No Reply to Demand Notice: Justified? – By Disha Karamchandani and Khushi Agrawal

No Reply to Demand Notice: Justified?

[Analysis of – M/s Durlum India Private Limited vs. M/s Sharma Kalypso Private Limited]

-By Disha Karamchandani and Khushi Agrawal, 2nd year students at NLU Jodhpur

Introduction

The meaning of the word “dispute” under IBC has been a subject of debate ever since IBC came into existence in the year 2016. Such debate arises in cases where the operational creditor files an application for the initiation of Corporate Insolvency Resolution Process [“CIRP”] against the corporate debtor [“CD”], and the adjudicating authority [“AA”] has to decide whether the application should be admitted or rejected. One of the conditions for admission of the application is that if “no notice of dispute has been received by the operational creditor or there is no record of dispute in the information utility”.[1] Despite such a condition being in place, the National Company Law Tribunal, Delhi [“NCLT”], in the case of M/s Durlum India Private Limited vs. M/s Sharma Kalypso Private Limited [“Durlum”], rejected the application filed by the operational creditor [“OC”]even when no notice of dispute was received by the operational creditor from the corporate debtor.[2] When an appeal was filed in the National Company Law Appellate Tribunal, Delhi [“NCLAT”] by the operational creditor, the NCLAT dismissed the appeal, and accepted the judgment of the NCLT. Further, the operational creditor has filed an appeal in the Supreme Court [“SC”], which has admitted the appeal but has put a stay on the NCLAT’s decision till it delivers a judgment of its own.[3]

The authors believe that in the present case the NCLT wrongly excused the CD for not serving a reply to the demand notice and such a precedent might be used as a justification by the CDs to absolve themselves of their duty to raise a dispute (if there is any) in the reply to a demand notice.

Brief of Facts

An application under Section 9 of the IBC was filed by the OC before the NCLT seeking to initiate CIRP against the CD. The impugned transaction between the two parties involved a supply of goods and the claim arising out of the said transaction was a sum of Rs. 38,67,500/-, which included the amount raised in two invoices and the freight charges. Allegedly, the CD issued two cheques to pay the amount raised in the invoices but the said cheques got dishonored due to insufficient funds, giving rise to a default. Therefore, under such circumstances, the OC issued a demand notice under Section 8 of IBC. On receipt of the demand notice neither a notice of dispute was sent by the CD to the OC, nor was a payment made, and hence an application was filed before the NCLT. It was only in the reply to the advance copy of the petition that the CD raised its objections. After hearing the submissions of both the parties, the NCLT found existence of a plausible contention in relation to dispute about the quantum of supply and rejected the application.

Legal Infirmities in the Judgement

I. Erroneous reliance placed on the SC judgement of Mobilox Innovations Pvt. Ltd. v. Kirusa Software Pvt. Ltd.[4] [“Mobilox”]

In the Mobilox case, the OC sent a demand notice to the CD, under Section 8 of the IBC, due to non-payment for the services rendered by the OC to the CD. The CD, in its reply to the demand notice, brought to the attention of the OC that there existed a dispute between the parties. However, it is imperative to pay attention to the fact that the CD in the case of Durlum did not even send a reply to the demand notice.

Despite such difference in facts of both the cases, the NCLT in Durlum, relied on paragraph 40 of judgment in the case Mobilox, to hold that since there existed inconsistency in the documents filed by both the parties, it gave rise to a plausible contention in relation to dispute with regard to the quantum of goods supplied. The relevant paragraph cited by the NCLT noted that the “reply to the demand notice” must bring to the notice of the OC the “existence” of a dispute or the fact that a suit or arbitration proceeding relating to a dispute is pending between the parties.[5] Furthermore, it was also noted by the SC that if no notice of dispute has been received by the OC from the CD or that there is no record of such dispute in the information utility, the AA, as per Section 9(5)(i)(d) of the IBC, must admit the application filed by the OC, after which CIRP gets triggered.[6] And thus, all that the AA has to see at this stage is whether the CD has brought up a plausible contention which requires further investigation.[7]

The reliance placed by NCLT on the abovementioned case is erroneous as it failed to pay attention to the emphasis laid by the SC on the importance of raising such a dispute in the “reply to the demand notice”.

