By – Ramesh Vaidyanathan, Suyash Sarvankar & Nidhi Doshi
Debt collection through civil court proceedings in India is a notoriously arduous process. A civil suit for recovery requires that a creditor approach a court with a written plaint explaining what happened, disclosing all the material supporting the claim, and then call upon the court to decide whether or not the amount is owed. If the court agrees, creditor should get the money back with some interest and often nominal cost. In reality, every step of this process, be it filing a plaint, submitting evidence, going through trial, and arguing the case will take comically long given the high pendency plaguing Indian courts. Therefore, even a basic suit for recovery drags on for a few years. Because of this, the probability of having to repay the principal debt amount with interest some years down the line creates very little pressure for the debtor to try and resolve the dispute with the creditor.
Given the status quo, a prudent creditor will try to short circuit the civil suit route through either criminal law or insolvency law. Supreme Court in SS Engineers vs Hindustan Petroleum Corporation Limited [1]has attempted to press brakes on the latter. SC held that the Insolvency and Bankruptcy Code, 2016 (“IBC”) makes it clear that where there exists a dispute with respect to the debt, IBC cannot be utilised. The main purpose of IBC was not to collect money on behalf of the creditors but to rehabilitate the corporate debtor and pull it out of insolvency and thereby maximise the value of its assets.
In this case, SS Engineers (“SSE”) was a service provider to HPCL Biofuels Ltd. (“HBL”). HBL did not pay certain invoiced amounts, and as a result SSE filed an application before the NCLT to initiate insolvency proceedings against HBL. NCLT admitted the application. HBL appealed to the NCLAT. The appeal was allowed by NCLAT on the ground that a ‘pre-existing dispute’ existed between SSE and HBL regarding the amounts owed. SSE then appealed to the Supreme Court.
Supreme Court held that NCLAT had committed an error by admitting the application of SSE since the claim was disputed by HBL. As per the IBC, the Tribunal needs to consider the following –
What is the debt owed by the company;
What is the validity of the entire claim of the creditor against the company; and
Whether there is any dispute that exists between the parties regarding the claim.
When any one of the abovementioned conditions is not fulfilled, the Tribunal should reject such an application. The respite to the debtor hinged on interpretation of the expression “existence of a dispute” under Section 8 (2)(a) of IBC, which now states, “(2) The corporate debtor shall, within a period of ten days of the receipt of the demand notice or copy of the invoice […] bring to the notice of the operational creditor— (a) existence of a dispute, if any, or record of the pendency of the suit or arbitration proceedings filed before the receipt of such notice or invoice in relation to such dispute …“ According to the Supreme Court, the existence of the disagreement and/or suit or arbitration proceeding must be ‘pre-existing’, that is, it must exist prior to the receipt of the Demand Notice. If there is such a pre-existing dispute, debt cannot be said to have attained finality as the debtor could avoid insolvency with a favourable verdict in a suit or arbitration. Given the facts, SC observed that the communication between the parties clearly portrayed a dispute regarding the claims of the service provider.
The ruling is consistent with Mobilox Innovations Private Limited vs. Kirusa Software Private Limited [2] and K Kishan vs. Vijay Nirman Co. Private Limited[3] where Supreme Court previously held that operational creditors cannot use the IBC either prematurely or for extraneous considerations or as a substitute for debt enforcement procedures. An operational debt contained in an arbitral award for a small amount cannot possibly jeopardise an otherwise solvent company worth significantly more. Such a debtor company would be well within its rights to state that it is challenging the arbitral award passed against it, and the mere factum of challenge would be sufficient to state that it disputes the award. Accordingly, an operational creditor can only trigger the CIRP process when there is an undisputed debt and a default in payment.
Of course, it is not open to the debtor to instigate frivolous and vexatious litigation in order to avail the pre-existing dispute defence and avoid CIRP. The Supreme Court ruled that NCLT must satisfy itself whether there is a plausible contention that requires further investigation and that the “dispute” is not a patently feeble legal argument or an assertion of fact unsupported by evidence. In doing so, NCLT does not need to be satisfied that the defence is likely to succeed. So long as a dispute truly exists in fact and is not spurious, hypothetical or illusory, the NCLT must reject the CIRP. [4]
It is often stated that the purpose of IBC is to rehabilitate and restructure a debt-ridden company and get it back on its feet. Be that as it may, due to ineffective debt collection mechanisms in India, operational creditors often found solace in IBC to build some pressure on the debtor and reach an acceptable settlement against the outstanding debt. Now, and perhaps correctly in line with the IBC text, the debtor has a right to avoid the threat of insolvency by the debtor has a right to avoid the threat of insolvency by outlining good defences in civil proceedings instead.
[1] Civil Appeal No. 4583 OF 2022.
[2] (2018) 1 SCC 353
[3] (2018) 17 SCC 662
[4] Anshul Vashishtha v. Jayhind Steel Traders, NCLAT Company Appeal (AT)(Insolvency) No. 656 of 2020, decided on September 30, 2020.