From Yatin’s Desk: Income Tax Settlement Scheme – An opportunity to close tax litigation

Update: 22.02.2020 – The tax settlement scheme which was initially proposed to cover litigation pending before Commissioner (appeals), Tax Tribunal, High Court, Supreme Court and international arbitration as on 31 January 2020 is expected to also cover matters under review by Dispute Resolution Panel (DRP), Revision applications before Commissioner and orders for which timeline for filing appeal has not expired as on 31 January 2020. The Government is going all guns blazing to make this scheme a success. A great opportunity for litigants.

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The Finance Minister, in her budget speech introducing the Finance Bill 2020 had announced bringing a direct tax settlement scheme with the intent of reducing over 4.8 lacs direct tax cases pending before various appellate authorities. In furtherance of the announcement, “The Direct Tax Vivad Se Vishwas Bill, 2020” has been introduced in the Parliament for consideration. The same will become effective from the date to be notified post approval by the parliament and presidential assent.

The scheme provides an opportunity to settle arrears of tax against appeals pending as on 31 January 2020 before the appellate forums [Commissioner (Appeal), Income Tax Appellate Tribunal, High Court and Supreme Court]. Where the arrears relates to disputed tax and interest & penalty on such disputed tax, there is a complete waiver of interest and penalty on payment of disputed tax by 31 March 2020. Payment beyond 31 March 2020 but within the last date (to be notified), will require additional payments of 10% of the disputed tax. Further where the tax arrears relates to disputed interest, penalty or fee, there will be a waiver of 75% of such amount if paid by 31 March 2020 and 70% where payment made beyond 31st March 2020 till the last date to be specified. The scheme further provided for immunity from prosecution.

The scheme requires the taxpayer to file a declaration before the designated Commissioner of Income tax who will within a period of 15 days from the date of receipt grant a certificate containing particular of tax arrears and the amount of tax to be paid. The taxpayer will thereafter be required to pay the tax determined within 15 days from the date of receipt of the certificate and intimate the payment thereof to the authorities. On issue of certificate, pending appeal before the Commissioner (Appeal) and Income tax Appellate Tribunal will be deemed to be withdrawn. With regard to appeals before High Court/Supreme Court or where proceedings for arbitration, conciliation or mediation have been initiated, the taxpayer will be required to withdraw the appeals. Rules and forms in relation to the scheme are yet to be notified.

The scheme leaves some open questions such as eligibility of tax payers who are yet to file appeal as on 31 January 2020 (within the timeline prescribed), impact on appeals deemed to be withdrawn before the appellate authorities upon issue of certificate where the taxpayer is unable to pay the liability with the 15 day timeline, adjustment of past pre-deposits, etc. Hopefully some FAQ’s will clarify on such aspect. Further, given the 15 days payment timeline, this may be a challenge for foreign companies not having operative bank account in India to facilitate money transfer. The Government may consider a mechanism to facilitate this.

Overall the tax settlement scheme is a welcome move by the government to reduce pending litigation. Tax payers should critically review their litigation exposure and avail the opportunity to get closure specifically where exposure of interest (due to long pending disputes), penalty and prosecution is high.

From Yatin’s Desk: MAT credit dilemma under 25% corporate tax rate option

In light of last week’s historical reduction in the corporate tax rates applicable during FY 2019-20, existing domestic companies (not availing tax exemptions/specified deductions) have the option to avail reduced corporate tax rate of ≈25%. Such companies have also been exempted from applicability of Minimum Alternate Tax (MAT). Companies not opting for such scheme will continue to be taxed at the current rate (≈29%/35%) and subject to MAT, albeit at the reduced rate of ≈ 17.5% vis-a-vis 21.5%.

In absence of MAT application to such companies or any change in MAT credit provisions specifically permitting set-off of MAT credit against 25% liability, the debate will continue for the next few days on the entitlement to set of unutilized MAT credit. However, if the view emerges against the set-off, it will be vital for companies to consider their MAT credit position before jumping into the perceptibly lucrative 25% tax regime. As a big picture, so long the companies have sufficient MAT credit, the liability can be restricted to 17.5% (MAT liability) by setting off excess liability computed (at general rate of 29%/35%) against MAT credit entitlement. Accordingly, it may be beneficial for companies to continue with the existing regime till the MAT credit is completely absorbed. There is always the option to exercise the 25% regime in future.

