Applicability of Section 14 of IBC to Proceedings in respect of Directors/Management of Corporate Debtor – By Muskaan Desai

Applicability of Section 14 of IBC to Proceedings in respect of Directors/Management of Corporate Debtor

– By Muskaan Desai, 4th year law student at NALSAR

Introduction

The objective of IBC is to keep the Corporate Debtor as a going concern. During the Corporate Insolvency Resolution Process (CIRP), S.14[1] that provides for moratorium plays an important role in protecting the interests of the Creditors. Moratorium gets triggered automatically on the initiation of CIRP. It acts as a shield for corporate debtor and also protects the interests in the company’s assets of the creditors. However, keeping in mind that IBC has made CIRP a process with creditors in possession of the corporate debtor (company), there is a need to strike a fine balance between the protection of rights of creditors and keeping the company as a going concern. To guarantee the effectiveness of the CIRP (which finally leads to the adoption of a resolution plan or the initiation of liquidation proceedings), the code allows for a ‘Moratorium’ u/s 14 of the code, which prevents any legal action against the corporate debtor until the CIRP is completed (which also causes a corporate debtor to postpone any payment to be made to creditor). Thus, a moratorium is a time of quiet during which creditors or other parties do not take any further action to recover debts from a corporate debtor.[2]

S.14(1) provides that – “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: – (a) the institution of suits or continuation of pending suits or proceedings against the corporate debtor including execution of any judgement, decree or order in any court of law, tribunal, arbitration panel or other authority; (b) transferring, encumbering, alienating or disposing off by the corporate debtor any of its assets or any legal right or beneficial interest therein; (c) any action to foreclose, recover or enforce any security interest created by the corporate debtor in respect of its property including any action under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (54 of 2002); (d) the recovery of any property by an owner or lessor where such property is occupied by or in the possession of the corporate debtor”.[3]

The commencement of moratorium is very essential in achieving the one of the avowed principles on which new insolvency and bankruptcy resolution framework was designed as posited by Bankruptcy Law Reforms Committee of Nov 2015 in its report as “ IV. The Code will ensure a collective process” which in the own words of Committee means: “The law must ensure that all creditors who have the capability and the willingness to restructure their liabilities must be part of the negotiation process. The liabilities of all creditors who are not part of the negotiation process must also be met in any negotiated solution.”

From above, it can be inferred that IBC 2016 was mainly brought up not just to take care of interest of one specific bank but to secure the financial interest of all kinds of creditors who are stakeholders in proper functioning of debtor company. This shows that not only the corporate debtor, but the persons holding a position in the company by virtue of which they have the right to dispose assets or any interests of the corporate debtor therein shall also be subject to moratorium. In the recent case of Anjali Rathi and Ors. v. Today Homes & Infrastructure Pvt. Ltd. and Ors.[4], the Supreme Court held that the moratorium declared under S.14 of IBC extends only to the corporate debtor and not its directors, promoters, or management. In this light, it becomes imperative to analyse the current judgement and its consequent implications.

Cases Involving the Question Under Section 14

The case of Anjali Rathi and Ors. v. Today Homes & Infrastructure Pvt. Ltd. and Ors.[5] was decided recently in September 2021. In the current case the plaintiffs had entered into homebuyer agreements with the defendant. The agreement saw a fallout due to the project being abandoned by the developer company. The aggrieved party filed a suit which led to a series of litigation. Later an insolvency application was made by an Operational Creditor, which was accepted by the National Company Law Tribunal (NCLT)[6] under S.9 of IBC[7]. In response to the creditors making a claim against promoters, asking to attach their personal assets, the Supreme Court held that the same is allowed, since the moratorium does not apply to the management, directors, and promoters of the Corporate Debtor. Therefore, a separate action can be raised against them and the proceedings can be initiated despite the pendency of CIRP and it is not barred by S.14.[8] The Supreme Court took a similar view in the case of P. Mohanraj v. Shah Bros. Ispat (P) Ltd.[9] Here such a judgement works in favour of the creditors, but not the corporate debtor. As mentioned, a balance needs to be made between both the parties. S.14(1)(a) has been interpreted in a scrutinizing fashion and this is the current position as laid down by Supreme Court. However, this section has been a contentious one, raising several doubts.

