Supreme Court Upholds Pre-Existing Dispute in Insolvency Case: Jai Balaji Industries vs. D.K. Mohanty (2021)

Introduction

Date of the Judgment: 01 October 2021
Citation: [Not Available in Source]
Judges: Hon’ble Mr. Justice Dinesh Maheshwari and Hon’ble Mr. Justice Vikram Nath.

Can a company initiate insolvency proceedings against another company when there’s an ongoing dispute about the debt, even if that dispute was temporarily paused due to a procedural issue? The Supreme Court of India recently tackled this question in a case involving M/s. Jai Balaji Industries and D.K. Mohanty & Anr. The core issue revolved around whether a dispute, which was temporarily dormant due to the dismissal of an appeal, could still be considered a ‘pre-existing dispute’ under the Insolvency and Bankruptcy Code, 2016 (IBC). The court’s decision has significant implications for how insolvency proceedings are initiated and managed in India.

The Supreme Court bench, comprising Justices Dinesh Maheshwari and Vikram Nath, delivered a unanimous judgment dismissing the appeals filed by M/s. Jai Balaji Industries. The court held that a dispute, which was subject to an appeal that was initially dismissed in default but later restored, constitutes a pre-existing dispute under the IBC, thus barring the initiation of insolvency proceedings.

Case Background

M/s. Jai Balaji Industries (the appellant), a manufacturer of iron and steel products, entered into two Memorandums of Understanding (MOUs) with Orissa Minerals Development Company Limited (respondent No. 2) in 2003 and 2004. Under these MOUs, the respondent company was to supply iron ore to the appellant. Disputes arose concerning the supply and payment, leading the appellant to initiate arbitration proceedings.

Arbitral awards were passed in favor of the appellant on 22 February 2010 and 15 February 2010, ordering the respondent company to pay Rs. 4.44 crores and Rs. 2.79 crores, respectively. The respondent company challenged these awards under Section 34 of the Arbitration and Conciliation Act, 1996. However, the District Court, Barasat dismissed these challenges on 27 February 2012 and 29 February 2012.

The respondent company then appealed these dismissals to the High Court of Calcutta on 7 August 2012 under Section 37 of the Arbitration and Conciliation Act, 1996. These appeals were dismissed in default on 22 November 2019 due to the non-appearance of the respondent company. Subsequently, the respondent company applied for restoration of these appeals on 17 December 2019, which were allowed by the High Court on 2 March 2020.

Timeline:

Legal Framework

The case primarily revolves around the interpretation of key provisions of the Insolvency and Bankruptcy Code, 2016 (IBC), specifically Sections 8 and 9, which deal with the initiation of the Corporate Insolvency Resolution Process (CIRP) by an operational creditor. Section 8 of the IBC outlines the procedure for an operational creditor to issue a demand notice to a corporate debtor for unpaid operational debt. It also stipulates that the corporate debtor, within ten days of receiving the demand notice, must notify the operational creditor of the existence of a dispute or the pendency of a suit or arbitration proceedings related to such dispute.

Section 9 of the IBC deals with the application for initiation of CIRP by an operational creditor. It states that if the operational creditor does not receive payment or notice of a dispute within ten days of the demand notice, they may file an application before the Adjudicating Authority (National Company Law Tribunal or NCLT) for initiating CIRP. The definition of “dispute” under Section 5(6) of the IBC includes “a suit or arbitration proceedings relating to the existence of the amount of debt.”

Additionally, the case also involves the Arbitration and Conciliation Act, 1996. Specifically, Section 34 deals with challenges to arbitral awards, and Section 37 deals with appeals against orders passed under Section 34. The interplay between these provisions and the IBC is crucial in determining whether a dispute exists for the purposes of initiating CIRP.

