Madras High Court: MSME Corporate Debtor Can't Misuse Clean Slate Theory To Withhold Information When Its Management Had A Duty To Disclose

Background Facts:

National Sewing Thread Co. Ltd. (Petitioner), a public limited company registered under the MSME Act, 2006, had obtained financial assistance from the Indian Overseas Bank ('IOB'). Due to substantial business losses, the petitioner was unable to service its loan, leading to its loan being classified as a Non-Performing Asset by IOB. On 24.03.2017, IOB assigned the said loan to Alchemist Asset Reconstruction Company Ltd. (Financial Creditor).

The Financial Creditor initiated a Corporate Insolvency Resolution Process ('CIRP') against the Petitioner under Section 7 of the Insolvency and Bankruptcy Code, 2017 (IBC) before the National Company Law Tribunal (NCLT). An Interim Resolution Professional ('IRP') was appointed, and a Committee of Creditors ('CoC') comprising IOB as the sole financial creditor was formed.

The CoC approved the Resolution Plan, which was further approved by the NCLT on 06.12.2021. Under the said plan, the Financial Creditor was partially compensated, as the value of the petitioner's assets was significantly less than its liabilities. Operational creditors were to be paid pro rata at 1% of their claim value. The approval of the Resolution Plan led to the petitioner rescuing itself from its debt situation.

However, on 19.01.2022, Tamil Nadu Generation and Distribution Corporation Limited ('TANGEDCO') issued a Demand Notice claiming Rs. 32 Lakhs as unpaid electricity charges which the petitioner owed from June 2019.

The petitioner responded that all outstanding dues even those that are not covered by the Plan were extinguished following the NCLT's approval of the Resolution Plan and by relying on Supreme Court's decision in Ghanashyam Mishra & Sons (P) Ltd., vs Edelweiss Asset Reconstruction Co. Ltd. Despite this, TANGEDCO disconnected the petitioner's electricity service. On 24.02.2022 the petitioner applied for a temporary LT Energy connection, which was denied by TANGEDCO, insisting the petitioner pay the outstanding electricity dues.

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

Contentions of the Respondent:

The Respondent argued that while TANGEDCO might be considered an operational creditor under the IBC framework, its operations are governed by the Electricity Act, 2003, and the Electricity Supply Code, preventing it from foregoing its claim. Further, as per these regulations, the owner or occupier of premises with provided electricity is liable for the entire arrears, unaffected by any IBC proceedings or approval of a resolution plan.

The Respondent also cited the Ghanashyam Mishra case, as referenced in the State Tax Officer vs. Rainbow Papers Ltd., where the Supreme Court held that a resolution plan ignoring certain dues to the instrumentality of the State instruments is invalid.

Observations by the High Court:

The Madras High Court observed that the petitioner cannot exploit the Clean Slate Theory by withholding information, especially when its management, which remained in control, had a duty to disclose such information.

The Court pointed out that the petitioner, as an MSME, participated in the resolution process and successfully proposed a resolution plan, which was approved by the NCLT. Further, the same promoters continued to manage the company and failed to disclose the petitioner's liability for outstanding electricity dues to TANGEDCO during the resolution process. Therefore, the petitioner cannot disregard the rights of undisclosed creditors when the suspended Board had the opportunity to disclose all its creditors during the resolution process.

The High Court also questioned why the Financial Creditor chose the route of IBC despite having SARFAESI as an option and what it gained since it was only promised repayment through asset sales. It observed a possible collusion between the petitioner and its sole financial creditor.

It remarked:

“The point is not about the financial creditor's choice of remedy-either under the SARFAESI Act or under the IBC, or its right to invoke them, but about the intent behind exercising its option. It is more significantly the fairness expected while evaluating the bonafide of a resolution plan as there is an obligation on the CoC to protect the interests of the operational creditors.”

It noted that presently, an MSME is in a debt trap with one secured financial creditor and potentially many operational creditors, none of which included TANGEDCO. The IBC aims to preserve MSMEs as going concerns, but if the financial creditor had truly wanted to support the goal without liquidating the petitioner, it could have invoked the SARFAESI Act, specifically Section 13(4)(b), to take over the petitioner's management and the approach would have protected both the petitioner and its operational creditors.

The Court held that the petitioner and the Financial Creditor could have achieved the solution of selling the non-core assets to repay the Financial Creditor via a mutual agreement. However, IBC was used as it appealed the Clean State Theory absolving all other creditor claims, unlike the SARFAESI Act.

In conclusion, the Madras High Court dismissed the Writ Petition observing that the petitioner cannot avoid its obligation to pay the unpaid electricity dues of 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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