Legal Implications of Increasing The Threshold Under The Insolvency And Bankruptcy Code, 2016

By Anubhav Sinha and Sreemantini Mukherjee
(The authors can be contacted at anubhavsinha90@gmail.com and sreemantini97@gmail.com or at 9830161450)

 

The nationwide lockdown to control the rapid spread of the Corona virus has led to suspension of businesses and disruption of payment atoms. Several policies have been implemented by the Central Government to deal with the emergent situations. At the regulatory level, the Central Government has published a notification which has changed the pecuniary jurisdiction of the National Company Law Tribunal(s) by changing Section 4 of the Insolvency and Bankruptcy Code, 2016 (Notification dated 24th March, 2020). The Ministry of Corporate Affairs has raised the threshold of default to rupees 10,000,000 (one crore) from rupees 1, 00,000 (one lakh).

This article discusses the legal implications of the notification on the pending cases, remedies available for the creditors and the impact this notification may have on the small scale creditors. It further discusses the constitutionality of the said notification.

 

Notification dated 24th March, 2020

On 24th March, 2020, the Government of India published a notification in exercise of its powers under Section 4 of the Insolvency and Bankruptcy Code, 2016 (‘IBC’) wherein the minimum amount of default for the initiation of Corporate Insolvency Resolution Process (‘CIRP’) was increased from the previously existing threshold of rupees one lakh to rupees one crore.
The notification states:

“In exercise of the powers conferred by the proviso to section 4 of the Insolvency and Bankruptcy Code, 2016 (31 of 2016), the Central Government hereby specifies one crore rupees as the minimum amount of default for the purposes of the said section.”

The notification has effectually amended Section 4 of the IBC which earlier stood as follows:

“4. (1) This Part shall apply to matters relating to the insolvency and liquidation of corporate debtors where the minimum amount of the default is one lakh rupees:
Provided that the Central Government may, by notification, specify the minimum amount of default of higher value which shall not be more than one crore rupees.”

The aforesaid notification does not contain a date from which it is to be effected. It further does not contain a saving clause in favour of the pending cases. The effect of the notification in other words, is that the pecuniary jurisdiction of every National Company Law Tribunal to assume jurisdiction would be rupees one crore and above. The change in the pecuniary jurisdiction of the tribunals present certain important issues of law which has been discussed hereinbelow:

 

1. Is the minimum amount of default inclusive of the interest on the principal amount?
The notification does not clarify whether the minimum amount of default is only the principal amount. There can be two situations that may arise.
First, if the chargeable rate of interest is already conceived in the contract or invoice, debt will include the principal amount along with the interest due thereon. This position has been upheld by the National Company Law Tribunal in Gulf Oil Lubricants India Ltd. v. Eastern Coalfields Ltd.
Secondly, if the contract or invoice does not provide for any stipulated rate of interest, then it cannot be included within the understanding of debt. Otherwise, a party by charging a huge rate of interest, may proceed to admit the dispute under the Insolvency and Bankruptcy Code. For example, A commits a default of principal amount of rupees twenty lakhs. B, the operational creditor charges compound interest at the rate of 300% on the principal amount. In such scenario, the total amount of default i.e the principal amount along with interest due thereon is more than one crore. Thereafter, B proceeds against A before the National Company Law Tribunal. Such action would constitute fraud and further defeat the purpose of the notification.

The understanding of “debt” under section _ of the IBC, therefore, cannot be understood to include interest due on the principal amount unless the chargeable rate of the same is already provided under the contract and/or invoice.

 

