Termination of Contracts During Corporate Insolvency Resolution Process: Part II

In Part I, I had discussed the regime under the unamended Section 14 governing the issue of termination of contracts. In this Part, I discuss the amendments to Section 14 introduced by the Insolvency and Bankruptcy Code (Amendment) Ordinance, 2019 and retained by the Insolvency and Bankruptcy Code (Amendment) Act, 2020.

The Ordinance inter alia inserted the following two provisions in Section 14.

A) Explanation to Section 14(1):

Explanation to Section 14(1) provides for instances where, broadly, a government or an authority established under law has granted a license, permit or a similar grant or right to the corporate debtor. The Explanation clarifies that the moratorium under Section 14(1) prohibits the suspension or termination of such licence, permit, etc. available with the corporate debtor “on the grounds of insolvency” of the corporate debtor. These prohibited grounds include not only the commencement of insolvency, but also other factors which are related to insolvency, such as non-payment of dues (Chapter I, para 8.9 of the Report of the Insolvency Law Committee).

The Explanation clarifies that the moratorium does not apply in the event that the corporate debtor defaults on its current dues payable as consideration for such licence, permit, etc. during the CIRP period. In other words, dues pending for the period prior to the commencement of CIRP do not constitute a ground for the termination of such licence, permit etc. The rights and obligations of the corporate debtor prior to the commencement of CIRP are, in effect, severed from its rights and obligations during the CIRP period. This approach is somewhat different from that prescribed by the UNCITRAL Legislative Guide on Insolvency Law. While the UNCITRAL (in Recommendation 79) also proposes that the counter party can be mandated to continue with the contract despite contractual breaches committed by the corporate debtor prior to the commencement of insolvency, it also requires the insolvency professional to cure the breach and put the counter party in substantially the same economic position it was in before the breach. The additional requirement imposed by UNCITRAL more adequately addresses the concerns of counter parties, as they may be reluctant to continue the contractual relationship with the corporate debtor on account of the prior defaults.

The Explanation to Section 14(1), gauged from its express terms – “[f]or the purposes of this sub-section, it is hereby clarified that”, suggests that it is intended to be clarificatory in nature. However, the scope of the Explanation indicates that it also substantively amends Section 14(1) insofar as termination of contracts is concerned. The express terms of the Explanation are not determinative of its supposedly clarificatory nature (Sedco Forex International Drill Inc. v. CIT). According to the unamended Section 14(1), once sub-clause (a) or sub-clause (d) was found to be applicable, the prohibition on termination of contracts was absolute and not subject to any exception. However, the Explanation to Section 14(1) restricts the scope of this prohibition in two ways: a) the prohibition applies only if the termination is on grounds related to insolvency; b) the prohibition does not apply if the corporate debtor defaults in payment of dues for use of the license, permit, etc. during the moratorium. Prior to the amendment, the phraseology of Section 14(1) did not permit these two exceptions to be read into it.

The substantive change brought about by the insertion of Explanation to Section 14(1) lends further ambiguity to the issue of effect of moratorium on termination of contracts. Should the two exceptions to the prohibition on termination of contracts be extended to scenarios where the Explanation is inapplicable but the termination is other prohibited under sub-clause (d) of Section 14(1), say, where the grant is conferred by a private entity? The first exception, which restricts the prohibition on termination to insolvency-related grounds, is founded on the notion that “the moratorium under Section 14 is not intended to dispense with obligations to comply with non-pecuniary requirements during the moratorium period” (Chapter I, para 8.10 of the Report of the Insolvency Law Committee). The second exception recognises that no counter party ought to be coerced into continuing with the grant if the corporate debtor is unable to pay for it during the CIRP period. The justification behind both the exceptions to the prohibition on termination of contracts during the CIRP period would be equally applicable where the counter party is a private entity and similarly, to any other contract entered into by the corporate debtor. Therefore, the two exceptions to the prohibition on termination contained in the Explanation must also be applied to instances where the Explanation is inapplicable.

B) Insertion of sub-section (2A) in Section 14:

The other amendment made to Section 14 by the Insolvency and Bankruptcy Code (Amendment) Ordinance, 2019 is the insertion of sub-section (2A). According to this provision, it is now the prerogative of the interim resolution professional or the resolution professional to determine the goods or services which are critical for the continuation of the corporate debtor as a going concern. The supply of such goods and services cannot be terminated, suspended or interrupted during the CIRP period.

This prohibition does not apply in the event that the corporate debtor defaults on the payment for supply of such critical goods or services made during the CIRP period. This is in contrast to Section 14(2), which does not contain any such exception for supply of ‘essential goods or services’. The obvious rationale behind this exception is also stated in the Report of the Insolvency Law Committee (Chapter I, para 8.18), i.e. compelling suppliers to continue supplying critical goods or services in the absence of any payment by the corporate debtor would cause distress to such suppliers.

The insertion of sub-section (2A) is laudable, as it recognises that besides the essential supplies referred to in Section 14(2), certain other goods and services may be essential for the survival of the corporate debtor as a going concern. It is premised on the correct assumption that the nature of such critical goods or services may vary and therefore, empowers the insolvency professional to determine on a case-to-case basis as to which goods or services are critical and whose supplies cannot be terminated by the counter party. However, it fails to appreciate that it is not only contracts relating to supplies made to the corporate debtor, but also other contracts, including contracts relating to supplies made by the corporate debtor which may be vital to ensure that the corporate debtor continues as a going concern. It is not unusual that the subsistence of a contract under which the corporate debtor is the exclusive supplier of goods or services is essential for its survival. The termination of such a contract by the counter party may not be affected by Section 14(2A) (or Section 14(1)). A wider phraseology of Section 14(2A) to include all contracts would have adequately addressed this concern.

Published by Sharad Bansal

Advocate, Bombay High Court

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