Ajay Kumar to Mohan Raj Case: Why Cheque Bounce Proceedings must become Non-Existent during CIRP
Mr. Nakshatra Gujrati
2nd Year BA LLB Hons Student at National Law University Odisha
Introduction
Back in 2019, the Madras High Court in the matter of Ajay Kumar vs Tap Engineering ruled that cheque bounce is an offence as mentioned under section 138 of Negotiable Instruments Act (herein afterwards NI Act) and for offences there happens to be prosecution by the state and the same should not be understood as proceedings under section 14 of Insolvency & Bankruptcy Code (herein afterwards as IBC). IBC was brought in with an intent to resolve the corporate debtor and revive his business without liquidating him in the first instance and that too at the earliest. To ensure this, IBC devised the Corporate Insolvency Resolution Process during which no fresh suits or proceedings against the corporate debtor were to be instituted and all the prior existing suits or proceedings before any court or tribunal would stand abated except the writ petition or a trial going for a criminal offence. The present article seeks to explain the implication of this ruling and whether the Hon’ble High Court’s approach was correct while interpreting the term ‘proceedings’ under section 14 of IBC. The apex court has rejected this ruling in the case of P.Mohanraj vs Ispat Bros (2021) ibclaw.in 24 SC.
The Issues From Ajay Kumar Case
Mr Ajay Kumar [2020] ibclaw.in 14 HC happened to be the managing director of M/s Tepcro Systems Ltd who purchased goods from the complainant and didn’t pay for the same. After repeated demands by the complainant, M/s Tepcro issued some post-dated cheques which were dishonoured by the bank. The complainant filed a complaint with the magistrate and case was made under section 138 of NI Act read with section 141 of the NI Act. Simultaneously, one of the financial creditors of M/s Tepcro filed an application with the NCLAT Delhi. Thereafter, the petitioner Ajay Kumar approached High Court of Madras and prayed to quash the petition made under section 138. The petitioner argued that “all the negotiable instruments issued by the company or its persons shall stand terminated and all the legal proceedings relating to the same must become non-existent”. This argument of the petitioner relied on the section 14 of IBC which imposes a moratorium on all the ongoing suits or proceedings against the corporate debtor. Moreover, the cheques were not issued by the petitioner in his personal capacity, rather it was issued on behalf of the company. The petitioner relied on the separate corporate entity and was requesting to not to look behind the veil. The High Court rejected the argument in toto and held that “dishonour of cheque amounts to an offence for which prosecution is initiated and prosecution is not similar to proceeding under section 14 of the IBC and hence moratorium doesn’t apply”. The implications of the ruling are interrogative and as follows –
(a) Whether the prosecution for cheque bounce must be understood as ‘proceeding’ under of section 14 of IBC?
(b) Whether the proceeding under section 138 NI is against the spirit of IBC when CIRP is ongoing?
(c) Whether the court was right in not quashing the personal criminal liability of the director and whether it is a valid ground to pierce the corporate veil?
Cheque Bounce is More of A Civil Wrong
To explain section 138 of NI Act, say for example, I have a liability of Rs 50,000 towards someone, and I draw a cheque for the said amount to absolve myself from the liability. When the person towards whom I had a liability deposits the cheque and he is notified by the bank via bounce memo that I didn’t have sufficient funds in my account, it becomes an offence of cheque bounce. The punishment for the same is “2 years of imprisonment or fine which may extend to twice the amount of cheque”. In case of a company, the section 141 of NI Act is to be read with section 138, but the concept remains same.
