Supreme Court Clarifies “Dispute” Under the Insolvency and Bankruptcy Code for Operational Debts: Mobilox Innovations Pvt. Ltd. vs. Kirusa Software Private Limited (2017)

Case Background

Mobilox Innovations Private Limited (the appellant) engaged Kirusa Software Private Limited (the respondent) to provide tele-voting services for the “Nach Baliye” program on Star TV. The appellant subcontracted the work to the respondent, issuing purchase orders between October and December 2013. The respondent was to provide toll-free numbers for viewers to cast votes, customize software, and coordinate results.

The respondent provided services and raised monthly invoices between December 2013 and November 2014, payable within 30 days. The respondent followed up for payments via emails between April and October 2014. A non-disclosure agreement (NDA) was executed between the parties on December 26, 2014, effective from November 1, 2013.

On January 30, 2015, the appellant informed the respondent that payments were being withheld because the respondent had disclosed their work for “Nach Baliye” on their webpage, breaching the NDA. This led to a dispute, culminating in a demand notice under Section 8 of the Insolvency and Bankruptcy Code, 2016, on December 23, 2016, for a total of Rs. 20,08,202.55. The appellant responded on December 27, 2016, claiming a bona fide dispute and denying any payment obligation due to the NDA breach.

Timeline

Course of Proceedings

The respondent filed an application under Sections 8 and 9 of the Insolvency and Bankruptcy Code, 2016, before the National Company Law Tribunal (NCLT) on December 30, 2016. The NCLT orally directed the respondent to rectify a defect by including the appellant’s notice of dispute on January 19, 2017, which the respondent complied with on January 24, 2017.

On January 27, 2017, the NCLT dismissed the application, stating that the appellant had disputed the claim and that the claim was hit by Section 9(5)(ii)(d) of the Code. The respondent then appealed to the National Company Law Appellate Tribunal (NCLAT).

On May 24, 2017, the NCLAT allowed the appeal, setting aside the NCLT’s order and remanding the case for reconsideration. The NCLAT held that the NCLT had acted mechanically and had not examined the issue of what constitutes a “dispute” in relation to services provided by operational creditors. The NCLAT found the defense of dispute to be vague and motivated to evade liability.

Legal Framework

The Supreme Court examined the relevant provisions of the Insolvency and Bankruptcy Code, 2016 (the Code), particularly those concerning operational debts and the definition of “dispute.”

✓ Section 3(12) of the Code defines “default” as the non-payment of debt when it becomes due and payable.

✓ Section 5(6) of the Code defines “dispute” as including “a suit or arbitration proceedings relating to— (a) the existence of the amount of debt; (b) the quality of goods or service; or (c) the breach of a representation or warranty.”

✓ Section 5(20) of the Code defines “operational creditor” as a person to whom an operational debt is owed.

✓ Section 5(21) of the Code defines “operational debt” as a claim in respect of the provision of goods or services, including employment, or a debt in respect of the repayment of dues arising under any law.

✓ Section 8(1) of the Code allows an operational creditor to deliver a demand notice of unpaid operational debt or a copy of an invoice demanding payment to the corporate debtor.

✓ Section 8(2) of the Code requires the corporate debtor to notify the operational creditor within 10 days of receiving the demand notice about the existence of a dispute, the record of a pending suit or arbitration, or the repayment of the debt.

✓ Section 9 of the Code outlines the procedure for an operational creditor to initiate the corporate insolvency resolution process if no payment or notice of dispute is received within 10 days.

The Court also referenced the Insolvency and Bankruptcy (Application to Adjudicating Authority) Rules, 2016, particularly Rule 5 (demand notice) and Rule 6 (application by operational creditor), along with Forms 3, 4, and 5.

Arguments

Appellant (Mobilox Innovations) Arguments:

• The application should have been dismissed because the operational creditor did not furnish a certificate from the financial institution (IDBI) confirming no payment of unpaid operational debt, as required under Section 9(3)(c) of the Code.

• Under Section 8 of the Code, the moment a corporate debtor brings to the notice of the operational creditor the existence of a dispute, the Tribunal must dismiss the application.

• The expression “existence of a dispute, if any, and record of the pendency of the suit or arbitration proceedings filed …” under Section (8)(2)(a) should be read disjunctively as “existence of a dispute” or “record of the pendency of the suit or arbitration proceedings filed.”

