Supreme Court Finally Interprets “Existence Of A Dispute” Under IBC – Mobilox V Kirusa
The Supreme Court of India (Supreme Court) in Mobilox Innovations Private Limited v Kirusa Software Private Limited (Mobilox v Kirusa) has finally settled the widely debated question of what constitutes “existence of a dispute” in the context of applications filed by operational creditors for initiation of corporate insolvency resolution process (CIRP) of corporate debtors under the Insolvency and Bankruptcy Code, 2016 (IBC). This path breaking judgment follows close on the heels of another landmark ruling of the Supreme Court in M/s Innoventive Industries Ltd. vs. ICICI Bank & Another, which was rendered in the context of a CIRP application filed by a financial creditor.
A CIRP of a corporate debtor can be initiated by its operational creditor on occurrence of a ‘payment default’ (of operational debt), by filing an application before the relevant National Company Law Tribunal (NCLT) under Section 9 of the IBC. Before making the application, the operational creditor must first issue a demand notice or copy of invoice (demanding payment of operational debt) to the corporate debtor under Section 8 (1) of the IBC (Demand Notice).
The corporate debtor has 10 (ten) days to either pay or bring to the notice of the operational creditor the “existence of a dispute and the record of the pendency of a suit or arbitration proceeding filed before the receipt of” such Demand Notice (Section 8 (2) of IBC) (Notice of Dispute). In case the corporate debtor has issued a Notice of Dispute, the CIRP application of the operational creditor is required to be rejected by the NCLT. It may be added that the term “dispute” is defined in Section 5(6) of the IBC as “dispute includes a suit or arbitration proceedings relating to: (a) the existence of the amount of debt; (b) quality of goods or service; or (c) the breach of a representation or warranty”.
One of the most interesting interpretational issues that have come up under the IBC is the meaning of “dispute” and “existence of dispute”. The journey of Kirusa/Mobilox deals with this issue which has been followed with great interest by various stakeholders and which has been finally laid to rest by the Supreme Court.
Mobilox engaged Kirusa for providing various services in relation to conduct of tele-voting for a TV program. The parties also executed a non-disclosure agreement (NDA) under which Kirusa had certain confidentiality obligations towards Mobilox. Kirusa raised monthly invoices on Mobilox for services provided. However, Mobilox informed Kirusa that payments against such invoices were being withheld due to breach of NDA by Kirusa. On 23 December 2016, Kirusa sent a Demand Notice to Mobilox under Section 8 (1) of the IBC. Mobilox responded to the Demand Notice stating, inter alia, that there was existence of serious and bona fide disputes between the parties, including breach of NDA by Kirusa, which was already brought to Kirusa’s notice long back on 30 January 2015.
Subsequently, Kirusa filed an application before the NCLT, Mumbai for initiation of CIRP of Mobilox. NCLT, Mumbai dismissed Kirusa’s application on the ground that Mobilox has issued a Notice of Dispute. An appeal against the NCLT order was filed by Kirusa before the National Company Law Appellate Tribunal (NCLAT). NCLAT allowed Kirusa’s appeal on the ground that Mobilox’s reply to the Demand Notice did not raise a dispute within the meaning of Section 5(6) or Section 8(2) of the IBC and that the defence raised by Mobilox was vague, got up and motivated. Incidentally, this was the first NCLAT ruling on the question of what constitutes a “dispute” and “existence of a dispute” under IBC. Against the said order of NCLAT, Mobilox went in appeal before the Supreme Court.
What Supreme Court Held
Interpreting the expression “existence of a dispute” occurring in Section 8(2)(a) of the IBC, the Supreme Court allowed Mobilox’s appeal holding that there was a dispute in existence which was sufficient to defeat the CIRP application filed by Kirusa. Some key points and takeaways emerging from this seminal ruling are discussed below:
- The word “and” occurring in Section 8(2)(a) of the IBC must be read as “or”
The highpoint of the Supreme Court ruling is that the word “and” occurring in Section 8(2)(a) of the IBC must be read as “or”.
