'S.138 NI Act Quasi-Criminal' : Supreme Court Refers To Larger Bench Whether IBC Moratorium Totally Bars Cheque Dishonour Case Against Company Director

The Supreme Court has referred to a larger Bench the question whether cheque bounce proceedings under Section 138 of the Negotiable Instruments Act can be stayed during the moratorium period under Part III of the Insolvency and Bankruptcy Code, while holding that such proceedings are predominantly criminal in nature and not merely debt recovery actions.

A Bench comprising Justice JB Pardiwala and Justice KV Viswanathan observed that proceedings under Section 138 NI Act cannot be treated purely as legal action for recovery of money. The Court disagreed with the view in P Mohanraj and others v M/s Shah Brothers Ispat Ltd (2021)  that cheque dishonour cases are essentially civil in nature, stating that the core objective of Section 138 is to preserve public faith in cheque-based commercial transactions by attaching criminal consequences to dishonour of cheques.

The Court said the offence under Section 138 is the act of cheque dishonour itself, while non-payment of debt is only the injury flowing from the offence. It stressed that the provision was enacted as a deterrent against issuing cheques without sufficient funds and “was not intended to be used as a recovery of debt mechanism.”

At the same time, the Bench acknowledged that Section 138 proceedings also contain a compensatory component. The Court therefore evolved a “tiered” understanding of cheque bounce prosecutions. According to the judgment, “Tier I” comprises the criminal aspect culminating in punishment such as imprisonment or fine, whereas “Tier II” relates to the compensatory element where courts may direct payment of compensation to the complainant.

Dealing with the interaction between the NI Act and the IBC, the Court held that the moratorium under Part III of the IBC cannot extend to the criminal consequences arising from cheque dishonour. It reasoned that Section 79(15) of the IBC expressly excludes liability to pay fine from the ambit of debts covered by moratorium provisions.

However, the Court held that the compensatory aspect of Section 138 proceedings stands on a different footing. Since compensation orders may deplete the assets of an insolvent debtor, the moratorium provisions under Part III of the IBC would apply to recovery of compensation during insolvency proceedings. The Bench clarified that the applicability of moratorium would therefore depend on the stage and nature of the Section 138 proceedings.

The Court further held that directors prosecuted under Section 141 of the NI Act would also be entitled to the benefit of moratorium in respect of the compensatory aspect of cheque bounce proceedings while undergoing personal insolvency. It observed that denying directors such protection merely because the original compensatory liability belonged to the company would prejudice both the debtor and other creditors.

In conclusion, the Bench said an authoritative pronouncement by a three-Judge Bench was necessary on the issue. 

The following issues were referred to the three-judge bench :

(i) Whether the provisions of Section 138 of the NI Act and the objective underlying the enactment thereof indicate that it is quasi- criminal in nature with a tilt towards the criminal side?

(ii) Whether the moratorium provisions under Part III of the IBC should be made applicable on the entire proceedings under Section 138 of the NI Act or only to the compensatory aspect thereof?

Background

The bench was hearing an appeal arising out of a Madras High Court's order refusing to quash the NI Act proceedings against the Appellant despite the insolvency moratorium was in operation.

The Court observed that while the criminal liability of directors under Sections 138 and 141 of the Negotiable Instruments Act, 1881, is well settled, the law remains unclear as to whether directors can still be directed to pay compensation when proceedings against the company are barred by a moratorium under Section 14 of the IBC.

The Court noted that the legal position regarding the extension of criminal liability to company directors under Section 141 of the Negotiable Instruments Act in prosecutions under Section 138 is well settled through the three-Judge Bench decisions in Ajay Kumar Radheshyam Goenka v. Tourism Finance Corporation of India Ltd., 2023 LiveLaw (SC) 195, and P. Mohanraj v. Shah Bros. Ispat (P) Ltd., 2021 LiveLaw (SC) 120.

However, the Bench observed that neither of those decisions had conclusively addressed the narrower issue of whether the moratorium imposed on a corporate debtor under the IBC would also shield the company's directors from liability to pay compensation under the Negotiable Instruments Act. 

