Edelweiss judgement: Fallacious initiation of CIRP by the NCLAT
The authors are Mohd. Fahad Ansari and Nikhil Prasad Singh, second year students at National University of Study and Research in Law (NUSRL) Ranchi.
The Insolvency and Bankruptcy Code 2016 (“Code”) came as a great respite for creditors whose debts could not be recovered. Recently, the NCLAT in Edelweiss Asset Reconstruction v. Perfect Engine Components (“Edelweiss”) in overruling the judgment of the NCLT has wrongly initiated the Corporate Insolvency Resolution Process (“CIRP”). Besides failing to take into consideration some noteworthy facts, the court also ignored the clauses stipulated in a debt restructuring package. Moreover, the NCLAT by giving a judgment in conflict with that of the higher courts has ignored the stare decisis rule, a legal maxim which puts a duty on courts/tribunals to bind themselves to precedents when dealing with a similar case.. Through this article, the authors have attempted to critically analyse the judgment by comparing it with the intent and objective of the code, judgments given by the higher courts and fundamentals of the law of Contract.
Some credit facilities were provided to the Corporate Debtor (“CD”) by the State Bank of India (“original lender”). The CD failed to pay its outstanding dues and as a consequence, the original lender declared the CD’s account as Non-Performing Asset (“NPA”).
By virtue of a deed of assignment, the original lender assigned Edelweiss Asset Reconstruction Company (“Petitioner”) as the lender in March 2014. Post the transfer of the debt in favour of the petitioner, two restructuring packages were granted by the petitioner for the CD on 7 November, 2014. The first package was released on 7 November, 2014, however the same was cancelled on 22 September, 2016. Thereafter, the second package was released on 30 June, 2017 but to the same fate as that of the first, it was also cancelled on 1 June, 2018, against the terms and conditions of the package.
An important and unalterable condition was present in both the restructuring packages, that the CD has to repay the package through ‘operational cashflow.’ The petitioner filed the current petition under section 7 of the Code by relying on the default made by the CD on the second package and calculated the limitation period on the basis thereof. By ruling in favour of the petitioner, the NCLAT stated that ‘the date of default’ does not necessarily mean the ‘date of NPA’ since the date of default as mentioned under Section 3(12) of the Code implies a failure to pay a debt either in whole or any part which the CD has failed to pay. The NCLAT further held that on the acknowledgement of debt and default by the CD within the period of limitation, the period of limitation shall be further elongated to three years.
An original application bearing No. 01/2014 was also filed by the petitioner in the Debt Recovery Tribunal. Without stating the facts of the package on record, the petitioner, post the sanctioning of the package, went on to prosecute the recovery application.
Unilateral termination of contract: Against the principles of Contract
To validly terminate a contract, it is an established principle in the law of contracts to fulfill either of the conditions- (a) violation of the agreement; or (b) termination by mutual consent,. In the absence of either of the circumstances, the unilateral termination entitles the other party to damages. Coming to the present case, neither was the agreement containing the restructuring package mutually terminated, nor had the CD violated any provision of the agreement. The agreement was unilaterally revoked by the petitioner. This revocation was contested by the CD who stated that as per the T&Cs of the agreement, it was bound to repay the package only through the operational cashflows.
The Delhi High Court in Jagbir Singh Sharma v. Municipal Corporation of Delhi, ruled that if a contract has terms stipulating the method through which the repayment should be made, then the repayment has to be made only according to that method. In the Edelweiss case, the CD was liable for committing the default only if it failed to pay back the loan in the event of it having operational cash flows. The NCLAT pronounced the judgment by not only disregarding the provisions of the agreement, but also the established principles of the law of contracts. The correct recourse for the NCLAT should have been to dismiss the petition of the petitioner since no default was committed by the CD.
Elongating the limitation period: Wrongly admitting a time-barred claim
While pronouncing its judgment, the NCLAT took into consideration the Apex Court’s judgment of Laxmi Pat Surana v. Union Bank of India. The issue with relying on this judgment is that it mostly talks about not construing the date of NPA as the date of default under Section 18 of the Limitation Act. The Apex Court in the Laxmi Pat held that the purpose of the Code cannot be said to revive a time-barred debt, instead, it highlighted that accrual of a new period of limitation in terms of Section 18 is within the Limitation Act itself, and it would not be a matter of granting time-barred debts a new lease. In addition to this, the court held that the contractual arrangement would decide whether the limitation period can be extended for enforcing the rights. In the Edelweiss Asset Reconstruction v. Perfect Engine Components case, the agreement containing the terms clearly shows that no default was committed by the CD since there was an absence of breach of repayment provision and thereby, the period of limitation should not have been extended.
The petitioner has wrongfully tried to initiate a new period of limitation by relying on the restructuring package. The balance sheet explicitly shows that in 2016 and 2019, not even a single situation arose which could prove the default by the CD, meaning thereby that there is the absence of any new default by the CD relating to the restructuring package. By stretching the period of limitation, the NCLAT has overlooked the audit report which doesn’t show any kind of default on behalf of the CD. The right to file a suit arises in case of occurrence of default, and in this case, 3 years have passed before the petitioner filed the application, hence its claim is time-barred under article 137 of the Limitation Act, 1963. 31 March, 2009 is the date when the cause of action arose. But, the date of filing of the petition is 8 August, 2020, hence making it a time-barred petition. The Apex Court in B.K. Educational Services Pvt Ltd v. Parag Gupta and Associates has ruled that the occurrence of default gives the right to sue under article 137 of the Limitation Act 1963. In the Edelweiss case, the passing of more than 3 years was sufficient for the NCLAT to dismiss the petition, yet it wrongfully accepted the petition which resulted in giving a contradictory judgment to that of binding precedents.
One of the very objectives of the Code is to aid insolvent entities who are incapable of repaying their debts and as a result, commit default. But in the present case, no default was committed by the CD since the only method through which the repayment was to be made was through the operational cashflows, and nowhere it was mentioned that the CD has failed to repay the debt after having a shortfall in its operating cash flows. Since no acknowledgement of debt was made by the petitioner, the NCLAT has wrongly implemented Section 18 of the Limitation Act by resuscitating the time-barred debt.
Absence of a Cause of Action
For terminating a contract, a cause of action is a pre-condition. This has been categorically upheld by the Supreme Court in Brij Mohan v. Surga Begum. In the Edelweiss case, the NCLAT started the CIRP of the CD in the absence of default by overlooking the conditions of the restructuring arrangement. It is a settled position that for initiating the CIRP under section 7 of the Code, there must be a commission of default. The NCLAT by starting the CIRP has failed to follow the Code as well as judgements pronounced by the higher authorities.
The primary purpose of the Code is to ensure the initiation of CIRP post the occurrence of default, this is the stage when a CD fails to pay a debt. While pronouncing its judgment, the NCLAT ignored the clauses stipulated in the agreement. In the current controversial judgment, there was no presence of default, logically following the absence of acknowledgement of debt and hence the CIRP was wrongfully commenced. It is submitted that each and every clause of an agreement should be carefully interpreted by the courts since incorrect interpretation of even one provision has the capacity of tilting the judgment towards the wrong side. This judgment has the potential of setting out a wrong precedent in the opinion of the author and therefore demands an immediate review.