• The definition of “dispute” under Section 5(6) of the Code is inclusive, and the original draft bill had the word “bona fide” before “suit or arbitral proceedings,” which is missing in the present Code. Therefore, the moment a real dispute exists, the Tribunal is bound to dismiss the application.

• There is a fundamental difference between applications filed by financial creditors and operational creditors. For financial creditors, the adjudicating authority must ascertain the existence of a default, whereas for operational creditors, the corporate debtor only needs to show the existence of a dispute.

• The Tribunal was incorrect in remanding the matter to find out whether the application is complete and in concluding that the dispute was vague, got up, and motivated to evade liability.

Respondent (Kirusa Software) Arguments:

• The only notice to rectify defects was an oral notice to supply the notice of dispute, which was done within time. The Tribunal dismissed the application only on non-fulfillment of conditions laid down in Section 9.

• The plea that the IDBI certificate was not furnished was taken for the first time in appeal and does not avail the appellants.

• The expression “dispute” under Section 5(6) covers only three things: the existence of the amount of debt, the quality of goods or services, or the breach of a representation or warranty. Since the defense was that the NDA was breached, it does not come within the definition of “dispute.”

• The breach of the NDA is a claim for unliquidated damages, which does not become crystallized until legal proceedings are filed. Therefore, there is no real dispute, and the Tribunal was correct in its finding that the dispute was a sham one.

[TABLE] of Submissions

Issues Framed by the Supreme Court

The Supreme Court framed the following issues:

1. Whether the application should have been dismissed on the ground that the operational creditor did not furnish a copy of the certificate from a financial institution under Section 9(3)(c) of the Code?

2. Whether the existence of a dispute between the parties, as claimed by the corporate debtor, is sufficient to reject the application under Section 9 of the Code?

3. Whether the definition of “dispute” under Section 5(6) of the Code is exhaustive or inclusive, and whether a breach of a non-disclosure agreement can constitute a “dispute” under the Code?

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:

On Interpretation of “and” as “or”:

• Samee Khan v. Bindu Khan (1998) 7 SCC 59: The Court held that the word “and” need not necessarily be understood as denoting a conjunctive sense and can be read as “or” to further the object of the statute.

• Gujarat Urja Vikas Nigam Ltd. v. Essar Power Ltd. (2008) 4 SCC 755: The Court held that sometimes “and” can mean “or” and vice versa to avoid an anomalous situation.

• Maharishi Mahesh Yogi Vedic Vishwavidyalaya v. State of M.P. (2013) 15 SCC 677: The Court reiterated that to carry out the intention of the legislature, it is occasionally necessary to read “or” and “and” one for the other.

On the “Existence of a Dispute”:

• Spencer Constructions Pty Ltd v. G & M Aldridge Pty Ltd [1997] FCA 681 (Australian High Court): This case defined “genuine dispute” as a plausible contention requiring investigation, not a mere assertion or a patently feeble legal argument.

• Hayes v. Hayes (2014) EWHC 2694 (Ch) (UK Chancery Division): The court emphasized that it does not need to be satisfied that there is a good claim or that it is likely to succeed, but should be alert to detect wholly spurious claims.

• In Re: Portman Provincial Cinemas Ltd. (1999) 1 WLR 157 (UK Court of Appeal): The Court discussed the need to try out a cross-claim before dismissing a winding-up petition, emphasizing that the claim should have some substance and not be a mere assertion.

On the Insolvency and Bankruptcy Code, 2016:

• Section 3(12): Definition of “default.”

• Section 5(6): Definition of “dispute.”

• Section 5(20): Definition of “operational creditor.”

• Section 5(21): Definition of “operational debt.”

• Section 8: Insolvency resolution by operational creditor.

• Section 9: Application for initiation of corporate insolvency resolution process by operational creditor.

[TABLE] of Authorities

Judgment

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

How each authority was viewed by the Court?

✓ The Court followed Samee Khan v. Bindu Khan [CITATION]*, Gujarat Urja Vikas Nigam Ltd. v. Essar Power Ltd. [CITATION]*, and Maharishi Mahesh Yogi Vedic Vishwavidyalaya v. State of M.P. [CITATION]* to interpret “and” as “or” in Section 8(2)(a) of the Code.

