Ignorance is Bliss (?): Analysing the Treatment of Contingent Claims under the Insolvency and Bankruptcy Code, 2016

[Saksham Chaturvedi and Devansh Sehgal are final year B.A. LL.B. (Hons.) students at National Law University, Odisha]

Any claim against the corporate debtor (‘CD’) which is pending adjudication or has not been crystallised as of the insolvency commencement date is known as a contingent claim. By virtue of the moratorium issued under section 14 of the Insolvency and Bankruptcy Code, 2016 (‘IBC, 2016’), a contingent claim cannot be adjudicated after the initiation of the Corporate Insolvency Resolution Process (‘CIRP’).

However, by allowing a pending arbitration claim involving an operational creditor to continue adjudication after approval of the resolution plan from the National Company Law Tribunal (‘NCLT’), the Supreme Court of India (“SC’) in Fourth Dimension Solutions Ltd. v. Ricoh India Ltd. & Others (‘Fourth Dimension’), has significantly diluted the application of the ‘clean slate’ theory.

Following suit from the SC’s order in Fourth Dimension, the adjudicating authorities have also allowed the continuation of adjudication of contingent claims post-approval of the resolution plan. Even though the departure from the spirit of the clean slate theory in these orders requires prompt attention, these orders are also significant in the respect that they have inadvertently underscored the need to integrate contingent claims within the framework of corporate insolvency.

This post advocates for the inclusion of contingent claims within the scheme of corporate insolvency and provides a tentative way forward. .

Meaning and Importance of the Clean Slate Theory

The ‘clean slate’ theory, as mentioned in Committee of Creditors for Essar Steel India Limited v. Satish Kumar Gupta & Ors.(‘Essar Steel’), forms an important part of the CIRP. The theory comes from section 31(1) of the IBC, 2016 which provides that a resolution plan approved by the NCLT is binding on all the stakeholders of the corporate debtor. This means that once a resolution plan has been passed by the Committee of Creditors (‘CoC’), and approved by the NCLT, all pending claims and liabilities against the corporate debtor are obliviated or stand extinguished. This foregoing section works in conjunction with section 14 and disallows the revival of any pending claims (including pending litigation and arbitrations) against the corporate debtor.

This theory was recognised and clarified by the SC in Ghanashyam Mishra & Sons (P) Ltd. v. Edelweiss Asset Reconstruction Co. Ltd. The SC in the instant judgment laid down that – on the date of approval of the resolution plan by adjudicating authority, all such claims, which are not a part of resolution plan shall stand extinguished and no person will be entitled to initiate or continue any proceedings in respect to a claim, which is not part of the resolution plan. The object behind this theory is that when someone successfully takes over a struggling company, they shouldn’t be surprised by unexpected financial claims later on.

The interplay between the theory and treatment of contingent claims was discussed by the Court in Essar Steel. While clarifying the position with respect to contingent claims, the Court weighed that all claims which are against the corporate debtor, before the commencement of the CIRP, must be consolidated and considered by the ‘Resolution Professional’ (‘RP’). All the claims and debts should be sorted out before the new owner takes charge, so they know exactly how much they need to pay. This way, the new owner can start with a clean slate and run the business smoothly.

Consolidation of Contingent Claims

Regulation 14(1) of the IBBI (Insolvency Resolution Process of Corporate Persons) Regulations, 2016 (‘IBBI Regulations’) provides that if the amount claimed by a creditor is not precise due to the existence of any contingency, the Interim Resolution Professional (‘IRP’) shall make a “best estimate” of the amount based on information at their disposal. Regulation 14(2) of the IBBI Regulations further empowers the IRP to revise this estimate when any additional information in the knowledge of the IRP, warrants him to do so.

The Courts have had an opportunity to consider the case of contingent claims during a CIRP. While hearing an appeal against the IRP who had refused to add a claim based on its contingency in the information memorandum, the Bombay High Court handed out a comprehensive judgment. In Tata Steel BSL Ltd. v. Varsha, the High Court allowed the admission of the claim of an operational creditor which was pending dispute before a Civil Court. The High Court clarified that the creditor cannot be denied the opportunity to have their claim added to the information memorandum. Accordingly, the Court directed the IRP to include the sub-judice claim at the notional face value of INR 1 (Indian Rupees One).

Along similar lines, the Mumbai Bench of the NCLT in Ultra Tech Cement Ltd. v. Minita D. Raja held that contingent claims are valid and have to be necessarily declared contingent claims in the resolution plan. The bench, upon perusal of the scheme envisaged in the IBC, 2016 and judicial precedents, held that an applicant who files a counterclaim before the Arbitral Tribunal possesses a claim that is dependent on the Tribunal’s adjudication. Therefore, the RP is obligated to designate such a claim as contingent in the information memorandum.

If any contingent claim has not been added during the CIRP, they shall necessarily be added for a ‘nil’ valuation. However, even in cases where contingent claims have been added, they can be ascribed a ‘nil’ valuation. The validity of such a resolution plan was upheld by the National Company Law Appellate Tribunal (‘NCLAT’) (Delhi Bench) in the matter of State of Haryana v. Uttam Strips Ltd.

A Case for Better Treatment of Contingent Claims

A perusal of the above judgments implies that contingent claims are allowed to be added to the information memorandum pending adjudication before the concerned Courts. However, herein is an anomaly. Even though Regulation 14(2) of the IBBI Regulations allows for the revising of claims, subject to the inflow of any additional information to the RP, this is a rarity. This is because, in terms of section 14 of the IBC, 2016,  the moratorium disallows the continuation of any pending claims against the corporate debtor to ensure certainty of the debtor’s financial state.

