Sunday, June 11, 2017

Resolution Application by Operational Creditors: Interpretation of the Term “Dispute”

[Post by Nitu Poddar, Associate at Vinod Kothari & Company, Corporate Law and Resolution Division (nitu@vinodkothari.com)

Other posts on related topics can be found here and here.]

To file an application under the Insolvency and Bankruptcy Code, 2016 (the Code), an operational creditor has to serve a demand notice on the corporate debtor ten days prior to the application. The corporate debtor can either make payment on receipt of such demand notice or bring to the notice of the operational the creditor existence of a dispute, if any, and record of pendency of the suit or arbitration proceedings filed before the receipt of such notice. In case payment has already been made, the corporate debtor should send the proof of such payment to the operational creditor.  

What the operational creditor essentially receives is either payment or a 'notice of dispute'. If proven that a dispute existed “before” the receipt of the demand notice by the corporate debtor, the operational creditor cannot initiate the corporate insolvency resolution process against such debtor. Accordingly, apart from existence of “default” which is required to initiate the process, there should be a “non-existence of dispute”.

Having said so, it is necessary to note quite a number of cases have emerged before different benches of the National Company Law Tribunal (NCLT) and the National Company Law Appellate Tribunal (NCLAT) over the interpretation of the terms “dispute” and “existence of dispute”. Most recently, the NCLAT has interpreted the meaning of “dispute” at length in Kirusa Software Private Ltd. v. Mobilox Innovations Private Limited (discussed here).

Demand notice is a mandatory condition precedent

Alhough the word "may" has been used in section 8(1) of the Code with respect to sending a demand notice, upon reading of sections 8 and 9 as a whole, an 'operational creditor,' upon the occurrence of a default, is mandatorily required to deliver a notice of demand.

In Seema Gupta v. Supreme Infrastructure, the NCLAT reiterated that no application can be preferred under section 9 of the Code without a notice under section 8(1). Similar question was considered by NCLAT in Era Infra Engineering Ltd v. Prideco Commercial Projects Pvt Ltd. Notices issued under winding up provisions cannot be considered as compliance of section 8 of the Code.

Pre-existence of dispute

The dispute must be in existence before the receipt of demand notice by the corporate debtor. The whole intent of the provisions of sections 8 and 9 will be rendered redundant if the dispute created after receipt of the demand notice is taken into consideration.

Existence of a valid dispute

While ascertaining the existence of a dispute, the Adjudicating Authority shall ensure that the dispute is a valid one.

In accordance with the definition of dispute in section 5(6), dispute can be with respect to three aspects only, viz (a) amount of debt; (b) quality of service; (c) breach of any representation / warranty.  The definition of “dispute” is illustrative and non-exhaustive. Accordingly, the same has to be interpreted in a wider sense, subject to the fact that the interpretation should be within the ambit of the aforesaid three aspects only and not as a dispute being raised by simply showing a record of dispute in a pending arbitration or suit.

Merely raising a dispute for the sake of it, unrelated or related to clauses (a), (b) or (c) of section 5(6), if not raised prior to application and not pending before any competent court of law or authority cannot be relied upon to hold that there is a 'dispute' raised by the corporate debtor.

However, a question remaining for interpretation is – in spite of the fact that the definition of dispute is an inclusive one – is it necessary for the same to be pending before any adjudicating authority for eligible to be called so under the Code?

The author’s submission is that to curb frivolous practices of the corporate debtor so as to avoid acceptance of application under the Code, only disputes pending before any adjudicating authority should be regarded. Mala fide dispute to stall the insolvency proceedings cannot be considered.

In any case, the intent of not accepting any application, which is sub-judice / pending elsewhere is to disallow parallel proceedings relating to the same matter before different forums. In case the dispute is not pending before any appropriate forum, the same can be adjudged by the NCLT.
  
Whether dispute pending in arbitration / civil court only valid

While section 5(6) refers to disputes pending in arbitration / civil court, however, the same does not render dispute pending in any other judicial forum invalid.  In any case, as mentioned above, the definition of “dispute” is an inclusive one. To substantiate its interpretation the NCLAT obtained reference from the judgement of the Supreme Court in Mithlesh Singh v. Union of India, (2003) 3 SCC 309:

It is not a sound principle of construction to brush aside word (s) in a statute as being inapposite surplusage: if they can have appropriate application in circumstances conceivably within the contemplation of the statute. In the interpretation of statutes the Courts always presume that the Legislature inserted every part thereof for a purpose and the legislative intention is that every part of the statute should have effect. The Legislature is deemed not to waste its words or to say anything in vain.

Accordingly, while the dispute should be in relation to the three aspects mentioned in clauses (a), (b) and (c) of section 5(6), however, it can go beyond arbitration or civil suits. For example, a dispute pending under section 59 of Sales of Goods Act (remedy for breach of warranty), or before any government authority, or dispute pending before labour court would be some such.

What if the dispute is resolved?

Form 5 of the Insolvency and Bankruptcy (Application to Adjudicating Authority) Rules, 2016 recognises “particulars of an order of a court, tribunal or arbitral panel adjudicating on the default, if any” as a particular of “debt”. Accordingly, in case a suit or arbitration or otherwise is decided and is not pending, the application will be maintainable as a petition under section 9 of the Code.

Conclusion

To conclude, the essentials of filing of resolution application by an operational creditor may be summarised as follows:

1.   There should be a right to payment;

2.   Such payment should become due and payable and should remain unpaid; and

3.   There should be no dispute with respect to such right;

The above interpretation with respect to the expression “dispute” has also been referred to by the NCLAT in Meyer Apparel Ltd and Others v Surbhi Body Products Pvt Ltd and Godolo & Godolo Exports Pvt Ltd.


- Nitu Poddar

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