The Corporate Death Principle and IBC: At crossroads?

Subham Bhut is a Legal Counsel at Tata Consultancy Services Limited.

Introduction

One of the laws which has been a subject of continuous judicial contention is the Insolvency and Bankruptcy Code, 2016 (“IBC”). Since its inception, the Supreme Court (“SC”) has been keen on making it workable towards its ultimate goal of insolvency resolution and value maximization of Corporate Debtor (“CD”) in a timely manner. In one of such attempts in the Gujarat Urja Vikas Nigam Ltd. v. Mr. Amit Gupta & Ors. (the “Gujarat Judgment”) the SC laid down the “Corporate Death” principle with the motivation to give a breathing life to the CD during the Corporate Insolvency Resolution Process (“CIRP”). The principle basically entails that where a CD is subject to CIRP, any contract (not limited to those contemplated under Section 14 IBC) which is crucial to its survival as a going concern in a manner that if it were terminated, it would make its corporate death certain, cannot be allowed to be so terminated by the other contracting party during the CIRP. The SC located this principle within National Company Law Tribunal’s (“NCLT”) jurisdictional powers under Section 60(5)(c) of IBC which provides that NCLT shall have the jurisdiction to dispose of any question of law or fact relating to CIRP or Liquidation Proceedings of CD and Corporate Persons.. In the same pursuit, it held that Section 14 of IBC is not the only exhaustive provision dealing with protective measures to be extended to the CD during CIRP and the NCLT has got wide extensive powers under Section 60(5)(c) to go beyond that. This principle has got even stronger foothold in the recent case of Tata Consultancy Services Ltd. v. Vishal Ghisulal Jain, Resolution Professional S.K.Wheels Pvt. Ltd. (“TCS Judgment”).

This article argues that the Corporate Death principle laid down in the Gujarat Judgment (which is the foundational authority for this principle) is bad in law on three grounds. First, Section 60(5)(c) of IBC is merely a procedural provision. It does not grant any inherent powers to the NCLT to go beyond the substantive provisions of IBC. Second, Section 14 of IBC (being the relevant substantive provision in questions relating to moratorium) is exhaustive law on the point of granting protection to the CD in the nature of “moratorium” during CIRP. The eventuality sought to be remedied by the SC through the Corporate Death principle is “casus omissus” and may be addressed through legislation, not adjudication. Third, not only that the Corporate Death principle does not find any support from the text of IBC (as per the earlier points), assuming that the SC was discharging its duty as a Constitutional Court and interpreting the law (i.e. IBC) widely beyond its text in order to further the purpose of insolvency resolution, while it invented a new species of moratorium protection in the form of the Corporate Death principle, it failed to retain in this principle that sound balance which is reflected in the entire scheme of moratorium protection in IBC (Section 14(2A) and 14(1) provide for Resolution Professional to pay off current dues to the supplier of critical goods and services and to Government for continuance of license, permit, grant etc.). This is also reflected in the peculiar facts of the Gujarat Judgment itself (as explained later) where the SC, by creating this principle, gave extreme significance to the “going concern” status of the CD at the cost of the other contracting party i.e. GUVNL (in that case) thus causing it serious prejudice. Thus, in matters of moratorium protection to which the Corporate Death principle as a species belongs, the principle is neither coherent in letter nor in spirit of IBC.

Background

In the TCS Judgment, Tata Consultancy Services Ltd. (“TCS”) terminated the “Facilities Agreement” (“Agreement”) entered with S.K. Wheels Pvt. Ltd. (“SKWPL”) on account of serious breach of SKWPL’s obligations under the Agreement. However, the termination notice was sent at a time when SKWPL was going through CIRP. SKWPL filed a Miscellaneous Application before the NCLT under Section 60(5)(C) IBC praying to quash the termination notice alleging no occurrence of breach on its part and improper termination by TCS. The NCLT stayed the termination notice and asked TCS to comply with the Agreement. The National Company Law Appellate Tribunal (“NCLAT”) affirmed NCLT’s order.

On appeal, the SC set aside the orders of both the NCLT and the NCLAT on the ground that the issue of termination of the Agreement in the present case was solely on account of breach by SKWPL of its contractual obligations, which is in no way related to IBC . However, in order to clarify the law in this regard, the SC reiterated its ruling in .the Gujarat Judgment, and held that NCLT has wide discretionary powers under Section 60(5)(c) IBC, to adjudicate disputes related to insolvency and bankruptcy even involving contractual terminations, including the power to restrain such terminations, provided such contract was crucial to the survival of the party who is the Corporate Debtor and such termination, if allowed, would certainly lead to its corporate death (the “Corporate Death” principle). This according to the SC, is corollary to the residuary power of NCLT under Section 60(5)(c) for serving one of the main purposes of IBC i.e. to ensure that the CD remains a “going concern”. In order to protect CD, this power, it held, need not be confined to the grounds specified under Section 14 of the IBC.

