The clean slate theory, since its inception, has sparked significant debate among the Bar and the Bench alike, with some vigorously advocating for it, while others standing in staunch opposition. Yet, undeniably, this subject, with its dual-edged allure, beckons some degree of wary contemplation from all quarters.
Breathing fresh wind into the sails of this long-standing debate, the recent decision of the Madras High Court in National Sewing Thread Co. Ltd. v. TANGEDCO1, may dismantle what has been regarded by some as the “sacrosanct” protection afforded to an entity having successfully undergone a corporate insolvency resolution process (CIRP) under the Insolvency and Bankruptcy Code, 20162 (IBC).
In essence, the theory envisions a new lease of life for a corporate debtor that has successfully completed a CIRP, absolving it of all its past liabilities, and insulating it from any claims pertaining to the pre-CIRP/CIRP period, which did not form part of the approved resolution plan. The approval of the resolution plan by the adjudicating authority marks the extinguishment of all such claims, thereby allowing the corporate debtor to continue its business operations unencumbered by pre-existing debts or obligations.
The decision of the Madras High Court3, however, circumscribes the otherwise expansive ambit of this theory, as expounded in Essar Steel India Ltd. (CoC) v. Satish Kumar Gupta4 and Ghanashyam Mishra & Sons (P) Ltd. v. Edelweiss Asset Reconstruction Co. Ltd.5, by introducing an exception for entities that, upon completion of the CIRP, are restored to the stewardship of their former management — the same management responsible for driving the company into insolvency in the first instance.
In 2021, National Sewing Thread Co. Ltd., the petitioner, successfully concluded its CIRP. However, in January 2022, the Tamil Nadu Generation and Distribution Corporation (TANGEDCO), the respondent, raised a demand of Rs 32,86,061 against the petitioner for outstanding electricity charges accruing from June 2019. The petitioner, invoking the “clean slate” theory, resisted this demand, asserting that such pre-CIRP liabilities stood extinguished upon the approval of its resolution plan. Despite this, TANGEDCO disconnected the petitioner’s electricity connection for non-payment of the claimed amount. Subsequently, the petitioner sought a temporary Larsen & Toubro (LT) energy connection, which TANGEDCO refused, citing the petitioner’s failure to settle the outstanding electricity charges. Consequently, the petitioner approached the Madras High Court challenging this action of TANGEDCO.
The Madras High Court, however, refused to extend any protection to the petitioner, noting that the petitioner, a micro, small and medium enterprises (MSME), had been returned to its previous management following the approval of a resolution plan submitted by them. Consequently, the Court deemed the petitioner ineligible for the protections envisioned by the clean slate theory.
While the underlying intent of the judgment is undeniably commendable, and the ruling itself adeptly illuminates several glaring shortcomings of IBC — such as the complete erosion of the rights of operational creditors, the potential for abuse of power by the interim/resolution professional (IRP/RP), the dangerously overarching dominance of financial creditors to the exclusion of others, and the risk of collusion among financial creditors, the IRP/RP, and resolution applicants — the Madras High Court may, however, have overstepped its judicial mandate. In doing so, it appears to have ventured beyond its role of statutory interpretation and into the domain of the legislature, whose exclusive prerogative it is to legislate. Additionally, Madras High Court may also have taken into account certain extraneous factors, further complicating the precedential value of its decision.
The Madras High Court, while justifiably voicing its concern over the treatment accorded to operational creditors under the approved resolution plan — where they were relegated to a paltry 1% of the aggregate value of their claims, to be distributed on a pro-rata basis — entirely disregarded the critical fact that TANGEDCO had failed to even file its claim before the IRP/RP. In doing so, the Court may have overlooked the broader implications of its ruling on the overall integrity of IBC. Such a precedent may embolden operational creditors and other stakeholders to seek redress outside the IBC framework, thereby undermining the very purpose of IBC, which sought to consolidate all insolvency-related disputes under a unified regime to ensure an effective and orderly resolution.
Since its inception, IBC has unfortunately seen a recurring trend of government authorities failing to file their claims in accordance with the stipulated provisions. Pertinently, a significant portion of the cases challenging the approved resolution plan, more often than not, are initiated by government authorities that had earlier neglected to submit their claims in a timely manner to the IRP/RP. While there is, unarguably, a need for amendments to IBC to ensure a more equitable treatment for all stakeholders, adherence to the Code’s provisions, as they presently stand, cannot be regarded as optional. The persistent laxity of government authorities has proven to be a formidable impediment, not only within the IBC framework but also in litigations generally, where they frequently seek leniency in timelines and procedural compliance — invoking, as a matter of right, the flexibility necessitated by bureaucratic delays. IBC has further exposed the inefficiencies within government bodies, revealing how complacency and obstinacy are routinely excused, often at the expense of broader legislative objectives.