The issue really was that the word “and” in Section 8 (2)(a) of IBC suggests that a dispute between the operational creditor and the corporate debtor will be in existence only if a suit or an arbitration proceeding on the dispute is pending before receipt of Demand Notice. The Supreme Court held that such an interpretation would lead to a great hardship and anomalous situations as the corporate debtor would then be able to stave off the bankruptcy process only if a dispute is already pending in a suit or arbitration proceedings and not otherwise. To highlight the hardship, the Supreme Court cited an example that in case of a dispute that arises a few days before triggering of the CIRP, there would be no time to approach either an arbitral tribunal or a court even though a dispute may exist.
Pertinently, the Supreme Court takes note of the fact that law permits long limitation periods, where even though disputes arise, they do not culminate into a suit or arbitration proceeding for up to 3 (three) years. The Supreme Court notes that if “and” occurring in Section 8(2)(a) of the IBC is not read as “or”, such persons would be excluded from the ambit of Section 8(2) of the IBC and commencement of CIRP against such persons would be a given, which anomaly could never have been the intention of the legislature.
- Dispute must be “pre-existing”
The Supreme Court reviews the entire scheme relating to CIRP applications filed by operational creditors and holds that what is important is that the existence of the dispute and/or the suit or arbitration proceeding must be “pre-existing” i.e. it must exist before the receipt of the Demand Notice.
- Formulation of a new “plausible contention” test
Interestingly, the Supreme Court rejects the “bona fide” test which held the fort in the jurisprudence relating to winding up proceedings on the ground of ‘inability’ or ‘neglect’ to pay debts under the Companies Act, 1956.
The Supreme Court delved deep into the background and legislative history of the IBC, referred to as a “path breaking legislation”, and noted the changes that came about during its journey, commencing with the report of the Bankruptcy Law Reforms Committee chaired by Shri T.K. Viswanathan, leading up to the enactment of the IBC in its current avatar.
In particular, the Supreme Court observed that in the first Insolvency and Bankruptcy Bill, 2015 that was annexed to the Bankruptcy Law Reforms Committee Report, “dispute” was defined to mean “a bona fide suit or arbitration proceeding….”. However, when the IBC was finally passed, “dispute” in Section 5(6) was defined in an inclusive manner and the word “bona fide” was dropped from the definition. The Supreme Court notes that this implies that the test of “bona fide” under the erstwhile jurisprudence on winding up and the old law contained in Madhusudan Gordhandas v. Madhu Woollen Industries Pvt. Ltd, is not relevant under the IBC anymore.
The Supreme Court then addressed the issue as to whether and to what extent can the NCLT go into the question of “existence of a dispute”. As stated above, the Supreme Court held that it was not possible to import “bona fide” into Section 8(2)(a) while determining “existence of a dispute”. Instead, the Supreme Court evolved a new test of “plausible contention” to determine whether there is an “existence of a dispute”.
The Supreme Court holds that while determining “existence of a dispute”, all that the NCLT is to see is whether there is “a plausible contention which requires further investigation and that the “dispute” is not a patently feeble legal argument or an assertion of fact unsupported by evidence.” While opining that “a spurious defence which is mere bluster” should be rejected, the Supreme Court adds a word of caution – while determining whether dispute exists or not, the NCLT is not required to satisfy itself that the defence is likely to succeed or to examine the merits of the dispute. So long as a dispute truly exists in fact and is not spurious, hypothetical or illusory, the application of an operational creditor must be rejected by the NCLT.
- Questions that the adjudicating authority must decide
Supreme Court holds that when examining an application under Section 9, NCLT will have to determine the following questions:
- Whether there is an “operational debt” as defined, exceeding Rs. One lakh?
- Whether the documentary evidence furnished with the application shows that the aforesaid debt is due and payable and has not yet been paid? and
- Whether there is existence of a dispute between the parties or the record of the pendency of a suit or arbitration proceeding on the dispute filed before the receipt of the Demand Notice?