The ratio of Ajay Kumar case laid down that “since cheque bounce is an offence and for an offence there will be prosecution and prosecution is not covered under proceedings as per section 14 of the IBC”. The issue is ‘whether the offence under section 138 should remain out of the purview of section 14 of IBC’. The answer must be no, because offences classified as under CrPC either cognizable or non-cognizable. Cognizable offences are those which are serious in nature, on contrary non cognizable are the ones that are not serious and are considered to be as private wrongs. Part II of schedule 1 of CrPC makes offences punishable with less than 3 years of imprisonment as non-cognizable and bailable. In the case of Meters Instruments[1], it was held that “the intention of the legislature was to increase confidence in cheque transaction by providing speedy remedy to the complainant without punishing the drawer.” Thus, the offence under section 138 of NI is not a serious offence.
The Moratorium Period Under IBC
The section 14 of the IBC states that the adjudicating authority “shall declare moratorium” as soon as the application for initiation of CIRP is admitted. The moratorium period is referred to as the calm period during which “any pending suits against the corporate debtor becomes non-existent and there can be no fresh institution of suits against the debtor”[2]. The intention of the Insolvency Code is to preserve the value of assets of the corporate debtor and ensure speedy resolution of the corporate debtor. In case moratorium is not imposed then every creditor of the corporate debtor will seek the way out that his beneficial to his own interest. The insolvency code seeks to balance the creditor’s right with corporate debtor’s business interests.
The clause (a) of section 14 is to be read as follows –
“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 question arises ‘whether criminal proceedings against the corporate debtor is covered by the above clause?’. In the case of Varsana Ispat Limited [2019] ibclaw.in 67 NCLAT –
“The resolution professional sought de-attachment of properties attached with the ED under the PMLA Act. The NCLAT held that section 14 of IBC is not applicable to the criminal proceeding or any penal action taken pursuant to the criminal proceeding.”
The above ratio was followed in the Ajay Kumar case, but again the offence under PMLA Act is more serious than cheque bounce. If the corporate debtor is not allowed the protection under section 14 of IBC in case of a cheque bounce, he may possibly be arrested at the same time when CIRP is going on leading to an extra burden over him. It is of no surprise that a corporate debtor will fail to pay the amount during financial stress and his arrest serves no good for the creditor, because the intent of section 138 NI is to compensate the complainant and during CIRP, the creditor will any how realise his debt. Thus, the prosecution under section 138 of NI must be understood as proceeding under section 14 of the IBC.
The Parallel Proceedings under NI Against The Spirit of IBC
The insolvency and bankruptcy code aims to resolve the corporate debtor and revive his business at the earliest. The moratorium ensures that the parallel proceedings against the assets or against the corporate debtor stands abated, as during financial stress it is important that each and every asset of the corporate debtor is preserved and utilised as per the resolution plan to revive the business. The proceedings under NI Act will serve to put an undue pressure on the company and force its members to resort to sell assets to escape the liability. This will in turn lead to delay in CIRP process and uncertainty in the process. Thus, the judgment of Ajay Kumar case is flawed.
Piercing of Veil and its Validity
The very first feature of a company is separate legal entity, that is to say, the members or directors are separate from the company. “The company can sue and get sued in its own name”. To understand this feature, say for example, a company is incorporated and it has 7 members. When the company was doing business, it incurred a liability and the creditor sued the members to recover the same. The creditor will fail in his action because by virtue of separate legal entity, as members and the company are to be considered as distinct identity. “The law recognizes the existence of a company quite irrespective of the motives, intentions, schemes or conduct of the individual shareholders”[3].
But despite everything, a company is formed by members and it fosters their interests and members being human beings are ambitious and thus greedy. Therefore, many times the motives, intentions and schemes are so dangerous for the public interest that it becomes very crucial for the court of law to see a company and its member working in cahoots. It has been held that the rule of separate legal entity must not be followed doggedly, but at the same time the corporate veil is not be lifted every now and then because it is the very feature which promotes business and its growth. The judiciary has recognized following grounds when corporate veil can be lifted –
“(a). Prevention of Fraud or Improper Conduct[4]
(b). Tax evasion[5]
(c). Avoidance of welfare legislation[6]
(d). Determination of character of a company[7]”
The judiciary can lift the corporate veil of an entity if it feels that a company is being used for any of the above-mentioned purposes, in addition to it, the section 141 of NI Act states that “every person who, at the time the offence was committed, was in charge of, and was responsible to, the company for the conduct of the business of the company, as well as the company, shall be deemed to be guilty of the offence”[8].
