Tag Archives: CIRP

Are Assured Returns or Damages in instances of Breach a “Financial Debt” under Insolvency & Bankruptcy Code 2016?

Under the Insolvency and Bankruptcy Code, 2016 (the Code), a financial creditor can initiate a Corporate Insolvency Resolution Process (CIRP) by filing an application before the jurisdictional National Company Law Tribunal (the NCLT) upon the occurrence of a default in the payment of its financial debt under section 7 of the Code.

Before making an application, the financial creditor shall ascertain that his dues are more than INR 1,00,000/- (Indian Rupees One Lakh only), to be eligible to make an application.bankruptcy-1156329_960_720

The paramount question that arises is what can be included as ‘Financial Debt’. The term Financial Debt is defined under Section 5 (8) of the Code, which means a debt along with interest, if any, which is disbursed against the consideration for the time value of money and includes:

(a) money borrowed against the payment of interest;

(b) any amount raised by acceptance under any acceptance credit facility or its dematerialized equivalent;

(c) any amount raised pursuant to any note purchase facility or the issue of bonds, notes, debentures, loan stock or any similar instrument;

(d) the amount of any liability in respect of any lease or hire purchase contract which is deemed as finance or capital lease under the Indian Accounting Standards or any other Standards as may be prescribed;

(e) receivables sold or discounted other than any receivables sold on non-recourse basis;

(f) any amount raised under any other transaction including any forward sale or purchase agreement, having the commercial effect of a borrowing;

(g) any derivative transaction entered into in connection with protection against or benefit from fluctuation in any rate or price and for calculating the value of any derivative transaction, only the market value of such transaction shall be taken into account;

(h) any counter-indemnity obligation in respect of a guarantee, indemnity, bond, documentary letter of credit or any other instrument issued by a bank or financial institution;

(i) the amount of any liability in respect of any of the guarantee or indemnity or any of the items referred to above;

The opening words of Section 5(8), i.e. the definition clause indicates that a financial debt is a debt along with interest which is disbursed against the consideration for the time value of money and it may include any of the events enumerated in sub-clauses (a) to (i). The above mentioned (a-i) are instances of a mere inclusive definition and the judiciary has powers to interpret other situations which can be considered as financial debt.

A Financial Creditor is a person who has the right to a financial debt. The key feature of financial transaction as postulated by section 5(8) of the Code is its consideration for the time value of money. In Black’s 12 Law- Dictionary (9th edition) the expression ‘Time Value’ has been defined to mean “the price associated with the length of time that an investor must wait until an investment matures or the related income is earned”. In both the cases, the inflows and outflows are distanced by time and there is a compensation for the time value of money.

A bare reading of the provision gives an impression that the financial transaction should be in the nature of debt and no equity has been implied by the opening words of Section 5(8) of the Code.

Also, the NCLT order in the Nikhil Mehta & Sons (HUF) v. M/s AMR Infrastructures Limited (AMR) case has provided “…that the financial transaction should be in nature of debt and no equity has been implied by the opening words of clause 5(8) of the IBC”. Even though this order has been superseded by the NCLAT order on the merits of the case, it is expected that the intent of the legislation is clear to exclude all equity transactions from the purview of financial debt in the spirit of “Verba intentioni, non e contra, debent inservire” which means that the words of the statute should serve its intentions, not the reverse.

In Nikhil Mehta & Sons (HUF) Vs. M/s AMR Infrastructures Limited (AMR)[1] the NCLAT held that in order to qualify as a “Financial Creditor”, first the essential requirements of “Financial Debt” has to be satisfied as the key feature of a financial transaction is its consideration for the time value of money.

Initially, the NCLT had denied the applicant’s petition stating that his contractual right under an MOU with AMR, whereby AMR had assured ‘assured/committed returns’ to him, from the date of execution of the MoU till the handing over of the physical possession of the unit(s) was an agreement for mere sale and purchase of a piece of property and not a financial debt as the transaction did not have consideration for the time value of money. On appeal, the NCLAT had reversed the decision of the NCLT and held that the promise of the ‘assured return’ makes the applicant analogous to a ‘Financial Creditor’ or an ‘investor’ that has chosen ‘committed return plan’.

The above judicial interpretation of ‘the time value of money’ in the context of financial debt has opened up a Pandora’s box and put forth the question of whether the treatment of other complex debt instruments (debt-like instruments such as redeemable preference shares, put and call options on securities) whose returns are linked to parameters observed in equity transactions as financial debt. It can be logically argued that to satisfy clause 5 (8) of the Code, the claim should be in nature of a debt, to begin with. However, it is true that there are complex financial instruments which may not provide an easy answer to decipher the true nature and meaning of a transaction as either debt or equity. There may be instances wherein debt instruments/hybrid instruments in investment transactions may come with the option of assured returns within a prescribed timeframe for the investors. It would be interesting to watch if these will now be covered under the broad umbrella of financial debt.

