Interplay between Negotiable Instruments Act and the Insolvency Code

The present post continues from the article titled “Cheque Proceedings against a Company during Insolvency Proceedings- A Legal Complication”, (2020) 1 SCC J-23 published by SCC Journal.

Introduction

Earlier this week, the Supreme Court in P. Mohanraj v. Shah Brothers Ispat (P) Ltd.[1] settled the long-standing issue:

whether the initiation of cheque bounce proceedings under the Negotiable Instruments Act, 1881 or the continuation of such proceedings against a debtor company and its directors is permissible or not, when the debtor company is undergoing resolution process.

The question revolved around whether the “moratorium” under Section 14 of the Insolvency and Bankruptcy Code, 2016 (hereinafter “IB Code”) also extends to covering proceedings under the Negotiable Instruments Act, 1881 (hereinafter “NI Act”).

 

Preceding NCLAT ruling

The National Company Law Appellate Tribunal (hereinafter “NCLAT”) in Shah Brothers Ispat (P) Ltd. v. P. Mohanraj[2], approved parallel continuation of proceedings under the NI Act against a company subjected to moratorium while undergoing resolution process under the IB Code.

The appellant creditors before the 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. In turn, the respondent placed reliance on Section 14 of the IB Code, which stipulates:

 

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

  1. 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;

(b) transferring, encumbering, alienating or disposing of by the corporate debtor any of its assets or any legal right or beneficial interest therein;

(c) any action to foreclose, recover or enforce any security interest created by the corporate debtor in respect of its property including any action under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (54 of 2002); and

(d) the recovery of any property by an owner or lessor where such property is occupied by or in the possession of the corporate debtor.                                              (emphasis added)

 

The respondent debtor contended that once a moratorium is imposed under Section 14(1) of the IB Code, proceedings under the NI Act would have to be halted. The NCLAT categorically rejected the submission holding that:

6 … as Section 138 is a penal provision, which empowers the court of competent jurisdiction to pass order of imprisonment or fine, which 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. In fact no criminal proceeding is covered under Section 14 of I&B Code[3]. (emphasis added)

 

Factors to be considered

 

In the article titled “Cheque Proceedings against a Company during Insolvency Proceedings — A Legal Complication”, I had argued that the major precise for the NCLAT to allow parallel continuation of proceedings was that the moratorium does not cover criminal proceedings.

It was then argued by me that while this position might be true, proceedings under the  NI Act cannot be classified as criminal proceedings in strict sense. The decision of the NCLAT raises multiple issues, namely, (a) whether the 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 it affects the rights of other creditors.

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

 

Supreme Court’s decision

The Supreme Court in the present case held that moratorium under Section 14 of the IB Code covers the proceedings under the NI Act on the following reasons:

 

(a) The word “proceedings” used in Section 14 in the phrase “proceedings against the corporate debtor including execution of any judgment, decree or order in any court of law, tribunal, arbitration panel or other authority”  also includes the proceedings under the Section 138 of the NI Act conducted before a Magistrate. The same, in the Court’s opinion, is a proceeding in a court of law in respect of a transaction, which relates to a debt owed by the corporate debtor.

(b) The proceedings under Section 138 of the NI Act are quasi-criminal in nature i.e. “a ‘civil sheep’ in a ‘criminal wolf’s’ clothing”. The Court reasoned that whether the proceeding is civil or criminal in nature is not to be judged with reference to the penalty that may be prescribed but with reference to the cause for which the penalty has been inflicted.

 

Simultaneously, the Court noted that the object of the Section 14 gets circumvented if:

25. … a quasi-criminal proceeding which would result in the assets of the corporate debtor being depleted as a result of having to pay compensation … would directly impact the corporate insolvency resolution process in the same manner as the institution, continuation, or execution of a decree in such suit in a civil court for the amount of debt or other liability[4].

 

In this light, it was held that it is impossible to discern any difference between the impact of a suit and a Section 138 proceeding, insofar as the corporate debtor is concerned which is to be helped in getting back on its own feet.

Resultantly, it was held that the proceeding under the NI Act against the corporate debtor would be halted by the moratorium.

On the issue of personal liability of the directors, the Court held that the proceedings against the directors would subsist and continue even if the proceedings against the corporate debtor stand on hold due to moratorium.

 

Analysis of the Supreme Court ruling

 

The decision of the Supreme Court reiterates the long-standing position that the proceedings under the NI Act are not stricto sensu criminal in nature.  The Supreme Court in catena of cases has laid down that the proceedings under Section 138 of the NI Act are civil in nature with the primary object to be compensatory. In Kaushalya Devi Massand v. Roopkishore Khore[5], the Supreme Court categorically stated:

 

11. Having considered the submissions made on behalf of the parties, we are of the view 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. An offence under Section 138 of the Negotiable Instruments Act, 1881, is almost in the nature of a civil wrong which has been given criminal overtones. (emphasis added)

 

In Meters and Instruments (P) Ltd. v. Kanchan Mehta[6], terming the offence under Section 138 as a “regulatory offence”, the Court noted that the nature of offence under Section 138 is primarily related to a civil wrong and the 2002 Amendment specifically made it compoundable.

The Court therefore correctly brings these proceedings within the ambit of Section 14 keeping in mind the objective behind moratorium. The proceedings under Sections 138 and 141 of the NI Act if decided against the corporate debtor would have resulted in depletion of a corporate debtor’s assets during the insolvency resolution process since a company would have to pay fine which may extend to twice the amount of the cheque.