While the taxpayers do their math, it will be worthy if the government clarifies its position.

SC weighs in on interplay of labour laws and IBC

By Abhishek Dutta and Vineet Shrivastava, Aureus Law Partners

20 June 2019

India as a welfare state has enacted various labour laws in order to ensure the protection and promotion of the social and economic status of workers and the elimination of their exploitation.

Under the Indian constitution, trade union, labour and industrial disputes are included in the concurrent list, where both the central and state governments are competent to enact legislation, with certain matters reserved for the central government. In addition to these, the preamble of the constitution has secured social, economic and political justice, equality of status and opportunity. There have been some recent court decisions under the Insolvency and Bankruptcy Code, 2016, (code) that deal with the interpretation of labour legislation.

Recently, the Supreme Court, in the case of JK Jute Mill Mazdoor Morcha v Juggilal Kamalpat Jute Mills Company Ltd, upheld the insolvency application filed under section 9 of the code by a registered trade union considering it to be an operational creditor for the purposes of the code.

The National Company Law Tribunal (NCLT), while adjudicating the application filed by the trade union on behalf of nearly 3000 workers of the debtor, had held that the trade union was not covered as an operational creditor and had dismissed the insolvency application. In the appellate proceedings, the NCLAT had also dismissed the trade union’s application by stating that each worker could file an individual application before the NCLT.

The Supreme Court, after studying various provisions of the Trade Unions Act, 1926 (act), observed that a trade union being an entity established under the provisions of the act would fall under the definition of a person under section 3(23) of the code.

Further, rule 6, form 5 of the Insolvency and Bankruptcy (Application to Adjudicating Authority) Rules, 2016, also recognizes that claims can be made not only in an individual capacity but also conjointly.

Also, a trade union that is recognized under section 8 of the act can sue or be sued in its name. The Supreme Court relied on the judgment of the division bench of Bombay High Court in the case of Sanjay Sadanand Varrier v Power Horse India Pvt Ltd, where a winding-up petition by a trade union under section 434 read with 439 of the Companies Act, 1956, was held to be maintainable. On the basis of these observations, the Supreme Court was of the view that filing individual petitions would be burdensome as each worker would, therefore, have to pay insolvency resolution process costs, costs of the interim resolution professional, costs of appointing valuers, and so on.

It observed that since a trade union is formed for the purpose of regulating the relations between employees and their employer, it can surely maintain a petition as an operational creditor under the code. On the basis of this, the Supreme Court remitted the petition to the NCLAT to decide the matter on its merits.

In another case, Alchemist Asset Reconstruction Co Ltd v Moser Baer India Limited, an application was filed by the workers of the debtor in liquidation, praying for a direction to the liquidator to exclude the amount that is due towards their provident fund, gratuity fund and pension fund from the waterfall mechanism provided for under section 53 of the code. The liquidator was of the view that as per explanation II to section 53 of the code, “workmen’s dues” have the same meaning as that assigned to it under section 326 of the Companies Act, 2013, and therefore gratuity shall be included for the purposes of section 53 of the code.

The NCLT observed that “liquidation estate” as defined under section 36 of the code clarifies in unequivocal terms that all sums due to any employee from the provident fund, pension fund and gratuity fund are not to be included in the expression “liquidation estate”.

Accordingly, the NCLT relying on the judgment of the NCLT Bombay bench in the case of Asset Reconstruction Company (India) Ltd v Precision Fasteners Ltd held that employees’ dues towards pension, provident fund and gratuity were not to be included in the liquidation estate and would not, therefore, be recovered by way of waterfall mechanism provided for under section 53 of the code. It further issued directions to make available funds to the provident fund, gratuity fund and pension fund of the debtor company in case of deficiencies in the said funds.