The treatment of contingent claims within the IBC, 2016 system is inherently unjust. These claims are relegated to a nominal value of INR 1 (Indian Rupees One) in the event of a resolution plan’s approval, rendering them practically worthless. The moratorium imposed by section 14 further exacerbates this inequity, as it bars the creditor from proceedings against the corporate debtor during the CIRP. This leaves claimants with no recourse, despite the potential validity of their claims.

Another reason which justifies the inclusion of contingent claims in the CIRP is that, over the years, we have witnessed cases involving little to no haircuts to creditors after the CIRP. Additionally, there are cases wherein the bid amounts have outweighed the total debt due to creditors. Notable examples include the CIRPs of MBL Infrastructure, Binani Cements, and Jalan Intercontinental – all of which yielded haircut-free resolutions to their creditors. This obviates any argument against accommodating contingent claims on the ground of the successful resolution applicant’s fiscal incapacity.

Contingent claims, though labelled as ‘undecided,’ hold the potential for future validation through civil proceedings. This possibility underscores the need to reevaluate their status. The current system overlooks the potential of these claims and stifles claimants’ ability to seek recovery for their dues. It is imperative to accommodate contingent claims – allowing them to be crystallized and realized against the assets of the corporate debtor. This reform is crucial to rectify the injustice in the treatment of contingent claims under the IBC, 2016.

Accommodating Contingent Claims under the IBC, 2016

Since the present scheme of IBC, 2016 does not have any mechanism to ensure the settlement of these claims, in our opinion, they can only be considered if express exceptions for them are carved out either under section 14 of the IBC, 2016, or as an exception to the Clean Slate Theory. This section analyses the legal and practical feasibility of both of these methods.

An Exception to Section 14

Introducing an exception to section 14 of the IBC, 2016, allowing adjudication of contingent claims during the moratorium period may seem like a plausible solution. However, upon closer examination, it becomes evident that this approach, may prove to be impractical.

By lifting the moratorium for contingent claims, the very essence of the CIRP could be jeopardized. The moratorium serves as a vital protective shield, ensuring that the resolution process can be conducted without undue interruptions. Without this safeguard, the CIRP could potentially stretch on indefinitely, as claims continue to accumulate and languish. This would hinder the timely and effective resolution of CD’s financial distress.

Moreover, this proposition is legally unfeasible. It would contradict a longstanding body of jurisprudence affirming the sanctity of the moratorium period. The established precedent(s) in P. Mohanraj v. M/S Shah Brothers ISPAT Private Limited, Liquidator of ABG Shipyard v. Central Board of Indirect Taxes and Customs and Swiss Ribbons Private Limited & Anr. v. Union of India & Ors., respectively, emphasizes the importance of this grace period in the CIRP framework.

Therefore, while it is crucial to address the treatment of contingent claims, doing so by tampering with the moratorium will disrupt the entire CIRP. Accommodating contingent claims and upholding the integrity of the resolution process without compromising the orderly and timely completion of the CIRP is essential.

Exception as to the Clean Slate Theory

A better approach to address contingent claims is by allowing select claims to persist even after the resolution process has concluded. While this directly challenges the Clean Slate Theory, it may be a more practical means of accommodating contingent claims within the framework of the Code. This exception would apply exclusively to those claims that have been included by the RP in the information memorandum and were pending before the initiation of the CIRP.

This proposed approach is substantiated by several key factors. The RP, who plays a pivotal role in verifying and consolidating claims, would have already evaluated and verified these contingent claims as legitimate and meritorious for inclusion. If any claim is rejected by the RP, the unsatisfied creditor can challenge such rejection under section 60(5) of the IBC, 2016, and get the same admitted. This ensures that only genuine claims are considered, reducing the risk of frivolous claims burdening the resolution process.

Additionally, the new resolution applicant, having access to the information memorandum, is equipped with the requisite information and specific details regarding these contingent claims. This allows for an informed evaluation and facilitates the resolution applicant in making an appropriate decision regarding their inclusion in the resolution plan. However, this would require the prospective resolution applicant to conduct a thorough legal risk assessment study to determine the future of such claims.

This approach aligns with the stance taken by the SC in the Fourth Dimension. The Court’s ruling, which permitted an operational creditor to recommence arbitration proceedings previously halted by the section 14 moratorium, serves as a legal precedent validating the consideration of select contingent claims post-resolution process. By adopting this exception, the IBC, 2016, can strike a balance between the need to preserve the integrity of the resolution process while addressing the legitimacy of contingent claims.

However, this approach is not without exceptions. In instances where the corporate debtor transitions into liquidation, the predicament of contingent creditors is even worse. Given the impracticality of adhering to stringent timelines in the liquidation process, contingent creditors will fail to find any remedy for themselves. Unlike financial and operational creditors who may receive some restitution, albeit with significant reductions, contingent creditors often face bleak outcomes. The uncertainty surrounding the eventual validation of their claims, combined with the intricacies of the liquidation process, leaves them with no recourse.

Concluding Remarks

The IBC’, 2016,s treatment of contingent claims requires re-evaluation. These claims, labelled ‘undecided,’ hold potential validation through future civil proceedings, yet they are marginalized, valued at a mere INR 1 (Indian Rupees One) upon resolution plan approval. The section 14 moratorium exacerbates this, leaving claimants powerless, irrespective of claim validity.

While there is a lot to practically conceive and achieve, the mere recognition of contingent claims’ legitimacy, setting their legal position straight, and adjusting their treatment are pivotal to a fair and efficient resolution process. Balancing stakeholder interests while upholding CIRP integrity remains paramount for a just outcome.

– Saksham Chaturvedi and Devansh Sehgal

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