Cheque Proceedings Against a Company During Insolvency Proceedings – A Legal Complication [SCC Archives]

The National Company Law Appellate Tribunal (hereinafter “Nclat”) recently in Shah Bros. Ispat1, approved parallel continuation of proceedings under the Negotiable Instruments Act, 1881 (hereinafter “the NI Act”) against a company subjected to moratorium while undergoing resolution process under the Insolvency and Bankruptcy Code, 2016 (hereinafter “the IB Code”). The decision of Nclat raises multiple issues ranging from an apparent conflict between the NI Act and the IB Code to practical impossibilities in allowing both the proceedings to continue simultaneously. The object of the article is to discuss the legal problems that may arise in light of the decision in Shah Bros. Ispat1, and why the decision needs to be revisited in light of the settled law.

DECISION IN SHAH BROS. ISPAT2

The appellant creditors before Nclat had initiated two separate proceedings under Section 138 of the NI Act, one prior to the admission of insolvency proceedings under the IB Code and one post the admission of insolvency proceedings under the IB Code. The respondent debtor contended that once a moratorium is imposed under Section 14(1)2 of the IB Code, proceedings under the NI Act would have to be halted. Nclat categorically rejected the submission and held:

6. … as Section 138 is a penal provision, which empowers the court of competent jurisdiction to pass order of imprisonment or fine, [and] cannot be held to be proceeding or any judgment or decree of money claim. Imposition of fine cannot held to be a money claim or recovery against the Corporate Debtor nor order of imprisonment, if passed by the court of competent jurisdiction on the Directors, they cannot come within the purview of Section 14. Infact no criminal proceeding is covered under Section 14 of I&B Code.3

The major precise for allowing parallel continuation of proceedings was that the moratorium does not cover criminal proceedings, but it is submitted that while this position might be true, proceedings under the NI Act cannot be classified as criminal proceedings in strict sense. The decision of Nclat raises multiple issues, namely:

(a) whether proceedings under the NI Act are purely criminal in nature,

(b) whether the accused company’s right to compose (and put an end to) a cheque bounce case is circumvented during the imposition of moratorium, and

(c) whether continuation of parallel proceedings under the NI Act and the IB Code conflict with the object as well as the procedure of the resolution process and if whether it affects the rights of other creditors.

For the purposes of the argument, the article does not distinguish between the NI proceedings initiated prior to the initiation of proceedings under the IB Code and the NI proceedings initiated post the initiation of proceedings under the IB Code since the reasoning of Nclat permeates both the scenarios.

NATURE OF PROCEEDINGS UNDER NI ACT

The Supreme Court in a catena of cases has laid down that the proceedings under Section 138 of the Negotiable Instruments Act, 1881 are civil in nature with the primary object to be compensatory. In Kaushalya Devi Massand4, the Supreme Court categorically held that “the gravity of a complaint under the Negotiable Instruments Act cannot be equated with an offence under the provisions of the Penal Code, 1860 or other criminal offences.”

The extent to which the proceedings under Section 138 of the Negotiable Instruments Act, 1881 have been categorised to be civil in nature can also be gauged from the question of law that was before the Hon’ble Court in the aforesaid case of Meters and Instruments5. The Court was confronted with the issue as to whether the consent of the complainant is required to bring an end to the proceedings under Section 138 of the Negotiable Instruments Act, 1881 or not. And noting the legislative history of the Act, it stated:

11. … The statutory scheme post-2002 amendment … has brought about a change in law and it needs to be recognised. … [b]asic object of the law is to enhance credibility of the cheque transactions by providing speedy remedy to the complainant without intending to punish the drawer of the cheque whose conduct is reasonable or where compensation to the complainant meets the ends of justice.6

(emphasis supplied)

The Court ultimately held that:

18. ***

18.2. The object of the provision being primarily compensatory, punitive element being mainly with the object of enforcing the compensatory element, compounding at the initial stage has to be encouraged….

