Supreme Court Refers Section 138 NI Act and IBC Moratorium Conflict to Three-Judge Bench

A Division Bench of Justice Pardiwala and Justice Viswanathan splits Section 138 proceedings into criminal and compensatory tiers before referring key questions to a larger bench.

A Division Bench of the Supreme Court has referred two significant questions to a three-judge bench: whether Section 138 of the Negotiable Instruments Act, 1881 is quasi-criminal with a tilt towards the criminal side, and whether the moratorium under Part III of the Insolvency and Bankruptcy Code, 2016 applies to the entirety of Section 138 proceedings or only to their compensatory aspect. The judgment, delivered on 27 May 2026 in Dinesh Chand Surana v. UCO Bank, arose from a cheque dishonour complaint filed against the former Managing Director of a company undergoing liquidation. Before making the reference, the Bench produced a 150-page analysis that introduces a two-tier framework for Section 138 proceedings and directly questions the durability of the three-judge bench ruling in P. Mohanraj v. Shah Bros. Ispat (P) Ltd., (2021) 6 SCC 258.

How the Dispute Reached the Court

Dinesh Chand Surana was the Managing Director of M/s. Surana Power Ltd. (SPL), a company engaged in electricity generation. On 26 December 2014, UCO Bank opened an Irrevocable Inland Letter of Credit in favour of SPL for the purchase of Indonesian coal worth Rs. 5,03,21,250. The arrangement required Surana to provide a blank cheque as security, which the bank could encash if SPL failed to pay within 90 days of the invoice.

When the Letter of Credit devolved on SPL, the bank became liable to pay the bills. Surana issued a cheque dated 26 March 2015 drawn on Punjab National Bank to clear the dues. The cheque was dishonoured on 18 June 2015 with the endorsement “Funds Insufficient”. UCO Bank issued a statutory notice on 23 June 2015 and filed C.C. No. 3645 of 2015 before the XIV Metropolitan Magistrate, Egmore, Chennai.

SPL was ordered into liquidation by the NCLT, Chennai on 19 February 2018. A first attempt by Surana to quash the complaint before the Madras High Court failed on 24 October 2018. Then, on 15 February 2022, the NCLT admitted a personal insolvency application against Surana under Section 95 of the IBC while the complaint remained pending before the Magistrate.

Surana filed fresh petitions before the Madras High Court in August 2023 seeking to quash the complaint and stay the proceedings, arguing that the interim moratorium under Section 96 of the IBC covered legal proceedings in respect of any debt. The High Court dismissed both petitions on 18 October 2023, holding that Section 138 is a criminal enactment providing for imprisonment and fine and is not merely a recovery proceeding against a debtor. Surana appealed to the Supreme Court by way of special leave.

The factual backdrop continued to evolve during the appeal. On 30 August 2024, the NCLT admitted the personal insolvency application, triggering the moratorium under Section 101 of the IBC. On 3 January 2025, the NCLT closed the insolvency matter and granted liberty to file a bankruptcy application. A bankruptcy order was passed on 12 November 2025, bringing the moratorium under Section 128 of the IBC into operation against Surana at the time of the Supreme Court's hearing.

The Conflict Between P. Mohanraj and Rakesh Bhanot

The central legal tension before the Bench was a conflict between two Supreme Court decisions. In P. Mohanraj, a three-judge bench held that Section 138 proceedings are a “civil sheep in a criminal wolf's clothing” and that the expression “legal action or proceeding in respect of any debt” in Sections 96 and 101 of the IBC covers proceedings under Sections 138 and 141 of the NI Act, including in cases of personal insolvency.

In Rakesh Bhanot v. Gurdas Agro Private Limited, (2025) 6 SCC 781, a coordinate bench took the contrary view. It held that the moratorium under Part III of the IBC is designed to offer breathing space to a corporate debtor and is not intended to shield individuals from personal criminal liabilities. It further held that the cause of action for prosecution under Section 138 commences on dishonour of the cheque and failure to pay within 15 days of the statutory notice, and that allowing individuals to evade prosecution by invoking the moratorium would undermine the NI Act.

Surana's counsel, Mr. Shreeyash Lalit, argued that Rakesh Bhanot was decided without considering the observations in P. Mohanraj on personal insolvency and was therefore in conflict with the larger bench. UCO Bank's counsel, Mr. Briijesh Kumar Tamber, relied on Rakesh Bhanot and on Ajay Kumar Radheshyam Goenka v. Tourism Finance Corporation of India Ltd., (2023) 10 SCC 545, to argue that signatories of dishonoured cheques face Section 138 proceedings regardless of whether the corporate debtor is in insolvency or liquidation.

The Court's Two-Tier Framework for Section 138 Proceedings

Before making the reference, the Bench undertook an extended analysis of the nature of Section 138. It held that the provision is predominantly criminal, not civil, and that the description of Section 138 as a “civil sheep in a criminal wolf's clothing” in P. Mohanraj was reached without the attention of that bench being drawn to the criminal aspects of Chapter XVII of the NI Act.