Another area of concern is whether damages awarded in instances of breach to the investor may also be categorized as “Financial Debt” under IBC. This discussion is relevant especially since various courts in judgments such as Cruz City v. Unitech’ [2] and ‘NTT Docomo v. Tata Sons’[3] have ruled in favor of foreign investors and have provided that any pre-determined rate of exit claimed by such foreign investors in nature of damages would be valid and enforceable in India. The Courts in these cases have held that any assured exit formulae in lieu of damages would not be violative of Foreign Exchange Management Act, 1999 (FEMA) as FEMA prohibits any and all assured return to foreign investors [4]. A right/option of assured returns can be termed as illegible instruments in accordance with RBI guidelines (RBI Circular No. RBI/2013-2014/436 A.P. (DIR Series) Circular No. 86 (January 09 2013). And Circular dated 14.07.2014 (A.P. (DIR Series) Circular No. 3

The Court opined that the RBI circular which bars exit at pre-determined returns would not apply, in cases where the option is exercised for making good for a breach. Thus, any pre-determined exit exercisable in the event of a breach of obligations is not necessarily an assured return but a mere downside protection. This interpretation is important as the RBI circular itself does not account for distinction on grounds of breach or non-breach for prohibiting a pre-determined exit price but merely puts a blanket restriction on the exit of foreign entities at a pre-determined price. One can draw an analogy of these judgments to Nikhil Mehta’s case as discussed above as even in the Nikhil Mehta’s case, the court held the constructor liable for payment in the instance of a breach.

Thus, even pre-determined exit clauses for foreign investors tailored in nature of breach may also fall within the domain of financial debt. In such instances, foreign investors may approach the NCLT under the Code and initiate a request for an insolvency process of Indian companies.

Even though these provisions may seem as investor friendly and boost investor confidence in the Indian judicial system, such broad interpretations may flood the gates of IBC with suits wherein investors approach under the garb of financial creditor and will be entitled to trigger the CIRP against the Corporate Debtor. If so, then all investors (even including holders of convertible instruments) may fall under the ambit of “financial creditors” as their investment in the company may be treated as a downside protection or assured return by virtue of the transaction documents. This would aggravate the very purpose and intent of the Code as a statute was a quicker and faster way to protect creditors interests and not that of the shareholders.

[1]Nikhil Mehta and Sons v AMR Infrastructure Company Appeal (AT) (Insolvency) No. 7 of 2017 (July 21, 2017).

[2] MANU/DE/0965/2017

[3] MANU/DE/1164/2017

[4] A right/option of assured returns can be termed as illegible instruments in accordance with RBI guidelines (RBI Circular No. RBI/2013-2014/436 A.P. (DIR Series) Circular No. 86 (January 09 2013). And Circular dated 14.07.2014 (A.P. (DIR Series) Circular No. 3

Co-authored by: Ashwin Bhat (Junior Partner) and Ayushi Singh (Associate) at NovoJuris Legal.

Supreme Court Judgement on ‘Existence of Dispute’ under Insolvency and Bankruptcy Code

‘Existence of Dispute’ in case of application by Operation Creditor

This blog is in continuation to our earlier blog dated 15 September 2017 which was titled as “Dispute” is heavily disputed under Insolvency and Bankruptcy Code (IBC) and written about the NCLT Order.  https://novojuris.com/2017/09/15/dispute-is-heavily-disputed-under-insolvency-and-bankruptcy-code/ On appeal, Supreme Court has weighed in on “existence of dispute” under IBC.  Read on.

Background:

Kirusa Software Private Limited (Kirusa) had filed an application before the National Company Law Tribunal (NCLT), Mumbai for initiation of Corporate Insolvency Resolution Process (CIRP) of Mobilox Innovations Private Limited (Mobilox) under Insolvency and Bankruptcy Code, 2016 (the Code).  The NCLT, Mumbai dismissed Kirusa’s application on the ground that Mobilox has issued a Notice of Dispute. An appeal against the NCLT order was filed by Kirusa before the National Company Law Appellate Tribunal (NCLAT). The NCLAT allowed Kirusa’s appeal on the ground that Mobilox’s reply to the demand notice does not raise any dispute within the meaning of Section 5 (6) or Section 8 (2) of the Code, that Mobilox has disputed the payment merely on “some or other account” and that its defence was “vague, got up and motivated to evade the liability”. Accordingly, the NCLAT had set aside the order of NCLT, Mumbai and remitted the case to it for consideration. Mobilox has appealed the NCLAT order with the Supreme Court of India (the Court) to set aside the order of the NCLAT highlighting that there is an “existence of dispute” and therefore the CIRP application has to be dismissed.