18.3. Though compounding requires consent of both parties, even in absence of such consent, the court, in the interests of justice, on being satisfied that the complainant has been duly compensated, can in its discretion close the proceedings and discharge the accused.7

From the above percipience, it becomes clear that a crucial element of a proceeding under Section 138 of the NI Act is its nature that basically involves an in personam legal action. Generally criminal law as enshrined under the Penal Code, or special Acts like the Narcotics, Drugs and Psychotropic Substances Act involves legal action in rem with the State initiating legal action against an accused. While understandably, the reason behind providing criminal overtone to the proceedings under Section 138 of the NI Act is to instil faith in the mode of conducting business, but the inherent nature of the cases under Section 138 of the NI Act remains the same i.e. to provide for a mechanism wherein a debtor can recover its dues from the creditors in a timely and more secured manner since fear of incarceration is the stick that dangles over the head of the accused debtor.

RIGHT TO COMPOSE A CHEQUE BOUNCE CASE IS CIRCUMVENTED DURING THE IMPOSITION OF MORATORIUM

The decisions of the Supreme Court in Meters and Instruments5, Kaushalya Devi Massand4 and Damodar Prabhu8, categorically lay down the option of paying reasonable compensation to the cheque-holder and thereby putting an end to the proceeding under Section 138 of the NI Act. It is submitted that this particular right gets circumvented when insolvency proceedings are admitted against a corporate debtor and a moratorium is imposed.

The IB Code has led to considerable change in the legal landscape pertaining to corporate entities and has brought in radical shift to the bankruptcy and insolvency process. Under the IB Code, in order to initiate resolution process of an insolvent company, it is necessary to prove that the alleged corporate debtor is insolvent. Once an insolvency petition is “admitted”, the resolution process is initiated and the current management is suspended and an Interim Resolution Professional (IRP) is appointed.9 Section 17 of the IB Code is categorical in its ambit when it stipulates:

17. Management of affairs of corporate debtor by interim resolution professional.—(1) From the date of appointment of the interim resolution professional—

(a) the management of the affairs of the corporate debtor shall vest in the interim resolution professional;

(b) the powers of the Board of Directors or the partners of the corporate debtor, as the case may be, shall stand suspended and be exercised by the interim resolution professional;

(emphasis supplied)

IRP is mandated to protect and preserve the value of the property of the corporate debtor and manage the operations of the corporate debtor as a going concern.10 The Resolution Professional who replaces IRP carries forward the mandate to protect and preserve the assets of the “corporate debtor company”11 and is statutorily mandated to conduct the entire corporate insolvency resolution process and manage the operations of the corporate debtor during the corporate insolvency resolution process period.12

Subsequent to all these steps, the resolution plan submitted by any resolution applicant is required to be presented for the approval of the “committee of creditors”13. Section 3114 of the Insolvency and Bankruptcy Code, 2016 stipulates that the resolution plan once approved would be binding on the corporate debtor and its employees, members, creditors, guarantors and other stakeholders involved in the resolution plan. In case the resolution plan is not approved, then the company goes into liquidation. However, during all this time, the Board of Directors of the company are suspended and possess no control over the financial decisions or the functioning of the company.

The Code in order to give full effect to its provisions and the object of insolvency resolution of companies, unencumbered by any other pending legal proceedings or legal right, provides for the imposition of moratorium that prohibits any interference with the assets of the company. The object of moratorium under Section 14 IBC is to keep the corporate debtor’s assets together during the corporate insolvency resolution process and to facilitate orderly completion of the entire process. A “moratorium” ensures that the company continues as a “going concern”, as long as the creditors take a view on the resolution of default. In its report, the Bankruptcy Law Reforms Committee states that the motivation behind the “moratorium” is that it is value-maximising for the entity to continue operations even as the company’s viability is being assessed by the Interim Resolution Professional. The same report further states that:

there should be no additional stress on the business after the public announcement of the Interim Resolution Professional. The order for the moratorium during the Interim Resolution Professional imposes a stay not just on debt recovery actions, but also any claims or expected claims from old lawsuits, or on new lawsuits, for any manner of recovery from the entity.

