Pre-Existing Dispute Under IBC: Supreme Court Rules in Favor of Corporate Debtor in Rajratan Babulal Agarwal vs. Solartex India Pvt. Ltd. (2022)

Date of the Judgment: October 13, 2022
Citation: Not Available
Judges: K.M. Joseph, J. and Hrishikesh Roy, J.

Can a company avoid insolvency proceedings by claiming a pre-existing dispute over the quality of goods? The Supreme Court of India recently examined this question in a case where a corporate debtor was accused of not paying for goods, arguing that the goods were defective. This case clarifies what constitutes a valid ‘pre-existing dispute’ under the Insolvency and Bankruptcy Code, 2016 (IBC). The Supreme Court bench, consisting of Justices K.M. Joseph and Hrishikesh Roy, delivered the judgment, with Justice Joseph authoring the opinion.

Case Background

The case revolves around a dispute between Rajratan Babulal Agarwal (the appellant), an ex-director of Honest Derivatives Pvt. Ltd. (the second respondent), and Solartex India Pvt. Ltd. (the first respondent). The first respondent filed an application under Section 9 of the IBC against the second respondent, claiming unpaid dues for coal supplied. The appellant argued that a pre-existing dispute existed regarding the quality of the coal, which should have prevented the insolvency proceedings.

The second respondent had placed a purchase order for 500 metric tonnes of Indonesian coal with the first respondent. The coal was intended for use in boilers for manufacturing starch and allied products. The purchase order specified the quality of coal in terms of Gross Calorific Value (GCV) and moisture content. The supply of coal began on October 28, 2016, and ended on November 2, 2016, with 412 metric tonnes being delivered.

The appellant claims that the coal supplied was of inferior quality, not conforming to the specifications outlined in the purchase order. This allegedly led to the malfunctioning of the boiler. The appellant sent emails on October 30, 2016 and November 3, 2016, to the first respondent, complaining about the quality of the coal. The first respondent responded on November 4, 2016, acknowledging the complaint and stopping further delivery.

The first respondent issued a notice under the IBC on February 3, 2018, claiming Rs. 15,73,279 plus interest. The second respondent replied on February 17, 2018, demanding Rs. 4.44 crores as damages due to the poor quality of coal and also filed civil suits against the first respondent and Rawalwasia Textile Industries Private Limited. Subsequently, the first respondent filed an application under Section 9 of the IBC, which was admitted by the NCLT. The NCLAT upheld the NCLT’s decision, leading to the present appeal before the Supreme Court.

Timeline:

Legal Framework

The Supreme Court examined several provisions of the Sale of Goods Act, 1930, to determine the rights and obligations of the buyer and seller. Key provisions include:

• Section 4: Defines a contract of sale as an agreement where the seller transfers or agrees to transfer the property in goods to the buyer for a price.
• Section 12: Differentiates between a ‘condition’ and a ‘warranty’ in a contract of sale. A condition is essential to the main purpose of the contract, and its breach gives the right to repudiate the contract. A warranty is collateral to the main purpose, and its breach gives rise to a claim for damages but not the right to reject the goods.
• Section 13: Specifies when a condition is to be treated as a warranty. If a buyer accepts goods, a breach of condition can only be treated as a breach of warranty, unless there is a specific term in the contract to the contrary.

  “Where a contract of sale is not severable and the buyer has accepted the goods or part thereof… the breach of any condition to be fulfilled by the seller can only be treated as a breach of warranty and not as a ground for rejecting the goods and treating the contract as repudiated, unless there is a term of the contract, express or implied, to that effect.”

• Section 14: Provides for implied conditions and warranties, such as the seller having the right to sell the goods and the buyer having quiet possession of the goods.
• Section 15: States that in a sale of goods by description, the goods must correspond with the description.
• Section 16: Deals with implied conditions as to quality or fitness of goods for a particular purpose.
• Section 19: States that property passes when intended to pass and provides rules for ascertaining the intention of the parties.
• Section 31: States that it is the duty of the seller to deliver the goods and of the buyer to accept and pay for them in accordance with the contract.
• Section 32: States that payment and delivery are concurrent conditions unless otherwise agreed.
• Section 41: Grants the buyer the right to examine the goods before accepting them.
• Section 42: Specifies when a buyer is deemed to have accepted the goods.

