Financial & Insolvency Law

Corporate Insolvency and the Admission of a Debt under the Negotiable Instruments Act

The National Company Law Appellate Tribunal (“NCLAT”) has in the case of Sudhi Sachdev Vs. M/s APPL  Industries Ltd. held that the pendency of a case under Section 138/141 of the Negotiable Instruments Act, 1881 (“NI Act”)  amounts to an admission of debt by the Corporate Debtor as against an Operational Creditor despite the criminal nature of the proceedings under Section 138/141 of the NI Act forming outside the scope of Section 8(2)(a) R/w Section 5(6) of the Insolvency and Bankruptcy Code, 2016 (“Code”). This article seeks to critically examine the rationale behind this decision.

 

Background

Under the Code, Section 8 stipulates that before an application for the initiation of Corporate Insolvency resolution Process (“CIRP”) can be made by the Operational Creditor, he must serve a demand notice demanding payment of the amount involved in the default along with the requisite documents. Within 10 days of the receipt of the demand notice, the Corporate Debtor may challenge the claims under the demand notice and 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.

 

The Case                                                                                                                

In this case, the Operational Creditor, M/s APPL Industries Ltd. had filed an application for the initiation of CIRP against the Corporate Debtor, M/s Auto Décor Pvt. Ltd. for an amount due of Rs. 34,25,251/- before the National Company law Tribunal (“NCLT”). Before making such application for insolvency, APPL had pursued a case under Section 138/141 of the Negotiable Instruments Act, 1881 (“NI Act”) with regard to 51 cheques previously issued by the Corporate Debtor in favour of APPL to the tune of Rs. 66,10,776/- and such proceedings are presently sub judice. In the course of these proceedings, the Corporate Debtor had made payments of Rs. 31,85,525/- to APPL reducing its liability to Rs. 34,25,251.

Before the NCLT(M/s APPL Industries Ltd. Vs. M/s. Auto Décor Pvt. Ltd.), the Corporate Debtor had claimed no defence of “dispute” in view of the ongoing proceedings under the NI Act but did raise defences of part of the debt being barred by limitation, which was negatived by the NCLT. Finally, NCLT admitted the application and initiated CIRP against the Corporate Debtor by an order dated 2nd August 2018.

Subsequently, the promoter of the Company appealed before the NCLAT (Sudhi Sachdev Vs. M/s APPL  Industries Ltd.) to seek the vacation of NCLT’s order raising the defence of a bonafide “dispute’ with regard to the debt in the form of the proceedings under Section 138/141 of the NI Act existing between the parties which would bar the initiation of CIRP. The NCLAT negatived such contention of the Appellant and rejected the appeal on the following grounds:

It is not in dispute that there is a debt payable to the Operational Creditor and default on the part of the Corporate Debtor. The pendency of the case under Section 138/441 of the Negotiable Instruments Act, 1881, even if accepted as recovery proceeding, it cannot be held to be a dispute pending before a court of law. Thereby we hold that the pendency of the case under Section 138/141 of Negotiable Instruments Act, 1881 actually amounts to an admission of debt and not the existence of a dispute.

 

Analysis

At the outset, it is misplaced for the NCLAT to hold in generality that proceedings under Section 138/141 of the NI Act amount to an admission of debt by the corporate debtor. Despite the fact that proceedings under the NI Act are sub judice, no inference can be drawn from such proceedings speaking of the liability of parties as the proceedings themselves are of a criminal nature and not meant to be civil recovery proceedings. Arguendo, even if such proceedings could come within the ambit of the Code and even if such proceedings had reached finality and determined to the guilt of the Accused/ Corporate Debtor, such determination does not amount to the admission of debt by the Accused/Corporate Debtor as the Court under Section 138/141 of the NI Act seeks to punish the drawer of fraudulent/dishonoured cheques and does not delve into the determination of existence/quantum of any liability of the nature that is stipulated as “Operational Debt” under Section 5(21) of the Code, which was inferred erroneously by the NCLAT in the present case. The holding of the NCLAT is erroneous for the following reasons:

 

  1. Pendency under the NI Act Irrelevant

Proceedings under Section138/141 of the NI Act have no bearing on the realm of dispute under Section 8 of the Code as its stipulates for the cognizance of disputes that are of a civil or arbitral nature as enshrined under Section 5(6) of the Code while the pending proceedings under the NI Act are of a criminal nature. Therefore, the existence of proceedings under Section 138/141 of the NI Act can have neither positive nor negative bearing upon the merits of an application under Section 9 of the Code. Thus, NCLAT’s holding to the contrary is erroneous.

