Multiple Section 9 filings under scrutiny: NCLAT’s efforts to prevent abuse of IBC – By Samriddhi & Pragya Saigal

Multiple Section 9 filings under scrutiny: NCLAT’s efforts to prevent abuse of IBC

Samriddhi & Pragya Saigal
3^rd Year, B.A. LL.B. (Hons.), National Law University, Odisha

Introduction

In the recent case of M/s Agarwal Foundries Private Limited vs. Posco E&C India Pvt. Ltd. (2024) ibclaw.in 577 NCLAT, the NCLAT, highlighting the core objectives of IBC, laid importance on fostering entrepreneurship, optimising asset values and ensuring a fair balance among the interests of all parties involved. The court used this reasoning to emphasise that if  Section 9 is treated as a mechanism to recover money from the operational debtor, it goes against the very objective of IBC. It should only be used to resolve insolvency issues.

Further, recurrent filings of insolvency petitions under section 9 to coerce a financially stable company into making unwarranted payments indicate the misuse of IBC by the creditors to trouble the debtors. The court further reaffirmed that a claim to be recognised as an operational debt must be directly linked to the supply of goods or services and that a claim becomes time-barred only from the date of default and not from the date of the demand notice.

This case also discusses the significance of consent from both parties for outlining the terms and conditions of a valid agreement for establishing a party as a corporate creditor. In this analysis, the authors will navigate through NCLAT’s judgment, suggesting a way forward towards an effective implementation of IBC laws.

Case background

In this case, the appellant is Agarwal Foundries Pvt Ltd, which was providing TMT Bars to Empathy Infra & Engineering Ltd, a contractor of respondent POSCO E&C India Ltd for the Nirvana Project. POSCO orders for these materials had been made through an email that the company sent on June 10, 2015. In response, the Appellant issued multiple invoices to Empathy. Empathy, on multiple occasions, responded by producing an invoice to the Appellant. Still, Empathy failed to provide the due amount. The Appellant also accused POSCO, which is said to have guaranteed these dues, having provided several email assurances that the payments would be made, yet no payments were received.

As the POSCO failed to pay further, Agarwal Foundries served demand notices under Section 8 of the IBC on July 27, 2017, October 11, 2017, July 17, 2018, and October 24, 2018, saying that the company had committed a default in payment. Subsequently, no reply was received by the Appellant, and they filed a petition under Section 9 of the IBC on February 11, 2019, for invoking the Corporate Insolvency Resolution Process against POSCO.

However, the NCLT dismissed the application for filing the claim beyond the limitation period. Also, the Tribunal observed that the Appellant did not have a contract with POSCO since the supply contract, as established by Agarwal Foundries, was with Empathy. For this reason, the application to start the CIRP process was declined.

Decision

The Tribunal refused the Appellant an opportunity to initiate the CIRP against POSCO, citing a lack of a valid guarantee agreement/ operational debt. Hence, the e-mails dated June 10, 2015, and June 24, 2015, were not considered as constituting an offer of guarantee from POSCO, while the third e-mail dated June 26, 2015, was found not to include any confirmation relating to any guarantee arrangement. Further, the records of a meeting that took place on the 19th of October 2015, which contained a payment schedule, were also dismissed because it lacked the signatures of the concerned parties. Unless and until no letterhead signed by an authorised signatory of POSCO was received, no legal acknowledgement of liability was considered.

The Tribunal made it clear that for a claim to be categorised as an operational claim, it has to have a link with the operational activity of the underlying contract. Here, however, the Tribunal was unable to discover any such connection between the Appellant, Agarwal Foundries and POSCO on the basis that the invoices that were submitted were issued by third parties. Therefore, there was an invalid debt claim that was operational.

In addition, the Tribunal endorsed the decision of the Adjudicating Authority on the ground of limitation, stating that the claim had been filed after the expiry of the prescription period of three years. The Tribunal also observed that the Appellant had filed a voluminous section 9 application against both POSCO and Empathy, which demonstrates that he has been abusing the legal process. It described the ways and manner in which the Appellant intended to coerce POSCO, a solvent firm, to claim money that is due from Empathy. Such behaviour was heavily criticised for misuse of the Insolvency and Bankruptcy Code (IBC), hence the dismissal of the appeal.

