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July 2017

Disputing a dispute under Insolvency and Bankruptcy Code, 2016

by Arun Mohanty

Debt recovery in India has been a challenge with creditors and debtors disputing  rights and obligations in legal wrangles under various provisions under applicable laws making the process time consuming and costly.

The Insolvency and Bankruptcy Code, 2016 (“IBC” or “Code”) was enacted on May 28, 2016 with an aim to inter alia address and resolve these issues in addition to providing for the mechanism for resolution of insolvency and bankruptcy matters in India. The laws in India prior to enactment of the Code were spread across several enactments with winding up being under the jurisdictions of the High Courts of India under the Companies Act, 1956. The Ministry of Corporate Affairs (“MCA”) has now notified provisions related to winding up of a company under the Companies Act, 2013 [See end Note i]and the Companies (Transfer of Pending Proceedings) Rules, 2014 [ See end Note ii], by virtue of which all pending proceedings [ See end Note iii] in relation to winding up of a company pending before the High Courts shall be transferred to the relevant bench of the National Company Law Tribunal (“NCLT”).

IBC being a new legislation is undergoing judicial tests which shall hopefully render its provisions robust and effective. Various benches of NCLT have pronounced conflicting orders giving rise to inconsistency in interpretation of IBC provisions. One issue  at the core of remedies available to a debtor under the IBC is the term ‘dispute’ under the IBC. The term has been the point of focus and interpretation of various orders of the NCLT in context of IBC.

For understanding the interpretation of the term ‘dispute’, it would be ideal to study the recent developments in light of the Order passed by National Company Law Appellate Tribunal (“NCLAT”) in the Kirusa case.

Kirusa Software Private Limited v. Mobilox Innovations Private Limited

In Kirusa Software Private Limited v. Mobilox Innovations Private Limited, the applicant operational creditor filed a petition under Section 9 of IBC claiming its outstanding dues and requesting NCLT, Mumbai to initiate corporate insolvency resolution process against the corporate debtor.

To satisfy requirements under Sections 8 and 9 of IBC, the operational creditor issued a demand notice on the corporate debtor. Per Section 8 of IBC, a corporate debtor may resist initiation of corporate insolvency process by either repaying the outstanding operational debt or bringing into notice the existence of a dispute in relation to such outstanding amount.

The corporate debtor responded to the demand notice by issuing a notice of dispute against the outstanding amount. NCLT, Mumbai adjudicated that the creditor was in receipt of and had admitted to the existence of a dispute in respect of the outstanding amount payable to the operational creditor and therefore, dismissed the petition.

The operational creditor appealed against NCLT’s order in the NCLAT. NCLAT determined that it is pertinent to examine the meaning of ‘dispute’ and ‘existence of dispute’ in light of Section 9 of IBC.

Section 5(6) of IBC defines ‘dispute’ as:

“…….(6) ‘dispute’ includes a suit or arbitration proceedings relating to:

  • (a)the existence of the amount of debt;
  • (b)the quality of goods or service; and
  • (c)the breach of a representation and warranty;……”

The question was reduced to examination of what constitutes a ‘dispute’. Further, NCLAT sought to determine whether it is necessary for a suit or arbitration proceeding to have been initiated to demonstrate existence of a dispute.

In the instant case, NCLAT was of the view that the definition of the term ‘dispute’ is inclusive and not exhaustive. The term ‘dispute’ has to be given a wider meaning provided it is relatable to the existence of the amount of debt, quality of goods or service, or breach of representation or warranty.

NCLAT further held that it is necessary to determine the circumstances in which the dispute has been raised by the corporate debtor. A genuine notice issued by the corporate debtor to the operational creditor shall suffice demonstration of a dispute. The judgment states that a “dispute” under Section 8 and 9 of the IBC would mean any proceeding initiated or pending before any consumer courts, tribunal, labour court, mediation or conciliation, including an action taken by a corporate debtor under any Act or law such as replying to a notice under Section 80 of the Code of Civil Procedure, 1908, or an action under Section 59 of the Sale of Goods Act, 1930 or an action regarding the quality of goods provided by an Operational Creditor. The dispute should be a genuine dispute and not one that was raised with malafides to stall the insolvency resolution process. While even in the pre-IBC era, the courts did not entertain disputes or winding up petitions pending before any authority, courts or tribunals, the IBC provides a legitimate possibility to request for a winding up of a company even if it is not insolvent (unable to pay its debts).

