Classifying the costs of a terminated project as CIRP costs: A Judicial Outlook
C A P Sai Srinivas
VthYear, B.com LL.B. (Hons.), School of Law Lovely Professional University
Introduction
The Corporate Insolvency Resolution Process (CIRP) under the Insolvency and Bankruptcy Code 2016 (IBC) enables the time-bound revival mechanism for debt-ridden entities. The framers of the code and the legislative intent set out at the backdrop of this process buttresses the notion to keep the corporate debtor alive as a going concern. The resolution process in its execution is associated with the costs which ought to be classified as CIRP costs as enumerated under definition part of section 5(13) of the code that ranges from raising interim finance, fees payable to the resolution professional, costs incurred to keep the corporate debtor as going concern and at last, any cost accounted for the statutory expense.
The distinguishing aspect ascribed to the CIRP costs compared to the other claims is, that the costs resulting out of CIRP have a statutory preference over and above any other costs under the waterfall mechanism as provided under section 53 of the IBC 2016. CIRP costs were essential to be discharged and paid in full contrary to other claims as stipulated under section 53(1)(a). This very feature of CIRP costs has certainly facilitated the creditors to address their apprehension to haircuts by duly crystallizing their claims under the domain of CIRP. This classification in many circumstances was dictated to obviate the positivist conviction of the corporate debtor operating as a going concern.
The trend of dubious classification has consequently affected the timebound process of CIRP in projects where sub-contractual agreements exists and thereby leading to vexatious litigations and inviting unwarranted delays to the issues that were self-evident and apparent. This write-up draws a critical analysis of the ruling in matters between Avil Menezes (Liquidator) v. Abdul Qudduskhan and Anr (2024) ibclaw.in 320 NCLAT, by the Hon‘ble NCLAT Delhi (Appellate Authority) at the outset to inquire the dues of a subcontractor as a cost arising to the possible extent of effectuating the corporate debtor as a going concern and reaffirming the commercial perspective to infer the role of CoC in the determination of such costs.
Brief facts of the case
The present appeal filed before the Hon’ble NCLAT Delhi between the Avil Menezes (appellant) v. Abdul Qudduskhan (respondent), wherein the appellant was the liquidator of the corporate debtor Sunil High Tech Engineering Ltd (SHEL) and the respondent was the subcontractor appointed under the main contract established between the corporate debtor (CD)and NTPC for the performance of fabrication and erection works at NTPC Darlipali project situated in Odisha. In September 2018 the Adjudicating Authority NCLT (Mumbai Bench) admitted the application for CIRP against the CD later in July 2019 the CoC decided to liquidate the CD and the appellant was appointed as the liquidator.
The respondent in the event of a distribution waterfall has compelled the liquidator to classify the dues arising out of the sub-contractual agreement as CIRP costs citing the relevant invoices and the work done during the initiation of CIRP i.e., post-September 2018. On the contrary, the liquidator has rejected the dues as CIRP costs as it is contingent on the approval of the CoC and reinstated the fact that the project subcontracted for the respondent has been duly terminated by NTPC and notified as inactive by the CD. There arises no question of qualifying the dues of the subcontractor as CIRP costs.
The respondent dissatisfied with the policy decision of the CoC, has approached the Adjudicating Authority to reconsider the decision of the CoC in classifying the dues as the costs associated with the CIRP of the CD. The Adjudicating Authority has directed the liquidator to classify the dues of the subcontractor as CIRP costs.
The liquidator aggrieved by the decision of the Adjudicating Authority contested the ruling before the NCLAT and the issues before the appellate authority stand out as
- Whether the dues of the subcontractor have enabled the corporate debtor as a going concern on a standalone basis.
- Whether the Adjudicating Authority has extended its horizon by examining the commercial wisdom of CoC.
Analysing the rationale of the decision
The Appellate Authority has dealt with the issues by affording a strict interpretation to section 5(13) along with regulation 31(e) of IBBI 2016 and arrived at the reasoning by laying down a strong impetus in encountering irregularities pertaining to the classification of CIRP costs arising out the claims submitted to the resolution professional or a liquidator. The two metrics that were propounded by the appellate authority are:
The Test of Going Concern
The basis of the IBC 2016 which draws its assumption to the Corporate Insolvency Resolution Process is to continue the entity as a going concern. The phrase going concern implies a retention in the status quo of the corporate debtor that existed prior to the initiation of the CIRP. In addition to that what essentially needs to be observed is ascertainment of the costs necessitated in keeping the corporate debtor as a running concern at this juncture of CIRP.