Further, even where a final determination is made as proving the criminal liability of the Accused, holding him to be guilty of an offence under Section 138/141, the same forms an irrelevant consideration when determining both admission of debt or dispute under the Code owing to its criminal nature.

Recently, the Kolkata bench of the NCLT had held in the case of Naviplast Traders Private Limited & Ors. Vs. M/s R G Shaw & Sons Private Ltd. that Proceedings under NI Act have nothing to do with an application under the Code.

 

  1. Pigeon-Holed View

The use of cheques as a medium of value exchange is not limited to the repayment of Operational Debt (as defined in Section 5(21) of the Code). Cheques are utilised to engage in multifarious transactions that may or may not form under the abovementioned debts. It then goes without saying that the amount in question under the proceedings under the NI Act between the parties can possibly exist for numerous reasons that may extend beyond the scope of operational debt stipulated under the Code. It is entirely possible for the amounts impugned in the proceedings under the NI Act to be of a nature beyond the scope of the operational debt like other business advances, security cheques, loans extended, etc.

What is to be understood is the nature of proceedings under the NI Act. Under the NI Act,  the drawer of the cheque is made liable to prosecution on dishonour of cheque with safeguards to prevent harassment to honest cheque bearers. The object of the provision is to facilitate the smooth functioning of any transaction between the drawer and the bearer. This safeguard applies in generality and the same cannot be ignored.

 

  1. Subject to Misuse

NCLAT’s holding in this present case can very easily fall subject to abuse/misuse as cheques issued for several other purposes in the course of business may be misused to strengthen an application for CIRP. This is against the interest of justice and the object of the Code. Further, the Bankruptcy Law Reforms Committee has affirmed in its report that the object of the dispute clause is to ensure that frivolous and fraudulent applications cannot pass muster the threshold of Section 9 and dilute the object of the Code.

For example, as a general business practice, cheques are issued as securities for transactions and services. This holding of the NCLAT would have the unintended effect of allowing ill-intentioned operational creditors to engage in depositing such cheques by filling any amount (whether liability had accrued or not) which would cause the same to be returned as unpaid due to insufficiency of funds or other constraints. Merely by initiating proceedings under Section 138/141 of the NI Act, the NCLT would have to allow such application under Section 9 of the Code following the reasoning of the NCLAT that the same amounts to an admission of debt. Moreover, such a false ploy could be engaged in even when no debt exists in the first place and would only ease the endeavours of fraudulent entities.

 

Conclusion

NCLAT’s decision in the case of Sudhi Sachdev Vs. M/s. APPL  Industries Ltd. is outrightly erroneous for the aforementioned reasons. Till the time this decision is not revised in an appeal before the Hon’ble Supreme Court, this holding will remain as binding precedent upon NCLTs that are the adjudicatory bodies for corporate persons under Part II of the Code. It is needless to say that such a position is against the interest of justice and one can only hope that this decision is challenged before and vacated by the Hon’ble Supreme Court, to be corrected, soon.

Where the Court cannot consider the existence of a proceeding as “dispute” under Section 8 of the Code, owing to its criminal nature, it cannot hold such a development as an admission of debt to the prejudice of the Corporate Debtor. The Code stipulates for only civil suits and arbitral proceedings as forming part of “disputes” under Section 8 of the Code and this decision of the NCLAT in this case, is in direct violation of this statutory principle.

The effective implementation of the Code has always suffered from the peril of extreme and unjust interpretations in many instances. Most of the contentious aspects of the Code have seen judicial challenge at all levels from the NCLT to the Hon’ble Supreme Court, all too often. This approach to the implementation of the Code has heavily diluted its implementation and marred most notably the stipulation of the stringent timelines, that remains no more than a dead letter today. Steps must be taken to ensure certainty of process under the Code along with loyalty to the object of the Code.

 

[This Article was first published on the IndiaCorpLaw Blog @ https://indiacorplaw.in/2018/12/corporate-insolvency-admission-debt-negotiable-instruments-act.html]

Siddharth is the Founder of CorpLexia and serves as its Editor. He is a student of BBA LL.B (Hons.) and has a special focus on corporate, commercial, insolvency, arbitration, securities and competition laws. He can be reached at siddharth@corplexia.com

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