Termination of Contracts During Corporate Insolvency Resolution Process: Part III

In Parts I and II, I had discussed the provisions of Section 14 of the Insolvency and Bankruptcy Code prior to the Insolvency and Bankruptcy Code (Ordinance), 2019, and the changes introduced to Section 14 by the Ordinance on the aspect of termination of contracts during the CIRP period. In this final Part, I look at the judgments on this issue.

Rajendra K. Bhutta v. MHADA and Section 14(1)(d)

While there is a wealth of jurisprudence on most vital issues concerning the insolvency resolution process of a corporate person, the consequence of a moratorium on the termination of contracts is an area that remains relatively unevolved. One of the earlier decisions on this issue was rendered by the Mumbai Bench of NCLT in Rajendra K. Bhutta v. Maharashtra Housing and Area Development Authority. Although this decision was eventually set aside by the Supreme Court (on a different issue), its reasoning throws some light on the Tribunal’s approach towards the issue.

In this case, the corporate debtor had entered into a Joint Development Agreement (“JDA”) with Maharashtra Housing and Area Development Authority (“MHADA”). MHADA terminated the JDA while the corporate debtor was undergoing insolvency. The NCLT rejected the corporate debtor’s submission that the moratorium imposed pursuant to Section 14(1) precluded MHADA from terminating the JDA. It held that sub-clause (a) of Section 14(1) was irrelevant to the termination since the termination could be effected without any ‘proceedings’ to be conducted before any ‘authority’. As to sub-clause (d) of Section 14(1), the NCLT held that in the facts of the case, this sub-clause did not preclude MHADA from taking possession of the property in question from the corporate debtor and consequently, sub-clause (d) did not have any bearing on the validity of the termination as well.

This reasoning of the NCLT assumes that sub-clause (d) may not merely prohibit the owner or lessor of a property from recovering the property occupied by or in possession of the corporate debtor, but it would also render invalid the termination of a contract which would entitle such owner or lessor to recover the property. The NCLT’s reading of sub-clause (d) has also been endorsed by the Insolvency Law Committee (Chapter I, para 8.5 of the Report). This broad construction of sub-clause (d) of Section 14(1) is not unassailable, as it is arguable that sub-clause (d) as per its express terms merely prohibits the recovery of any property occupied by or in possession of the corporate debtor, and not the termination of a contract which may lead to such recovery.

The PPA Cases

The other decisions concerning the legality of termination of a contract during the CIRP period have been in the context of power purchase agreements (“PPAs”). The first of these is the NCLT’s (New Delhi Bench) judgment in Astonfield Solar (Gujarat) Private Ltd. v. Gujarat Urja Vikas Nigam Limited (dated 29th August 2019). Here, the corporate debtor was in the business of generation of solar power and its only buyer was Gujarat Urja Vikas Nigam Limited (“GUVNL”). After the corporate debtor went into insolvency, GUVNL terminated the PPA entered into with the corporate debtor solely on the ground of insolvency (which was permitted under the terms of the PPA). There was no default on the part of the corporate debtor in performing its obligations under the PPA. The NCLT declared the termination as invalid, ruling that the termination of the PPA “may have adverse consequences on the status of the Corporate Debtor as ‘going concern’”. It then relied upon the non-obstante clause in Section 238 of the Code to hold that even though the PPA allowed termination solely on the ground of insolvency, the provisions of the PPA would be overridden by the provisions of Code.

It is submitted that the NCLT’s reasoning in Astonfield is inadequate and unconvincing. First, the fact that the PPA may be vital to ensure that the corporate debtor survives as a going concern is in itself insufficient to declare the termination of the PPA as invalid. The NCLT ought to have traced the invalidity to specific provision(s) of the Code relevant to this issue. While it is crucial to ensure that the corporate debtor continues as a going concern during the CIRP period, this broad policy objective can be implemented in specific contexts only through statutory means. This is particularly where the rights of counter parties (here, GUVNL) are impacted as a result of the termination being held invalid. Second, the non-obstante clause in Section 238 would come into effect only if there is a conflict between the provisions of the Code and any other ‘law’ or ‘instrument’. The NCLT failed to elaborate as to which provision of the Code came into conflict with the provision of the PPA which empowered GUVNL to terminate the PPA solely on the ground of insolvency. Finally, the NCLT (perfunctorily) made an observation that the prohibition on termination of PPA would not apply if the corporate debtor went into liquidation. This remark was entirely unwarranted since the NCLT was not concerned with this question at all, and the issue requires a detailed examination of the provisions of the Code before it can be conclusively answered.