The report added that the moratorium would be active for the period over which IRP is active.

In light of the above-mentioned discussion, the position under the Insolvency and Bankruptcy Code can be summarised in the following terms:

(a) once proceedings for Insolvency and Bankruptcy against a company are initiated and “admitted” before the National Law Company Tribunal, the company goes into resolution process,

(b) once resolution process is initiated the Board of Directors of the debtor company are suspended from their positions,

(c) during the resolution process, the operations of the company are carried on by the “interim resolution process” only,

(d) during the resolution process there is an imposition of “moratorium” which prohibits institution of suits or continuation of pending suits or proceedings against the corporate debtor; also prohibits transferring, encumbering, alienating or disposing of by the corporate debtor any of its assets or any legal right or beneficial interest therein; and

(e) the financial institutions maintaining accounts of the corporate debtor shall act on the instructions of the “Resolution Professional” only and in relation to such accounts and furnish all information relating to the corporate debtor available with them to the “Resolution Professional”.

Therefore, it is clear that the proceedings under Section 138 of the NI Act cannot be composed/settled during the time moratorium is operational since the control over the financial and functioning of the Company is tied up in the hands of the Resolution Professionals with the object of allowing the “committee of creditors” explore and evaluate better plans to make the company solvent again.

POSSIBLE CONFLICT BETWEEN THE NI ACT AND THE IB CODE

It is submitted that carrying on of the proceedings under the Negotiable Instruments Act, 1881 also conflicts with the overriding, non obstante clause in the Code under Section 23815. Once an insolvency application is admitted by the adjudicating authority, it is mandated that a public announcement be released intimating admission of insolvency proceedings against a company and imposition of a moratorium.16 The same is required so that all the creditors can submit their respective claims before IRP who can process them further.17 Consequently, all the creditors have to submit their claims to the committee of creditors that has to evaluate the claims and prepare a resolution plan that once approved, is binding on the corporate debtor and its employees, members, creditors, guarantors and other stakeholders involved in the resolution plan.14

Therefore, if a creditor seeks recovery of its dues independent of the resolution proceedings, there is an attempt to reclaim dues by two parallel proceedings. Furthermore, by allowing parallel proceedings, rights of other creditors according to the “priority” list prescribed under the IB Code are compromised:

178. Priority of payment of debts.—(1) Notwithstanding anything to the contrary contained in any law enacted by Parliament or the State Legislature for the time being in force, in the distribution of the final dividend, the following debts shall be paid in priority to all other debts

(a) firstly, the costs and expenses incurred by the bankruptcy trustee for the bankruptcy process in full;

(b) secondly—

(i) the workmen’s dues for the period of twenty-four months preceding the bankruptcy commencement date; and

(ii) debts owed to secured creditors;

(c) thirdly….

(emphasis supplied)

Once the drawee complainant is provided compensation under the NI Act, the priority list of the creditors is affected and the entire purpose of all the creditors submitting their claims for the resolution process to collate is defeated.

Furthermore, while proceedings under Section 138 of the NI Act are against “individuals” and result in personal liability of the person implicated and charged, in case a cheque is issued by an artificial person i.e. “company”, the liability is put primarily on the issuing company. If the company were solvent, then it would not be undergoing an insolvency resolution process, but if it has to escape prosecution under Section 138 of the NI Act, it would have to pay the amount in toto. On account of the insolvency of a company and the consequent inability to pay the cheque amount, the criminal liability in effect falls upon the Directors of a company, who are more often than not, the signatory on the cheques when acting on behalf of the company. On the other hand, the Directors cannot take the funds of the company to settle the NI proceedings, since they are suspended from their positions in the company. Clearly, there is an inherent contradiction between the two Acts and the respective framework they envisage.

