Authored by Hammurabi & Solomon Partners

2020 has witnessed two legal developments that will impact the recovery strategies of operational creditors in India. The first development is the insertion of section 32A into the Insolvency and Bankruptcy Code, 2016 (code), which received affirmation from the Standing Committee on Finance in its 4 March 2020 report on the Insolvency and Bankruptcy (Second Amendment) Bill, 2019. Section 32A ensures that former promoters of corporate debtors do not escape criminal prosecution, including prosecutions brought under the Negotiable Instruments Act, 1881.

The second critical development is the proposed overhaul of judicial mechanisms to ensure the expeditious trials of cases brought under section 138 of the act, as ordered by a bench of the Supreme Court presided over by the Chief Justice in its order dated 5 March 2020 in the case of Makwana Mangaldas Tulsidas v The State of Gujarat and Anr.

These developments are bound to have widespread commercial implications for the strategic aspects of recovery efforts of operational creditors under the code, money suits, proceedings under the Arbitration and Conciliation Act, 1996, and winding-up proceedings initiated under the Companies Act, 1956. There will also be an impact on home-buyers seeking refunds from developers under the provisions of the Real Estate (Regulation and Development) Act, 2016.

Operational creditors, when negotiating the terms of settlement, usually further safeguard their interests by asking for a series of post-dated cheques from the promoters of the corporate debtor to secure future payments and as a prerequisite for the withdrawal of proceedings against the corporate debtor. This allows the operational creditor to take advantage of summary proceedings under section 138 read with section 141 of the act in the event of default by the corporate debtor in honouring the payment terms. Such proceedings will not be subject to the moratorium consequent upon the entry of the corporate debtor into the corporate insolvency resolution process (CIRP). The proceedings will continue against the promoters even after the resolution of the corporate debtor. The significant advantage is that operational creditors can take advantage of their right to file their claims with the resolution professional of the corporate debtor and at the same time pursue proceedings against the promoters of the corporate debtor.

It is settled law that a criminal prosecution against the promoters of corporate debtors undergoing CIRP can continue even during the moratorium. This was laid down by the High Court of Madras in the recent case of Ajay Kumar Bishnoi v M/s Tap Engineering. Comparing the criminal nature of proceedings under the act and the insolvency provisions of the code as they affect the promoters and directors of the corporate debtor, the court noted that section 138 of the act provides not only for imprisonment but also for the payment of fines and compensation. A convicted person can be punished with imprisonment or with a fine of up to twice the amount of the cheque or with both. Of course, a company cannot be imprisoned. However, the person in charge of the entity can be imprisoned under section 141 of the act. The amount of fine and compensation can also be recovered from the assets of the corporate debtor or from those of its directors and officers who have been found guilty and vicariously liable in the same trial.

The recent order of the Supreme Court has identified the key lacunae in proceedings under the act, in particular the problem of delay. The case of Makwana Mangaldas Tulsidas had taken 15 years from first appearance to the hearing before the Supreme Court. The court directed that its order be separately registered, and appointed an eminent member of the bar as the lead amicus curiae. The court further endeavoured to plug the gaps by directing that notices be sent to the government, the directors general of police of the states and union territories, the National Legal Services Authority, the Reserve Bank of India and the Indian Bank Association, Mumbai, as the representative of banking institutions. The court has thus brought within its ambit members of the executive, the judiciary and the banking industry in order to strengthen the operation of the act.

The conclusion to be drawn from this analysis is encapsulated in the words of the high court in Ajay Kumar Bishnoi.

“The very object of the [code] is to provide for insolvency resolution in a time bound manner for maximization of the value of assets. It has not been enacted to provide succor to those who by their misconduct contributed to the defaults of the corporate debtor.”

This article was originally published in Indian Business Law Journal