Conflicting interpretations of the term ‘Dispute’:

Various benches of NCLT have had contradictory views on interpretation of the term ‘dispute’. The Delhi bench of NCLT, in the matter of One Coat Plaster, Shivam Construction Company v. Ambience Private Limited held that the term ‘dispute’ needs to have a broad and inclusive definition. The Delhi bench further held that it is not mandatory on part of the debtor to have initiated a suit or arbitration proceeding prior to the receipt of demand notice to assert the existence of a dispute. Mere response to the demand notice showcasing existence of a bona fide dispute shall suffice. The NCLAT affirmed these views in the Kirusa case.

In the Kirusa case, the order stated that if the legislative intent was to determine a dispute by showing a record of a pending suit or arbitration proceedings, the term ‘dispute’ would have been defined in such restrictive manner in the Code.

The Mumbai bench of NCLT in the matter of DF Deutsche Forfait AG and Another v. Uttam Galva Steel Limited held that the ‘existence of a dispute’ means that a suit or arbitration proceedings must be pending before an operational creditor serves a demand notice. Raising a dispute in reply to the demand notice does not amount to notice of an existing dispute. Similarly, filing a suit or initiating arbitration proceedings subsequent to receipt of demand notice shall not amount to an existing dispute.

Conclusion:

Such conflicting orders have their own ramifications. While it is prudent to analyze the circumstances in which a dispute has arisen, there are no set parameters to verify if a thwarted dispute is kosher.

To avoid frivolous disputes being raised in response to a demand notice, NCLAT, in the Kirusa case held that merely raising an illusory dispute in response to a demand notice shall not be used as a tool to reject an application if the Adjudicating Authority believes that there is a debt and default on the part of the corporate debtor. It is pertinent to note that the Adjudicating Authority is empowered and required to verify the bona fides of a dispute if the application for initiation of corporate insolvency resolution process is filed by a financial creditor. However, such is not the situation in the event the dispute relates to an operational creditor. In such a scenario, the onus to prove the existence of a bona fide dispute shifts from the operational creditor to the corporate debtor.

The NCLAT order mandates analyzing circumstances while deciding upon the existence of a bona fide dispute. It may not be possible to scrutinize every dispute on subjective criteria. While IBC survives its testing times, it would have been efficient if NCLAT had laid down clear principles of determining a dispute. Determination of disputes on subjective criteria may give rise to interpretational inconsistencies.

A look back at an order passed under the Companies Act, 1956 in relation to winding up of a company – In K. Appa Rao v. Sarkar Chemicals Private Limited [ See end Note iv], the Andhra Pradesh High Court held that where a company has prima facie sustainable defence or a bona fide dispute of its obligations to discharge the alleged debts or liabilities, the court may not entertain proceedings for winding up, much less order winding up.

Such conflicting orders have implications on both operational creditors and corporate debtors. The corporate debtors should, if there exists any dispute in relation to the amount of debt or the quality of goods and services or breach of representation and warranty, raise a notice of dispute against the operational creditors in a proactive manner. On the contrary, operational creditors have an upper hand since raising a dispute or initiating a suit in response to a demand notice may not hold water of its bona fides, during adjudication. Parties should also consider the issue while drafting their dispute resolution clauses where they agree to a settlement period prior to raising formal process such as arbitration or a court process. This is significant in view of the possibility of operational creditors with malafide intent seeking to pursue a process under the IBC in the wake of a legitimate dispute by the debtor, who perhaps has not initiated a formal dispute process before any authority while the settlement discussions are ongoing. While eventually this would be considered by the NCLT, it may cause undue hardships to justified debtors especially in view of several conflicting judgments.

With the current stance, we are sure to witness a lot of debate on the determination of bona fides of a dispute. It would be interesting to await further interpretation of the term ‘dispute’ and await judicial orders laying down strict guiding principles on this issue.

[The author is a Senior Associate in Corporate law Practice, Lakshmikumaran & Sridharan, Mumbai]


[i] MCA Notification dated December 7, 2016
[ii] MCA Notification dated December 7, 2016
[iii] as on December 15, 2016
[iv] 1995 84 CompCas 670 AP

 

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