Excerpts of the Judgement by the Supreme Court

While passing an order by the Court in relation to aforementioned case in determining “existence of a dispute” occurring in Section 8(2)(a) of the Code, the Court uplifted Mobilox’s appeal holding that there was a dispute in existence which was sufficient to withhold and dismiss the CIRP application filed by Kirusa with the NCLT, Mumbai. Few considerations by the Court before its verdict is discussed below:

Existence of Dispute prior to the Demand notice issued by the Operational Creditor

The Court contented that the CIRP applications filed by operational creditors should be dismissed, in case if it is corporate debtor is able to prove that the existence of the dispute and/or the suit or arbitration proceeding must be “pre-existing” i.e. it must exist before the receipt of the Demand Notice.

Test to be tried by the adjudicating authority and ambit of the “Dispute”

The NCLT, while admitting the CIRP application is only required to identify is whether there is a plausible contention which requires further investigation and that the “dispute” is not a deliberate legal argument or an assertion of fact unsupported by evidence. The Court also contended that, the NCLT while determining whether dispute exists or not, it is not required to satisfy itself that the defence is likely to succeed or examine the merits of the dispute. So long as a dispute truly exists in fact and is not spurious, hypothetical or illusory, the adjudicating authority has to reject the application.

One of the arguments made by Kirusa was that since Non-Disclosure Agreement executed between Kirusa and Mobilox does not fall under any of the three sub-clauses of Section 5(6), no “dispute” is there on the facts of this case. However, the Court rejected the argument and said that the intention of legislature was to make the definition of “dispute” to be an inclusive one and therefore, the word “includes” substituted the word “means” which occurred in the first Insolvency and Bankruptcy Bill. The “dispute” is said to exist, so long as there is a real dispute as to payment between the parties that would fall within the inclusive definition contained in Section 5(6). The correspondence between the parties would show that on 30 January 2015, the appellant clearly informed the Kirusa that they had displayed the Mobilox’s confidential client information and client campaign information on a public platform which constituted a breach of trust and a breach of the NDA between the parties. They were further told that all amounts that were due to them were withheld till the time the matter is resolved. Basis this Mobilox in response to the demand notice, disputed in detail in its reply dated 27 December, 2016, which set out the e-mail of 30th January, 2015. Going by the test of “existence of a dispute”, the Court held noted that without going into the merits of the dispute, the Mobilox had raised a plausible contention requiring further investigation which is not a deliberate legal argument or an assertion of facts unsupported by evidence. The defense is not spurious, mere bluster, plainly frivolous or vexatious. A dispute does truly exist in fact between the parties, which may or may not ultimately succeed, and the Appellate Tribunal was wholly incorrect in characterizing the defense as vague, got-up and motivated to evade liability.

Conflict between “AND” – “OR” in Section 8(2)(a) of the Code

Section 8(2)(a) of the Code reads that the corporate debtor in within 10 days from the date of receipt of Demand Notice from operational creditor, had to bring to the notice of operational regarding the existence of a 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. In this case, the Court has highlighted that the word ‘and’ occurring in Section 8(2)(a) must be read as ‘or’ and also highlighted that the legislative intent and the fact that it will be inconsistent if it is not read as ‘or’. Further, one may note that if the aforementioned section is read as ‘and’, then the corporate debtor could stave off the CIRP only if the dispute is already pending in a suit or arbitration proceedings and not otherwise before the demand notice is received from operational creditor. This would lead to great hardship; in that a dispute may arise a few days before triggering of the insolvency process, in which case, though a dispute may exist, there is no time to approach either an arbitral tribunal or a court. This would cease the right of the corporate debtor available under the said section.

Timelines under the I&B Code – Mandatory

The Court held that the timelines fixed under the Code are intrinsic to the CIRP and are important to its effectiveness. It pointed out that the intention of the legislature is to speedy CIRP and both the NCLT and NCLAT shall be adhere to the timelines prescribed under the Code. The Court, referred to the judgment delivered in Innoventive Industries Ltd. v. ICICI Bank & Anr, wherein, it has clearly laid down that strict adherence of the timelines is of essence to both the triggering process and the insolvency resolution itself. It also stated that one of the principal reasons why the Code was enacted was because liquidation proceedings went on perpetually, thereby damaging the interests of all stakeholders and in which case the management would continue to hold on to the company without paying its debts. Therefore, Court directed both the NCLT and the NCLAT to keep in mind this principal objective sought to be achieved by the Code and to strictly adhere to the time frame within which they are to decide matters thereunder.

Considering above-mentioned points, the Court has set aside the order passed by the NCLAT and rejected the application made by the Kirusa for CIRP.