  “The buyer is deemed to have accepted the goods when he intimates to the seller that he has accepted them, or when the goods have been delivered to him and he does any act in relation to them which is inconsistent with the ownership of the seller, or when, after the lapse of a reasonable time, he retains the goods without intimating to the seller that he has rejected them.”

• Section 43: States that a buyer is not bound to return rejected goods.
• Section 55: Provides for a suit for price by the seller when the buyer wrongfully neglects or refuses to pay for the goods.
• Section 59: Outlines the remedies for breach of warranty, including setting up the breach in diminution or extinction of the price or suing for damages.

  “Where there is a breach of warranty by the seller, or where the buyer elects or is compelled to treat any breach of a condition on the part of the seller as a breach of warranty, the buyer is not by reason only of such breach of warranty entitled to reject the goods; but he may — (a) set up against the seller the breach of warranty in diminution or extinction of the price; or (b) sue the seller for damages for breach of warranty.”

Arguments

Appellant’s (Rajratan Babulal Agarwal) Submissions:

• The appellant contended that a pre-existing dispute existed regarding the quality of coal supplied by the first respondent. The coal did not meet the specifications in the purchase order, leading to boiler malfunctions.
• The appellant argued that the email sent on October 30, 2016, by STDPL, a sister concern of the second respondent, to the first respondent, highlighted the quality issues. The email also referenced the supply of coal to the second respondent.
• The appellant relied on the email dated November 3, 2016, sent by the second respondent to the first respondent, which explicitly complained about the inferior quality of coal and its impact on the boiler.
• The appellant contended that under Section 12 of the Sale of Goods Act, the quality of goods was a condition and that the second respondent had elected to treat the breach of condition as a breach of warranty.
• The appellant argued that the second respondent had the right to examine the goods under Section 41 of the Sale of Goods Act.
• The appellant asserted that the second respondent, under Section 59 of the Sale of Goods Act, could sue for damages or seek extinction of the price due to the breach of warranty.
• The appellant pointed out that civil suits were filed within the period of limitation, indicating the genuineness of the dispute.
• The appellant argued that the NCLAT erred in overlooking the email dated October 30, 2016, and in concluding that there was no dispute.
• The appellant contended that under Section 13(2) of the Sale of Goods Act, the acceptance of goods would not deprive the buyer of the right to seek remedies under Section 59 of the Act.

Respondent’s (Solartex India Pvt. Ltd.) Submissions:

• The first respondent argued that the emails relied upon by the appellant did not constitute a valid dispute.
• The first respondent contended that the second respondent consumed the goods even after the alleged deficiency, indicating no genuine dispute.
• The first respondent pointed out that no arbitration or suit was initiated before the notice under the IBC.
• The first respondent argued that the second respondent did not raise a debit note or return the coal, which showed that the claim of dispute was a sham.
• The first respondent argued that the purchase order required a certificate of analysis, which was not disputed by the appellant.
• The first respondent claimed that the analysis reports relied upon by the appellant were concocted.
• The first respondent argued that the purchase order contemplated payment within 7 days of delivery, and there was no denial of liability to pay before November 12, 2016.
• The first respondent contended that the dispute was raised to avoid liability for payment.
• The first respondent contended that the emails relied upon by the appellant were merely an attempt to wriggle out of the obligation to pay for the goods.

Interim Resolution Professional’s (IRP) Submissions:

• The IRP contended that the NCLT should not act mechanically and must ascertain whether a credible dispute exists.
• The IRP questioned whether the consumption of coal constituted acceptance and obliged the second respondent to make payment.
• The IRP stated that there was no evidence that the right to reject the material was exercised.
• The IRP argued that the emails did not evidence any deficiency in the quality of coal or damage to the corporate debtor.
• The IRP contended that the accounts did not show that the coal was not used or that any loss occurred.