Right to compose a cheque bounce case is circumvented during the imposition of moratorium

There is one aspect of the discussion that remains relatively lesser addressed. The position with respect to the directors who can still be made liable for the liabilities on the cheque issued by the company, even if moratorium halts such proceedings against the corporate debtor.

The decisions of the Supreme Court in Meters and Instruments case[7], Kaushalya Devi Massand case[8] and Damodar S. Prabhu v. Sayed Babalal H.[9], categorically lay down the option of paying reasonable compensation to the cheque-holder and thereby putting an end to the proceedings under Section 138 of the NI Act. It is submitted that this particular statutory right gets circumvented when insolvency proceedings are admitted against a corporate debtor and a moratorium is imposed.

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.[10] Section 17 of the IB Code is categorical in its ambit when it stipulates:

    1. 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 added)

 

Resultantly, the financial institutions maintaining accounts of the corporate debtor shall act on the instructions of the “resolution professional” only.

This leads to one peculiar issue. Not only the fact that moratorium covers only the main accused i.e. the corporate debtor, but the change in the management of the debtor means that the suspended directors of the corporate debtor cannot act on behalf of the company to compromise the proceedings under Section 138 of the NI Act. Since during the time a moratorium is operational, the control over the financial and functioning of the company is tied up in the hands of the resolution professionals, the directors will personally be liable to face the proceedings for the cheques bounced.

The Court by allowing the proceedings under Section 138 read with Section 141 to continue against the directors, the Court has again left the promoters to be hung out to dry.

The position of law, however, is not unprecedented. Section 14(3)(b) itself excludes “a surety in a contract of guarantee to a corporate debtor” from the coverage of moratorium. Explaining the rationale of Section 14(3)(b), the Supreme Court in SBI v. V. Ramakrishnan[11] stated:

 

26.1 Section 14 refers only to debts due by corporate debtors, who are limited liability companies, and it is clear that in the vast majority of cases, personal guarantees are given by directors who are in management of the companies. The object of the Code is not to allow such guarantors to escape from an independent and co-extensive liability to pay off the entire outstanding debt, which is why Section 14 is not applied to them.

 

Similarly the Supreme Court in Essar Steel India Ltd. v. Satish Kumar Gupta[12] had also rejected the argument that a part of the resolution plan was illegal since it stipulated that the claims of the guarantor on account of subrogation would be extinguished. The erstwhile promoters argued that their personal guarantees are being invoked. Therefore, if they honour those guarantees then they should be allowed to recover from the corporate debtor. But the resolution plan provided that such right to recovery was extinguished.

The Supreme Court rejected this argument stating that Section 31 of the IB Code categorically states that a resolution plan once approved, it is binding on all the creditors and guarantors. The Court held:

 

106. … it is difficult to accept Shri Rohatgi’s argument that that part of the resolution plan which states that the claims of the guarantor on account of subrogation shall be extinguished, cannot be applied to the guarantees furnished by the erstwhile directors of the corporate debtor.[13]

 

Conclusion

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.

However, by allowing continuation of the proceedings under Sections 138/141 of the NI Act against the promoters, the Court has reinforced its previous jurisprudence on this issue as seen in Essar Steel case[14] and SBI v. V. Ramakrishnan[15].

In light of the above discussion, the judgment is a welcome step that has addressed the issue appropriately in light of the letter and spirit of the IB Code.

 

Akaant K M, Advocate, National Company Law Tribunals and Constitutional Courts and author of the commentary “Insolvency and Bankruptcy Code – Law and Practice” foreword by Justice Suryakant and available HERE . He is also visiting Faculty at NUJS Kolkata

[1] 2021 SCC OnLine SC 152.

[2] 2018 SCC OnLine NCLAT 415.

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

[4] P. Mohanraj v. Shah Brothers Ispat (P) Ltd., 2021 SCC OnLine SC 152.

[5] (2011) 4 SCC 593.

[6] (2018) 1 SCC 560.

[7] Id.

[8] (2011) 4 SCC 593.

[9] (2010) 5 SCC 663 : (2010) 2 RCR (Cri) 851. The Court framed guidelines for compounding cases under S. 138 of the NI Act:

(i) (a) That directions can be given that the writ of summons be suitably

modified making it clear to the accused that he could make an application for compounding of the offences at the first or second hearing of the case and that if such an application is made, compounding may be allowed by the court without imposing any costs on the accused.

(b) If the accused does not make an application for compounding as aforesaid, then if an application for compounding is made before the Magistrate at a subsequent stage, compounding can be allowed subject to the condition that the accused will be required to pay 10% of the cheque amount to be deposited as a condition for compounding with the Legal Services Authority, or such authority as the court deems fit.

(c) Similarly, if the application for compounding is made before the Sessions Court or a High Court in revision or appeal, such compounding may be allowed on the condition that the accused pays 15% of the cheque amount by way of costs.

(d) Finally, if the application for compounding is made before the Supreme Court, the figure would increase to 20% of the cheque amount.

[10] Insolvency and Bankruptcy Code 2016, S. 17.

[11] (2018) 17 SCC 394.

[12] (2020) 8 SCC 531.

[13] Essar Steel India Ltd. v. Satish Kumar Gupta, (2020) 8 SCC 531.

[14] Id.

[15] (2018) 17 SCC 394.

One comment

  • A director can be held guilty only when the the company is found to be guilty. So so when company cannot be proceeded against how can the directors be held guilty. Actually this judgement help the directors who are guilty. The supreme court seems to have omitted to notice this fact.

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