Supreme Court rules on the scope of moratorium under the Insolvency and Bankruptcy Code

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Supreme Court rules on the scope of moratorium under the Insolvency and Bankruptcy Code

Introduction

The Supreme Court of India (‘SC’), in the recent judgement of P. Mohanraj and others v. Shah Brothers Ispat Pvt. Ltd. (‘Judgement’) dated 01 March 2021, held that proceedings under section 138/141 of the Negotiable Instruments Act, 1881 (‘NI Act’) are covered by the moratorium provisions under the Insolvency and Bankruptcy Code, 2016 (‘IBC’). In other words, a proceeding under section 138/141 of the NI Act cannot be instituted/ continued with respect to a corporate debtor who is under moratorium under the IBC.

The judgement also examined the interpretation of the moratorium provisions under section 14 of the IBC, including its object and scope. This alert discusses the key findings of the Judgment in relation to section 14 of the IBC.

Background

Brief facts of the Judgement are that steel products were supplied by Shah Brothers Ispat Pvt. Ltd. (‘Operational Creditor’) to Diamond Engineering Pvt. Ltd. (‘Company’).

The Company had issued cheques to the Operational Creditor, all of which were dishonored.

A statutory notice under section 8 of the IBC was issued by the Operational Creditor to the Company, resulting in the initiation of the corporate insolvency resolution process (‘CIRP’) and declaration of moratorium under section 14 of the IBC against the Company.

The Operational Creditor had also issued a statutory demand notice under section 138 read with section 141 of the NI Act upon the Company and its three directors. Since no payment was made post issuance of the demand notice, the Operational Creditor filed criminal complaints under section 138 read with section 141 of the NI Act before the Additional Chief Metropolitan Magistrate, Kurla, Mumbai (‘Magistrate’).

The National Company Law Tribunal, Chennai (‘NCLT’) stayed further proceedings in criminal complaints pending before the Magistrate. An appeal was filed before the National Company Law Appellate Tribunal (‘NCLAT’). The NCLAT set aside the order of the NCLT.

An appeal was filed before the SC from the order of NCLAT, and the main question that emerged was whether the institution or continuation of a proceeding under Section 138/141 of the NI Act, can be said to be covered by the moratorium provision, namely, Section 14 of the IBC.

Interpretation of section 14 of IBC

The SC referred to section 14 of the IBC and examined section 14 (1) (a) in detail. The sub-section has been reproduced below:

“Subject to provisions of Sub-sections (2) and (3), on the insolvency commencement date, the Adjudicating Authority shall, by order, declare moratorium for prohibiting all of the following, namely- the institution of suits or continuation of pending suits or proceedings against the corporate debtor including execution of any judgment, decree or order in any court of law, tribunal, arbitration panel or other authority”

The SC analyzed the term ‘proceedings’ occurring in section 14 (1) (a) of the IBC and emphasized that the width of this term can be gathered from the expression ‘any judgement, decree or order’ and ‘any court of law, tribunal, arbitration panel or other authority’.

The SC noted that since criminal proceedings under the Code of Criminal Procedure, 1973 are conducted before the courts mentioned in Section 6, Code of Criminal Procedure, it is clear that a Section 138 proceeding being conducted before a Magistrate would certainly be a proceeding in a court of law in respect of a transaction which relates to a debt owed by the corporate debtor.

The SC concluded that “it is clear that a Section 138 proceeding being conducted before a Magistrate would certainly be a proceeding in a court of law in respect of a transaction which relates to a debt owed by the corporate debtor”.

Object of section 14 of IBC

The SC examined the object of section 14 of the IBC to understand its intended scope. The court referred to the Report of the Insolvency Law Committee of February 2020. The report provided that the object of moratorium is to see that there is no depletion of a corporate debtor’s assets during the CIRP so that it can be kept running as a going concern, thus maximizing value for all stakeholders.

The SC held that the idea of moratorium is to provide the corporate debtor a breathing space, to organize its affairs, so that a new management may ultimately take over and bring the corporate debtor out of financial sickness, which will ultimately be beneficial for all stakeholders.

The SC also highlighted that if proceedings under section 138 of the NI Act are maintained, it would result in the depletion of the assets of the corporate debtor, as a result of having to pay compensation twice the amount of the dishonored cheque. This would not only impact the CIRP but will also not allow the corporate debtor to function as a going concern.

The SC concluded that the wording of section 14 (1)(a) of the IBC (which refers to monetary liabilities of the corporate debtor) and 14 (1)(b) of the IBC (which refers to the assets of the corporate debtor) together shield the corporate debtor from pecuniary attacks during the moratorium period.

Scope of section 14 in relation to other moratorium sections provided in the IBC

The SC compared the scope of section 14 of the IBC to other moratorium sections provided in the IBC, namely section 81, 85, 96 and 101. The SC examined the language of all these sections and gathered that the language of section 14 is wider than the language provided in the other moratorium sections.

For example, the moratorium provisions relating to individuals and firms permit recovery of any property by an owner or lessor where such property is occupied or in possession of the individual/ firm. However, section 14 of the IBC relating to corporate debtors, prohibits such recovery of property of the corporate debtor.

SC emphasized that the prohibition contained in section 14 during the moratorium is in respect of transactions entered in by the corporate debtor, including transactions relating to debts.

Nature of proceedings under chapter XVII of NI Act

The SC relied on various judgements to ascertain the nature of proceedings under chapter XVII of the NI Act.

The SC held that “it is clear that a Section 138 proceeding can be said to be a “civil sheep” in a “criminal wolf’s” clothing”, as it is the interest of the victim that is sought to be protected, the larger interest of the State being subsumed in the victim alone moving a court in cheque bouncing cases…”

The SC concluded that the proceedings under chapter XVII are quasi-criminal in nature as they result in the enforcement of a civil remedy and would amount to ‘proceedings’ within section 14(1) (a) of the IBC, and the moratorium would attach to such proceedings.

Whether natural persons are covered by section 14 of IBC

The SC held that the moratorium provision contained under section 14 of the IBC would apply only to the corporate debtor. Under section 141(1) and (2) of the NI Act proceedings can be initiated against natural persons of a company for offence committed by company under section 138 of the NI Act.

In essence, proceedings under section 138 of the NI Act can be initiated/ continued against a director/ employee of the corporate debtor during the moratorium period.

Conclusion

This Judgement clears the ambiguity created for proceedings under section 138/141 of the NI Act with respect to the IBC. It overrules the judgements of the Bombay High Court and Calcutta High Court dealing with similar questions of law.

The Judgment conclusively states that proceedings under section 138/141 of the NI Act cannot be instituted or continued in respect of a corporate debtor during the moratorium period.

This Judgement clarified that moratorium does not protect natural persons, against whom proceedings can still be initiated and continued under section 141(1) and (2) of the NI Act.