The question before the Supreme Court of India in Malayan Banking Berhad (2020) ibclaw.in 35 SC) was whether the moratorium imposed under Section 14(1)(a) of the IBC would only apply in civil suits filed “against the Corporate Debtor”, and since the suit before the Bombay High Court was filed “by the Corporate Debtor”, i.e., Ushdev International Ltd., the moratorium under Section 14(1)(a) of the IBC would not apply in the present case. Because the judicial tendency indicates a competing and diverging opinion, the legal position pertaining to the application of Moratorium upon adjudication of actions brought by the Corporate Debtor is ambiguous. When a majority of the petitions submitted before the NCLT under Sections 7, 9, or 10 of the IBC are allowed, a moratorium is invariably imposed under Section 14(1)(a) of the IBC against any proceedings initiated or to be commenced by or against the corporate debtor. It’s worth noting that, despite the fact that the identical actions initiated “by the Corporate Debtor” are likewise stayed, Section 14(1)(a) of the IBC clearly says that proceedings “against the Corporate Debtor” are to be stayed.  In Power Grid Corporation of India Ltd. v. Jyoti Structures Ltd., the Delhi High Court was required to interpret this issue, and the Single Judge outlined  the considerations to consider when determining whether a moratorium should be applied to proceedings initiated by a corporate debtor. The grounds were: 1. “The substance of the proceedings must be assessed; and 2. if such proceedings are in the Corporate Debtor’s favour or against the Corporate Debtor must be determined.”

If the responses to the considerations favour the Corporate Debtor, then continuing the proceedings during the moratorium would be detrimental to the Corporate Debtor and would also be contrary to the IBC’s goals. The Single Judge was of the opinion that the application of a moratorium should not be employed to put a blanket suspension on all actions; rather, in proceedings brought by the Corporate Debtor, the continuation of the case should be considered if it would benefit the Corporate Debtor. A proceeding would not be barred under Section 14(1)(a) of the IBC unless it had the effect of jeopardising, depleting, dissipating, or adversely affecting the assets of the Corporate Debtor. The legislative intent, as palpable by the narrow construction of the phrase “against the Corporate Debtor” in Section 14(1)(a) of the IBC, was to limit the meaning and applicability of the moratorium under Section 14(1)(a) of the IBC to proceedings brought against the Corporate Debtor and not by the Corporate Debtor. The Delhi High Court’s and NCLAT’s interpretations in the aforementioned instances do pose a relevant question about the meaning and applicability of the phrase “against the corporate debtor” as defined under Section 14(1)(a) of the IBC. On the surface, it appears that the legislative objective was to limit the scope and meaning of the moratorium as defined under Section 14(1)(a) of the IBC, and that this interpretation would favour the Corporate Debtor, its corpus, and creditors. Despite the obvious benefits of this approach, there are a few disadvantages as well: Allowing the corporate debtor’s proceedings to continue might cause the whole process as well as the statutorily prescribed time limit to be delayed.

  1. If the proceedings are allowed to continue, it may cause financial stress in the form of additional litigation expenses; and
  2. If the Courts are asked to determine whether a proceeding is in favour or against the Corporate Debtor, it is the same as making an assessment based on a preliminary understanding of the proceeding, which may be injurious to the parties involved and may result in situations of judicial powers and functions overlapping.[10]

The purpose of section 14 i.e., imposition of moratorium against the Corporate Debtor is basically to ensure that there is no depletion of assets of the corporate debtor during the insolvency resolution process and at the same time it could be kept afloat as a going concern during the CIRP thereby maximizing the value for all stakeholders.