Furthermore, the SC in the Mobilox case provided the importance of serving a reply to the demand notice by stating that the 10 days’ time provided to the CD to send a reply to the demand notice ensures that OC, whose debt claims are usually smaller, are not able to put the CD into the insolvency resolution process prematurely or initiate the process for extraneous considerations.[8] Moreover, such reply may also facilitate informal negotiations between such creditors and the CD, which may result in a restructuring of the debt outside the formal proceedings.[9]

Even in the Notes on Clauses annexed to the Bill of the Insolvency Code, 2015 [“Bill”] the same intention of the lawmakers, as observed by the SC in the abovementioned paragraph, was found.[10]

Despite such judgments and notes, the AA in Durlum outrightly rejected the OC’s contention that the CD failed to reply to the demand notice on the basis that the OC provided a flawed reasoning. The AA excused the CD for not sending a reply to the demand notice on the basis that even if the CD would have served a notice of dispute, the AA would still have to check if the defence put up in the said notice isn’t “sham or illusory”.[11] In our opinion, the AA by doing so has gone beyond the wordings of the statute, i.e., Section 9(5)(i) of IBC, which mandates the AA to admit the application filed by the OC if no notice of demand has been received by the OC from the CD. In Union of India v. Braj Nandan Singh, AIR 2005 SC 4403, the apex court had held that “Courts cannot read anything into statutory provision which is plain and unambiguous”. Further, in KeshavjiRavji and Co. v. CIT (1990) Taxmann 87 SC, “The meaning of literal rule is stated that, as long as there is no ambiguity in the statutory language, resort to any interpretative process to unfold the legislative intent becomes impermissible.” Thus, there being no ambiguity in the wordings of Section 9(5), and the tribunal still reading its own interpretation into it is clearly impermissible. Even in a recent judgment (Totem Media Solutions v. V2 retail[12]) delivered in 2020, the NCLT, applying Section 9(5)(i), admitted the application stating that V2 retail had failed to raise any dispute by not serving a reply to demand notice to the OC within the stipulated period of 10 days.

The tribunal, in Durlum, has paid no heed to the object of the legislature behind giving the 10 days’ time period to the CD to reply to the demand notice. For example, in the present case itself, the NCT, as well as the NCLAT, on reading the CD’s reply to the petition found out that there existed a dispute. Now, if the CD had sent a sent a reply to the demand notice itself, and had brought to the attention of the OC, existence of a dispute, such reply would have given rise to the possibility of OCnot being able to put the CD into the insolvency resolution process prematurely or initiating the process for extraneous considerations.Moreover, such reply might have also facilitated informal negotiations between the OC and the CD, which might have resulted in a restructuring of the debt outside the formal proceedings, without having the OC approach the tribunal. This would have saved the time of the tribunal which is already burdened with as many as 10,860 IBC cases.[13]

II. Diluted the difference between FC and OC

The IBC has created a distinction between the procedure of initiation of CIRP in the case of a financial creditor [“FC”] and an OC. According to Section 8 of IBC before filing an application for initiation of CIRP, OC is required to deliver a demand notice of unpaid operational debtor and a copy of invoice demanding payment of the amount involved in the default to the corporate debtor in such form and manner as may be prescribed.[14] However, in the case of FC, no such pre-requisite of sending a demand notice is provided under Section 7, and according to the said section the FC can himself or jointly file an application for initiating CIRP, directly before the AA when a default has occurred.[15]

The constitutional validity of the said distinction was challenged before the SC, in Swiss Ribbons Pvt. Ltd. v. Union of India[16], wherein the apex court upheld the constitutional validity of all the provisions challenged before it. With regard to the difference in filing of CIRP application between FC and OC, the SC held that financial creditors have to prove “default” on the basis of solid documentation that is easily verifiable, whereas OC only “claims a right to payment of a liability or obligation in respect of a debt which may be due”.[17] Furthermore, the court stated that this difference is not only intelligible, but directly relates to the objectives sought to be achieved by IBC.[18] The court has relied on the Bankruptcy Law Committee Report, 2015 wherein the Committee has stated that while both types of creditors can trigger the CIRP under IBC, the evidence presented to trigger varies and hence the difference.[19]

The court in the case of Durlum has excused the CD for his failure to raise a dispute by sending a reply to the demand notice, and has allowed him to prove existence of dispute even at a later stage i.e. in the reply to the petition itself. The AA, by doing so, has reduced the importance of sending the reply to demand notice which, in turn, makes the action of delivering a demand notice by the OC futile. By holding so, the AA has diluted the distinction between FC and OC, whose validity has been upheld by the apex court in the abovementioned case.