NCLAT says statutory dues also operational debt

By Abhishek Dutta and Sayli Petiwale, Aureus Law Partners

7 May 2019

The National Company Law Appellate Tribunal (NCLAT) on 20 March 2019 dismissed a batch of appeals in the matter of PR Director General of Income Tax (Admn & TPS) v Synergies Dooray Automotive Ltd & Ors, which claimed taxes to be an exception to the definition of operational debt under section 5(21) of the Insolvency and Bankruptcy Code, 2016 (IBC).

The NCLAT held that taxes were subsumed within the definition of operational debt and tax authorities were operational creditors under IBC.

Abhishek Dutta id — **Abhishek Dutta**
Founder and managing partner
Aureus Law Partners

Section 5(21) of IBC: The appellants challenged section 5(21) of the IBC stating that the word “or” before the sentence “…a debt in respect of the payment of dues arising under any law for the time being in force payable to the Central Government…” should be interpreted as “and”. Therefore, they argued that: (i) debt would be related only to supply of goods or services rendered to the corporate debtor; and (ii) tax does not qualify as either, and would not be an operational debt.

Discussing the scope and nature of the term operational debt, the NCLAT, based on the precedents in statutory interpretation, considered the positioning of the words “or” as well as “and” in the provision. It observed that there was no ambiguity in the IBC and that the legislature has intentionally used the words “or” and “and” at different places in the provision.

The NCLAT, relying on the judgment in the Swiss Ribbons Pvt Ltd & Anr v Union of India & Ors (2018) case, held that “and” had to be read conjunctively while “or” had to be read disjunctively in the said provision. On the basis of this, the NCLAT held that statutory dues were operational debt.

The appellants argued that because the corporate debtors’ operation did not rely on statutory dues, the question of tax being an operational debt would not arise. The NCLAT, instead, observed that taxes had a direct nexus with the corporate debtor’s operation as they would not arise if the corporate debtor was not in operation.

Sayli-Petiwale-Aureus-Law-Partners — **Sayli Petiwale**
Associate
Aureus Law Partners

Based on the above, it held that statutory dues such as taxes were an operational debt; and tax authorities as such would qualify as operational creditors.

What the NCLAT did not discuss: Another argument made by one of the appellants was that liability under the tax statute is a first charge and therefore cannot be a part of the resolution plan. Although the NCLAT did not discuss this point, the case of Pr Commissioner of Income Tax v Monnet Ispat And Energy Ltd, is seminal in this regard, where the Supreme Court categorically adjudged that section 238 of the IBC overrides any statute inconsistent with it, including the Income Tax Act, 1961. Therefore, it would appear that having a first charge (under another statute) may become immaterial if a company enters the ambit of insolvency under IBC.

Ambiguity over tax statutes and IBC: This decision raises significant questions regarding the status of the tax authorities’ claims in light of the overriding effect of the IBC provisions.

In August 2018, High Court of Andhra Pradesh and Telangana, in Leo Edibles and Fats Limited v The Tax Recovery Officer case, permitted liquidation of assets of a company undergoing liquidation under IBC despite ongoing recovery proceedings by the income tax authorities.

The high court said in no uncertain terms that the income tax authorities could not be considered at par with secured creditors. The court also said that because the income tax authorities are not secured creditors, they must take recourse under section 53 of the IBC with regards to the distribution of assets and they would come fifth in the order of the disbursal of claims as taxes are a contribution to the Consolidated Fund of India. It is interesting to note here that section 53 of the IBC does not mention the term operational creditor.

With the NCLAT’s decision declaring the tax authorities as operational creditors, the ambiguity exists in the interplay between tax (dues) and the IBC. The tax department in October 2018 was reported to have prepared a proposal seeking the intervention of the Ministry of Finance to resolve the issue.

Recently, the Insolvency and Bankruptcy Board of India has reconstituted the Insolvency Law Committee as the Standing Committee to review the implementation of the IBC. It will be interesting to see what recommendations the committee will make on the issue of the ambiguity regarding tax and the IBC.

