  The Court observed that in future cases the tribunal would have to be “wary of setting aside valid contractual terminations which would merely dilute the value of the corporate debtor, and not push it to its corporate death by virtue of it being the corporate debtor’s sole contract (as was the case in this matter’s unique factual matrix)” (at paragraph 183). This observation is a significant departure from the approach taken by the tribunals previously – where any contract which has an adverse effect on the corporate debtor was not permitted to be terminated. Relying on this judgment, it can argued that the threshold for termination of a contract owing to a breach has been lowered, where a third party can now terminate the contract even if it “dilutes the value” of the corporate debtor, and provided it does not lead to its “corporate death”.

Hence, to summarise, a case may now be made that a third party can terminate a contract with the corporate debtor on the grounds that (i) the nature of the contract is not explicitly barred under section 14; (ii) the corporate debtor has committed a breach under the terms of the contract; (iii) the alleged breach is unrelated to the insolvency of the corporate debtor; (iv) the contract being terminated is not the sole contract of the corporate debtor; and (v) the termination of this contract would merely dilute the value of the corporate debtor and not lead to its corporate death.

– Vaishali Movva