Reported by: banking|Updated: September 13, 2017
The Insolvency and Bankruptcy Code, 2016 was introduced to consolidate laws in relation to reorganization and insolvency resolution of corporates, firms and individuals in a time bound manner to maximize the value of their assets. However, certain inconsistencies in the wording of the Code has led to a confusion about when an operational creditor can approach the National Company Law Tribunal (NCLT) for filing an insolvency application. Specifically, the lack of clarity in how the word ‘dispute’ is to be construed in Section 5(6), Section 8 and Section 9 of the Code has caused varying judgments to be pronounced by different benches of the NLCT in the past few months.
First, under Section 5(6) of the Code, the word ‘dispute’ has been defined to include a suit or arbitration proceedings relating to:
Secondly, Section 8 of the Code provides that an operational creditor could issue a demand notice to the debtor upon occurrence of a default in payment. Once a demand notice under Section 8(1) is issued, if the debtor disputes the amount due, he would have to bring to the operational creditor the existence of the dispute within 10 days of receiving the demand notice and record of the pendency of the suit or the arbitration proceedings.
Lastly, Section 9 of the Code provides for the procedure to file a corporate insolvency resolution in case the debt is not paid back upon receiving the demand notice. Specifically, Section 9(5)(ii) provides for grounds under which the NCLT may reject the application for declaring the debtor as insolvent. Section 9(5)(ii)(d) provides that the application can be rejected when notice of dispute has been received by the operational creditor or there is a record of dispute in the information utility.
A consolidated reading of the above three provisions has been a cause of confusion before the NCLT since some benches have held that a dispute can only be said to be there when there is a legal proceeding initiated while other benches have said that a response to the demand notice by the debtor on any of the grounds mentioned in Section 5(6) would be sufficient to be adjudged as a “dispute”. In this article, we seek to understand how different benches of the NCLT have interpreted the term ‘dispute’ in the Code.
View 1: The term ‘dispute’ to be construed broadly
The first case that came out in this series of cases is Kirusa Software v. Mobilox Innovations Pvt Ltd. In this case, Kirusa, the operational creditor, filed a petition claiming that the debtor was liable to pay a certain amount and had failed to do so even after the demand notice was issued. The debtor responded to the demand notice disputing the amount and the operational creditor admitted to receiving the notice of dispute. The NCLT Mumbai bench referred to Section 9(5)(ii)(d) and held that a petition for insolvency could not be filed by the operational creditor since there was a dispute pending.
The NCLT Principal Bench came to the same conclusion in the matter of One Coat Plaster v. Ambience Private Limited. However, the court relied on the term “includes” in Section 5(6) in coming to this conclusion. It held that Section 5(6) only provides for an inclusive definition of what constitutes a dispute but not an exhaustive one. Therefore, there could also be said to be a dispute when the debtor contests the amount as was done in the present case. Therefore, the Principal Bench held that the petition of the operational creditor to commence insolvency proceedings could not be sustained.
On 21 April 2017, the case of VDS Plastics Pvt Ltd v. Pal Mohan Electronics Pvt Ltd was heard before the New Delhi Bench of the NCLT. In this case, the operational creditor had filed a petition for initiation of insolvency resolution process on grounds of the outstanding liability against invoices raised by them for supplying goods to the debtor. Emails were produced before the court whereby the debtor had disputed the correctness of the amount claimed by the operational creditor. There were further submissions that due to the dispute as to the amount pending between the two parties, there were meetings held to reconcile the differences but were to no avail. The debtor also claimed that they had called upon the operational creditor to resolve the dispute but no response was received. Therefore, the debtor claimed that there was a dispute in existence and insolvency proceedings could not be resorted to. The creditor claimed that a suit of arbitration proceeding needs to have been initiated to constitute a dispute. The NCLT, while rejecting the claim of the creditor held that exchange of emails between the parties was sufficient proof that there was a dispute as to the amount due and therefore the petition was rejected.
Lastly, on 8 May 2017, in the case of Design Worx Infrastructure India Pvt. Ltd. v. Premier Restaurant Private Limited, the NCLT Delhi Bench ruled along the same lines as the above case. In this case, upon the operational creditor filing an insolvency petition under Section 8 of the Code, the corporate debtor pointed out that they had been dissatisfied with the work of the operational creditor as they had indicated to them via emails. The corporate debtor had asked the operational creditor to rectify certain snags and only on the failure to do so by the operational creditor, the corporate debtor had to employ a third-party service provider. The Delhi Bench in this case refused to limit the scope of “dispute” to only formal legal and arbitration proceedings and held that even the email responses sent to the operational creditor about the dissatisfaction of the quality of work would amount to a “dispute” under Section 9(5)(ii) and therefore, insolvency proceedings could not be initiated.