2. What is the legal implication of the notification on pending cases?
The general principle of law is that if the pecuniary jurisdiction of a judicial body, more particularly of a tribunal or court, is altered then the pending cases below the new threshold cannot be adjudicated by that forum. In case the alteration is unconditional and without a saving clause in favour of the pending cases, all actions which does not fulfill the requirements of pecuniary jurisdiction must stop and if final relief has not been granted before the alteration of pecuniary jurisdiction takes effect, it cannot be granted afterwards. As such the change shall have retrospective effect. (Kolhapur Canesugar Works Ltd. V. Union Of India (2000) 2 SCC 536, Motichand Jain vs M. Jaikumar And Ors. 2004 (1) A.P.L.J 269 (HC), Pandit Gopalkrishna Sharma v. Pandit Bhagirath Prasad Sharma, 1997 (2) MPLJ 587, Tukaram Pandurang Gaikwad v. Smt. Hababi Eabumiya Shaikh & Ors. 1999 SCC OnLine Bom 885). As a matter of practice and prudence a “saving clause” usually accompanies a pecuniary jurisdiction change. Such a clause allows the tribunal and /or court to continue hearing the matters which were already pending before it even if the same do not meet the new threshold. A “saving clause” may also provide for a different court or judicial body in which pending matters may be transferred. The aforesaid notification while raises the minimum amount of default from rupees one lakh to rupees one crore, it does not provide for a “saving clause” in favour of the pending cases in which the amount of default is less than one crore. In such circumstances, the tribunal being a creature of a statute will not have pecuniary jurisdiction to decide the disputes already submitted before it.

 

3. Will the National Company Law Tribunal(s) continue to have exclusive jurisdiction for all company matters?

The Hon’ble Supreme Court in Shashi Prakash Khemka v. NEPC Micon, (2019 SCC OnLine SC 223) followed by the National Company Law Appellate Tribunal in MAIF Investment India PTE Ltd. v. Ind- Barath Power Infra Ltd., (2019 SCC OnLine NCLAT 203) held that the the National Company Law Tribunal has exclusive power to decide all disputes relating to any company and parties are barred from filing any civil suit to that effect. The general proposition put forth by the aforementioned judgements remained true with respect to other remedies available under the companies Act. But the remedies under section 7 and 9 of the IBC would henceforth have a threshold of rupees one crore and above. All parties having a claim below rupees one crore would have to resort to other judicial remedies.

 

4. What are the remedies available for creditors at this juncture?
In the present circumstances, the creditors will be constrained to resort to pre- existing remedies for amount of default which is below one crore. The available remedies are,

i) Arbitration: One of the most effective and comparatively speedy remedy, which the creditors can resort to is arbitration, provided that the agreement contains a clause to that effect. The arbitration can often be expensive and small scale creditors may not be able to sustain the same. After the 2015 the time limit

ii) Dispute resolution mechanism provided under Section 18 of the Micro, Small and Medium Enterprises Development (MSMED) Act, 2006: The dispute resolution mechanism under Micro, Small and Medium Enterprises Development (MSMED) Act, 2006 is available to parties who are registered under the said Act. Section 18 of the MSMED Act provides for a dispute resolution mechanism through conciliation and thereafter, arbitration failing conciliation. The practice of the MSME facilitation council often derelicts from the Arbitration and Conciliation Act, 1996 inasmuch as the same persons act as both conciliators and arbitrators and often confidentiality of the conciliation proceeding is compromised. An award passed by facilitation council with all such procedural irregularities may be set aside by courts under section 34 of the Arbitration and Conciliation Act, 1996. The benefit of this dispute resolution mechanism is that many matters gets settled during the conciliation process. A second advantage is that the MSMED Act allows for 24% interest rate over the principle due (section 16).

iii) Commercial Suit: Filing a commercial suit, if the amount of default is above three lakhs under the Commercial Courts Act, 2015 is a remedy available to the creditors. Initially, the value of the subject matter of the suit was required to be one crore rupees. However, the amendment of 2018 has lowered it to three lakhs. The real challenge is that the judicial officers presiding over the commercial courts have all been elevated from the subordinate judiciary. Practical experience shows that the learned judicial officers do not have sufficient experience with commercial matters and there is no certainty that commercial courts would be able to provide a quick and cost effective judicial remedy.

 

5. What can be the effect of the notification on small scale creditors?
The alteration of pecuniary jurisdiction has blocked avenues for MSME creditors, sole proprietorships from taking on defaulting firms with deeper pockets. This notification, in effect, may end up protecting certain habitual defaulters. Small and medium businesses may consider immediate registration under the MSMED Act and further firm up their contractual clauses. It is however important to note that there is a disagreement between different High Courts as to application of an Arbitration Clause when the remedy under MSMED Act is available. The High Court at Calcutta has taken a very restrictive view that even in the presence of an independent arbitration clause the MSME Facilitation Council would have jurisdiction. Many other High Courts have, however, taken the view that an independent arbitration clause shall overwrite the jurisdiction of the MSME Facilitation Council. If a party wants to avail the remedy under the MSME Act as a measure of caution it should not agree to arbitration clause in its contract.

