Moratorium Under Section 13 & 14 Of The Insolvency And Bankruptcy Code, 2016

Author: Nathan Gomes Student, Gujarat Law Society, Ahmedabad

“CREDIT IS THE BACKBONE OF ANY GROWING ECONOMY BUT A HARSH REALITY IS THAT BUSINESSES DO FAIL”

Introduction

What happens to the creditors when a business fails, is what the insolvency regime tries to answer. We are well versed with the fact that, all discussions revolving around the IBC, 2016 boils down to: 1. The time bound process of resolution of Corporate Persons, 2. Maximization of the value of assets 3. The revival of the Corporate debtor or the business of the Corporate debtor, but the question which arises here is why IBC? The shortest and the most simplified answer to it is that a codified legislation is always better than other multiple legislations in order to deal with aspects of financial difficulties faced by a Company. What happened earlier is that creditors were exercising their rights to recovery through laws under the SARFAESI Act 2002, SICA 1985, or as per the schemes put out by the Reserve Bank of India, thereby leading to a procedure which was seemingly never ending, meaning thereby life did exist before the IBC.

An example of what actually happened under the previous legislations for a better understanding is that: “A” the corporate debtor (A person who owes money to another person) has assets worth Rs.100, ‘B’, ‘C’, ‘D’ are the creditors (a person to whom money is owed). The corporate debtor owes these 3 creditors Rs.100, Rs.50 and Rs.60, each. Now here, we can clearly see that the corporate debtor is falling short of Rs. 200. What used to happen in these situations earlier, when there was no specific regime in place to monitor how these 100 Rs. would be distributed amongst the creditors is that every creditor would try and grab the first asset that he could have his hands on. Every creditor would file their own suit i.e., assuming that ‘B’ (creditor) is a bank, what they would do is file a suit for recovery before the Debt Recovery Tribunal and get their share. The result of such a regime would provide an optimal outcome for one of the three creditors i.e.,‘B’ while everyone else is left in a lurch. This was something that was not intended. Therefore, it was necessary to devise a system where two things can happen 1. That the outcome that is reached is as close to optimal as possible and to see if by any chance, the financial problems may be resolved 2. Sometimes businesses have to shut down, but when they shut down what can be the best manner in which the money they owe can be distributed.

When we compare the same example with the present regime under the IBC, what we see is that the present regime tries to answer aforementioned question as to how these 100 Rs. that the Corporate debtor has and which is ultimately limited, is equally distributed amongst all the creditors. This is how an insolvency regime is different from a mere recovery. This is a brief overview as to how the regime under the IBC is different from that of the regime which existed before 2016. The present article would mainly focus on the aspect of moratorium and how it comes in motion along with the interpretation of Section 14 of the IBC.

Operative Portion

Basically, insolvency is shorthand for state in which a company has liabilities which are exceeding its assets. It is a state where a company owes Rs.300 but has only Rs.100. It is important to understand why is this insolvency process termed as CIRP or why is this term CIRP used, what it simply means is that it resolves the insolvency of the Corporate Debtor. Another question that is necessary to answer is that by whom is this CIRP initiated? A simple answer to this is that Section 7 of the Code provides for the initiation of the CIRP by the Financial Creditors (e.g. loan given by a bank, here bank is the financial creditor). Likewise this CIRP is also initiated by the Operational creditors (A service provider or a goods provider) and the Corporate Persons. But here, the question then which is of utmost importance is that when is the CIRP initiated? The procedure of CIRP is initiated by the Creditors when there is a default on the part of the Debtor and there arrives a situation where the Debtor is unable to return the said amount which he owes to the Creditor. Another question that arises here is that, when such default arises on the part of the Debtor, what action can the Creditor take? A simplified answer to this is that, this Creditor (Financial/Operational/Corporate Persons) will file an application before the National Company Law Tribunal (Adjudicating Authority) along with the proof of default on the part of the Debtor. In addition to this, it shall also name a resolution professional that the Creditor proposes to act as an interim resolution professional. The Adjudicating Authority, will then within 14 days from the date of the application, decide if there exists a default or not.

Note: The Process of initiation for both i.e. 1. Financial Creditor & 2. Operational Creditor is almost the same; the only difference in the initiation of CIRP by the Operational Creditor is that, before making an application to the NCLT, there is a mandate under section 8 that a demand notice needs to be served to the Debtor which is not a mandate for the initiation of CIRP by the Financial Creditors.

What next? After the Adjudicating Authority decides that there exists a default on the part of the Debtor, and that there is no proceedings pending against the Resolution Professional proposed, it will admit this application. On such admission, the CIRP commences. After the application is admitted, this Adjudicating Authority will DECLARE A MORATORIUM under section 13 of the code. What does this moratorium mean and what does it do? A simple meaning of moratorium is STAY OF ONGOING PROCEEDINGS? Does it stay all the proceedings? Here, it becomes significant to refer to section 14 of the Code, which specifies what proceedings are stayed when the moratorium is imposed.