Conclusion

Since the Code become effective, there were ambiguity and the conflicting interpretation of Dispute and the Existence of Dispute. With the intervention of the Court, there is a clear instruction to the NCLT and NCLAT on the tests to be adopted while entertaining the CIRP application from the operational creditor with reference to the “existence of dispute” and it is hoped that the uncertainties and ambiguities in the Code, would get settled. However, the wide meaning that has been accorded to the term ‘dispute’ may become a shackle around the necks of operational creditors.

It is also pertinent to note that with the clear instruction of the Court in adhering to stricter timelines, it can be expected that the NCLT and NCLAT would take note of the principal objective of the Code as discussed above and completion of CIRP process would be expected within the timeline provided under the Code.

Author: Ashwin Bhat is a Senior Associate with NovoJuris Legal

“Dispute” is heavily disputed under Insolvency and Bankruptcy Code

 Interpretation of ‘Dispute’ in case of application by Operation Creditor

Introduction

Under the Insolvency and Bankruptcy Code, 2016 (“Code”), an operational creditor can initiate a corporate insolvency resolution process (“CIRP”) by filing an application before the jurisdictional National Company Law Tribunal (“NCLT”) upon occurrence of a default in payment of its operational debt under section 8 and 9 of the Code.

Before making an application, the operational creditor shall issue a demand notice or issue a copy of invoice to corporate debtor. Such corporate debtor, within a period of 10 days from the date of receipt of notice, shall either repay the outstanding debt or bring to the notice of operational creditor regarding the existence of any Dispute before any authority.

The term ‘Dispute’ is defined under sub-section 6 of section 5 of the Code. Dispute includes a suit or arbitration proceedings relating to (a) the existence of the amount of debt; (b) the quality of goods or service; or (c) the breach of a representation or warranty;

In case if the operational creditor doesn’t receive either the outstanding payment or notice of existence of dispute, then he can make an application to NCLT to initiate the CIRP.

The ambit of the definition of Dispute is discussed in case of 24thMay17_in_the_matter_of_Kirusa_Software_Private_Ltd_vs_Mobilox_Innovations_Private_Ltd (Company Appeal (AT) (Insolvency) 6 of 2017 dated 24 May 2017 and decided the definition of Dispute under section 5 of the Code.

Facts of the Case

The Appellant had issued a demand notice on Respondent as an operational creditor, demanding payment of certain dues. Respondent issued a reply to the demand notice (“Mobilox Reply”) inter alia stating that there exists serious and bona fide dispute between the parties and Appellant had breached the terms of an NDA between the parties.

Later, the Appellant had filed application with NCLT, Mumbai Bench for CIRP. However, the NCLT rejected application on the grounds that the Respondent has issued a notice to Appellant on the existence of the Dispute. The Respondent in his notice had quoted that the claim of the Appellant is not due and payable as there exist serious and bonafide dispute in case of breach of the terms and conditions of the Non-Disclosure Agreement (the NDA) and divulged the client’s confidential information and the debt has been disputed by the Respondent. Basis this, the NCLT, Mumbai Bench rejected the Application vide its order dated 27 January 2017.

The Appellant challenging the order of NCLT, filed petition with National Company Law Appellate Tribunal (NCLAT) claiming that mere disputing a claim of default of debt cannot be a ground for rejection under section 9 of the Code. The NCLAT observed the definition of Dispute under the Code and it was noted that the definition of dispute is “inclusive” and not “exhaustive”. The same has to be given wide meaning provided it is relatable to the existence of debt, quality of goods or service, breach of representation and warranty. Such dispute cannot be confined to suit or proceedings only.

The question that has arisen before NCLAT is whether a corporate debtor can raise all kinds of disputes or can the notice of dispute only refer to pendency of a suit or arbitration before receipt of the demand notice. The NCLAT also observed the same in case of Mithlesh Singh v/s Union of India (2003) 3 SCC 309 that the intent of legislature is not to limit the dispute to only a pending suit or arbitration proceedings and record of pendency becomes irrelevant if the corporate debtor proves the existence of dispute and there is no default, before the receipt of demand notice under section 8(1) of the Code. The statutory requirement under section 8(2) of the Code is that the corporate debtor must raise dispute with sufficient particulars and such dispute shall be relatable to the existence of debt, quality of goods or service, breach of representation and warranty. It was also noted that mere raising a dispute for the sake of showing existence of dispute, shall not be entertained.

Judgement

Referring to the notice in Form D received from corporate debtor it was held that the Respondent’s notice does not raise any dispute within the meaning of Section 5 (6) or Section 8 (2) of the Code, that Respondent has disputed the payment merely on “some or other account” and that its defence was “vague, got up and motivated to evade the liability”. The NCLAT has set aside the order of NCLT, Mumbai and remitted the case to it for consideration.

Ashwin Bhat, is a Senior Associate with NovoJuris Legal