Applicability of Triangular Set-off in the Indian Insolvency Regime

[Ankit Singh Rajput and Pragati Yadav are fourth-year law students at Faculty of Law, Jamia Millia Islamia, New Delhi]

Triangular set-off occurs when A owes a debt to B, B owes a debt to C and C owes a debt to A. In the triangular set-off, A attempts to set off the amount it owes to B against the amount that C owes to A. The validity of triangular set-off in the bankruptcy context, as distinguished from common law, is subject to debate, given the lack of mutuality involved. Various courts around the globe have adjudicated the issue of triangular set-offs. The concept of triangular set-off is claimed to have originated from the USA in the 1929 in the Bromfield v Trinidad National Inv Co case. Triangular set-off is akin to the concept of set-off that has been widely accepted not only in the Indian insolvency regime but also around the globe. The only difference between the two concerns the parties, as set-offs usually occur between two parties, however, triangular set-offs operationally require three parties. Since the word triangular set-off involves the concept of a set-off, it would be imperative for us to first ascertain whether the concept of set-off is recognised under the Indian insolvency regime. The post will, therefore, first discuss the concept of set-off under Indian insolvency law. Second, it will discuss the concept of a triangular set-off, comparing its treatment across prominent jurisdictions. Finally, the post will explore whether this concept can be applied in the Indian jurisdiction. 

Applicability of Set-off in the Indian Insolvency Regime

Under insolvency law, a set-off comes into play when two parties, the debtor and the creditor, have claims against each other, pursuant to which they try to settle it by mutual dealings wherein the mutual debt stands cancelled against each other. For example, A is indebted by 100 Rupees from B and B is indebted by 50 from A, then B’s debt of 50 rupees stands cancelled against A’s 100 rupees and now the debt against A stands to 50 rupees only. The essence of set-off is “mutuality ”; a set-off without mutuality holds no value in the insolvency regime. Mutuality connotes the existence of a debt between the “same parties” in the “same capacity.” In the insolvency regime, the facility of set-off basically provides pre-insolvency rights to the parties to mutually deal with the debts they owe to each other.

In India, the right to set-off cannot be directly inferred under the current insolvency regime, laid down by the Insolvency and Bankruptcy Code, 2016 (‘IBC’). However, in the past, this right was provided in the Provincial Insolvency Act, wherein Section 46 of the Act gave a right to mutually deal with the parties in order to set off any sum due from the other party. This was because the said law did not provide for a collective action proceeding that allows for the resolution of the debtor.

The Supreme Court of India, in Swiss Ribbon v Union Of India, observed that a set-off may be considered at the stage of filing of proof of debt, while initiating a resolution process by the resolution professional. However, the possibility of its application after the filing of the resolution petition or initiation of the corporate insolvency resolution process (‘CIRP’) was answered negatively by the National Company Law Appellate Tribunal (‘the Tribunal’ or ‘NCLAT’) in Vijay Kumar v. Bharti Airtel. The Tribunal in Vijay Kumar saw this concept as equivalent to making a preferential payment over other operational creditors, and also violating the moratorium imposed under the IBC. Therefore, while deciding such disputes on counterclaims or set-offs, the NCLAT requires the examination of the two questions. First, whether there was mutuality between the parties or not?; and second, whether the set-off was done before the initiation of the CIRP process? In case of a deviation from any of the aforementioned pre-requisites, the courts and tribunal have the right to term set-off as invalid.

Applicability of Triangular Set-off in the Indian Insolvency Regime

The concept of triangular set-off holds importance in the pre-insolvency resolution process. Over the years, courts across the globe have disallowed a triangular set-off in insolvency proceedings. For example, in the case In re Lehman Bros. Inc., the southern district of New York ruled that a multi-party triangular set-off does not satisfy the Bankruptcy Code’s mutuality requirement, and thus cannot be validated.

However, the question as to whether a triangular set-off in case of pre-petition contracts will be applied or not was also answered negatively by the United States Bankruptcy Court for the District of Delaware (‘Delaware Bankruptcy Court’) in In re SemCrude, L.P., wherein it was held that a creditor in bankruptcy cannot affect a triangular set-off of debt owed between herself and three affiliated debtors, despite pre-petition contracts that expressly contemplated multiparty set-off.

As already discussed, courts in India have expressed a mixed opinion about the applicability of the concept of ‘set-off’ in the present insolvency regime. The IBC does not mention the concept of set-off, as opposed to the provincial insolvency act. The concept of ‘set off’ can be found in Order 8 Rule 6 of the Civil Procedure Code 1908 (‘CPC’). However, given the overriding effect of the IBC, it is unlikely that courts will allow set-off in insolvency proceedings despite provisions for it in the CPC. The concept of a ‘triangular set-off’ does not find its existence in the IBC nor have there been any cases involving the question of its applicability.

If the rationale applied in rulings in other jurisdictions is to be applied, one could argue that there is little basis for courts to allow multi-party ‘triangular set-off’ in insolvency proceedings. It is argued that if a multi-party set-off is allowed in Indian insolvency proceedings post or prior to the filing of the insolvency petition, then it will be violative of the principle of pari passu (principle according to which similarly situated creditors are treated equally in the distribution of the claims arising out of assets of the corporate debtor), and will also frustrate the very objective of the IBC, which is to maximize the value of the corporate debtor. It will treat similarly-situated creditors with different opportunities and unequal status. Further, a triangular set-off cannot be permitted because it lacks the essence of mutuality, as affirmed by the Delaware Bankruptcy Court in In re SemCrude (supra).

Therefore, parties approaching courts and tribunals for its applicability in India will face difficulty in proving mutuality in multi-party set-offs. However, chances of its application may improve if two entities in a triangular set-off can prove a parent-subsidiary relationship, and convert the transaction from into a dual party set-off from a multi-party set-off. This was affirmed by the United States Court of Appeals in the Inland steel (supra).

Conclusion

The provincial insolvency regime in India was believed to be a debtor-friendly regime. However, with the enactment of the IBC, a creditor possession regime was instituted, which has resulted in the absence of the concept of mutual dealings. Therefore, incorporating the concept of triangular set-offs will raise concerns of bias against the corporate creditors. Further, the NCLAT in the past has observed that once CIRP is initiated, any repayment of debt can be only done per the scheme of the IBC. Therefore, once the resolution plan is approved, the applicability of the concept of triangular set-off in the Indian insolvency regime cannot be positively affirmed.

– Ankit Singh Rajput and Pragati Yadav

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