The major purpose of moratorium is to keep the Debtors assets together during the process of insolvency, thereby also facilitating the completion processes during the insolvency resolution and ensuring that the company is revived. The imposition of moratorium also restricts the multiplicity of proceedings against the Debtor and thereby also helps to remove the chances of conflicting decisions of such related proceedings.

The plain reading of section 14 of the Code inter alia states that, when the moratorium is imposed, this imposition shall thereby prohibit the institution or continuation of any legal proceeding or suit against the Debtor and also prohibits the disposal of any assets of the Debtor or any other action. A simplified meaning of this prohibition under section 14 is that there is a standstill on the initiation and continuation of legal proceedings[1]. Therefore, the Creditors herein cannot resort to any kind of individual actions of enforcement as it would defeat the very purpose of the CIRP. However, in addition to this, it also prevents the termination of contracts that provide for the supply of essential goods and services as the same may be important for the completion of the proceedings. It is very important to note that this period of moratorium shall continue and shall be effective till the conclusion of the CIRP or till the resolution plan is approved by the Adjudicating Authority. These stay on proceedings against the Debtor work as a progressive step in maximizing the value of the assets of the Debtor and thereby also keep the assets of the Debtor together. This also in addition to the aforementioned shall help the Debtor continue as a “Going Concern” during the time when the creditors are thinking of how to resolve this default.

Note: The moratorium shall not apply to the surety in the contract of guarantee to the Debtor. Section 14 in my view thereby needs more clarity on these aspects, as the committee did not intend to stay any action on the asset of the guarantor[2]. This clarification should thereby be inserted under Section 14 of the Code. As, until the debt owed by the Debtor is not final, the liability of the surety would also be unclear[3].

When the moratorium is declared, it is mandatory for the Adjudicating Authority to pass an order prohibiting the institution or continuation of pending suits or proceedings as per clause (a) of section 14. The question that would then come to our mind is that, does this mean that any proceedings or suit under the sky will be stayed when a moratorium is imposed?  The answer to this is that the moratorium that is imposed is against Suits and Proceedings including Arbitration Proceedings[4] and recovery of any property by owner or lessor. Here, apart from the aforementioned question, another point that crops up is whether a complaint filed under the Criminal Procedure Code falls within the ambit of suit? The answer to this is NO. So, when we talk about stay on the initiation or continuation of any suit or proceeding, it cannot mean to be a stay on the criminal proceedings. The Bombay High Court in the case of Indorama Synthetics v. State of Maharashtra[5], held that the expression “suit or other proceedings”, therefore has to be construed accordingly and not to be interpreted so liberally and widely so as to include each and every proceedings of whatsoever nature initiated against a company, including criminal proceedings such as for the offence under section 138 of the Negotiable Instrument Act, 1881.

In reply to the question aforementioned, it is important to take note of those matters which do/did not fall under the ambit of section 14 of the Code or the proceedings which are/were not stayed when the moratorium was imposed and the same are: 1. The proceedings initiated by the Debtor, where he is owed a particular sum by another person 2. Writ proceedings are not stayed when the moratorium is imposed

  1. Up till now, the moratorium imposed under section 14 of the Code did not affect the proceedings under Section 138 of the Negotiable Instruments Act, but the three judge bench of the Supreme Court in its recent judgement in the case of P. Mohanraj & Ors v. M/s Shah Brothers Ispat Ltd. and other connected cases[6] held that, “MORATORIUM IMPOSED UNDER SECTION 14 OF THE CODE COVERS THE PROCEEDINGS UNDER SECTION 138 AGAINST THE CORPORATE DEBTOR FOR THE DISHONOUR OF CHEQUE.”

The other processes which follow after the application is admitted and the moratorium is imposed are: 1. Appointment of an Interim Resolution Professional within 14 days of the commencement of insolvency 2. Interim Resolution Professional shall on appointment make a public announcement calling for claims within three days of his appointment 3. The creation of the Creditors Committee.

Conclusion

I shall conclude by stating that where businesses in such trying times of Covid-19 tend to fail, this process adopted under the Code helps in a time bound resolution and revival in some cases thereby avoiding multiplicity of proceedings as well. Moreover, the conflicting decisions over the same subject matter which often occurred under the previous regime shall also be avoided.

[1] Section 14 of the Insolvency And Bankruptcy Code, 2016

[2] NCLAT New Delhi, Comp Appeal (Insolvency) No 116/2017

[3] (2017) 9 ADJ 723

[4] [2017] 145 SCL 428

[5] (2016) 190 Comp Cas 46 (Bom)

[6] LL 2021 SC 120

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