Section 138 Cheque Bounce Cases Split Into Two Tiers; Criminal Limb Not Shielded by IBC Moratorium
A Supreme Court bench of Justices Pardiwala and Viswanathan holds that personal insolvency moratorium shields only the compensatory, not the criminal, aspect of cheque dishonour proceedings, and refers two questions to a three-judge bench.
The Supreme Court has held that proceedings under Section 138 of the Negotiable Instruments Act, 1881 are not a single, undivided action but a tiered proceeding with a criminal limb and a compensatory limb. The moratorium triggered by personal insolvency under Part III of the Insolvency and Bankruptcy Code, 2016 — whether under Sections 96, 101, 124, or 128 — can stay only the compensatory tier. The criminal tier, which may result in imprisonment or fine, is expressly excluded. The bench, comprising Justice J.B. Pardiwala and Justice K.V. Viswanathan, delivered this judgment on 27 May 2026 while disposing of appeals arising from a Madras High Court order that had refused to quash a Section 138 complaint against the former Managing Director of M/s. Surana Power Ltd. Because the questions raised conflict with observations of a three-judge bench in P. Mohanraj v. Shah Bros. Ispat (P) Ltd., (2021) 6 SCC 258, the matter has been referred to the Chief Justice of India to constitute an appropriate three-judge bench.
How the Dispute Reached the Court
Dineshchand 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. Surana provided a blank cheque as security, with the understanding that the bank could encash it if the liability devolved on it due to non-payment within 90 days.
The Letter of Credit duly devolved on SPL. Surana then 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 thereafter filed C.C. No. 3645 of 2015 before the XIV Metropolitan Magistrate, Egmore, Chennai.
An earlier attempt by Surana to quash the complaint — Criminal OP No. 24740 of 2019 — was dismissed by the Madras High Court on 24 October 2018. Separately, SPL was ordered into liquidation by the NCLT, Chennai on 19 February 2018.
The present round of litigation began when the NCLT admitted a personal insolvency application against Surana under Section 95 of the IBC on 15 February 2022, while the Section 138 complaint was still pending before the Magistrate. Surana filed fresh petitions before the Madras High Court in August 2023 seeking quashing of the complaint and a stay of proceedings, arguing that the interim moratorium under Section 96 of the IBC covered the Section 138 proceedings as a “legal proceeding 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 a proceeding for recovery of money from a debtor. Surana challenged that order before the Supreme Court. During the pendency of the appeal, the NCLT admitted the personal insolvency application on 30 August 2024, triggering the Section 101 moratorium. The insolvency proceedings closed on 3 January 2025, and a bankruptcy order was passed on 12 November 2025, bringing Section 128 of the IBC into operation.
The Conflict With P. Mohanraj and the Competing Arguments
The appellant's counsel, Mr. Shreeyash Lalit, anchored his submissions on the three-judge bench decision in P. Mohanraj, which described Section 138 proceedings as a “civil sheep in a criminal wolf's clothing” and held that the expression “legal action or proceeding in respect of any debt” in Sections 96 and 101 of the IBC includes Section 138 proceedings. He argued that the moratorium under Part III affords even wider protection than Section 14 of the IBC because it operates in respect of “any debt” rather than being debtor-specific. He further submitted that a two-judge bench decision in Rakesh Bhanot v. Gurdas Agro Private Limited, (2025) 6 SCC 781, which held that personal insolvency moratorium does not shield individuals from criminal liability under Section 138, was in direct conflict with the larger bench in P. Mohanraj.
UCO Bank's counsel, Mr. Briijesh Kumar Tamber, relied on Ajay Kumar Radheshyam Goenka v. Tourism Finance Corporation of India Ltd., (2023) 10 SCC 545, and Anjali Rathi v. Today Homes & Infrastructure (P) Ltd., (2021) SCC OnLine SC 729, to argue that the moratorium under Section 14 and Part III of the IBC applies only to the entity undergoing restructuring and does not shield individuals from personal criminal liability. He also placed reliance on High Court decisions from Delhi, Madhya Pradesh, and Punjab and Haryana, all of which had held that Section 138 proceedings are penal in nature and not covered by the expression “any debt” in Section 96 of the IBC.
The Court's Analysis of Section 138's Nature
Justice Pardiwala, writing for the bench, undertook an extended analysis of the nature of Section 138 before addressing the moratorium question. The Court held that the deeming fiction in Section 138 — which makes dishonour of a cheque a deemed offence — must be given its full effect. Relying on Bhavnagar University v. Palitana Sugar Mill (P) Ltd., (2003) 2 SCC 111, the Court said that once a legal fiction is created, the consequences that flow from it must also be treated as real. The civil origin of the underlying debt does not strip the proceeding of its criminal character.
