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08 June 2017

Pendency of winding up petition when not bars initiation of corporate insolvency process

Key points:

  • If a notice for winding-up is served to the corporate debtor/respondent company or if the application for winding-up is pending before the High Court and no order has been passed as on date: an application under Insolvency Bankruptcy Code, 2016 (IBC) can be filed with the National Company Law Tribunal (NCLT) without any leave from the High Court.
  • The objective of form(s) for statutory notice and application prescribed under the IBC is to provide and incorporate necessary information required under law. The requirement of providing a “notice” is mandatory; however, the form in which such notice is to be given is a matter of procedure and hence directory.

 

Facts:

The applicant company being the operational creditor was engaged in a supply arrangement with the respondent company i.e. the corporate debtor, for supply of certain diagnostic equipment(s), eye care pharma and vision care products on credit basis through its consignment agent.

During the supply arrangement, the corporate debtor began to default on payments towards certain invoices and despite several reminders, the corporate debtor failed to make the payments.

This resulted in huge amount of outstanding payable(s) to the operational creditor, which was duly acknowledged by the corporate debtor.

Pursuant to this, the operational creditor and the corporate debtor executed an agreement of milestone including a hypothecation agreement, which specifically stipulated that failure to pay any one installment shall give rise to a material default.

Consequentially, liability for the entire outstanding amount including for the supplies made till the date of default shall be of the corporate debtor.

The inability of the corporate debtor to pay even the first installment resulted in the issuance of statutory notice under Section 8 of the IBC in respect of which no response was received from the corporate debtor.

While the corporate debtor admitted that response to the notice was intentionally not given and that the outstanding amount payable was not under “dispute”, certain objections were raised by the corporate debtor with respect to the maintainability of the application:

  1. The statutory notice received by the corporate debtor was not in accordance with the forms prescribed under IBC as well as the provisions of the IBC (Application to Adjudicating Authority) Rules, 2016;
  2. As per the hypothecation agreement, the items supplied by the operational creditor are under its ownership and any dispute arising from the agreement shall be resolved through consultation and ultimately by arbitration;
  3. The corporate debtor’s liability to pay the outstanding amount cannot be construed as “operational debt” as per Section 5(21) of the IBC;
  4. An application for winding-up was sub-judice before the High Court of Madras and a forensic audit of the corporate debtor was being conducted.

 

Order of the Tribunal:

The NCLT observed that both the statutory notice and the application were in accordance with the forms prescribed under IBC and rules made thereunder, stating that the said forms were meant to merely provide necessary information required under the law.

The NCLT noticed that ‘substance’ is more important than the ‘form’ coupled with the fact that no irregularity was found between the statutory notice and the application filed by the “operational creditor”.

In so far as the ownership of items supplied under the hypothecation agreement was concerned, the NCLT noted that it is normal business practice for sellers to have a lien over the goods supplied unless the entire payment is made by the buyer.

This does not shift the obligation away from the corporate debtor for making payment towards the “supply” of goods.

The term ‘goods’ as defined under Section 5(21) of the IBC includes machinery/equipment(s), and therefore the outstanding amount owed by the operational creditor shall clearly fall within the purview of ‘operational debt’ as defined in the IBC.

Section 9 of the IBC provides for the procedure for initiation of a corporate insolvency resolution process.

The NCLT was of the view that the presence of an arbitration agreement between the parties does not bar the operational creditor from filing an application to initiate corporate insolvency proceedings.

Similarly, the pendency of a winding up petition cannot be a bar under IBC for initiating the corporate insolvency resolution process, because the High Court has not passed any order for winding up of the corporate debtor and no Official Liquidator had been appointed.

Based on the following observations, the NCLT allowed the application and ordered the commencement of the corporate insolvency resolution process which is to be concluded within 180 days.

During the said period, “moratorium” as directed under Section 14 of the IBC shall come into effect without affecting the supply of essential goods or services to the corporate debtor.

An interim insolvency professional as suggested by the operational creditor to oversee the insolvency process was also appointed by the NCLT.

 

Analysis:

Although an appeal challenging the said order has been preferred by the corporate debtor before the National Company Law Appellate Tribunal, the present NCLT order for the time being protects the right of the creditor to approach the NCLT and safeguard its interest(s) during the pendency of a winding-up petition.

The underlying principle here is that the courts in India shall prefer restructuring by way of corporate resolution rather than winding-up of the entity as an option to settle operational as well as financial debts.