The relevant sections are:

• Section 5(6) of the Insolvency and Bankruptcy Code, 2016: 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 8(2)(a) of the Insolvency and Bankruptcy Code, 2016: States that the corporate debtor must bring to the notice of the operational creditor the “existence of a dispute, [if any, or] record of the pendency of the suit or arbitration proceedings filed before the receipt of such notice or invoice in relation to such dispute”.
• Section 9 of the Insolvency and Bankruptcy Code, 2016: Outlines the procedure for an operational creditor to file an application for initiating CIRP.
• Section 34 of the Arbitration and Conciliation Act, 1996: Deals with applications to set aside an arbitral award.
• Section 37 of the Arbitration and Conciliation Act, 1996: Deals with appeals from orders made under Section 34.

Arguments

Appellant’s Arguments:

• The appellant contended that for an application under Section 9 of the IBC to be barred, a dispute must exist prior to the service of the demand notice under Section 8 of the IBC. They argued that the language of Section 8(2)(a) requires the dispute to be existing as a matter of fact on the date of the demand notice, as laid down in Mobilox Innovations Pvt. Ltd. v. Kirusa Software Pvt. Ltd. [(2018) 1 SCC 353].
• The appellant submitted that any later developments, such as the restoration of appeals, should not affect the adjudication of the application under Section 9 of the IBC. They emphasized that Section 8(2)(a) aims to negate any post-facto developments concerning the default amount.
• They argued that the doctrine of ‘relation back’ should not be applied universally and should not be used in the adjudication of applications under Section 9 of the IBC. They also contended that the National Company Law Appellate Tribunal (NCLAT) wrongly relied on the majority judgment in Vareed Jacob v. Sosamma Geevarghese & Ors. [(2004) 6 SCC 378], which dealt with the revival of interim orders upon restoration of a suit.
• The appellant further submitted that the minority view in Vareed Jacob, which discussed the legal treatment of rights accrued in the interregnum, should not have been ignored, and that the doctrine of relation back cannot be invoked without limitations, as held in Addagada Raghavamma & Anr. v. Addagada Chenchamma & Anr. [AIR 1964 SC 136].

Respondent’s Arguments:

• The respondents argued that a pre-existing dispute existed because the matter was pending in arbitration proceedings, which pre-dated the receipt of the demand notice. They stated that the applications for restoration of appeals were pending in the High Court before the demand notices were received, with advance notice to the appellant.
• The respondents contended that once an appeal is restored, it relates back to the original date of filing. They relied on the majority view in Vareed Jacob, which held that interlocutory orders stand revived upon restoration of an appeal unless otherwise directed.
• The respondents argued that the Insolvency and Bankruptcy Code, 2016 (IBC) discourages recovery proceedings and that the Code should not be used to execute decrees or recover money. They contended that the IBC should only be used when there is no real dispute about the debt.
• They submitted that the applications for restoration were filed with advance notice to the appellant, and therefore, a dispute existed before the demand notices were issued. They relied on Mobilox Innovations and K. Kishan v. Vijay Nirman Company Pvt. Ltd. [(2018) 17 SCC 662] to support their argument that a pre-existing dispute bars the initiation of CIRP.

Submissions of Parties

Issues Framed by the Supreme Court

The Supreme Court did not explicitly frame specific issues in a dedicated section. However, the core issue that the court addressed was:

• Whether the dismissal of appeals under Section 37 of the Arbitration and Conciliation Act, 1996, in default, and their subsequent restoration, affects the existence of a “pre-existing dispute” under Section 8 of the Insolvency and Bankruptcy Code, 2016, for the purpose of initiating Corporate Insolvency Resolution Process (CIRP).