The appellate authority has relied upon this principle through the lens of Sec 5(13)(c) which signifies the cost incurred by the RP to run the business of CD as a going concern. In the present case, the appellate authority noted that the expenses incurred by the subcontractor have failed to necessitate the condition of going concern to the CD with regards to the fact that the project at Darlipali was terminated during the time of initiation of CIRP and declared as an inactive business concern of the CD by the CoC.
The view put forth by the respondent states that since the costs were incurred after the commencement of the CIRP period recorded in the books of accounts, and duly acknowledged by then RP these factors were self-evident to automatically affect them as the CIRP costs and without actually delving into the test of going concern. This contention of the respondent has widened the scope to inquire in considering the time factor of the costs incurred and it has recorded the following
“a mere occurrence of the costs during the period of CIRP will not automatically take the colour of insolvency resolution process costs unless the said costs enable the corporate debtor as a going concern”
The respondent emphasized the ruling of the Adjudicating Authority in Southern Engineers v. Innoventive Industries Limited, in which the view to consolidate the businesses or projects associated with the CD to qualify it as a going concern, irrespective of the fact whether such project stands terminated or notified as inactive was in question before this appellate authority.
The appellate authority reasoned that the act of consolidating the terminated projects does not withhold the stance of going concern. The adjudicating authority was required to segregate and examine the cost incurred in relation to the business in which the respondent was involved. Such an approach outlines the decisive measure in examining the CD as a going concern related to the business indulged by the respondent.
The view to consolidate the businesses or projects of CD vitiates the waterfall mechanism under Sec 53 of the IBC 2016. In furtherance it derails the procedure mandated by the code, by securing the claims of the subcontractor it prioritizes the payments and encroaches on the rights of other stakeholders in the distribution waterfall, and there by the subcontractor will be accorded an unjustifiable benefit with the consolidation of the terminated projects.
Captivating the Commercial wisdom of CoC
The IBC 2016 through its evolving jurisprudence has encapsulated an undisputed discretion implanted upon the financial creditors being part of the Committee of Creditors to have an ultimate say on commercial technicalities and financial know-how in the form of commercial wisdom. Regulation 31(e) of IBBI affirms the standpoint with the determination of CIRP costs by the Committee of Creditors.
The appellate authority relied upon the ruling in Bharat Hotels v. Tapan Chakraborty (2022) ibclaw.in 650 NCLAT and Mehul Parekh & Ors v. Unimark Remedies (2024) ibclaw.in 320 NCLAT, CoC was entrusted with the responsibility to look after the policy decisions by including the financial determinatives of the corporate debtor and emphasizing the cost associated with the CIRP. In the present case, since NTPC has deferred the payments to the CD under the main contract, the CoC in its 5th meeting has undertaken the decision regarding the payment of dues to the subcontractor which is contingent upon the receipt of payment from the NTPC. The CoC highlighted the sub-contractual agreement that existed between the respondent and CD, has provided for the payment clause to the respondent on a back-to-back basis. The decision concerning the payment of the respondent is purely an exercise of commercial prudence attributed to the CoC.
The Adjudicating Authority by its direction to give effect the dues of the subcontractor as CIRP costs has overstepped its jurisdiction and has led to an impediment on the commercial wisdom of the CoC in the exercise of its policy decision. As it was stated by this appellate authority the decisions of the CoC attribute a deeming fiction by carving out the principle of judicial inquiry from the purview of the adjudicating authorities inquiring into the viability or the reasonable aspect of the commercial decisions undertaken collectively by the CoC.
Conclusion
The framework of sub-contractual agreements prevails in the normal course of every business pertaining to manufacturing, real estate, and infrastructure. The observations undertaken by the appellate authority in the present ruling form a relevant and applicable notion to the companies on the verge of undergoing the CIRP process. Eventually, the rationale of the decision manifests a litmus test of the claims submitted during CIRP, these claims were necessarily be examined solely from the viewpoint of going concern. It also emphasizes the role of RPs and Liquidators to be vigilant enough in categorizing the claims as CIRP costs, and any effort by the claimants (as the respondent in this matter) to circumvent the distribution mechanism thereby resulting an unjust priority over the incumbent stakeholders is considered to be an act of impairment to the time-bound revival mechanism under the code.