 

6. Is the recent notification unconstitutional?
The argument against the notification stems from the idea that it creates a class within a class. Following this chain of argument it has been suggested that the notification may be contrary to the Article 14 of the Constitution. A pecuniary limitation does not in any matter create classes within a class. It is to be remembered that a pecuniary limit was already present and the same has only been enhanced. The code itself, under the proviso of section 4, recognises the right on the Central Government to alter the minimum amount of default which shall not be more than one crore rupees. The notification has not created any new class or a sub class within a class. It has merely narrowed scope of the class which is already existing. Therefore, the contention that the notification is unconstitutional on the ground of arbitrary and unreasonable classification is not tenable in law.

 

Conclusion
The present circumstances necessitate that the parties assess and allocate risk with regard to repayment before initiating a commercial venture. Even though the threshold of the pecuniary limit under the Insolvency and Bankruptcy Code has been raised, other judicial remedies can be availed. At the present juncture, it is advisable that the companies, proprietorships and small vendors should assess repayment risk before initiating a commercial transaction and accordingly secure payments by execution of commercial documents in the nature of bank guarantee, letters of credit etc.

Application of Force Majeure clauses in India in reference to Covid- 19

By Anubhav Sinha and Sreemantini Mukherjee

(The authors can be contacted at anubhavsinha90@gmail.com and sreemantini97@gmail.com or at 9830161450)

 

The rapid outbreak of the Corona virus and the nationwide lockdown for efficient control of the same has posed significant challenge in the corporate world. Several projects have come to a pause due to the restriction necessitated. In such a scenario, the courts are anticipated to be flooded with contentious proceeding invoking the force majeure clause or the doctrine of frustration.

 

Force majeure: In General
The concept of force majeure is found in Civil Law. It is neither recognised under the common law nor under the Indian Law. Force majeure as a law infact reprieves a party to a contract from discharging its contractual obligations on occurrence of an unforeseen event. Force majeure can be invoked in India only if the contract specifically incorporates a force majeure clause. A force majeure clause typically spells out specific circumstances or events, which would qualify as force majeure events and conditions which would have to be fulfilled for such clause to come into effect. It is a contractual provision allocating the risk of loss if performance becomes impossible or impracticable, especially as a result of an event that the parties could not have anticipated or controlled.

 

Force majeure in India

Force majeure as a concept of general substantive law has not been accepted by courts in India.
In several judgements, including, Satyabrata Ghose v. Mugneeram Bangur & Co (1954 SCR 310: AIR 1954 SC 44) and Energy Watchdog v. CERC((2017) 14 SCC 80 : (2018) 1 SCC (Civ) 133), the Supreme Court has taken a restrictive understanding opining that an affected party was only entitled to remedies provided under the law of frustration as embodied under section 56 of the Indian Contract Act, 1872 or under any applicable contractual clause. This would indicate that application of a broader understanding of force majeure is subject to specific terms and definitions which may be contained in a particular contract. In the absence of a contractual provision parties have to trace their reliefs within the ambit of section 56 of the Indian Contract Act.

 

Government Force majeure Notifications
Present day commercial contracts usually contain elaborate force majeure clauses clearly indicating all probable situations in which a party may be able to take benefit. The sudden outbreak of the Corona virus has led to nationwide lockdown and several commercial projects have come to a halt due to the restrictions. The Ministry of Finance, Government of India has published a notification dated 19th February, 2020 which states

“A doubt has arisen if the disruption of the supply chains due to spread of corona virus in China or any other country will be covered in the Force Majeure Clause (FMC). In this regard it is clarified that it should be considered as a case of natural calamity and FMC may be invoked, wherever considered appropriate, following the due procedure….”

Similar notification has been published by the Ministry of New & Renewable Energy and the Ministry of Shipping on 20th March, 2020 and 31st March, 2020 respectively.