Treatment of the Issue by the Court

Authorities

The Supreme Court relied on the following authorities:

On the Interpretation of “Dispute” under IBC:

• Mobilox Innovations Pvt. Ltd. v. Kirusa Software Pvt. Ltd. [(2018) 1 SCC 353] – Supreme Court of India
  • The Court referred to this case to emphasize that the objective of the Code with regards to operational debts was to ensure that these debts did not enable operational creditors to initiate insolvency resolution process against the corporate debtors prematurely. It also stated that the Adjudicating Authority was not required to examine the merits of the dispute but it was supposed to examine only prima facie if a dispute truly existed between the parties, and that the same was not patently feeble or imaginary.
• K. Kishan v. Vijay Nirman Company Pvt. Ltd. [(2018) 17 SCC 662] – Supreme Court of India
  • The Court referred to this case to reiterate that the IBC is not a substitute for recovery proceedings and that an operational debt in an arbitral award cannot be allowed to jeopardize a solvent company. It also stated that the mere factum of challenge to the arbitral award would be sufficient to state that it disputes the award.

On the Doctrine of ‘Relation Back’:

• Vareed Jacob v. Sosamma Geevarghese & Ors. [(2004) 6 SCC 378] – Supreme Court of India
  • The Court used the majority opinion in this case to support the principle that restoration of an appeal revives the proceedings to their original status, including interlocutory orders, unless otherwise directed.
• Addagada Raghavamma & Anr. v. Addagada Chenchamma & Anr. [AIR 1964 SC 136] – Supreme Court of India
  • The Court discussed this case to clarify that the doctrine of relation back cannot be invoked without limitations, and retroactivity must not affect any vested rights.

On Legal Provisions:

• Section 5(6) of the Insolvency and Bankruptcy Code, 2016: The court referred to the definition of “dispute” under this section, which includes arbitration proceedings relating to the existence of debt.
• Section 8 of the Insolvency and Bankruptcy Code, 2016: The court interpreted this section to emphasize that the existence of a dispute, or record of a pending suit or arbitration, before the receipt of a demand notice, bars the initiation of CIRP.
• Section 9 of the Insolvency and Bankruptcy Code, 2016: The court referred to this section to highlight the procedure for initiating CIRP by an operational creditor and the conditions for admitting or rejecting an application.
• Section 34 of the Arbitration and Conciliation Act, 1996: The court noted that this section deals with challenges to arbitral awards, and that a challenge to an award constitutes a dispute.
• Section 37 of the Arbitration and Conciliation Act, 1996: The court noted that this section deals with appeals against orders passed under Section 34, and that the pendency of such an appeal indicates a dispute.

Judgment

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

How each authority was viewed by the Court?

• Mobilox Innovations Pvt. Ltd. v. Kirusa Software Pvt. Ltd. [(2018) 1 SCC 353]: The Court reiterated the principles laid down in this case, emphasizing that the Adjudicating Authority should only see if a dispute truly exists and not examine the merits of the dispute.
• K. Kishan v. Vijay Nirman Company Pvt. Ltd. [(2018) 17 SCC 662]: The Court applied the principles of this case, stating that the IBC is not a substitute for recovery proceedings and that a challenge to an arbitral award constitutes a pre-existing dispute.
• Vareed Jacob v. Sosamma Geevarghese & Ors. [(2004) 6 SCC 378]: The Court relied on the majority view in this case, which supported the principle that restoration of an appeal revives proceedings to their original status, including interlocutory orders.
• Addagada Raghavamma & Anr. v. Addagada Chenchamma & Anr. [AIR 1964 SC 136]: The Court clarified that the doctrine of relation back cannot be invoked without limitations and that retroactivity must not affect any vested rights.

What weighed in the mind of the Court?

The Supreme Court’s decision was heavily influenced by the principle that the Insolvency and Bankruptcy Code, 2016 (IBC) is not intended to be a debt recovery mechanism. The court emphasized that the IBC should only be invoked when there is a clear case of default and no genuine dispute exists between the parties. The court was also influenced by the need to protect corporate debtors from being subjected to insolvency proceedings prematurely or for extraneous considerations.

The court’s reasoning was also driven by the understanding that the restoration of an appeal revives the dispute to its original status. The court was wary of allowing a temporary procedural lapse, such as the dismissal of an appeal in default, to be used as a basis for initiating insolvency proceedings when a substantive dispute was still pending.