The Hon’ble High Court in the Ajay Kumar case has committed no error of law by rejecting the argument of petitioner that “he didn’t sign the cheques in personal capacity, rather he was representing his company and thus the criminal petition against him must be quashed”[9], but it ought to have consider the grim situation that director was facing and the interpretation could have been more liberal.
Judicial Correction in Shah Ispat Bros Case
The Hon’ble Apex court finally rectified the error made by the Hon’ble High Court of Madras in the case of P. Mohanraj[10], it was held that –
“The gravity of complaint under Negotiable Instruments Act, 1881 cannot be equated with criminal offences under IPC or other criminal offences. An offence under section 138 of Negotiable Instruments Act, 1881, is almost in the nature of a civil wrong which has been given criminal overtones”[11]
The language of section 14 might raise the question that “whether section 14 covers natural persons in case of section 130 r/w 141?”[12]. The apex court answered in affirmative, since the section 141 includes members and the company itself and therefore, without company, the members cannot be sued. Thus, it means that once moratorium is imposed there can be no proceedings against the corporate debtor, that is company which also includes natural persons as per the judgment.
Conclusion
The judgment of Hon’ble High court can be termed as literal interpretation of law, as section 138 of NI uses the word ‘offence’ so the court ruled that offence follows prosecution which doesn’t come under proceedings as per section 14 of the IBC. Thereafter, the court took the literal interpretation of section 141 and rejected the argument of the petitioner, whereas the court ought to have consider the financial status of M/s Tepcro and therefore its failure in not being able to pay the standing amount. The section 138 of NI Act was brought in with an aim to compensate the complainant and foster the cheque transaction. The literal interpretation in Ajay Kumar case would have caused undue stress to the members of the company especially when it is already going through a financial difficulty. Not only this, the interpretation was against the spirit of section 14 of IBC which aims to give calm period to the corporate debtor so as to revive his business at the earliest. The ruling by the Hon’ble Supreme Court in P. Mohanraj is liberal in interpretation and it has undone the harm to be caused.
Reference:
[1] Meters Instruments Pvt Ltd vs Kanchan Mehta (2018) 1 SCC 560.
[2] Alchemist Asset Reconstruction Company Ltd vs Hotel Gaudavan Pvt Ltd [2017] ibclaw.in 09 SC.
[3] Abdul Haq vs Das Mal, (1910) 19 IC 595.
[4] Gilford Motor Co. vs Horne, (1933) 1 Ch 935.
[5] In Re, Sir Dinshaw Maneckjee Petit, AIR 1927 Bom 371.
[6] Workmen of Associated Rubber Industry vs Associated Rubber Industry Ltd., (1985) 4 SCC 114.
[7] Daimler Co. Ltd. vs Continental Tyre and Rubber Co., (1916) 2 AC 307.
[8] Supra, note 2, section 141.
[9] Supra, note 1.
[10] P. Mohanraj v. Shah Bros. Ispat (P) Ltd., (2021) ibclaw.in 24 SC.
[11] Ibid, para 59.
[12] Supra, note 28, para 102.
Disclaimer: The Opinions expressed in this article are that of the author(s). The facts and opinions expressed here do not reflect the views of IBC Laws (http://www.ibclaw.in). The entire contents of this document have been prepared on the basis of the information existing at the time of the preparation. The author(s) and IBC Laws (http://www.ibclaw.in) do not take responsibility of the same. Postings on this blog are for informational purposes only. Nothing herein shall be deemed or construed to constitute legal or investment advice. Discussions on, or arising out of this, blog between contributors and other persons shall not create any attorney-client relationship.
Follow for daily updates: