1. Operational creditors & dispute threshold

Operational creditors & dispute threshold

The scheme for admission of an insolvency petition is different for financial creditors and operational creditors.

Published: September 27, 2017 4:35 AM
NCLT, IBC, Supreme Court, CIRP, NDA, corporate debtors,  insolvency laws,  financial creditors, operational creditors On the receipt of the said demand letter, the corporate debtor can get out of the clutches of IBC if it can show that a dispute existed between the parties prior to the receipt of the demand letter.

Abir Roy

The scheme for admission of an insolvency petition is different for financial creditors and operational creditors. While financial creditors can directly approach the NCLT in case of default in payment of debt, operational creditors must first serve a demand notice to the corporate debtor stating that the debtor has committed a default in debt. On the receipt of the said demand letter, the corporate debtor can get out of the clutches of IBC if it can show that a dispute existed between the parties prior to the receipt of the demand letter. The Supreme Court noted that the difference in the mode of admission stems from the clauses annexed to the insolvency Bill which noted that operational debts tend to be of smaller amounts, recurring in nature and chances of debt being disputed is higher.

There are multiple definitions under IBC that are relevant for admission of a petition: (1) default means non-payment of debt; (2) debt means payment due and payable in respect of claim; (3) claim means right to payment, even if it is a disputed right. Thus, the scheme of IBC provides that debt can be of a disputed claim. Thus, a financial creditor can initiate a CIRP even if it’s based on disputed debt; the operational creditor does not have that leeway. Dispute has been defined under IBC to include suit or arbitration proceedings in relation to existence of debt, quality of goods or service or breach of representation or warranty. There were interpretational issues as what is a “dispute” and when does it deem to “exist” for admission of a claim under IBC in relation to an operational creditor?

The relevant facts before the Supreme Court were as follows: The corporate debtor, who was engaged for conducting tele-voting for the dance programme, entered into an arrangement with the creditor to provide toll-free numbers through which viewers could cast their votes. An NDA was also signed between the parties. The creditor had raised invoices on the debtor for payment; however, the debtor informed that they were withholding payments due to them as they had violated the terms of NDA.

Tracing the evolution of insolvency laws and culmination into the current form of IBC, the Supreme Court noted that the definition of dispute is broad in scope and it is not limited to court proceedings. It noted that under the Bill which preceded IBC, dispute was defined to mean a bona fide suit or arbitration proceeding regarding (a) the existence or the amount of a debt, (b) the quality of a good or service, or (c) the breach of a representation or warranty. However, under IBC, the definition of dispute has become an inclusive definition and the definition of dispute includes suit or arbitration proceedings relating to existence of debt, quality of goods or service or breach of representation of warranty. Thus, the legislative intent was to define dispute in a broader manner and it is not limited to dispute between the parties before a court. The Supreme Court noted that if the inclusive approach is not taken, it would stave off the bankruptcy process only if they are already pending in a suit or arbitration proceedings and not otherwise. 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.

So, based on the various reports preceding IBC, the Supreme Court noted that dispute must exist in fact and the ground for alleging the existence of dispute should not be spurious and hypothetical. It further observed that at the stage of examining the existence of dispute, the NCLT/NCLAT must see 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. The Supreme Court also noted that at this stage, the NCLT/NCLAT need not go into the merits of the dispute, thus the role of the NCLT/NCLAT would be limited to reviewing the veracity of dispute and not adequacy thereof.

By giving a wide interpretation to the term “dispute”, the Supreme Court has given a wide leeway for corporate debtors to defend themselves in a CIRP from operational creditors. And operational creditors are at a back foot since their action of initiating CIRP would be starved off in case of a dispute that is not only limited to court proceedings. Having said that, the Supreme Court has observed that existence of dispute must be supported by evidence and must be existing at the time of receipt of demand notice. So, there is a need to review all the existing agreements between the buyers and suppliers to include clauses as to clearly identify the milestones of payment to determine when is the debt due and payable, mode of raising dispute, need for periodical written communication in case there has been any breach of contract, etc. In addition, it would be pertinent to note that when a potential dispute is in the offing, the operational creditor has to make sure that suitable factual response is provided to disputes raised by corporate debtors so any feeble or dispute unsupported by any evidence is not raised before the NCLT.

Writer is Partner, Lakshmikumaran & Sridharan

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