Conditional Application of Section14(2) of the IBC:Frustrating the objectives of our Bankruptcy Code

The author is Anushka PS, second year BA.LLB (Hons.) student at the National Law School of India University, Bangalore.

The Indian Bankruptcy and Insolvency Code of 2016 (“the IBC”) seeks to consolidate the laws concerning the resolution of corporate insolvency in India. Its provisions are designed to assist in the maximization of the corporate debtor’s assets and thereby facilitate a time-bound resolution of the insolvency process.

Essential Services during the Moratorium: To Pay or Not to Pay?

In furtherance of this objective, Section 14 of the IBC mandates the Adjudicating authority to declare a “moratorium” on the institution and continuation of various suits or proceedings detrimental to the corporate debtor’s property interests. Simply put, the debtor will be exempt from all pecuniary proceedings against its property in the moratorium period. This enables the debtor to discharge outstanding debts on its property. As the Supreme Court has succinctly postulated in P. Mohanraj v Shah Brothers Ispat Ltd, Section 14 is intended at “shielding the corporate debtor from monetary attacks so that it gets the breathing space to continue as a ‘going concern’ and ultimately rehabilitate itself.” The court further observed that fissures in this shield emanating from interpretation had to be avoided to prevent adverse effects on the objective of Section 14.

Section 14(2) provides that the supply of essential goods and services “shall” not be terminated during the moratorium period. The overarching idea is that the debtor will manage his operations smoothly using these services during his insolvency resolution. Regulation 32 of the CIRP Regulations defines ‘essential services’ to include electricity, water, information and telecommunication services. Section 14(2) is worded in mandatory language- this stems from the fact that these services are essential to maintain the value of the corporate debtor.

Section 14(2A) of the IBC: No Impediment to Section 14(2)

The IBC was amended in 2020 to include Section 14(2A), which provides that when a resolution professional “considers certain services to be critical to the protection and preservation of the value of the corporate debtor, the supply of such services would not be terminated except where the corporate debtor has not paid the dues arising from such supply during the moratorium period.” That is, the continued supply of critical services requires due payment by the debtor, failing which the supply would be terminated. On a prima facie consideration, this section may be interpreted as limiting the application of Section 14(2).

This view is mistaken for one primary reason- the payment of dues for essential services “during the moratorium period” would deplete the value of the corporate debtor’s assets and hamper the resolution process. Further, it will offend the objective of the IBC- the protection of the corporate debtor’s assets for a timely discharge of its debts. Therefore, it is apt to posit that Section 14(2) has an unconditional application, unaffected by Section 14(2A)’s requirements.

In that light, I will argue that judicial interpretation of Section 14(2) of the IBC is pervaded by confusion and inconsistency, with courts failing to gauge the unqualified nature of this provision. Second, I will demonstrate that this judicially introduced element of conditionality bears the potential to undermine the IBC’s overriding objective, that is, securing the assets of the corporate debtor during the insolvency process.

Shailesh Verma: The Pinnacle of Judicial Confusion

The 2022 NCLAT decision in Shailesh Verma v Maharashtra State Electricity Distribution Co. Ltd is an apposite example of judicial ineptitude in interpreting Sections 14(2) and 14(2A). Here, the Tribunal was concerned with the issue of whether the Maharashtra State Electricity Distribution Company Ltd. (“MSEDCL”) could be compelled to continue providing electricity to Lavasa Corporation during its moratorium period while its outstanding dues remained unpaid. The answer was predicated upon the interpretation of 14(2). On the one hand, if the Tribunal took 14(2) to be unconditional in its application, MSEDCL would be constrained to continue electric supply in the moratorium without Lavasa being required to discharge its outstanding dues. However, on the other hand, if the Tribunal infused 14(2A) requirements into 14(2), electric supply would be conditional upon Lavasa discharging its dues.

It is pertinent to note that the service in question was of electric supply, electricity being mentioned as an “essential” service in Regulation 32 of the CIRP Regulations. Regulation 31 specifies that the amount due to essential service suppliers falls under the scope of “insolvency resolution process costs” in the IBC. Section 30(2) of the IBC provides that such insolvency resolution process costs would be covered by the resolution plan approved by the adjudicating authority. When an amount is designated under the resolution plan as per Section 31, it has to be transferred to the creditor only after the retraction of the moratorium. A cumulative reading of these provisions indicates that no monetary transfer needs to be effectuated during the actual moratorium. Consequently, it is evident that Section 14(2A) applies only to “critical” services not mentioned in Regulation 32- it does not apply to electric supply. Thereby, the Tribunal ought to have reaffirmed the unconditionality of Section 14(2).

However, contrarily, the court adopted the second prong of reasoning. By citing the object and purpose of Section 14(2A) as being the “filling up of critical gaps in the insolvency framework,” the Tribunal interpreted 14(2) by supplementing it with Section 14(2A). While it is true that Section 14(2A) seeks to fill a critical gap, the gap pertains merely to the supply of materials other than “essential services” which are still deemed necessary by the resolution professional to maintain the debtor as a going concern. Otherwise, there would be no determinable reason for Parliament to define exhaustively in Regulation 32 as to what precisely can be considered an essential service. Such incorrect reasoning has been adopted by the NCLAT in Damodar Valley Corporation v Dimension Steel and Alloys. Nevertheless, in this case, the allocation of funds in the resolution plan was violative of the West Bengal Electricity Regulations, and thereby the resolution plan was held wholly ineffective (Section 238 of the IBC).

Upholding the Objective of our IBC

The correct position was highlighted in Executive Engineer Uttar Gujrat v Devang Samapat. The issue was whether Uttar Gujrat was entitled to claim dues for electric supply during the CIRP period. Here, electricity was being used to manage the operations of the corporate debtor. The NCLAT astutely opined that the use of electricity for running the office of the debtor could not be qualified by Section 14(2A). This holding prioritises the objective of the IBC and ensures the protection of the debtor’s assets.

This unconditional interpretation is also consonant with the overbroad interpretation that Alchemist Asset Reconstruction v Hotel Gaudavan has given to “proceedings” under Section 14. The Supreme Court held that all debt-recovery proceedings against the debtor were prohibited during the moratorium period. In Power Grid Corporation v Jyoti Structures, the Delhi HC held that proceedings that “favoured the corporate debtor” were allowed during the moratorium period. Referring to Innovative Industries v ICICI Bank Ltd, the Court postulated that the “objective of the IBC is to provide relief to the corporate debtor through a standstill period in which all its assets are protected from all dissipation and diminution.” As has previously been stated in this blog, this judgement emphasised the importance of adopting interpretations which advance the objectives of the IBC rather than defeating it. Consequently, all proceedings detrimental to the corporate debtor’s interests are precluded during the moratorium.

Conclusion

Therefore, when essential services are necessary to maintain the corporate debtor, the corporate debtor should not be harassed to pay the outstanding dues during the moratorium itself. Rather, the resolution plan must contain a provision towards such payment, with the dues being transferred after the moratorium lapses. Section 14(2A) should be applied to services not deemed by the legislature to be “essential,” but still important to the corporate debtor. Shailesh Verma and Damodar Valley Corporation bear the potential to defeat the objectives of our Insolvency Code. It is therefore pertinent that our adjudicating Tribunals exercise keen insight both into the comprehensive structure of the IBC and into the holdings in previous cases.