If even one of the conditions mentioned above is found to be lacking, the NCLT must reject the application.
- The three conditions in Section 5(6) – when applicable
One of the arguments advanced by Kirusa was that “dispute” between the parties must relate to one of the three sub-clauses mentioned in Section 5(6) of the IBC i.e. it must relate to existence of the amount of the debt; or quality of goods or services; or breach of a representation or warranty. This contention was rejected by the Supreme Court on the basis that the definition of “dispute” was an inclusive one and that the present case was not one where a suit or arbitration proceeding had been filed before receipt of Demand Notice, only in which case the dispute must “relate to” the three sub clauses of Section 5(6).
On the facts of the case, the Supreme Court holds that the correspondence between the parties showed that on 30 January 2015, Mobilox had clearly informed Kirusa that on account of breach of the NDA by it, payments were being withheld till the time the matter was resolved. This was followed by further exchange of correspondence between the parties. Further, the Demand Notice sent by Kirusa was disputed in detail by Mobilox in its reply where it again referred to its e-mail of 30 January 2015. Going by the test of “existence of a dispute”, the Supreme Court held that without going into the merits of the dispute, it was clear that Mobilox had raised “a plausible contention requiring further investigation which was not a patently feeble legal argument or an assertion of facts unsupported by evidence”. Mobilox’s defence was not “spurious, mere bluster, plainly frivolous or vexatious” but a dispute truly existed in fact between the parties, which may or may not ultimately succeed.
Since the inception of the IBC, the meaning of the expression “dispute” and “existence of a dispute” has been a hotly contested one, giving rising to conflicting interpretations from different benches of the NCLT. While the NCLAT ruling in Kirusa v. Mobilox did bring about some semblance of uniformity in interpretation, a conclusive ruling by the Supreme Court has finally settled this question.
While there is no gainsaying the above mentioned key takeaways from this landmark ruling, there remains one area of concern. Given the emphasis placed by the Supreme Court on the requirement of dispute being “pre-existing” (i.e. existing before the receipt of the Demand Notice), it remains to be seen as to how a corporate debtor, who for the first time becomes aware of the operational creditor’s claim on receipt of the Demand Notice, is able to save itself from the rigours of CIRP. While this question is likely to be addressed in one or the other case, the message from the Supreme Court ruling is clear - that a corporate must be vigilant with respect to debts owed by it to its operational creditor(s) and in case of a real dispute, a corporate must raise the same with the operational creditor(s) at the earliest possible time in order to avoid a CIRP being initiated against it.
Going forward, it will also be interesting to watch how the NCLTs apply the “plausible contention” test developed by the Supreme Court. The thrust of this test appears to be on the aspect that the defence must be in the nature of a contention which is plausible and meriting trial, rather than the likelihood of success, which would be something akin to the prima facie test applied while deciding an application for interim injunction. In contrast with the “plausible contention” test, the “bona fide” test, as laid down by the Supreme Court in Madhusudan Gordhandas v. Madhu Woollen Industries Pvt. Ltd. required the defence to be raised in “good faith” and as one which is “likely to succeed in point of law”.
Before parting, it is pertinent to highlight the emphasis placed by the Supreme Court on the sanctity of strict timelines prescribed under the IBC. It categorically observes that “strict adherence of these timelines is of essence to both the triggering process and the insolvency resolution process”. As per the Supreme Court, the importance of these timelines becomes clearer in light of one of the principal reasons behind the enactment of the IBC – to address indefinite liquidation proceedings which proved damaging to the interests of all stakeholders, except a recalcitrant management which would continue to hold on to the company without paying its debts. Observing that “both the Tribunal and the Appellate Tribunal will do well to keep in mind this principal objective sought to be achieved by the Code”, the Supreme Court calls upon them to “strictly adhere to the time frame within which they are to decide matters under the Code”.
Pooja Mahajan is the Managing Partner and Mahima Singh is an Associate at Chandhiok & Associates, Advocates and Solicitors