The Bench reasoned that the deeming fiction in Section 138 — which makes cheque dishonour a deemed offence — must be given its full effect. The civil origin of the underlying dispute does not convert the proceeding into a civil one once Parliament has legislated a criminal consequence. The Statement of Objects and Reasons of the Banking, Public Financial Institutions and Negotiable Instruments Laws (Amendment) Act, 1988 showed that the predominant object was to increase public faith in the integrity of cheques in commercial transactions, not to create a debt recovery mechanism.

The Bench drew a distinction between the fine imposed under Section 138 and compensation. Section 138 provides for punishment by imprisonment, fine, or both. The power to direct compensation to the complainant out of the fine amount flows from Section 395 of the Bharatiya Nagarik Suraksha Sanhita, 2023 (formerly Section 357 of the CrPC), not from Section 138 itself. A court may convict and sentence to imprisonment without imposing any fine at all. The fine, when imposed, is not mandatorily directed as compensation.

On this basis, the Bench introduced what it called a tiered structure. Tier I is the criminal aspect: prosecution, conviction, and punishment by imprisonment or fine. This is mandatory and is the primary object of Section 138. Tier II is the compensatory aspect: the discretionary power of the court to direct that the fine amount, or part of it, be paid as compensation to the complainant under Section 395 of the BNSS. Tier II causes an overlap between criminal and civil actions.

The Bench also noted that Section 79(15) of the IBC, which defines “excluded debts”, expressly excludes “liability to pay fine” from debts in respect of which legal actions are stayed by the moratorium under Part III. This express exclusion, the Bench held, makes it clear that allowing Section 138 proceedings to enjoy the benefit of moratorium in their criminal aspect is not good law.

Moratorium and the Compensatory Tier

Having separated the two tiers, the Bench reached different conclusions for each. The criminal aspect of Section 138 proceedings — Tier I — is not covered by the moratorium under Part III of the IBC. The moratorium provisions in Sections 96, 101, 124, and 128 of the IBC do not stay the prosecution, trial, or punishment of an individual for cheque dishonour.

The compensatory aspect — Tier II — stands on different footing. The Bench held that the moratorium under Sections 96 and 101 of the IBC applies to the compensatory aspect of Section 138 proceedings because the expression “any debt” in those provisions is wide enough to cover the pecuniary liability that arises from a compensation order. Allowing enforcement of the compensatory liability during the moratorium period would deplete the individual debtor's assets and undermine the insolvency resolution process.

For the bankruptcy stage, the Bench held that the moratorium under Sections 124 and 128 of the IBC would stay any suit or legal proceedings against the properties of the debtor instituted with the purpose of enforcing the bankruptcy debt, which includes the compensatory aspect of Section 138 proceedings. The Bench went so far as to observe that the moratorium under Sections 124 and 128 would bar the use of Section 461 of the BNSS to recover compensation in the same manner as a fine.

Directors Vicariously Liable Under Section 141

The Bench also addressed whether directors vicariously liable under Section 141 of the NI Act, who are themselves undergoing personal insolvency, can claim the benefit of the moratorium. It answered in the affirmative, but only for the compensatory aspect.

The reasoning was that when the corporate debtor is protected by the moratorium under Section 14 of the IBC, Section 138 proceedings cannot continue against the company. In that scenario, the pecuniary liability of compensation shifts to the directors. If a director is simultaneously undergoing personal insolvency, depriving him of the moratorium benefit on the ground that the compensatory liability was not originally his personal obligation would be detrimental both to him and to other creditors who stand to benefit from minimal depletion of his assets.

The Bench held that the moratorium under Sections 96 and 101 of the IBC applies to directors saddled with the compensatory obligation of the company by virtue of the words “any debt” in those provisions. The moratorium under Sections 124 and 128 would similarly stay proceedings against the director's properties to enforce the bankruptcy debt. The criminal aspect, however, remains unaffected: directors cannot escape personal criminal liability under Section 138 read with Section 141 by invoking the moratorium.

Why the Reference Was Made

Despite the detailed analysis, the Bench declined to deliver a final ruling. It held that the conflict between P. Mohanraj (a three-judge bench) and Rakesh Bhanot (a two-judge bench), combined with the complexity of the questions, required an authoritative pronouncement by a three-judge bench after a comprehensive consideration of all aspects.

The Bench directed the Registry to place the matters before the Chief Justice of India for constitution of an appropriate three-judge bench. The two questions referred are: first, whether Section 138 of the NI Act is quasi-criminal in nature with a tilt towards the criminal side; and second, whether the moratorium under Part III of the IBC should apply to the entire Section 138 proceedings or only to the compensatory aspect.

Outcome

The appeals arising out of SLP (Crl.) No. 12135 of 2024 and SLP (Crl.) No. 12136 of 2024 were disposed of by directing the Registry to place the matters before the Chief Justice of India for constitution of a three-judge bench. The impugned judgment of the Madras High Court dated 18 October 2023 was not set aside. The two-tier framework and the analysis of the moratorium provisions set out in the judgment will be available to the three-judge bench when it takes up the referred questions.