Madras High Court: Clean State Theory Not Applicable To Undisclosed Creditors Left Out Due To Negligences Of IRP Or RP

Background Facts:

National Sewing Thread Co. Ltd. (Petitioner), a public limited company registered under the MSME Act, 2006, was under the Corporate Insolvency Resolution Process under Section 7 of Insolvency and Bankruptcy Code, 2016 ('IBC') due to its failure to service the loan obtained from the Indian Overseas Bank.

From June 2019, the petitioner also failed to pay the electricity charges due to Tamil Nadu Generation and Distribution Corporation Limited ('TANGEDCO'). On 19.01.2022, TANGEDCO issued a Demand Notice claiming Rs. 32 Lakhs as unpaid electricity charges.

The petitioner contended that since the CoC under its commercial wisdom passed the Resolution Plan which also received the NCLT approval, all the outstanding claims or liabilities, not covered by the Plan are extinguished.

The petitioner filed the writ of certiorari and mandamus to quash the Demand Notice issued by TANGEDCO and to further direct it to provide the electricity connection.

Observations by the High Court:

The Madras High Court dismissed the writ petition and held that the Clean State Theory shall not apply to undisclosed creditors to protect them from the deliberate non-disclosure or silence by the suspended board of directors or negligence of IRP or RP towards disclosing their claims.

The Court examined the applicability of the Clean Slate Theory to creditors by categorizing them into two groups: disclosed creditors and undisclosed creditors, including both financial and operational creditors.

The Court noted that disclosed creditors are those who had the opportunity to participate in the resolution process, whereas undisclosed creditors are those whose existence only the IRP and the RP could have discovered with due diligence.

The High Court held that the said theory shall be applicable for disclosed creditors until any aggrieved creditors challenge the resolution plan approved under Section 31 of IBC before the National Company Law Appellate Tribunal ('NCLAT') which is the Appellate Authority.

However, it noted that for undisclosed creditors, applying the Clean State Theory would amount to unfairly penalizing such creditors by not taking into account their claims by the negligence of the IRP and RP or the deliberate non-disclosure or silence by the suspended board of directors.

The High Court also stressed upon the roles and responsibilities of the suspended directors observing that even though an IRP is appointed to replace the board of the Corporate Debtor, Section 19 of IBC legally requires the suspended board to assist and cooperate with the IRP. It noted that such a mandate to "extend all assistance and cooperation" signifies that the suspended board must fully disclose all pertinent information needed by the IRP to prepare a comprehensive statement of the corporate debtor's assets and liabilities.

The Court also pointed out that though the language and wording opted by the Parliament may not be ideal, interpreting it in any other way would harm the rights of creditors and undermine the objectives of IBC.

In conclusion, the Madras High Court determined that the Clean Slate Theory cannot be used as a tool by those seeking to exploit the IBC framework to the detriment of other stakeholders such as undisclosed creditors, particularly operational creditors. Therefore, the petitioner cannot avoid the unpaid electricity charges due to TANGEDCO.

Case Title: National Sewing Thread Co. Ltd. vs Superintending Engineer, TANGEDCO and Anr.

Case No.: W.P. No.29845 of 2022 and WMP.No.29233 of 2022

Counsel for Petitioner: Mr. E. Omprakash, Senior Counsel assisted by Mr.Imayavaramban for M/s.Ramalingam & Associates

Counsel for Respondents: Ms.Keerthana R.Shenoi for Mr.V.Venkata Seshaiya, Standing Counsel for TANGEDCO

Date of Judgment: 07^th June, 2024

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