Further Analysis and Conclusion

The above cases have been decided keeping in mind the extent of repercussions of the corporate debtor, leaving out the impact such judgements or future judgements on the same line might have on the creditors’ interests. However, in the abovementioned cases, the creditors hold a power over the corporate debtor by having the liberty to initiate suits against its management, hence going against the objective of S.14(1)(a) itself. Here, the court, without any sound reasoning rules that promoters or directors being natural persons, are not corporate debtor, taking a very restrictive and mechanical view, without considering the substantive implications. Under S.14(1)(a), the legislative intent is to protect the corporate debtor from facing further litigation during the pendency of CIRP. Similarly, clause (d) is also in order to protect the corporate debtor. But S.14(1)(b & c), provide that – (b) transferring, encumbering, alienating or disposing off by the corporate debtor any of its assets or any legal right or beneficial interest therein; (c) any action to foreclose, recover or enforce any security interest created by the corporate debtor in respect of its property including any action under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (54 of 2002)”. Thus, these two clauses are necessary to prevent the disposal of assets bearing interests of the creditors. Therefore, non-application of moratorium to the key managerial persons of the company puts the creditors’ interests in jeopardy. Though the above cases had a factual scenario relating to litigation against the promoter and directors of corporate debtor, seeming to be in interest of creditor, the same extension under S.14(1)(b & c) would jeopardize their claim. The directors, promoters have the authority to deal with corporate debtor’s assets and could handle them on its behalf. They are the soul of the company and take all the major decisions with regards to its functioning. This would lead to further rounds of litigation to handle the loss of assets/properties holding creditors’ interest, effectively making the objective of CIRP and moratorium itself moot. It leads to forum shopping, thereby having an adverse impact on both the parties. The moratorium provision under S.14, being the core of IBC, should thereby be read expansively in the sense that a full effect is given to the intent and objective of the provision as well as the code itself. Therefore, in my view, the decision of Supreme Court in these cases could act as a grey area with ambiguity, leading to further problems and litigation.

Reference:

[1] Insolvency and Bankruptcy Code, 2016, S.14, No. 31, Acts of Parliament, 2016.

[2] ‘All about Moratorium under IBC Including Judicial Pronouncements – IBC Laws’. Accessed 26 October 2021. https://ibclaw.in/all-about-the-moratorium-under-ibc-including-judicial-pronouncements/.

[3] Ibid.

[4] Anjali Rathi and Ors. v. Today Homes & Infrastructure Pvt. Ltd. and Ors., (2021) ibclaw.in 152 SC.

[5] Ibid.

[6] ‘Moratorium Declared Under Section 14 Of The IBC Does Not Apply To Proceedings In Respect Of Directors Or Management Of Corporate Debtor: Supreme Court Of India – Insolvency/Bankruptcy/Re-Structuring – India’. Accessed 25 October 2021. https://www.mondaq.com/india/insolvencybankruptcy/1113078/moratorium-declared-under-section-14-of-the-ibc-does-not-apply-to-proceedings-in-respect-of-directors-or-management-of-corporate-debtor-supreme-court-of-india.

[7] Insolvency and Bankruptcy Code, 2016, S.14, No. 31, Acts of Parliament, 2016.

[8] ‘Moratorium under IBC Applies Only to Corporate Debtor Not to Promoters: SC | Business Standard News’. Accessed 25 October 2021. https://www.business-standard.com/article/companies/moratorium-under-ibc-applies-only-to-corporate-debtor-not-to-promoters-sc-121091601418_1.html.

[9] (2021) ibclaw.in 24 SC

[10] ‘“Against the Corporate Debtor”- Ambiguity around Section 14(1) (a) of IBC | SCC Blog’. Accessed 26 October 2021. https://www.scconline.com/blog/post/2021/02/16/insolvency-and-bankruptcy-law/.

 

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