However, such extremely wide interpretation of Section 60(5)(c) IBC by the SC in the Gujarat Judgment (as also reaffirmed in the TCS Judgment), not only sits in the teeth of the provisions of IBC but it is also beyond the legislative intent itself.

Section 60(5)(c) IBC - a procedural provision simplicitor

Section 60(5)(c) IBC simply consolidates the jurisdiction of NCLT over matters of insolvency resolution or liquidation. As noted by the SC itself in the Gujarat judgment (para 67), existence of multiple forums dealing with insolvency and bankruptcy prior to IBC led to inordinate delays and huge expenditure by the CD, thus, diminishing the value of its assets and frustrating the prospects of a successful resolution, or liquidation. To address this, IBC was enacted embodying a single, unified legislation dealing with insolvency and bankruptcy, providing an exclusive forum(‘NCLT’) to expeditiously resolve the insolvency process and ensure maximization of value of assets of the CD.

Thus, Section 60 (being a procedural provision and not a substantive one) simply provides for exclusivity of territorial as well as subject-matter jurisdiction of NCLT over other forums in matters of insolvency. Questions like how such jurisdiction may be exercised i.e. the manner, scope and extent of NCLT’s power, do not have their answer in Section 60. Rather, the answer lies in other provisions of IBC which are substantive in nature and pertaining to the questions of fact and law at hand. Here the SC’s decision in the Gujarat Judgment that by virtue of its wide powers under Section 60(5)(c) IBC, the NCLT can restrain a party from terminating a contract where such termination if allowed, would make certain the death of the other party i.e., the CD, is absolutely beyond the legislative contemplation and de hors the legislative prescription in Section 14 IBC (as explained in the next section), a provision which exhaustively deals with all ways in which moratorium or protection may be extended to a CD facing CIRP (a substantive provision pertaining to questions of law and fact related to moratorium).

Therefore, NCLT cannot exercise its jurisdictional powers under Section 60(5)(c) of IBC in a manner not intended or provided by the legislature (as explained in the next section).

SC going beyond Section 14 IBC in order to fill up a casus omissus

Section 14 of IBC exhaustively lays down the specific circumstances wherein the protective cover of moratorium would apply. These include prohibition on initiating or continuing any suit or proceeding against the CD before any court, tribunal, arbitral panel etc, enforcement, recovery or foreclosure action of any security interest by the CD, any transfer or disposal by the CD of its property or rights, any action to recover property where the CD is the lessee etc. The moratorium protection also extends to protecting the CD from termination of any permit, grant, license, concession etc by the Government on the ground of insolvency and from termination of any contract of supply of critical goods and services to the CD on the same ground provided the CD pays all the present Government fees and charges of the supplier getting due during the CIRP. The case contemplated by the Corporate Death principle does not fall within any of them.

In the Gujarat Judgment, GUVNL (the Appellant in that case) was the sole customer/consumer of Astonfield Solar (Gujarat) Pvt. Ltd. (the CD in that case) (“Astonfield”) by virtue of the Power Purchase Agreement (PPA) entered between them.The PPA was a commercial contract between GUVNL and Astonfield and not a form of license, permit, registration, quota, concession, clearance, grant or similar right to Astonfield in exchange of a particular amount of dues or fees. Neither was GUVNL a supplier of essential / critical goods or services to the CD. Rather on the contrary, GUVNL was itself the customer or the consumer of the solar power supplied by Astonfield. In other words, it is a case where Astonfield i.e. the CD is indeed the supplier of goods and services (solar power) to the other party i.e. GUVNL. Thus, the decision of the SC in prohibiting GUVNL from terminating the PPA and compelling the continuance of a contract with the CD was de hors the text of IBC which is exhaustive on this point.

The UNCITRAL Legislative Guide on Insolvency Law from which IBC has drawn fundamentally, permitted ipso facto contractual clauses to be overridden by the insolvency law (in other words, restraining termination of contract with the CD during pendency of its insolvency process) provided that any resulting negative impact must be mitigated by providing compensation to the counter-party (i.e. the other contracting party) (para 118).

