The main objective of Section 14 of the Insolvency and Bankruptcy Code is to preserve the debtor’s property. The said section mandates a moratorium that has to be issued on the corporate debtor’s assets while the Corporate Insolvency Resolution Process (“CIRP”) takes place. A moratorium is basically an interlude for the corporate debtor instead of manoeuvring into liquidation of assets right away. The critical issue here is to understand the contractual obligation of the corporate debtor during the CIRP and most importantly the stand of the third party when it comes to the termination of the contract.
The code takes into account the situations of the moratorium as stated by section 14. According to the Code, the term “moratorium” is not defined per se; however, it is a period of legal proceeding to recover, foreclose, sell or transfer assets, or terminate material contracts that are prohibited. Such terminations must not be initiated or continued against the Corporate Debtor, which essentially means that the company which is allegedly insolvent. The authors of this article hover across the entire conundrum and assess the grounds that in what scenarios a contract may or may not be terminated.
Maximizing value remains one of the bankruptcy code’s primary goals; however, entering into CIRP is a material breach of an agreement, and it allows a third party to come forward and terminate the said agreement. However, the courts and tribunals have a contrasting opinion, owing to the objective of asset maximization, and if a third party agreement might contribute termination of such is a massive misstep.
In the event of a moratorium, in which legal proceedings against the company debtor cannot be initiated because of the termination of essential contracts, the question arises of what happens in PPA cases and what rights and obligations the parties have in the ensuing disputes, to keep the corporate debtor as a going concern, Tribunals favour the adherence to section 14, in fact in Gujarat Urja Vikas Nigam Limited v. Amit Gupta and ors. The Supreme Court held that power purchase agreements should not be terminated during the insolvency resolution process, also; in Tata consultancy services limited v. Vishal Ghisulal Jain, The National Company Law Appellate Tribunal (“NCLAT”) opposed the termination of the contract, the general pretence in both these cases was if these terminations were allowed, then it would have undoubtedly affected the debtor’s capital gains most certainly in a negative manner.
It is, however, quite pertinent to note that if a default has been committed by the corporate debtor, which is not certainly an insolvency-related default, still third party might not come forward and terminate the contract, so happened in the case of GRIDCO Limited v. Surya Kanta Satapathy and others, the corporate debtor failed to provide the services which they were bound to provide, during the CIRP, GRIDCO terminated the Power Purchase agreement, the adjudicating authorities were of the view that such termination was a blatant violation of the moratorium however the NCLAT upheld the order and were consonant with the adjudicating authority’s opinion.
The solid repercussion of this decision made by the NCLAT is the sole focus on elevating the value of the assets of the corporate debtor while the actual ends which were supposed to meet as per the agreement were never actually met.
Understanding the scope
However, there were few instances where the tribunals did allow the termination of the contract, where the Debtor was in blatant breach of the agreement. The courts have observed whether the termination of the agreement was solely on the basis of insolvency; if not, then the termination may be carried forward if there has been a breach of any clause of the agreement by the corporate Debtor. In Orbit Lifesciences Private Limited vs Raj Ralhan PWC professional services LLP, the corporate debtor was behind on payments of some outstanding dues; hence the termination was indeed valid.
Also, Termination on the grounds of a “material breach” has always been a paramount solution. If the agreement facilitates a “material breach” clause, either party has the option to come ahead and terminate the contract by giving a 30 days’ notice if the “default” has not been rectified by the defaulting party. Again, it has to be established that if the breach has been solved within the requisite period then a Termination is uncalled for, keeping in mind that the said “default” should not be a corporate debtor’s insolvency.
However, in the case of Tata consultancy services limited v. Vishal Ghisulal Jain, NCLAT relied on the contentions presented by the corporate debtor and acknowledged their standpoint of them rectifying the default in the mentioned requisite period even though Tata consultancy services limited presented a contrary opinion. The NCLAT ordered the parties to adhere to the conditions of the contract without any failure thus putting a stay on the termination of the contract. Now, one might argue, that TCS would have wanted to opt-out of the agreement owing to the current financial status of the corporate debtor, as such defaults might transpire frequently, this unquestionably and beyond any doubt proves that NCLAT has backed the fact that the corporate debtor should remain a going concern and could provide maximum value with their assets during liquidation.
The moratorium does not per se prohibit third parties from terminating the contracts entered into with the corporate debtor, but the tribunals have the termination of rental agreements, supply contracts, and other already existing contracts with the corporate debtor, the termination of which result in a loss of the moratorium or the continuation the corporate debtor would endanger, however, To provide a basic rundown, few elements have been established which should be considered before a third party moves ahead and terminate the contracts. Primarily, it has to be established that the breach is nowhere related to the corporate debtor’s insolvency or him/her entering into CIRP. Additionally, the contract which is about to get terminated or has been terminated was the sole contract that the corporate debtor ever entered and will eventually lead to a corporate death of the debtor, eventually thinning out the entire value.
This Article is written by Mr Shashank Gupta and Ms Khushi Shukla (Indore Institute of Law, DAVV)