The court’s decision was further influenced by the fact that the respondent company had applied for restoration of the appeals before the demand notices were issued, thus demonstrating that the dispute was not merely a post-facto creation to avoid insolvency.

Fact:Law Ratio

Logical Reasoning:

The Court considered alternative interpretations, such as the argument that the dispute ceased to exist when the appeals were dismissed in default. However, the Court rejected this interpretation, emphasizing that the restoration of the appeals revived the dispute to its original status. The Court also rejected the argument that the doctrine of ‘relation back’ should not apply, stating that it is a well-established legal principle that applies in such cases.

The Court concluded that the applications for initiation of CIRP were required to be rejected under Section 9(5)(ii)(d) of the IBC, as a notice of dispute had been received by the operational creditor, and there was a record of dispute. The Court also highlighted that the appeals were restored on the same day the applications under Section 9 were filed, further negating the appellant’s arguments.

The Supreme Court also quoted from the judgment:

“We are impelled to observe at the outset that the entire approach of the appellant seems to be founded on a basic misconception that the Code has provided another avenue for enforcing money recovery by a creditor against the corporate debtor…”

“…it becomes clear that operational creditors cannot use the Insolvency Code either prematurely or for extraneous considerations or as a substitute for debt enforcement procedures.”

“…for the purpose and in the scheme of the Code, even pendency of an application for restoration is sufficient to bring the matter within the four corners of “pre-existing dispute”.”

The court did not have a minority opinion. The bench was unanimous in its decision.

Key Takeaways

• A dispute that is subject to an appeal which is initially dismissed in default but later restored, constitutes a pre-existing dispute under the Insolvency and Bankruptcy Code, 2016.
• The Insolvency and Bankruptcy Code, 2016 is not a debt recovery mechanism and should not be used as a substitute for debt enforcement procedures.
• The doctrine of ‘relation back’ applies to the restoration of appeals, meaning that the proceedings are revived to their original status.
• Operational creditors cannot initiate insolvency proceedings against corporate debtors when a genuine dispute exists, even if that dispute was temporarily dormant due to a procedural issue.
• The mere pendency of an application for restoration of an appeal is sufficient to bring the matter within the ambit of a “pre-existing dispute.”

Potential Future Impact:

• This judgment reinforces the principle that the IBC should not be used for debt recovery and will likely deter operational creditors from using the IBC as a pressure tactic.
• It provides clarity on the interpretation of “pre-existing dispute” under the IBC, especially in cases where appeals are dismissed in default and subsequently restored.
• The judgment may lead to a more cautious approach by Adjudicating Authorities when dealing with applications for CIRP initiated by operational creditors.

Directions

The Supreme Court did not issue any specific directions in this judgment. The court dismissed the appeals and upheld the order of the NCLAT, which had set aside the NCLT’s order admitting the applications for initiating CIRP.

Specific Amendments Analysis

There is no specific amendment analysis in this judgment.

Development of Law

Ratio Decidendi: The ratio decidendi of this case is that a dispute that is subject to an appeal, which is initially dismissed in default but later restored, constitutes a pre-existing dispute under Section 8 of the Insolvency and Bankruptcy Code, 2016, and thus bars the initiation of Corporate Insolvency Resolution Process (CIRP) by an operational creditor.

Change in Previous Positions of Law: This judgment does not change any previous positions of law. Instead, it reinforces and clarifies the existing legal principles relating to the interpretation of “pre-existing dispute” under the IBC and the application of the doctrine of ‘relation back’. The judgment emphasizes that the IBC is not a debt recovery mechanism and should not be used as a substitute for debt enforcement procedures. It also clarifies that the mere pendency of an application for restoration of an appeal is sufficient to bring the matter within the ambit of a “pre-existing dispute.”