The aforesaid notifications may not strictly apply to private contracts. However, it indicates the legislative to characterise the current situation as an emergency and to be treated as a force majeure event in general. It must be noted that the wordings used in the office memoranda and the notifications point towards force majeure clauses contained in a contract, whereby, the legislative intent not to declare a substantive law of force majeure but only provide relief in cases where a force majeure clause already exists.

 

Judicial Interpretation

The aforesaid notification of 19th February, 2020 came up for consideration in matters relating to the invocation of letters of credit and bank guarantees before the High Court at Bombay and the Delhi High Court. Curiously, the High Courts differed in their approach with regard to the application of the aforesaid notification and as such reached divergent conclusions.

The High Court at Bombay, in the case of Standard Retail Private Limited v. G. S Global Corp., refused to grant an order restraining the respondent bank from encashing letters of credit on the ground of force majeure. The sellers had already shipped the steel and steel products from South Korea. The Hon’ble Court refused to grant an injunction for inter alia, on the ground that the lockdown was for a limited period and the petitioners cannot obtain protection under the force majeure clause to resile themselves from making payment to the respondent for services already rendered. The Court further refused to grant an injunction on the ground that letters of credit are an independent transaction with the bank, and the bank are not concerned with the dispute between the buyer and the seller. Surprisingly, the court failed to appreciate that the current situation of the country amounts to a natural calamity (as per Government notification) and in such an event special equities exist under which the court could restrain the respondent bank from encashing letters of credit. In our view, the interpretation advanced by the Hon’ble Court is impractical and warrants reconsideration.

The Delhi High Court, however, granted an injunction in M/S Halliburton Offshore Services Inc v. Vedanta Limited & Anr, where the petitioner sought to restrain the respondent from encashing eight bank guarantees issued in its favour to secure the performance of obligations under a contract to drill petroleum wells. Rejecting the contention that courts could stay the invocation of bank guarantees only in exceptional circumstances, the Delhi High Court observed that in cases where special equities exist, the court is empowered, in a given set of facts and circumstances, to injunct invocation, or encashment, of a bank guarantee.

On the issue whether special equities can be said to exist during the lockdown, the Hon’ble Court observed that the countrywide lockdown is prima facie in the nature of force majeure and such event is unprecedented, and was incapable of having been predicted either by the respondent or by the petitioner. It was further held that prima facie covid 19 lockdown and its extended ramification are in the nature of special equities and the same would operates as a justification to injunct the respondent from invoking the bank guarantees.

 

Conclusion

A difference of opinion exists among the two Hon’ble High Courts in India, on the issue whether the nationwide lockdown due to the outbreak of corona virus and its extended ramifications constitute special equities. In our view the legislative intent is extremely clear that benefits of force majeure clauses should readily be granted to parties to a contract. In current economic scenario it is imperative that courts take a more liberal view in sync with Government economic policy rather than follow strict legal constructions. We do not suggest that the laws of bank guarantee and/or letters of credit injunctions need to be watered down in any manner whatsoever. However, in sync with the government policy, a departure is required during the force majeure period. We are also mindful of the fact that there are many bank guarantees which may expire during the length of the lockdown period and/or during the course to which the force majeure period extends.

It may be argued that in such circumstances it may become imperative for the court to decline an order of injunction for otherwise the beneficiary of such bank guarantee and letters of credit would loose an important monetary right. In this regard, the Hon’ble courts may borrow a jurisprudential strain which has been embodied in the COVID- 19 (Temporary Measures) Act, 2020 of Singapore. A condition precedent for any party to gain an injunction against the invocation of a bank guarantee and letter of credit is to first extend the period of such bank guarantee or letters of credit. Our civil courts have inherent power to make any order of injunction conditional.

Thereby the courts can ensure that the applicant before it would be under an obligation to extend bank guarantee and/or letters of credit for such period as may be directed by the court. This will ensure that no respondent is unduly prejudiced during the period of operation of the applicable force majeure clause. The courts, thereby, must not construe the provisions and remedies available under the law in a narrow manner at the present situation for the same will result in an unrealistic commercial approach. The courts must, on prima facie satisfaction that the default occurred due to applicable force majeure conditions should grant remedies to protect applicant parties till the restrictions imposed are lifted and the situation becomes normal.