The Court traced the Statement of Objects and Reasons of the Banking, Public Financial Institutions and Negotiable Instruments Laws (Amendment) Act, 1988, which introduced Chapter XVII of the NI Act. The object was to “enhance the acceptability of cheques in settlement of liabilities” by attaching penal consequences to dishonour — not to create a debt recovery mechanism. The Court observed that had Parliament intended to punish mere failure to repay debt, it would have extended criminal consequences to dishonour of all negotiable instruments, not just cheques.
The bench drew a careful distinction between the fine that may be imposed under Section 138 and the compensation that a court may order out of that fine under Section 395 of the Bharatiya Nagarik Suraksha Sanhita, 2023. Section 138 itself provides for imprisonment, fine, or both — these are punishments. Compensation is a secondary, discretionary order made from the fine amount. The Court also noted that Chapter XII of the NI Act, which deals with compensation for dishonour of negotiable instruments under Section 117, is a wholly civil remedy that predates Chapter XVII and operates on different principles.
The Court acknowledged the quasi-criminal characterisation of Section 138 proceedings adopted in M. Abbas Haji v. T.N. Channakeshava, (2019) 9 SCC 606, and H.N. Jagadeesh v. R. Rajeshwari, (2019) 16 SCC 730, but held that the quasi-criminal label does not tilt the proceeding towards the civil side. The strict liability standard — absence of any requirement to prove mens rea — reinforces the deterrent, criminal character of the provision.
The Court then revisited P. Mohanraj and found that the three-judge bench's characterisation of Section 138 as a “civil sheep in a criminal wolf's clothing” was based primarily on the procedural features of Chapter XVII — the 15-day cure window, the use of affidavit evidence, the civil-style service of summons, and the compoundability of the offence — without full consideration of the predominantly criminal objective of the provision. The present bench held that the predominant nature of Section 138 proceedings is criminal, not civil.
The Two-Tier Framework and Moratorium Applicability
To resolve the tension between the NI Act and the IBC, the Court bifurcated Section 138 proceedings into two tiers.
Tier I is the criminal aspect: the trial, conviction, and punishment by way of imprisonment, fine, or both. This tier is mandatory and flows directly from the deeming fiction in Section 138. The Court held that the moratorium provisions under Part III of the IBC — Sections 96, 101, 124, and 128 — cannot apply to Tier I. The reason is textual: Section 79(15) of the IBC defines “excluded debts” and expressly excludes “liability to pay fine” from the category of debts in respect of which moratorium operates. Allowing the criminal limb of Section 138 to be stayed by a moratorium would contradict this express exclusion and undermine the deterrent purpose of the NI Act.
Tier II is the compensatory aspect: the discretionary order directing payment of compensation out of the fine amount, which the Court treated as a civil remedy causing depletion of the debtor's assets. The Court held that the moratorium under Sections 96 and 101 of the IBC applies to Tier II because the expression “any debt” in those provisions is wide enough to cover the compensatory liability arising from Section 138 proceedings. Similarly, the moratorium under Sections 124 and 128 of the IBC would stay any suit or proceeding against the properties of the debtor instituted to enforce the compensatory liability as a bankruptcy debt under Section 79(5) of the IBC.
On the question of directors vicariously liable under Section 141 of the NI Act, the Court held that when the corporate debtor is shielded from Section 138 proceedings by the Section 14 moratorium, the compensatory liability shifts to the directors. If those directors are themselves undergoing personal insolvency or bankruptcy under Part III, they are entitled to the benefit of moratorium in respect of that compensatory liability. The Court reasoned that depriving a director of moratorium protection on the ground that the compensatory obligation was not originally his personal debt would be detrimental both to the director and to other creditors who stand to benefit from preservation of the debtor's asset pool.
The Court was careful to reiterate that the criminal aspect of Section 138 proceedings — Tier I — continues against directors regardless of any moratorium, consistent with the position affirmed in Rakesh Bhanot and Ajay Kumar Radheshyam Goenka.
Outcome
The bench answered the three issues it had framed as follows. First, Section 138 proceedings are not in the nature of a legal action for recovery of money; their predominant character is criminal. Second, the moratorium under Part III of the IBC applies only to the compensatory aspect (Tier II) of Section 138 proceedings, not to the criminal aspect (Tier I). Third, directors liable under Section 141 who are themselves undergoing personal insolvency or bankruptcy are entitled to moratorium protection in respect of the compensatory aspect of Section 138 proceedings.
However, because the Court's conclusions on the nature of Section 138 and the scope of the moratorium depart from observations made by the three-judge bench in P. Mohanraj, the bench directed that the matter be placed before the Chief Justice of India to constitute an appropriate three-judge bench. That bench is to consider: (i) whether Section 138 of the NI Act is quasi-criminal in nature with a tilt towards the criminal side; and (ii) whether the Part III moratorium should apply to the entire Section 138 proceeding or only to its compensatory aspect. The Registry was directed to place the papers before the Chief Justice of India for appropriate orders.