No change in nature of debt in case of breach of settlement terms by the Corporate Debtor – Analysis of the NCLAT’s Order in ‘Priyal Kantilal Patel v. IREP Credit Capital Pvt. Ltd. & Anr.’[1]

BRIEF FACTS

The Financial Creditor, being one of the holders of debentures issued by the Corporate Debtor, had filed an application under Section 7 (“Section 7 Application”) of the Insolvency and Bankruptcy Code, 2016 (“IBC”) before the National Company Law Tribunal, Mumbai Bench(“Adjudicating Authority”), inter alia, for commencement of the corporate insolvency resolution process (“CIRP”) against the Corporate Debtor, due to the default by the Corporate Debtor in redemption of the debentures held by the Financial Creditor.

During the pendency of the Section 7 Application, the Financial Creditor and the Corporate Debtor entered into a settlement / consent terms, recorded in a settlement agreement following which the Adjudicating Authority disposed of the Section 7 Application. Subsequently, the Corporate Debtor defaulted in meeting its obligations under the settlement agreement and certain cheques issued by the Corporate Debtor towards its payment obligations thereunder were also dishonored.

In view of the said default and failure of the Corporate Debtor to comply with the settlement agreement, the Financial Creditor filed a fresh Section 7 Application before the Adjudicating Authority.

It was, inter alia, alleged by the Corporate Debtor that the act of filing of a fresh Section 7 Application by the Financial Creditor was contrary to the stipulation under the settlement agreement, which provided that in the event of default by the Corporate Debtor, the Financial Creditor shall be entitled to revive the disposed of Section 7 Application.

However, the Adjudicating Authority proceeded to hear the fresh Section 7 Application and the same was subsequently admitted by the Adjudicating Authority (“Admission Order”), inter alia, directing commencement of CIRP for the Corporate Debtor.

The Corporate Debtor assailed the Admission Order before the National Company Law Appellate Tribunal, New Delhi (“NCLAT”). On behalf of the Corporate Debtor, the two primary objections that were taken with respect to the Admission Order were: (i) the Corporate Debtor contended that the breach the settlement agreement does not constitute a financial debt and therefore, the fresh Section 7 Application ought not to have been entertained by the Adjudicating Authority; and (ii) the Corporate Debtor contended that the Financial Creditor had obtained the consent of the majority Debenture Holders in relation to the Corporate Debtor, and therefore, the Section 7 Application ought not to have been admitted.

The Financial Creditor contended that nature of debt under both Section 7 Applications remains the same, i.e., a financial debt in relation to the debentures issued by the Corporate Debtor. The filing of a fresh Section 7 Application instead of reviving the earlier/disposed of Section 7 Application was based on legal advice.

OBSERVATIONS AND ORDER BY THE NCLAT

The NCLAT examined the fresh Section 7 Application and observed that the financial debt claimed by the Financial Creditor was the same as originally claimed in the earlier/disposed of Section 7 Application. The claim of the Financial Creditor was not based solely on the default/ breach of the settlement agreement between the Parties; but was on the basis of original financial debt provided by the Financial Creditor to the Corporate Debtor.

The NCLAT, inter alia, held that merely because the consent terms were breached, it did not lead to a conclusion that the financial debt would be wiped out or the nature and character of the financial debt shall change.

Further, in relation to filing of a fresh Section 7 Application by the Financial Creditor instead of reviving the disposed of Section 7 Application as stipulated in the settlement agreement, the NCLAT held that the same cannot be a ground to reject the fresh Section 7 Application.

With respect to the contention that the consent of the majority of the Debenture Holders had not been obtained to initiate CIRP proceedings against the Corporate Debtor, the NCLAT, inter alia, held that the same cannot preclude/prevent a minority financial creditor who is otherwise entitled to initiate proceedings under Section 7 Application, to take appropriate action under IBC.

Accordingly, the NCLAT dismissed the Appeal filed by the Corporate Debtor and upheld the Admission Order of the Adjudicating Authority.

OUR ANALYSIS

The NCLAT judgement is in the right direction and affirms the established position that in the event a corporate debtor enters into a settlement with the creditor after a creditor has filed an application for commencement of CIRP for a default in relation to a financial debt or an operational debt, but subsequently defaults in meeting its payment obligations under the terms of such settlement agreement, the creditor shall be at liberty to revive the application under the relevant provisions of IBC for commencement of CIRP or to file a fresh application for commencement of CIRP against the Corporate Debtor. The financial creditor should not be lured into a settlement where its statutory rights are taken away, and consequently in a default of such settlement the corporate debtor should not be able to escape its financial liabilities.

Essentially, the judgment of the NCLAT also clarifies is that even in cases where ‘revival’ of the proceedings is agreed upon between the parties, the creditor can also proceed to file a fresh application for initiation of CIRP, thereby safeguarding the interests of the creditor and preventing an errant corporate debtor from misusing/avoiding payments under the settlement agreement/terms and escaping the CIRP through devious means.

It is also pertinent to clarify that the said NCLAT judgment does not opine / depart from the previously settled position of law that a mere obligation to pay an amount under a settlement agreement does not amount to disbursal of an amount towards consideration against the time value or money and therefore, does not constitute financial debt for the purposes of initiation of CIRP[2]. Therefore, a settlement agreement would not alter the nature of the original debt between the creditor and the corporate debtor.

Footnotes:
[1] Company Appeal (AT) (Insolvency) No.1423 of 2022 passed by the National Company Law Appellate Tribunal, Principal Bench, New Delhi on February 2, 2023.
[2] Amrit Kumar Agrawal v. Tempo Appliances Pvt Ltd., Company (Appeal) (AT) 1005 of 2020, National Company Law Appellate Tribunal, New Delhi.