Supreme Court Calls For Law To Clarify Validity Of 'Ipso Facto' Contractual Clauses In Relation To Insolvency

The Supreme Court has observed that lack of a legislative voice on the issue of validity/invalidity of ipso facto clauses relating to insolvency will lead to confusion and reduced commercial clarity.

The bench comprising Justices DY Chandrachud and MR Shah observed thus while upholding the order of the National Company Law Tribunal which stayed the termination by the Gujarat Urja Vikas Nigam Limited of its Power Purchase Agreement with Astonfield Solar (Gujarat) Private Limited. 

In this case, PPA was signed on 30 April 2010, in accordance with which the Nigam has to purchase all the power generated by the Corporate Debtor. On 20 November 2018, the NCLT admitted a petition filed by the Corporate Debtor under Section 10 of the IBC and commenced the Corporate Insolvency Resolution Process. In May 2019, the Nigam issued termination notices in which it stated thus : Under Article 9.2.1(e) of the PPA, the Corporate Debtor undergoing CIRP under the IBC amounts to an 'event of default' (b) under Article 9.2.1(a) of the PPA, there was a default in the operation and maintenance of the Plant. Rejecting the reply issued by the Corporate Debtor, the Nigam stated that they will terminate the PPA under Articles 9.2.1(e) and 9.3.1 since the Corporate Debtor is under CIRP. Thereafter, the Corporate Debtor filed applications under Section 60(5) of the IBC before the NCLT in regard to the Notices issued by the appellant to the Corporate Debtor, and sought an injunction restraining the Nigam from terminating the PPA. On 29 August 2019, the NCLT issued its final order restraining Nigam from terminating the PPA and setting aside the First Notice.

One of the issues considered by the court was whether the appellant's right to terminate the PPA in terms of Article 9.2.1(e) read with 9.3.1 is regulated by the IBC.

To answer this, the bench considered the validity of ipso facto clauses (contractual provisions which allow a party (terminating party) to terminate the contract with its counterparty (debtor) due to the occurrence of an 'event of default'. Referring to laws followed in international and multilateral organisations, the bench noted thus:

(i) Many jurisdictions follow the US model of legislatively invalidating ipso facto clauses. Interestingly, this shift has been far more prominent in the last decade even though the US Bankruptcy Code has had this position since 1979;

(ii) Some of the recent jurisdictions to follow the US model, such as Australia and Singapore, invalidate ipso facto clauses prospectively, i.e., ipso facto clauses contained in the contracts entered into before the laws came into effect will not be invalidated;

(iii) The UK, through the CIGA, only invalidates ipso facto clauses in supplier contracts, which is similar to the effect of Section 14(2) of the IBC. Further other ipso facto clauses are understood to be valid, based on the UKSC's decision in Belmont Park (supra). However, as noted previously, the UKSC decision was given in the context of the application of the antideprivation rule, which protects against the dilution of the value of the company in debt and does not necessarily affect the status of the company as a 'going concern';

(iv) Greece is one of the few countries which legislatively upholds ipso facto clauses;

(v) The position of law in the Republic of Korea is unclear due to contradictory judicial decisions, which has prompted demands for legislative clarity. This highlights the growing commercial importance of legislative clarity in this area;

(vi) Generally, even where ipso facto clauses are invalidated, it does not have effect on the termination rights of the terminating party based on other events of default in the contract;

(vii) Some nations which invalidate ipso facto clauses, such as Austria, Canada, Singapore and UK (limited to supplier contracts), provide for an exception based on 'hardship' being caused to the terminating party. This 'hardship' is to be determined by the courts; and

(viii) Even in nations which legislatively invalidate ipso facto clauses, there are often contrasting judicial decisions in relation to the scope of their invalidation. There are certain judicial decisions which go beyond the legislative text to invalidate ipso facto clause on broad considerations of the object and purpose of the relevant insolvency regimes. On the other hand, there are judicial precedents, which follow a more conservative approach and strictly construe the legislative mandate.

The court also noted that in India ipso facto clauses are invalid in: (i) Government licenses, permits, registrations, quotas, concessions, clearances or a similar grant or right given by the Central Government, State Government, local authority, sectoral regulator or any other authority constituted under any other law for the time being in force, in accordance with the Explanation to Section 14(1); and (ii) Contracts where the counter-party supplies essential/critical goods and services to the Corporate Debtor, within the meaning of Sections 14(2) and 14(2A). However, no clear position emerges in relation to the validity of ipso facto clauses in other contracts, from the bare text of the IBC, the bench said.

The court observed that the following complex questions will arise while deciding on the issue of the validity/invalidity of ipso facto clauses:

"(i) The extent of invalidation of ipso facto clauses, i.e., termination solely based on an 'insolvency event' (filing of an application for commencement of CIRP, commencement of CIRP, appointment of RP, et al) within the IBC will be invalid;
(ii) Whether the invalidation is absolute or conditional during the insolvency process;
(iii) What kinds of contracts should be exempt from this invalidation;
(iv) What should be the nature of the exceptions to the invalidation of ipso facto clauses to preserve the interests of the terminating party;
(v) Whether the invalidation should happen prospectively or retrospectively; and (vi) What safeguard will be required to ensure that parties do not circumvent the invalidation."

Taking note of these, the bench observed that the question of the validity/invalidity of ipso facto clauses is one which it ought not to resolve exhaustively in the present case.

"Rather, what we can do is appeal in earnest to the legislature to provide concrete guidance on this issue, since the lack of a legislative voice on the issue will lead to confusion and reduced commercial clarity", the bench added.

The court made the following observations in the judgment:

 It is through the instrumentality of an inter-institutional dialogue that the doctrine of separation of powers can be operationalized in a nuanced fashion

The Court is at its heart, an institution which responds to concrete cases brought before it. It is not within its province to engraft into law its views as to what constitutes good policy. This is a matter falling within the legislature's remit. Equally, when presented with a novel question on which the legislature has not yet made up its mind, we do not think this Court can sit with folded hands and simply pass the buck onto the Legislature. In such an event, the Court can adopt an interpretation – a workable formula – that furthers the broad goals of the concerned legislation, while leaving it up to the legislature to formulate a comprehensive and well-considered solution to the underlying problem. To aid the legislature in this exercise, this Court can put forth its best thinking as to the relevant considerations at play, the position of law obtaining in other relevant jurisdictions and the possible pitfalls that may have to be avoided. It is through the instrumentality of an inter-institutional dialogue that the doctrine of separation of powers can be operationalized in a nuanced fashion. It is in this way that the Court can tread the middle path between abdication and usurpation.

Case: Gujarat Urja Vikas Nigam Limited vs. Amit Gupta [CA 9241 of 2019]

Coram: Justices DY Chandrachud and MR Shah

Counsel: Sr. Adv Shyam Diwan, Adv Ranjitha Ramachandran, Sr. Adv C U Singh, Sr. Adv Nakul Dewan, Sr. Adv V Giri

Citation: LL 2021 SC 142

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