Consequently, this decision of the Madras High Court may serve as a dangerous precedent, encouraging government authorities as well as other creditors to flout the provisions of IBC with impunity.
The Madras High Court, while carving out an exception to the clean slate theory, has stressed upon the suspended management’s duty to make complete disclosure vis-à-vis the outstanding dues of the corporate debtor. While this position is, in principle, sound, it may be important to note that prior to 2023, neither IBC nor the rules and regulations thereunder explicitly mandated such specific disclosures. It was only with the amendment of the Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations, 20166 (CIRP Regulations) in September 2023, that the responsibility of the suspended management to make detailed disclosures regarding the assets and liabilities of the corporate debtor was expressly codified by introducing Regulation 3-A. This Regulation imposes an affirmative obligation on the suspended management, marking a significant departure from the broader mandate of Section 19 of the IBC7, which merely required the suspended management to cooperate with and assist the IRP/RP. Under the previous framework, the onus was effectively placed on the IRP/RP to seek such information from the suspended management, rather than the latter having a proactive duty to disclose it.
In light of this legislative gap prior to 2023, it is questionable whether the Madras High Court could justifiably presume the existence of such an obligation on the part of the suspended management, absent any explicit statutory mandate at the time.
Additionally, the Madras High Court has impressed upon the duty of the RP to exhaustively collate information pertaining to the assets and liabilities of the corporate debtor and to ensure its full disclosure within the information memorandum, while holding that any failure in this regard should attract the consequences as contemplated in the judgment. However, this reasoning appears fundamentally flawed as even in instances where the RP meticulously compiles such information, IBC lacks any provision obliging a resolution applicant to extend treatment to creditors who have failed to submit their claims. In the absence of such a statutory mandate, the value of comprehensive disclosure by the RP is arguably diminished, as it offers no recourse to creditors who remained outside the IBC framework. Consequently, while the Court’s ruling may be well-intentioned, it appears to lack the requisite legislative foundation.
It is also noteworthy that IBC framework has undergone significant amendments between 2022 to 2023, specifically aimed at addressing the growing issue of creditors failing to submit their claims in a timely manner during CIRP. The introduction of Regulation 6-A to the CIRP Regulations stands out as a key development, mandating the IRP to notify all creditors, as appearing in the last available books of accounts of the corporate debtor, provided such information is accessible, regarding the commencement of CIRP. Further, Regulation 13 has been amended to allow the RP to accept claims received beyond the period stipulated in the public announcement made under Regulation 12, up to seven days before the date of meeting of creditors for voting on the resolution plan or the initiation of liquidation, as the case may be.
Nonetheless, it is noteworthy that no concurrent amendment, mandating a resolution applicant to extend treatment to creditors who have failed to file their claims with the IRP/RP, has been brought in IBC. In the absence of such provisions, the onus remains on the creditor to actively pursue its claim as per the provisions of IBC.
In carving out this exception to the clean slate theory, the Madras High Court also appears to have lost sight of not only the intent and objectives underlying the enactment of the IBC but also the fundamental purpose of such legislations. It vital to recount that such laws are designed not only to facilitate the resolution of insolvency and to safeguard a nation’s economic fabric, but also to cultivate a nurturing environment for future entrepreneurial efforts, thereby also fostering economic growth. Such measures are meant to ensure that those who embark on business ventures, even if their pursuits falter through no fault of their own, are not dissuaded from daring to venture again by the heavy weight of undue consequences.
The Madras High Court seems to have neglected the reality that business failures can sometimes transpire without any fault or malfeasance on the part of the company or its management. Additionally, the Court appears to have missed that IBC already incorporates robust measures to identify and penalise transactions undertaken by the suspended management that are outside the ordinary course of business or aimed at defrauding creditors. Thus, IBC does not afford a sanctuary to an offending ex-management, as implied in the judgment.
Nonetheless, this does not diminish the loopholes and the inadequacies that presently exist in IBC, particularly concerning the rights of the operational creditors — or rather, the glaring absence thereof. The judgment serves as a pivotal opportunity for the legislature to address these gaps and enhance the framework’s equity, thereby reinforcing compliance. Absent such legislative intervention, we may be poised to witness the erosion of yet another insolvency regime.
†AOR and Founding Partner at DSNR Legal Advocates and Solicitors. Author can be reached at: ritika.gambhir@dsnrlegal.com.
††Senior Associate at DSNR Legal Advocates and Solicitors. Author can be reached at: akshaya.ganpath@dsnrlegal.com.
†††Associate at DSNR Legal Advocates and Solicitors. Author can be reached at: saumya.tiwari@dsnrlegal.com.
2. Insolvency and Bankruptcy Code, 2016.
3. National Sewing Thread Co. Ltd. v. TANGEDCO, 2024 SCC OnLine Mad 2330.
6. Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations, 2016.