Notwithstanding this recommendation, the Parliament (and also the Bankruptcy Law Reforms Committee) opted it in a narrow manner covering only contracts with suppliers of essential / critical goods and services and grants, licenses, concessions, quotas etc given by the Government but not consumer/ commercial contracts such as the PPAs.

A casus omissus (a case overlooked by the legislature) cannot be supplied by the court except "in the case of clear necessity and when reason for it is found in the four corners of the statute itself". Such necessity arises when “literal construction of a particular clause leads to manifestly absurd or anomalous results, which could not have been intended by the legislature”. The present decision of extending moratorium protection to the CD through continuance of the PPA where the CD is rather a supplier of goods and services to the other party, is indeed a case squarely unintended by the legislature if Section 60(5)(c) and Section 14 were to be literally construed. Thus, it is not the literal construction of Section 60(5)(c) and Section 14, but the judicial imposition of the Corporate Death Principle that leads to absurd and anomalous results completely unintended by the legislature. Thus, the SC’s approach is more of a legislative nature which is unwarranted.

Ensuring “going concern” status of the CD through the Corporate Death principle - Is it absolute and unqualified?

The SC’s one-sided approach of solely focusing on Astonfield’s “going concern” status in isolation to GUVNL’s legitimate rights resulted in causing serious prejudice to the latter. This, coupled with the absence of adopting any mitigating measures tends to offend the balanced scheme of moratorium protection as envisaged in the IBC.

A. The prejudice caused to GUVNL-

The SC noted in the Gujarat judgment, that as per the 2nd tariff order passed by GERC, GUVNL had to pay Rs. 9.98 per unit for first 12 years and Rs. 7 per unit for next 13 years respectively. In such type of fixed-price mechanism, the PPA price is higher than the utility rate (market rate) at the beginning. However, in the course of time, such utility rate is expected to overtake the PPA price so that it generates positive long term savings for the buyer (here GUVNL) over the entire life of the contract. In this case, GUVNL agreed to pay a higher tariff in the first 12 years and then a lower tariff in the next 13 years. This manifests GUVNL’s intention to avail solar power at cheaper prices in the next 13 years keeping in mind the future rise in market prices. This commercial benefit on the part of GUVNL is one of its main reasons to enter into a long term PPA.

However, once Astonfield became subject to CIRP under IBC, the possibility of continuing its obligations under the PPA and concomitantly, the scope of supplying power at cheaper rates to the appellant in future seriously came into question. It struck at one of the core commercial benefits to be derived by GUVNL under the PPA.

Adding to the miseries of GUVNL was the fact that the SC’s decision has compelled it to pay the current higher tariff i.e. Rs. 9.98 per unit (higher than the low market rates prevailing during 2017-19- see GERC Solar Tariff Order,2015 at Pg-15, MW scale ) for the supply of solar power during the entire CIRP despite the current state of ambivalence as to whether it can makeup in future by getting power at cheaper rate if Astonfield survives.

Thus, it can be inferred that GUVNL is seriously prejudiced by the decision of the SC restraining it from terminating the PPA because it is completely uncertain whether the extra price (i.e. the difference between the higher tariff for first 12 years as agreed in PPA minus the current market rate) which it has to pay for buying solar power from Astonfield can be definitely compensated by gaining an equivalent or more amount of money by supply through the cheaper rate agreed for the next 13 years. And the onslaught of COVID-19 has exacerbated this uncertainty exponentially.

B. Failure to mitigate the prejudice and consequent imbalance-

Also the SC did not consider the suggestions of the UNCITRAL Legislative Guide on Insolvency Law (explained earlier) in respect of providing compensation to the counter-party (here GUVNL) to mitigate its loss/ serious risk of loss, in particular requiring the insolvency representative to guarantee payment or performance to the counter party, such as through a bank guarantee or letter of credit or the personal liability of the insolvency representative for performance (para 133).

This is even contrary to the spirit of moratorium under Section 14 wherein the Government and the supplier of such goods/services which are critical to protect and preserve the value of the CD, at least get the monetary equivalent of what they had expended towards the CD during the moratorium period i.e., current dues being paid by Resolution Professional (RP).

Therefore, even though the Corporate Death principle is beyond the text of IBC in matters of moratorium protection, the SC while exercising its extra-ordinary jurisdiction as a Constitutional Court could definitely have adopted this principle in a more coherent, harmonious and balanced manner by suitably accommodating the contractual and commercial interests of the other contracting party so that resolution of one does not come at the cost of the other but on the continued progress of both.