Insolvency & Bankruptcy Code- SC Interprets Scope Of ‘Existence Of Dispute’ Between Operational Creditor And Corporate [Read Judgment]

The judgment of the Supreme Court in Mobilox Innovations Pvt.Ltd. v.Kirusa Software Pvt.Ltd. rendered by a bench of Justices R. F Nariman and Sanjay Kishan Kaul settles a significant issue under the Insolvency and Bankruptcy Code 2016. The issue was whether the existence of a dispute by itself without the record of initiation of any suit or arbitration proceedings in relation to it is sufficient to make an application for insolvency resolution at the instance of operational creditor unsustainable.

Under the Insolvency Code, an operational creditor can file application for insolvency resolution of a corporate debtor under Section 9. A claim in respect of the provision of goods or services including employment is an operational debt(Sec.2(21), and a creditor to whom operational debt is owed is an operational creditor(Sec.2(20).  The respondent before the Supreme Court, Kirusa Software Ltd., claimed that it was an operational creditor to Mobilox Innovations Ltd, the appellant.  Kirusa Software had rendered software and telecommunication supports to the appellant under a sub-contract, in relation to the contract the appellant had with Star TV for conducting viewers’ poll for the program ‘Nach Baliye’.

Kirusa Ltd. claimed that amounts were outstanding to it under the invoices raised to Mobilox Ltd.   Kirusa raised a demand of operational debt by sending notices under Section 8(1).  Mobilox responded to the notice by pointing out stating the Kirusa had breached the Non-Disclosure Agreement(NDA) by disclosing to the public that it had a sub-contract under Mobilox. According to Mobilox, the breach of NDA amounted to a ‘dispute’ within the meaning of Section 8(2)(a), and therefore the demand was not liable to be met. In this context, it may be helpful to note that the demand raised by the operational creditor under Section 8(1) has to be responded to by the corporate debtor within ten days of receipt of demand by  either :-

• Bringing out to the notice of debtor the existence of a dispute, if any, and record of the pendency of the suit or arbitration proceedings filed before the receipt of such notice or invoice in relation to such dispute;(Sec.8(2)(a)) or,


• Repayment of the debt with the proof of payment.

Kirusa approached the NCLT by filing application for insolvency resolution process against Mobilox under Section 9. The NCLT dismissed the application under Section 9(5)(ii)(d)  on the ground that notice of dispute had been received by the operational creditor . Kirusa filed appeal before the NCLAT. The NCLAT allowed the appeal and directed the NCLT to process the application. Feeling aggrieved by the order of NCLAT, Mobilox filed appeal before the Supreme Court.

After tracing the background and legislative history of the IBC, the Supreme Court settled the following issues after an enlightening discussion.

DISTINCTION BETWEEN FINANCIAL CREDITOR AND OPERATIONAL CREDITOR.

 Before delving into the heart of the issue, the Court emphasised the distinction between operational creditor and financial creditor.The operational creditors are those creditors to whom an
operational debt is owed, and an operational debt, in turn,
means a claim in respect of the provision of goods or services. Financial debts are owed to financial creditors who advanced financial aid. The insolvency process initiated a financial creditor is under Section 7; whereas then insolvency process by operational creditor is under Section 9. A financial creditor need only establish default by the corporate debtor to sustain the insolvency process. Whether the debt is disputed or not is not an issue in a claim by financial creditor. However, a claim by operational creditor can be defeated showing the existence of a dispute as to the claim. The judgment referred to the earlier judgment rendered by the very same bench in Innoventive Industires v. ICICI Bank which had discussed the distinction in detail.

Since the case at hand was at the instance of an operational creditor instead of a financial creditor, the existence of dispute was material in determining the claim.

SECTION 8(2)(a)- ‘AND’ HAS TO BE READ AS ‘OR’

Section 8(2)(a) of IBC states that the creditor debtor within ten days of receipt of demand notice by operational creditor shall point out the existence of dispute and record of the pendency of the suit or arbitration proceedings filed before the receipt of such notice or invoice in relation to such dispute. The argument by the operational creditor was that existence of dispute by itself is not sufficient, and that there should be a suit or arbitration proceedings filed before the receipt of such notice or invoice in relation to such dispute.

The Court however held that such an interpretation will lead to injustice and anomalies, and hence construed ‘and’ as ‘or’ to make the phrases disjunctive. It was held as follows

Even otherwise, the word “and” occurring in Section 8(2)(a) must be read as “or” keeping in mind the legislative intent and the fact that an anomalous situation would arise if it is not read as “or”. If read as “and”, disputes would only stave off the bankruptcy process if they are already pending in a suit or arbitration proceedings and not otherwise. This would lead to great hardship; in that a dispute may arise a few days before triggering of the insolvency process, in which case, though a dispute may exist, there is no time to approach either an arbitral tribunal or a court. Further, given the fact that long limitation periods are allowed, where disputes may arise and do not reach an arbitral tribunal or a court for upto three years, such persons would be outside the purview of Section 8(2) leading to bankruptcy proceedings commencing against them. Such an anomaly cannot possibly have been intended by the legislature nor has it so been intended. We have also seen that one of the objects of the Code qua operational debts is to ensure that the amount of  such debts, which is usually smaller than that of financial debts, does not enable operational creditors to put the corporate debtor into the insolvency resolution process prematurely or initiate the process for extraneous considerations. It is for this reason that it is enough that a dispute exists between the parties.

‘EXISTENCE OF DISPUTE’-SCOPE OF

Having held that Section 8(2)(a) has to be understood disjunctively, construing ‘and’ as ‘or’, the Court proceeded to examine the width and ambit of the phrase ‘existence of dispute’.  Referring to various foreign authorities, it was held that the adjudicating authority need to satisfy itself that a plausible dispute existence, without needing to examine whether the dispute is likely to succeed or not.  It was held as follows :-

All that the  adjudicating authority is to see at this stage is whether there is a plausible contention which requires further investigation and that the “dispute” is not a patently feeble legal argument or an assertion of fact unsupported by evidence. It is important to separate the grain from the chaff and to reject a spurious defence which is mere bluster. However, in doing so, the Court does not need to be satisfied that the defence is likely to succeed. The Court does not at this stage examine the merits of the dispute except to the extent indicated above. So long as a dispute truly exists in fact and is not spurious, hypothetical or illusory, the adjudicating authority has to reject the application.

Applying the above principles to the facts, the Court held that the claim of corporate debtor that there existed a dispute in relation to breach of Non Disclosure Agreement is sufficient to refuse entertainment of the insolvency application by the operational debtor.

Read the Judgment Here