View 2: Initiation of formal legal proceedings necessary for a debt to be considered as “disputed”
Essar Projects Limited v. MCL Global Steel Private Limited was one of the first cases where the NCLT Mumbai Bench took a contrary view from the above rulings to hold that formal legal proceedings need to have been initiated for a debt to be “disputed”. In this case, Essar Projects Limited (“Essar”) filed a petition before the NCLT to initiate insolvency proceedings against the debtor, MCL Global Steel Pvt Ltd (“MCL”). MCL responded to the notice of the petition filed under Section 8 by Essar claiming that they are “disputing” the quality of services extended by Essar and hence a Section 8 petition cannot be filed by Essar. Essar however contented that for the debtor to be able to claim the benefit of Section 9(5)(ii)(d), there should be a “dispute in existence” and responding to a Section 8 notice would not constitute a “dispute”. The NCLT agreeing with Essar held that there needs to be a pre-existing legal or arbitration proceeding for the debtor to be able to claim that there is a dispute. A debtor cannot take advantage of the provision by claiming that they are disputing the amount or quality of services once an insolvency petition is filed as that would beat the purpose of the provision.
This was followed by the case of Deutsche Forfait AG and Anr v. Uttam Galva Steel Ltd. The facts of the case are similar to the before mentioned case whereby the operational creditor issued a demand notice and the debtor responded with a notice disputing the amount. Deutsche Forfait AG, the operational creditor then filed a petition under Section 8 and 9 of the Code for initiation of corporate insolvency resolution process. The NCLT, Mumbai bench in this case looked into the Kirusa Software case but differed from it. The NCLT Mumbai Bench in this case while looking into the meaning of “dispute” in Section 9 said that it has to be read along with Section 8 since Section 8 is the substantive provision on applications and Section 9 provided for the procedures. It, therefore, was of the opinion that since under Section 8 provides that the debtor must bring to the notice of the operational creditor of the existence of the dispute within 10 days of receiving the demand notice and record of the pendency of the suit or the arbitration proceedings, it would mean that a dispute would only be present when there is a record of the pendency of the suit of arbitration proceeding. If this was true for Section 8, the term “dispute” would have to be read along the same lines in Section 9 as well since Section 9 is only a procedural section which derives its power from Section 8.
Apart from this, the Bench also looked into Section 5(6) and whether dispute could be interpreted widely since it provides for an inclusive definition of what constitutes a dispute. However, the Bench looked into various Supreme Court decisions where “includes” has been interpreted as “means”. It, therefore, held that a co-joint reading of all the three sections, i.e. Sections 5(6), 8(2) and 9 would mean that there would be a dispute in existence only when there was a pendency of suit or arbitration proceedings. Therefore, the petition for insolvency was admitted.
On 24 May 2017, the matter of is Kirusa Software v. Mobilox Innovations Pvt. Ltd (facts discussed above) was taken up by the National Company Law Appellate Tribunal (“NCLAT”) thus settling the dispute between the varied views adopted by the different benches of the NCLT. The NCLAT disagreed with the Mumbai Bench decisions and held that a formal legal proceeding such as a suit or an arbitration is not necessary to be in existence for it to be considered a “dispute”. However, they did hold that a mere illusory dispute raised post the demand notice being issued could not constitute a dispute. They held that “prior notice” disputing the amount/quality/breach of representation or warranty would be essential. This is to ensure that corporate debtors were not raising a dispute post the demand notice merely to evade their liability. It can be seen that the NCLAT has opined along the same line as View 1 to the extent that a formal legal proceeding is not necessary to constitute a dispute. However, they have adopted the reasoning provided by the Mumbai bench of the NCLT so as to ensure that debtors do not take undue advantage of the inclusive definition of dispute to avoid their liability.
This judgment has been subsequently relied on by other benches such as in the cases of Capital Partners v. Reliance Defence & Engineering Ltd and; Pitambara Enterprises v. Valeda Herbals Private Limited to hold that where a dispute regarding the amount was raised prior to the demand for notice, it could be considered to be a “disputed debt” within the meaning of the Code. Therefore, it can be said that it is settled now that notice of a ‘dispute’ should be given before-hand and not while replying a notice served under Section 8 read with Section 9 of the Code.
The ability of a corporate debtor to escape an insolvency application initiated against it has been considerably reduced by the interpretation of NCLAT in the Kirusa Software case. Nevertheless, the NCLAT has also protected the rights of the debtor by allowing for any “prior notice” disputing the amount, quality or breach of representation or warranty to be considered as a “dispute”. This appears to be a balanced interpretation of a “disputed debt” and a view which is likely to be upheld and enforced by the courts going forward.
Shishir Mehta is partner, Nikita Nehriya, senior associate and Praneetha Vasan, associate, at legal firm Khaitan & Co.