Feigning Dispute Under Insolvency & Bankruptcy Code

A Financial creditor/s or Operational creditor may make an application for initiating corporate insolvency resolution process, if the minimum amount of default committed by the Corporate/Operational debtor, as the case maybe, is one lakh rupees.

S.7 of I & B Code which deals with application for initiating corporate insolvency resolution process by financial creditor against corporate debtor on occurrence of default, National Company Law Appellate Tribunal (NCLAT) has in Karan Goel vs. M/s. Pashupati Jewellers & Anr. (Company Appeal No. 1021 of 2019) held pendency of suit cannot be a ground to reject application u/s.7 of I & B Code. Pre-existing dispute cannot be a subject matter of Section 7, though it may be relevant u/s.9 of the I & B Code.

S.8 of I & B Code mandates requirement of sending demand notice by the operational creditor to operational debtor on occurrence of default. The operational debtor may either raise the defence of existence of a dispute i.e. pendency of the suit or arbitration proceedings filed before the receipt of such notice or that there has been repayment of unpaid operational debt, within 10 days of receipt of such demand notice.

S.5 sub-section (6) of I & B Code defines "dispute" as follows:

S.5(6) "dispute" includes a suit or arbitration proceedings relating to:

• the existence of the amount of debt;
• the quality of goods and services; or
• the breach of a representation or warranty.

S.9 of I & B Code deals with application for initiation of Insolvency resolution process by operational creditor against operational debtor if the operational debtor fails either to raise a valid pre-existing dispute or repay the unpaid operational debt within 10 days of delivery of demand notice.

Whereas u/s.7 of I & B Code it is pointless to raise pre-existing dispute as defence, as there is no prerequisite of delivery of demand notice as required u/s.9 of I & B Code and as rightly held in Karan Goel (supra), there has been a rise in feigning pre-existing dispute by operational debtors in applications u/s.9 of I & B Code majorly in following two ways: (i) Operational debtor after receiving demand notice or filing of application for Insolvency resolution process puts up the defence of receiving inferior quality of goods or defective services; and (ii) Filing appeals under arbitration after receiving demand notice and stating that the matter is sub judice before the Appellate Court.

As far as first instance is concerned, the Tribunals have taken a stern view against raising such sham defence after consuming alleged inferior goods or defective services. The Tribunals have called upon Operational debtors to show why they have consumed such alleged inferior quality goods and services without raising any objection whatsoever till receiving demand notice or the filing of application for initiation of Insolvency resolution process for default of operational debt.

As far as second defence is concerned, let's take the following circumstance, wherein an Arbitral award passed by MSE Facilitation Council against a PSU, the same was first challenged by the operational debtor under the Writ jurisdiction of the High Court to avoid payment of 75% of award amount as required u/s.19 of MSMED Act and later on challenged the award in Appeal u/s.34 of Arbitration and Conciliation Act when High Court refused to entertain Petition without payment of 75% of award amount. The Tribunals have been rather reluctant to entertain such applications as the Operational debtors state that the award is challenged and the matter is sub judice before Appellate Court. The seminal question before Tribunals in such facts would be whether operational debtors who use such dilatory tactics by first filing Writ Petition and then filing appeal u/s.34 of Arbitration and Conciliation Act when they fail to obtain favourable order from High Court in its Writ jurisdiction amounts to Forum shopping hence making the defence of pre-existing dispute by operational debtor a moonshine defence or at best an afterthought.

In the alternative, can an award passed by Facilitation Council and delivery of demand notice in pursuance of such award by the operational creditor on the operational debtor before filing of Appeal by the debtor u/s.34 of Arbitration and Conciliation Act extinguish pre-existing dispute as there was no proceeding under suit or arbitration pending at the time of delivery of demand notice as required u/s.5(6) of I & B Code. Will the statutory right of the operational debtor to appeal u/s.34 of Arbitration and Conciliation Act reverse the clock as far as pre-existing dispute is concerned.

The correct or balanced view in the aforesaid situations, would depend on facts and circumstances of each case but it would be appropriate to see whether the operational debtor has indulged in forum shopping or has the operational debtor preferred appeal u/s.34 of Arbitration and Conciliation Act by paying 75% of award amount without prejudice to its rights and contentions.

If the operational debtor has indulged in forum shopping then such sham defence of pre-existing dispute cannot stand judicial scrutiny and such defence must fail but if the operational debtor has directly preferred appeal u/s.34 of Arbitration and Conciliation Act then even if demand notice is delivered prior to preferring appeal then such application for Insolvency resolution process must either be withdrawn with liberty or kept in abeyance till the appeal under Arbitration and Conciliation is decided on merits.

As held by the Apex Court in Mobilox Innovations Pvt. Ltd. Vs. Kirusa Software Pvt. Ltd. (2018) 1 SCC 353, what will have be to ascertained while accepting or rejecting application u/s.9 of I & B Code in respect of pre-existing dispute is that the defence is not a patently feeble legal argument to delay payment of dues. If the defence is spurious, mere bluster, plainly frivolous or vexatious, the defence of pre-existing dispute shall fail.

(Views expressed in this Article are based on personal understanding and interpretation of the Author)