COVID19-XVIII: Force Majeure Not (Under) the IBC; Act of God v/s ‘Act’ of Legislature

Akshay Sharma and Kunwar Surya Pratap

Even though COVID-19 qualifies for a force majeure event, it may not act as a valid defence for most of the corporate entities since it is difficult to accommodate the same in the scheme of the IBC.

This is the 18th post of our COVID-19 series.


Background

The outbreak of COVID-19 is going to have a major impact upon the economy of India and survival of various businesses.  The Government of India has declared this pandemic a natural calamity. To mitigate the devasting effect of economic slowdown, the government has increased the default amount under the Insolvency and Bankruptcy Code, 2016 (‘IBC/ Code’) to prevent the companies especially micro, medium and small enterprises (MSME) from facing the threat of insolvency. It is also mulling at the suspension of the rights of creditors to file an insolvency application under the Code.

The commercial difficulty faced by the businesses in this unprecedented situation has resultantly led the companies invoking the force majeure clause. An event qualifies as a force majeure when it renders the performance of the agreement impossible or illegal. The applicability of force majeure clause is no longer res integra inasmuch as commercial contracts are concerned and there is a catena of cases on the same.  However, there is dearth of precedents and clarity in relation to the applicability of ‘force majeure’ to the summary proceedings under the Code, which the authors have endeavored to analyze in this article.


Force Majeure vis-à-vis Financial Creditors

A financial creditor can initiate insolvency proceedings against the Corporate debtor under Section 7 of the Code. There is no requirement of prior notice by the financial creditor under the Code and on a single default, the insolvency application can be filed against the corporate debtor.  The Supreme Court in Innoventive Industries Ltd. v. ICICI Bank (2017) observed that a financial creditor is only required to proof that there is disbursement of debt., debt is due & payable and there is a default by the corporate debtor and if these three requisites are fulfilled, the adjudicating authority is bound to admit the Application. The same was reiterated by the Supreme Court in the case of Swiss Ribbons Pvt. Ltd. v. Union of India (2019) wherein the constitutional validity of the Code was challenged. Furthermore, the National Company Law Appellate Tribunal (‘NCLAT’) also observed that the only defence which the Corporate Debtor has is to prove that the debt is not due but if the adjudicating authority is satisfied that there exists a default, the application will be admitted.

In the case of a financial creditor, default amounts to non-payment of monies which can even be verified by the information utility under the Code. Thus, it can be concluded that a corporate debtor has, effectively, very limited defence against an application filed by a financial creditor. Once it is established that there exists a default, the adjudicating authority will not ascertain the reason behind the same even though it is force majeure and proceed with the admission of the application.


Stand Alone Precedent – Major Conundrums

In Navin Raheja v. Shipla Jain (2020), a case concerning the appeal by a real estate company assailing the application made by allottees (financial creditors) under Section 7 of the IBC, the NCLAT allowed the defence of force majeure and held that;

            “55. If the delay is not due to the ‘Corporate Debtor’ but force majeure, as noticed above, it cannot be alleged that the ‘Corporate Debtor’ defaulted in delivering the possession.”

Though this is the single case wherein the NCLAT allowed the defence of force majeure against a financial creditor, authors are hastened to add that the same may not be followed in other cases by financial creditors because of the following reasons.

Firstly, the abovementioned judgment seems to be in direct contravention with the case of Pioneer Urban Land & Infrastructure Ltd. v. Union of India (2019) wherein the Supreme Court allowed a limited scope of defence to the real estate companies which doesn’t include force majeure even though it was pleaded but was not considered by the Supreme Court.

Secondly, the NCLAT also based its reasoning on the amended threshold for the allottees of real estate companies. However, it is pertinent to mention that the very same amendment is under challenge before the Supreme Court and there is a status quo being maintained on the same.

Even otherwise, a default by the real estate companies implies non-delivery of units/ apartments whereas in cases of other companies it is the non-payment of monetary dues. Therefore, while force majeure may be taken up as a ground for such non-delivery of units/ apartments, its applicability may only be confined to the cases filed against real estate companies analogous to the case of Parvesh Magoo v. IREO Grace Realtech Pvt. Ltd. (2020).


Force Majeure vis-à-vis Operational Creditors

The scheme of the Code with respect to an operational creditor is significantly different from that of a financial creditor. An operational creditor is the one who has a claim in lieu of the supply of goods and services. The corporate debtor has the liberty of raising a genuine dispute in an application filed under Section 9 by the operational creditor. ‘Dispute’ as defined in Section 5(6) of the Code includes pending suit, arbitration, or quality of goods and services.

It has been made clear by the Supreme Court in K. Kishan v. Vijay Nirman Co. (2018) that the objective of the Code, insofar as operational creditors are concerned, is to put insolvency process against a corporate debtor only when there exists no real dispute between the parties. The point was further discussed in Mobilox Innovations Pvt. Ltd. v. Kirusa Software Pvt. Ltd. (2017) wherein the Supreme Court stated that the dispute raised must be a plausible contention which requires further consideration and the same shall not be a patently feeble argument unsupported by evidence. It further stated that it is not the duty of adjudicating authority to ascertain whether the corporate debtor will likely to succeed as far as there is an existence of dispute, the application shall be rejected. Furthermore, the Supreme Court in the case of Swiss Ribbons v. Union of India (2019) held that the possibility of a dispute is much higher in case of operational debts as compared to financial debts and the said dispute may also include substandard goods or services.

Thus, considering the statutory definition of ‘dispute’ and its judicial interpretation, it can be deduced that the invocation of force majeure clause will not qualify as a ‘dispute’. Companies cannot invoke a force majeure clause to deny payment of already received goods and services as the operational creditors more often claim monies after the delivery of goods and services. Also, the companies generally don’t enter into commercial contracts with the operational creditors containing clauses like force majeure et. al., rather they usually rely on invoices and purchase orders to substantiate their claims.

However, there appeared to be a little ray of hope for the corporate debtors in the case of Indo Alloys v. SMW Metals (2020) wherein the NCLAT held that the unilateral termination of a contract qualifies for a ‘dispute’ and cannot be adjudicated under the IBC but in this case the parties had reconciled their outstanding operational debts and thereafter entered into a payment schedule/ agreement which was subsequently terminated by the corporate debtor.


Conclusion and the Way Forward

One of the imminent threats of the present economic slowdown is the grinding halt of companies, thereby slipping into insolvency. Even the characterization of this pandemic as a natural calamity by the government would not come to the rescue of the corporate entities facing the threat of the proceedings under IBC for the reasons enumerated in the article. The summary adjudication under the Code leaves no room for the companies to raise the defence of force majeure apart from a single exception carved by the NCLAT for in case of a real estate company.

Owing to the exceptional hardship of the situation, the correct approach would be to dissuade the creditors from initiating insolvency proceedings instead of invoking the ‘force majeure’ clause as the same doesn’t qualify for a valid defence as per existing  law. Recently, the Reserve Bank of India (RBI) advised the banks and NBFCs (primary financial creditors) to impose a 90 days moratorium on installments and to exclude the same time period for classification of an account as Non-Performing Asset (NPA). Singapore had also taken steps in the same direction by enacting COVID-19 (Temporary Measures) Act, 2020 which suspends creditor’s right to initiate insolvency proceedings as the law minister of Singapore said that this is not the time of talking about contract but the time of equity and justice and what is the right thing to do.


The authors are students at the National University of Study and Research in Law, Ranchi.


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