An operational creditor who took a haircut can set off the whole of its extinguished claim

Justices J.B. Pardiwala and K. Vinod Chandran held the clean slate principle protects the successful resolution applicant, but allowed a set-off to keep the arbitration equitable.

An operational creditor whose Rs 12.26 crore claim was admitted at 0.72 per cent in a resolution plan can be pursued by the successful resolution applicant for what it owed the corporate debtor before insolvency — but it may set off the entirety of its own extinguished claim against whatever the arbitrator finds due. A Division Bench of Justice J.B. Pardiwala and Justice K. Vinod Chandran framed the question as whether an operational creditor who suffered a major haircut in the resolution process can be proceeded against by the successful resolution applicant for pre-CIRP dues owed by the creditor to the entity that fell into insolvency. The judgment was authored by Justice Chandran.

A Rs 133 crore contract and a termination that came too late

The parties contracted on 9 July 2018 for the civil and structural work of constructing an office building, the total contract amount being Rs 133.68 crore. Clause 19.13 provided for arbitration of disputes relating to or arising out of or touching the contract. The appellant paid the mobilisation advance and the respondent furnished a bank guarantee of Rs 1,56,13,250 towards successful completion.

The respondent's case was that work commenced on 1 June 2018, the timeline was extended once to 31 December 2019, and 95 per cent of the work was complete when the appellant threatened termination unless the defects pointed out were rectified within fourteen days. The appellant stands by its notice and the termination effected on 25 February 2020 — by which date, admittedly, the respondent had already been admitted into the corporate insolvency resolution process, on 11 December 2019. It was after that admission that an application was made to register the respondent as a small enterprise with the Ministry of Micro, Small and Medium Enterprises.

The appellant took a claim of Rs 12,26,30,840 to the Resolution Professional. Only 0.72 per cent of it survived the haircut in the resolution plan submitted by the erstwhile promoter — a plan open to him because the corporate debtor was an MSME, by virtue of Section 240A(1) of the Insolvency and Bankruptcy Code. The plan carried the majority of the Committee of Creditors and the appellant's claim was allowed to the extent of Rs 8,82,942 with interest.

Why the erstwhile promoter cannot say he did not know

The reasoning turns on what the insolvency process puts in front of a resolution applicant, and the Bench walked through the statutory duties to show it.

On appointment the interim resolution professional must collect all information on the assets, finances and operations of the corporate debtor to determine its financial position, and receive and collate all claims submitted, among the other matters in Section 18. The Resolution Professional takes custody and control of the assets and from then on represents and acts on behalf of the corporate debtor, exercising rights for its benefit against third parties. Section 19 obliges the personnel of the corporate debtor, its promoters and others associated with its management to extend cooperation to the interim professional, and that information passes to the Resolution Professional. Under Section 29 the Resolution Professional must prepare an Information Memorandum and give any resolution applicant access to all the information, which by the Explanation to that section includes the financial position of the corporate debtor and all information on disputes by or against it.

From that the Bench drew its conclusion. The erstwhile promoters are not completely alien to the insolvency proceedings; their active participation while the interim professional collates every piece of information, claims included, in order to constitute the Committee of Creditors, is statutorily provided for. The operational creditor's claim had been received by the Resolution Professional and disclosed in the Information Memorandum. The erstwhile promoters, who were the resolution applicant, therefore knew of it, and by providing 0.72 per cent in the plan they submitted, they are deemed to have accepted the claim. It is on that very same transaction that the successful resolution applicant now proposes to raise a claim and seek arbitration.

What the High Court got wrong, and what it got right

The High Court had left it to the arbitrator to decide whether the clean slate principle applies equally to the successful resolution applicant. The Bench held that cannot be accepted, because the legal position is clear: as against the successful resolution applicant the clean slate principle applies, while the applicant may proceed for the dues of the corporate debtor. Nothing remains for the arbitrator on those aspects.

The appointment of an arbitral tribunal was not disturbed. The Bench found no ground to interfere with it on the extinguishment of a creditor's claim as against the corporate debtor, or on the right of the successful resolution applicant to proceed against any debtor of the corporate debtor. What it wanted was a measure that would not interfere with the clean slate principle and would still ensure an equitable consideration of both parties' claims under the contract.

The set-off

For that the Bench drew on Ujaas Energy Ltd. v. West Bengal Power Development Corporation Ltd., a decision expressly stated to rest on the peculiar facts of that case but which the Bench found almost similar so far as the equitable directions sought here are concerned; there too the appellant was registered as an MSME.

The direction that follows is the practical holding. If the arbitral tribunal finds any amounts due from the appellant to the respondent, there shall be a set-off to the extent of the entire counterclaim as put forth by the appellant. Even in the extreme event of the respondent's claim being found untenable in its entirety, the appellant cannot seek any payment on the basis of such an award, because its claim stands extinguished as against both the corporate debtor and the successful resolution applicant. The benefit of the set-off, the judgment records, is granted only to ensure equity and to further the preservation of the corporate debtor's assets in the hands of the successful resolution applicant, within the contours of the Code.

Order

The appeal was disposed of with that modification. The question the respondent had raised about the encashment of the bank guarantee it furnished, and whether that was proper or improper, is also to be considered by the arbitral tribunal. Pending applications stood rejected.