Despite the many flaws in the reasoning in Astonfield, GUVNL’s appeal against the NCLT’s decision was dismissed by the NCLAT. The NCLAT also simply held that the PPA was necessary to keep the corporate debtor as a going concern, without explaining as to how this in itself was sufficient to hold the termination invalid. It, however, set aside the NCLT’s ruling on the legality of termination of PPA during liquidation and held that the PPA could not be terminated even during liquidation. The NCLAT’s decision in GUVNL was cited by the NCLT (Hyderabad Bench) in Yes Bank Limited v. Gujarat Urja Vikas Nigam Limited to hold that a PPA cannot be terminated during liquidation process of the corporate debtor solely on the ground of liquidation.

The most recent decision of the NCLAT on the legality of termination of a PPA during the CIRP period is GRIDCO Limited v. Surya Kanta Satapathy. As in GUVNL, the NCLAT in GRIDCO held that the termination of PPA during the CIRP period was invalid. This time, however, the NCLAT expressly founded the illegality on Section 14(1) of the Code (amongst other reasons). It did not explain any further as to how the termination during the CIRP was in violation of Section 14(1). A crucial distinguishing factor in GRIDCO was that the ground for termination was not the mere fact of commencement of insolvency, but a default on the part of the corporate debtor in performing its contractual obligations, viz. the failure to supply power to GRIDCO according to the terms of the PPA. Nonetheless, the NCLAT held that such a default could not justify the termination of the PPA.

The absence of any reasoning behind the NCLAT’s conclusion that the termination of the PPA was in violation of Section 14(1) of the Code could perhaps give the erroneous impression that the illegality of the termination is a well-settled consequence of the moratorium under Section 14(1). Far from it, the issue is a vexed one and the NCLAT lost an opportunity to expound on it while taking into account the amendments to Section 14 introduced vide the Insolvency and Bankruptcy Code (Amendment) Ordinance, 2019 and confirmed by the Insolvency and Bankruptcy Code (Amendment) Act, 2020. At the least, the NCLAT ought to have considered as to whether the amendments were clarificatory in nature. This is because if they are held to be clarificatory (which, it is submitted, is not the case), the amendments would be applicable retrospectively and govern the facts of GRIDCO as well.

Had the NCLAT in GRIDCO considered the amendments to Section 14 and applied them to the facts of the case, it may have arrived at the opposite conclusion and held that GRIDCO’s termination of the PPA was justified on account of the default on the part of the corporate debtor in supply of power, especially during the moratorium. The Explanation to Section 14(1) and sub-section (2A) of Section 14 both allow the termination of contract for default in payment of dues during the moratorium period. Though these two provisions were not directly applicable to facts in GRIDCO, their purport is clear: that a default on the part of the corporate debtor in performance of its contractual obligations during the CIRP period would entitle the counter party to terminate the contract. There is no reason why this rationale should not be applied where the corporate debtor defaults in its capacity as a supplier, entitling the counter party to terminate the contract.

Conclusion

The state of the law on operation of contracts during the corporate insolvency resolution process subsequent to the amendments introduced in 2019 has become more nuanced and it does seek to fairly balance the competing interests of the corporate debtor and the counter party. At the same time, it is far from exhaustive and the norms for termination in scenarios not included within the Explanation to Section 14(1) and Section 14(2A) need to be laid down clearly. (Some such scenarios are discussed in Part II). An application of the general provisions relating to moratorium under Section 14(1) on an ad-hoc basis would lead to inconsistent outcomes, which would not only create uncertainty for counter parties but also ensnare the corporate debtor in litigation over the issue of legality of termination of a contract by the counter party. This is evidenced by the judgments of the NCLT and NCLAT available on this issue. Till the next round of legislative intervention, it is hoped that the Supreme Court will have an opportunity to elucidate and set right the law within the existing statutory framework.

Published by Sharad Bansal

Advocate, Bombay High Court

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