✓ The Court relied on Spencer Constructions Pty Ltd v. G & M Aldridge Pty Ltd [CITATION]*, Hayes v. Hayes [CITATION]*, and In Re: Portman Provincial Cinemas Ltd. [CITATION]* to define the “existence of a dispute,” emphasizing that a plausible contention requiring investigation is sufficient to constitute a dispute.

✓ The Court considered Sections 3(12), 5(6), 5(20), 5(21), 8, and 9 of the Insolvency and Bankruptcy Code, 2016 [CITATION]* to interpret the relevant provisions of the Code.

What weighed in the mind of the Court?

The Supreme Court’s decision was primarily influenced by the need to prevent the misuse of the insolvency process by operational creditors for recovery of disputed debts. The Court emphasized that a mere assertion of a debt is not enough to trigger insolvency proceedings, especially when a genuine dispute exists. The Court also noted the need to read “and” as “or” in Section 8(2)(a) to avoid an anomalous situation where only disputes already pending in court or arbitration could prevent insolvency.

The Court was also influenced by the fact that the definition of “dispute” under Section 5(6) of the Code is inclusive, not exhaustive. The Court noted that the word “bona fide” was removed from the definition of dispute from the earlier draft of the Code. The Court also took into consideration the correspondence between the parties which showed that a dispute about the breach of the NDA existed.

[TABLE] of Sentiment Analysis

Fact:Law Ratio

Logical Reasoning Flowchart

The Court reasoned that the appellant had raised a plausible contention regarding the breach of the NDA, which was not a patently feeble legal argument. The Court held that a dispute truly existed in fact between the parties and that the Appellate Tribunal had erred in characterizing the defense as vague.

The Court stated, “Therefore, all that the adjudicating authority is to see at this stage is whether there is a plausible contention which requires further investigation and that the “dispute” is not a patently feeble legal argument or an assertion of fact unsupported by evidence.”

The Court further clarified, “It is important to separate the grain from the chaff and to reject a spurious defence which is mere bluster. However, in doing so, the Court does not need to be satisfied that the defence is likely to succeed.”

The Court also stated, “So long as a dispute truly exists in fact and is not spurious, hypothetical or illusory, the adjudicating authority has to reject the application.”

Key Takeaways

• A mere allegation of debt is not sufficient to trigger insolvency proceedings against a corporate debtor.

• The existence of a genuine dispute, even if not pending in a suit or arbitration, is sufficient to prevent the initiation of insolvency proceedings by an operational creditor.

• The definition of “dispute” under Section 5(6) of the Insolvency and Bankruptcy Code, 2016, is inclusive and not exhaustive.

• The word “and” in Section 8(2)(a) of the Code should be read as “or” to avoid an anomalous situation.

• Adjudicating authorities must carefully examine the existence of a dispute and not act mechanically.

• The judgment emphasizes the need to prevent the misuse of the insolvency process by operational creditors.

Directions

The Supreme Court allowed the appeal and set aside the judgment of the Appellate Tribunal. The Court did not impose any costs.

Conclusion

The Supreme Court’s judgment in Mobilox Innovations Pvt. Ltd. vs. Kirusa Software Private Limited is a landmark decision that clarifies the scope of “dispute” under the Insolvency and Bankruptcy Code, 2016, particularly in the context of operational debts. The Court emphasized that a mere allegation of debt is insufficient to initiate insolvency proceedings and that the existence of a genuine dispute, even if not pending in a suit or arbitration, is enough to reject an application by an operational creditor. This judgment safeguards corporate debtors from frivolous insolvency claims and underscores the need for adjudicating authorities to scrutinize the existence of a dispute carefully.

The Court’s interpretation of the word “and” as “or” in Section 8(2)(a) of the Code is a significant contribution to the jurisprudence on insolvency law. This interpretation ensures that the Code is not used as a mere debt recovery mechanism. By holding that the definition of “dispute” is inclusive, the Court has broadened the scope of what can constitute a valid dispute, providing more protection to corporate debtors.

The judgment serves as a reminder that the Insolvency and Bankruptcy Code, 2016, is not intended to be a substitute for debt recovery mechanisms and that insolvency proceedings should be initiated only in cases where a genuine default exists and not when there is a bona fide dispute.