CONCLUSION

Due to the admission of insolvency proceedings against a company under the IB Code, and imposition of moratorium, two consequences arise, namely, (a) the option to compose a cheque bounce is not available to the company and its erstwhile Directors, and (b) since the claims of the creditors have to be submitted before a committee of creditors, there would result a scenario where two separate recoveries over same cause of action would be carried on. The primary liability in a cheque bounce case is upon the drawer company, and since the accounts of the same are under the control of a resolution professional, there is a sword hanging over the former suspended Directors of the company whereby vicarious criminal liability is imposed on them.

Apart from the practical impossibilities that arise by carrying on proceedings under the Negotiable Instruments Act, 1881, there are legal conflicts that result. Proceedings under Section 138 of the NI Act are not purely criminal in nature with the provision for incarceration and fine provided only to pressurise the accused debtor to repay the debt owed to the complainant. When all types of civil proceedings are suspended, allowing continuation of proceedings under Section 138 of the NI Act results in defeating the object of resolution process. Also, the resolution process and the resolution plan caters to the claims of all creditors since under Section 31 of the IB Code once a resolution plan is approved, it binds all the creditors. By allowing independent recovery process to the drawee complainant, the entire process of resolution stands undermined.

In light of the above discussion, it is needed that this issue is thoroughly addressed in light of the letter and spirit of the IB Code.


Advocate, Punjab and Haryana High Court, Chandigarh, BA LLB (Hons.) and Executive Member, Bar Association of Punjab and Haryana High Court. Graduated in 2016 from National Law University, Delhi. Ph. No: +918447586173. Email Address mittalakaant@gmail.com, akaant.mittal.alumni@nludelhi.ac.in.

** This article was first published in Supreme Court Cases (2020) 1 SCC J-23. It has been reproduced with the kind permission of Eastern Book Company

[1] Shah Bros. Ispat (P) Ltd. v. P. Mohanraj, 2018 SCC OnLine NCLAT 415.

[2] Insolvency and Bankruptcy Code 2016, Section 14(1) states:

14. Moratorium.—(1) Subject to provisions of sub-sections (2) and (3), on the insolvency commencement date, the adjudicating authority shall by order declare moratorium for prohibiting all of the following, namely:

(a) the institution of suits or continuation of pending suits or proceedings against the corporate debtor including execution of any judgment, decree or order in any court of law, tribunal, arbitration panel or other authority;

(emphasis supplied)

[3] Shah Bros. Ispat (P) Ltd., 2018 SCC OnLine NCLAT 415, para 6.

[4] Kaushalya Devi Massand v. Roopkishore Khore, (2011) 4 SCC 593, 595, para 11.

[5] Meters and Instruments (P) Ltd. v. Kanchan Mehta, (2018) 1 SCC 560.

[6] Id, 568, para 11.

[7] Id, 571-72, para 18.

[8] Damodar S. Prabhu v. Sayed Babalal H., (2010) 5 SCC 663. The Court framed guidelines for compounding cases under Section 138 of the NI Act.

[9] Insolvency and Bankruptcy Code, 2016, Section 17.

[10] Insolvency and Bankruptcy Code, 2016, Section 20.

[11] Insolvency and Bankruptcy Code, 2016, Section 25.

[12] Insolvency and Bankruptcy Code, 2016, Section 23.

[13] Insolvency and Bankruptcy Code, 2016, Section 30.

[14] Insolvency and Bankruptcy Code, 2016, Section 31 stipulates:

31. Approval of resolution plan.—(1) If the adjudicating authority is satisfied that the resolution plan as approved by the committee of creditors under sub-section (4) of Section 30 meets the requirements as referred to in sub-section (2) of Section 30, it shall by order approve the resolution plan which shall be binding on the corporate debtor and its employees, members, creditors, guarantors and other stakeholders involved in the resolution plan.

(emphasis supplied)

[15] Insolvency and Bankruptcy Code, 2016, Section 238 states:

238. Provisions of this Code to override other laws.—The provisions of this Code shall have effect, notwithstanding anything inconsistent therewith contained in any other law for the time being in force or any instrument having effect by virtue of any such law.

(emphasis supplied)

[16] Insolvency and Bankruptcy Code, Section 13.

[17] Insolvency and Bankruptcy Code, Section 15.

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