The Bench indicated that while directors may continue to face prosecution and punishment, whether they can independently be directed to compensate the complainant despite the moratorium operating against the company remains an open question requiring authoritative determination.

Court's Observations

The Court examined the dual nature of Section 138 proceedings, distinguishing between criminal punishment and compensatory relief.

It noted that imprisonment and fine constitute the punitive aspect of the offence, whereas compensation awarded under Section 395 of the Bharatiya Nagarik Suraksha Sanhita, 2023 serves a compensatory objective aimed at reimbursing the complainant.

"We have no qualms in observing that though Section 138 of the NI Act is based on a civil dispute as regards repayment of debt, yet, it cannot be treated on par with a civil proceeding for recovery of money. The deeming fiction makes its sufficiently clear that the provision is punitive and makes the act of dishonouring a cheque a criminal offence," stated the judgment authored by Justice Pardiwala.

The Bench observed that the jurisprudence surrounding Section 138 has consistently recognized the provision as having both deterrent and compensatory purposes, therefore, the bench made a prima facie opinion that “the moratorium provisions under Part III of the IBC must be made applicable in respect of recovery of compensation in Section 138 proceedings.”, thereby saving the directors, who was also undergoing in personal insolvency, from paying the compensation.

However, the benefit of the moratorium would not be extended to the criminal liability of the director, the court clarified.

“We are of the view that allowing Section 138 proceedings to enjoy the benefit of moratorium, especially in light of such express exclusion of criminal liability, is not a good law.”, the Court held, referencing Ajay Kumar Radheshyam Goenka (supra) and P. Mohanraj (supra).

Interplay Between NI Act And IBC

The Court's observations arise from the growing conflict between cheque dishonour prosecutions and insolvency proceedings under the IBC.

Under Section 14 of the IBC, once corporate insolvency resolution proceedings commence, proceedings against the corporate debtor are stayed. Similar protections exist under Part III of the IBC for individuals undergoing personal insolvency.

The unresolved issue is whether complainants can bypass the moratorium by seeking compensation directly from directors who are vicariously liable under Section 141 NI Act.

The Court indicated that this issue requires deeper examination because compensation under Section 138 may effectively amount to recovery of debt, even though the proceedings themselves are criminal in nature.

Background

The dispute arose from a cheque issued by the appellant towards repayment of over ₹5 crore due to UCO Bank under a Letter of Credit facility. The cheque was dishonoured in June 2015 for insufficiency of funds, following which proceedings under Section 138 NI Act were initiated before a Chennai Magistrate Court.

Subsequently, Surana Power Ltd. went into liquidation, while personal insolvency proceedings were initiated against the appellant under Part III of the IBC.

The Madras High Court had rejected the appellant's plea seeking protection under the insolvency moratorium, holding that proceedings under Section 138 of the Negotiable Instruments Act are criminal in nature and therefore not barred by insolvency proceedings. Aggrieved by the decision, the appellant approached the Supreme Court, where the issue arose as to whether the compensatory liability arising from cheque dishonour proceedings against a company undergoing liquidation could also be enforced against its director, who was himself undergoing personal insolvency proceedings.

Cause Title: Dineshchand Surana v. UCO Bank (with connected case)

Citation : LiveLaw (SC) 555

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Appearance:

For Petitioner(s) : Mr. Shreeyash Uday Lalit, Adv. Mr. Himanshu Vats, Adv. Mr. Angad Pahel, Adv. Mr. Lavam Tyagi, Adv. Ms. Ishita Khurana, Adv. Mr. Aviral Kumar Mishra, Adv. Mr. Ishaan George, AOR Ms. Shashi Bala, Adv. Mr. Prateek Kushwaha, AOR

For Respondent(s) : Ms. Tanu Priya Gupta, AOR Mr. Brijesh Kumar Tamber, AOR Mr. Vinay Singh Bist, Adv. Ms. Arani Mukherjee, Adv. Mr. Yashu Rustagi, Adv. Mr. Sahas Bhasin, Adv.