Submissions of Parties

Issues Framed by the Supreme Court

The Supreme Court framed the following issue for consideration:

1. Whether the appellant has raised a dispute which can be described as a ‘pre-existing dispute’ as understood by this Court in the decision in Mobilox Innovations Private Limited v. Kirusa Software Private Limited.

Treatment of the Issue by the Court

The following table demonstrates as to how the Court decided the issues

Authorities

The Supreme Court considered the following authorities:

Judgment

How each submission made by the Parties was treated by the Court?

How each authority was viewed by the Court?

• Mobilox Innovations Private Limited v. Kirusa Software Private Limited [(2018) 1 SCC 353]: The Court heavily relied on this case to interpret the meaning of “dispute” under the IBC, emphasizing that the dispute need not be bona fide but should not be spurious or a patently feeble legal argument.
• Balwant Singh and others v. Anand Kumar Sharma and others [2003 (3) SCC 433]: The Court did not find it necessary to pronounce on the effect of Rule 150 being breached by the NCLT.
• Hayes v. Hayes [2014 EWHC 2694 (Ch)]: The Court used this case to support the view that it does not need to be satisfied that there is a good claim or even that it is a claim which is prima facie likely to succeed.
• Ahmadsahab Abdul Mulla (2) (dead) v. Bibijan and others [(2009) 5 SCC 462]: The Court referred to this case in the context of Section 55(2) of the Sale of Goods Act.
• Mangilal Karwa v. Shantibai [AIR 1956 Nag 221]: The Court cited this case to support the view that even after delivery, the buyer may still have remedies available for breach of warranty.

What weighed in the mind of the Court?

The Supreme Court’s decision was influenced by the need to ensure that the insolvency process is not misused to recover operational debts where a genuine dispute exists. The court emphasized that the threshold for establishing a pre-existing dispute is not high and that the adjudicating authority should not delve into the merits of the dispute. The court was also influenced by the fact that the emails sent by the corporate debtor clearly indicated a dispute regarding the quality of the goods, which was further supported by lab reports. The court also took into account the provisions of the Sale of Goods Act, particularly Sections 13(2) and 59, which allow a buyer to seek remedies even after accepting the goods.

Fact:Law Ratio

Logical Reasoning

Key Takeaways

• A ‘pre-existing dispute’ under the IBC does not require a full-fledged legal battle but must be a plausible contention supported by some evidence.
• The adjudicating authority should not delve into the merits of the dispute but only determine if a plausible contention exists.
• Even if a buyer has accepted goods, they can still claim a breach of warranty and seek remedies under Section 59 of the Sale of Goods Act, 1930.
• Emails and other communications between parties can be considered as evidence of a pre-existing dispute.
• The absence of a debit note or return of goods does not necessarily negate the existence of a dispute.

Directions

The Supreme Court set aside the order of the NCLAT and rejected the application filed by the first respondent against the second respondent under Section 9 of the IBC. The Court left open all the remedies and contentions available to the first respondent in law.

Development of Law

The ratio decidendi of this case is that a pre-existing dispute under the IBC need not be a bona fide dispute but should be a plausible contention supported by some evidence. The court clarified that the threshold for establishing a pre-existing dispute is not high and that the adjudicating authority should not delve into the merits of the dispute. This ruling reinforces the principles laid down in Mobilox Innovations Private Limited v. Kirusa Software Private Limited and provides further clarity on the interpretation of “dispute” under the IBC. The judgment also clarifies that acceptance of goods does not bar the buyer from seeking remedies under Section 59 of the Sale of Goods Act.

Conclusion

The Supreme Court’s ruling in Rajratan Babulal Agarwal vs. Solartex India Pvt. Ltd. clarifies the scope of a ‘pre-existing dispute’ under the IBC. The Court held that a dispute over the quality of goods, supported by emails and lab reports, constitutes a valid pre-existing dispute, preventing the initiation of insolvency proceedings. This judgment emphasizes that the adjudicating authority should not delve into the merits of the dispute but only determine if a plausible contention exists.