III. Unjustified employment of principle of Natural Justice

One of the many grounds on which the tribunal has thought it to be justified for the CD to raise a dispute even in the reply to the petition (having failed to send a reply to the demand notice), was based on the principle of natural justice. It held that according to Section 424 of the Companies Act, 2013,[20] the tribunal was bound by the principles of natural justice to hear both the sides and all the evidence placed by them.[21] However, the IBC cases in which the court/tribunal was prompted to employ natural justice was in the cases with FC as the creditor, in which the corporate debtor, by the virtue of Section 7 of IBC is not given even a single chance to put forth its arguments before the FC filed an application for initiation of CIRP. However, in the case of OC, the CD is given sufficient opportunity by the virtue of Section 8 to provide its side of the story and be heard. Thus, in our opinion, until and unless the CD is able to prove that it was, in no way, possible for it to send a reply to the demand notice due to certain reasons, the CD should not be allowed to place forth arguments in relation to existence of dispute at a later stage (i.e., in the reply to petition). Since in Durlum, the CD has raised absolutely no contention with regard to its inability to send a reply due to unavoidable reasons and circumstances, courts and tribunals in future must not blindly follow the ratio of Durlum as “the rule”.

Conclusion

Thus, from the above observations, the AA has reduced the importance of Section 9(5) to a mere nullity by rejecting the application even though no notice of dispute was served by the CD to the OC. This action of the tribunal has led to judicial overreach and the importance of both demand notice and reply to the demand notice, as was intended by the legislature, has not been acknowledged by the court. This path taken by the court has the potential of having the other CDs not sending a reply to the demand notice and failing to fulfil their duties as endowed upon them by the law. Although the SC is yet to deliver a judgement in this regard, the authors of this post are of a strong belief that the intent of the legislature behind obligating the corporate debtor to either send a notice of dispute or make the payment of the unpaid operational debt, and the intent of the legislature behind differentiating between the procedure of initiation CIRP application in the case of FC and OC should be given due credence and not be reduced to a mere show up.

Reference

[1] Insolvency and Bankruptcy Code 2016, s 9(5)(i)(d).

[2] Drulum India Pvt. Ltd. v. Sharma Kalypso Pvt. Ltd. [2018] SCC OnLine NCLAT 916.

[3] Drulum India Pvt. Ltd. v. Sharma Kalypso Pvt. Ltd.; https://indiankanoon.org/doc/147713321/

[4] Mobilox Innovations Private Limited v. Kirusa Software Private Limited [2018] 1 SCC 353.

[5] Ibid.

[6] Ibid.

[7] Ibid.

[8] Ibid.

[9] Ibid.

[10] Insolvency and Bankruptcy Bill, 2015.

[11] Supra note 2.

[12] Totem Media Solutions v. V2 retail [2020]; https://www.outlookindia.com/newsscroll/v2-retail-settles-dispute-with-creditor-expects-to-come-out-of-insolvency/1890070

[13] “10,860 cases under IBC pending before NCLT at the end of September: Govt” (The Economic Times, 03 December, 2019) <https://economictimes.indiatimes.com/news/economy/policy/10860-cases-under-ibc-pending-before-nclt-at-the-end-of-september-govt/articleshow/72348493.cms?from=mdr. > accessed 15 July,2020.

[14] Insolvency and Bankruptcy Code, 2016 s  8(1).

[15] Insolvency and Bankruptcy Code, 2016 s 7(1).

[16] SCC OnLine SC 73 (2019).

[17] Ibid.

[18] Ibid.

[19] Bankruptcy Law Committee Report 2015.

[20] The Companies Act, 2013 s 424(1).

[21] Supra note 2.