Paradigm shift in insolvency law by Supreme Court

By Sakal Bhushan

For invoking insolvency proceedings against a corporate debtor, an operational creditor is required to issue a notice of demand under Section 8(1) of the Insolvency and Bankruptcy Code, 2016 (IBC). Then under Section 8(2)(a) of IBC, the corporate debtor shall within 10 days of the receipt of that notice bring to the notice of the operational creditor “existence of dispute, if any, and record of the pendency of the suit or arbitration proceedings filed before the receipt of such notice or invoice in relation to such dispute”.

This portion of the statute was interpreted by the NCLAT in its landmark judgement delivered on 24.05.2017 in appeal entitled Kirusa Software Pvt. Ltd. Vs. Mobilox Innovations Pvt. Ltd.

It was held in para 21 of the said judgement that that the expression “existence of dispute, if any” is disjunctive from the expression “record of the pendency of the suit or arbitration proceedings”. In other words the expression “and” was read as “or”, thereby enlarging the scope of the “disputes”, which can be raised by the corporate debtors under IBC. Two important things were held by the NCLAT in its judgement.

One, the disputes under IBC (even in the case of disputes other than those in a pending suit or arbitration) must relate to the specified nature in clauses (a), (b) and (c) of Section 5(6) of IBC, i.e., existence of the amount of debt, the quality of goods or services, and the breach of a representation or warranty. (Para 31 of the judgement).

And two, the showing of the record of the pendency of suit or arbitration proceedings filed before the receipt of the notice or invoice in relation to a dispute was enough to defeat the insolvency application, meaning thereby that no further enquiry was to be done in case of disputes pending adjudication in a suit or arbitration. (Para 28 of the judgement).

The effect of the above judgement delivered by NCLAT was that, though the scope of disputes which could be raised by the corporate debtors under IBC was enlarged by reading the expression “and” as “or” and including within its ambit the disputes other than those in a pending suit or arbitration as well, yet the scope remained confined (even in the case of disputes other than those in a pending suit or arbitration) to the specified nature in clauses (a), (b) and (c) of Section 5(6) of IBC. These clauses are existence of the amount of debt, the quality of goods or services, and the breach of a representation or warranty. Further in case of the other disputes pending in a suit or arbitration, the mere showing of the record of such pendency was enough without any further jurisdiction of NCLT to enquire into the genuineness of those disputes.

In an appeal taken to the Supreme Court against the said judgement by the corporate debtor, Mobilox Innovations Pvt. Ltd., the said judgement of NCLAT was set aside. Though the Supreme Court vide its judgement delivered on 21.09.2017 maintained the reading of the expression “and” as “or” and the enlarged scope of Section 8(2)(a) of IBC, it did alter the NCLAT’s above two findings of law in a manner so as to further enlarge the scope of disputes in the case of disputes other than those in a pending suit or arbitration, and also enlarge the scope of enquiry which could be undertaken by the NCLT in case of the other disputes pending in a suit or arbitration.

Two important things emerge from the careful reading of the Supreme Court judgement entitled Mobilox Innovations Pvt. Ltd. Vs. Kirusa Software Pvt. Ltd.

One, the disputes under IBC (in the case of disputes other than those in a pending suit or arbitration) may not necessarily relate to the specified nature in clauses (a), (b) and (c) of Section 5(6) of IBC, i.e., existence of the amount of debt, the quality of goods or services, and the breach of a representation or warranty. Only in the case of the other disputes pending in a suit or arbitration, it is necessary that those must relate to the specified nature in clauses (a), (b) and (c) of Section 5(6) of IBC. (Para 57 of the judgement, enlarging scope of disputes in favour of the corporate debtors).

And two, the distinction between the two categories of disputes, i.e., ‘disputes other than those in a pending suit or arbitration’ and ‘those in a pending suit or arbitration’ was eliminated for the purpose of the power of the NCLAT to see whether there is a plausible contention which requires further investigation and that the dispute is not a patently feeble legal argument or an assertion of fact unsupported by evidence or is not spurious, hypothetical or illusory. (Para 54 of the judgement, enlarging scope of enquiry in favour of the operational creditors).

The effect of the above judgement delivered by Supreme Court is that the scope of disputes which could be raised by the corporate debtors under IBC remains wide enough by reading the expression “and” as “or” and including within its ambit the disputes other than those in a pending suit or arbitration as well, and this scope was further enlarged (in the case of disputes other than those in a pending suit or arbitration) making those free of the requirement of the specified nature in clauses (a), (b) and (c) of Section 5(6) of IBC, and further even in case of the other disputes pending in a suit or arbitration, the mere showing of the record such pendency is not enough. The NCLAT is empowered to see whether there is a plausible contention, which requires further investigation and that the dispute is not a patently feeble legal argument or an assertion of fact unsupported by evidence or is not spurious, hypothetical or illusory.

Sakal Bhushan is an Advocate practising in Delhi.