Analysis

The recent judgment of NCLAT is significant for all companies that have been threatened with multiple filings of insolvency applications as it restricts misuse of the IBC. Thus, the ruling helps to avoid the abuse of the IBC’s mechanisms, forcing the proper consideration of the company’s situation for legitimate claims only. This ensures that the IBC remains relevant in its main roles of solving insolvency and rehabilitating companies while at the same time maintaining the integrity of the debtors by preventing individuals from filing reckless practices.

The judgment also serves the genuine creditors in the best way by validating the credibility of the insolvency application without being swayed by vengeful shareholders or management temper tantrums, hence restoring the integrity of the Committee of Creditors (CoC) and  NCLT. It reduces the cases of filed claims with low merit and improves the efficiency of the insolvency mechanism.

Finally, it is significant for the broader business environment, especially small and medium enterprises (SMEs), since it establishes that insolvency proceedings should not and cannot be a tool in payment disputes. It only provides ways how to file civil suits or arbitration so that it will improve the standard of business practices. The judgment underlines the ethical legalism of insolvency proceedings and their compatibility with justice, equity, and probity.

While this judgment brings various positive impacts, it also raises certain legal and ethical concerns. The judgment may indirectly benefit debtor companies since it reduces the avenues available to operational creditors particularly. This may enable lots of companies who are solvent to default payment without the worry of facing insolvency, which, as a result, puts pressure on the smaller credit organisations to try and claim their dues.

Critics have held the opinion that this was a way through which debtors would find legal means by which to avoid making payments. Also, the protection of creditor’s rights with genuine claims is insufficient to deter nuisance cases without a clear provision on how to undertake that. Such uncertainty can mean irregularity in how the IBC is executed, which can leave creditors guessing when they can proceed with the recovery process of debts.

Way forward

These recommendations have been framed in a way that balances the needs, interests and security of the stakeholders, including operational creditors and the debtors.

• The following amendments can be incorporated under section 9:

1. • Identify and define “repeated filings” as where a corporate creditor files more than two applications against the same corporate debtor before the tribunal within 12 months.
   • Where creditors make a repeated filing, there shall be a necessity for preparing affidavits about:

• • • Reasons for withdrawing the petitions on previous instances.
    • Reasons for filing for fresh petition.
    • Changes in conditions that have occurred following the earlier petition.
    • Steps were taken to reach out to the tribunal settlement.
• Creditor Protection Clause:

There should be an additional clause that specifies that no creditor shall suffer discomfort, penalty or allegations on the grounds for misuse of its power for repeated filing if he can prove to the satisfaction of the tribunal that:

• • There were reasonable grounds for believing the debt was due and payable;
  • The application was not for vexation or oppression of the corporate debtor
  • All material facts and affidavits are disclosed in good faith.
• Penalty System

Fines shall be imposed to deter the applicants from the frivolous filing of multiple suits before the tribunal. In the first instance of proven misuse, a fine of 1 lakh or up to 1 per cent of the total debt claimed shall be imposed. In the second instance of proven misuse, a fine of 5 lakhs or up to 5 per cent of the total debt claimed shall be imposed in addition to barring filing a new suit for the next four months. In the third instance of proven misuse, a fine of 10 lakhs or up to 10 per cent of the total debt claimed shall be imposed in addition to barring filing a new suit for the next one year.

Conclusion

In conclusion, it can be said that NCLAT’s decision in Agarwal Foundries Pvt. Ltd. vs. Posco E&C India Pvt. Ltd. is very significant in furthering the spirit of the Insolvency and Bankruptcy Code. It reflects the necessity to defend against misuse of insolvency procedures by a creditor to recover the debt from a non-bankrupt company. In this context, it must be asserted that it is paramount to find the right balance between the enforcement of creditor’s rights and the discouragement of vexatious litigations, which can be overcome with the help of amendments to the IBC and a structured fine system.