Conclusion

In summary, the Supreme Court dismissed the appeals filed by M/s. Jai Balaji Industries, upholding the decision of the National Company Law Appellate Tribunal (NCLAT). The court held that a dispute, which was subject to an appeal that was initially dismissed in default but later restored, constitutes a pre-existing dispute under the Insolvency and Bankruptcy Code, 2016. This decision reinforces the principle that the IBC is not a debt recovery mechanism and should only be used when there is a clear case of default and no genuine dispute exists between the parties. The judgment also clarifies the application of the doctrine of ‘relation back’ in such cases.

Category

Parent Category: Insolvency and Bankruptcy Code, 2016

Child Categories:

• Section 8, Insolvency and Bankruptcy Code, 2016
• Section 9, Insolvency and Bankruptcy Code, 2016
• Pre-existing Dispute
• Corporate Insolvency Resolution Process (CIRP)
• Operational Creditor
• Arbitration and Conciliation Act, 1996
• Doctrine of Relation Back

FAQ

Frequently Asked Questions (FAQ)

Q: What is a ‘pre-existing dispute’ under the Insolvency and Bankruptcy Code (IBC)?

A: A ‘pre-existing dispute’ refers to a dispute that exists before the operational creditor issues a demand notice to the corporate debtor under Section 8 of the IBC. This dispute can be related to the existence or amount of debt, quality of goods or services, or breach of a representation or warranty. It includes pending suits or arbitration proceedings.

Q: What was the main issue in the Jai Balaji Industries vs. D.K. Mohanty case?

A: The main issue was whether a dispute, subject to an appeal that was initially dismissed in default but later restored, could be considered a ‘pre-existing dispute’ under the IBC, thus barring the initiation of insolvency proceedings.

Q: What did the Supreme Court decide in this case?

A: The Supreme Court held that a dispute, subject to an appeal that was initially dismissed in default but later restored, does constitute a ‘pre-existing dispute’ under the IBC. Therefore, insolvency proceedings cannot be initiated in such cases.

Q: What is the doctrine of ‘relation back’ and how does it apply here?

A: The doctrine of ‘relation back’ means that when an appeal is restored, it is considered as if it was never dismissed. In this case, the Supreme Court held that the restoration of the appeal related back to its original filing date, thereby establishing a pre-existing dispute.

Q: Can an operational creditor initiate insolvency proceedings if there is an ongoing dispute?

A: No, an operational creditor cannot initiate insolvency proceedings if a genuine dispute exists. The IBC is not intended to be a debt recovery mechanism, and insolvency proceedings should not be used when a dispute is pending.

Q: What is the significance of the Supreme Court’s decision in this case?

A: The decision reinforces the principle that the IBC should not be used as a substitute for debt enforcement procedures. It clarifies the interpretation of ‘pre-existing dispute’ and provides guidance for cases where appeals are dismissed in default and subsequently restored. It also protects corporate debtors from premature or extraneous insolvency proceedings.

Q: What is the role of the National Company Law Tribunal (NCLT) and the National Company Law Appellate Tribunal (NCLAT) in this case?

A: The NCLT initially admitted the applications for initiating the Corporate Insolvency Resolution Process (CIRP). However, the NCLAT set aside the NCLT’s order, stating that a pre-existing dispute existed. The Supreme Court upheld the NCLAT’s decision.

Q: What does Section 8 of the IBC say about pre-existing disputes?

A: Section 8 of the IBC states that the corporate debtor must notify the operational creditor of the existence of a dispute, or record of the pendency of a suit or arbitration proceedings, within ten days of receiving a demand notice. This provision is crucial for determining whether a pre-existing dispute exists and whether insolvency proceedings can be initiated.

Q: How does this judgment impact future insolvency cases?

A: This judgment is likely to deter operational creditors from using the IBC as a pressure tactic and will lead to a more cautious approach by Adjudicating Authorities when dealing with applications for CIRP initiated by operational creditors. It also provides clarity on the interpretation of “pre-existing dispute” under the IBC.