From Yatin’s Desk: Withholding tax (TDS) default, no more business as usual

Indian tax laws mandate payers to withhold taxes at source on payments to residents (in case of specified payments) and also non-residents (where their income is taxable in India). Non-compliance has penal consequences. While failure to withhold tax has interest and penalty implications (i.e. financial costs), consequences are severe in case of non-deposit or late deposit of tax collected leading to additional prosecution implications (financial+ criminal implications). Given the humongous amount of data collated by the Revenue Authorities and use of data analytic, it is not unusual to find show cause notices being issued to defaulter now days. However what should raise alarm for the defaulters is the fact that where the default relates to non/delayed deposit of taxes leading to prosecution proceedings, the Magistrate Courts are taking a serious view on the matter with defaulters being sentenced to imprisonment.

One recent case before the Ballard Pier Magistrate Court (Mumbai), related to a delayed payments of approx. INR 850K, which was paid with interest and also penalty. The Magistrate Court disregarded the plea of financial constraint and proceeded to convict the defaulter sentencing to 3 months imprisonment. Though, the decision is appealable before higher Appellate Courts, one needs to take note that such proceedings are highly complex, time consuming and financially expensive. Take for instance this specific matter – it related to withholding default in financial year 2009-10, criminal complaint before Magistrate Court was filed in 2004 and after almost 30 odd hearings/adjournments before the Magistrate Court, the proceedings concluded in April 2019; a 10 year saga, which will further continue for years before higher Courts.

It is also relevant to take note that where the defaulter is a Company, the direct impact is on the directors, who generally are proceeded against leaving it for them to defend their innocence. A clear message – by no means delay or fail to deposit taxes deducted if you want to be on the right side of law, else don’t complain of government action!!

From Yatin’s Desk: Changes proposed to the rules for attribution of income to Permanent Establishment

Attribution of profits to a Permanent Establishment (PE) of a Multinational Enterprises (MNE) in India has been a commonly ligated matter and marred with uncertainty. The Indian tax administration has placed for public comments report of the Committee constituted to examine the existing scheme of profit attribution to PE, with the intent of framing guidelines for profit attribution, bringing certainty and transparency. While the debate on the proposals will surely continue for long, the document is a valuable read for India’s position which highlight India reservation to the authorized OECD approach for PE income attribution.

The Committee in its report emphasizes the fact that the Indian tax treaties are predominantly based on UN Model Convection which under Article 7 legitimizes attribution of profits to a PE on the basis of apportionment of the total profits of the enterprise to its various parts. Such methods is adoptable where profits cannot be determined through a direct method i.e. based on verifiable books of accounts prepared as per acceptable accounting standards. In contrast, Article 7 of OECD model convention post 2010 advocates the approach of allocation taking into account the functions performed, assets used and risks assumed (FAR analysis) by the enterprise through the permanent establishment and through the other parts of the enterprise.

The Committee has observed that business profits are contributed by both demand and supply of the goods. Article 7 of the OECD Model Tax Convention and approach recommended by OECD (based on FAR) is purely supply side approach towards profit attribution and disregards the role of demand in contributing to profits attributable to PE. Further, the Indian tax treaties have not included the concept of Income attribution based on FAR as advocated by OECD model convention, thereby permitting attribution of profits in a manner different from the authorized OECD approach i.e. by resorting to the direct accounting method and where that may not be possible, by apportionment of profits.

Accordingly, the Committee has suggested PE profit attribution based on a combination of (i) profits derived from Indian operations and (ii) three factor method based on equal weight accorded to sales (representing demand), manpower and assets (representing supply including marketing activities). In other words, profits of the multinational enterprise will first be apportioned for India sales (amount arrived at by multiplying the revenue derived from India x Global operational profit margin). As a second step, such profits will be attributed proportionately to (a) sales within and outside India; (b) employees and wages within and outside India; and (c) assets deployed within and outside India for Indian operations, each with 33% weightage. Further to address a situation whether the multinational enterprise suffers losses or has profit margin less than 2%, a margin of 2% of revenue derived from India sale is proposed to be regarded as deemed profit for India operation, thereby recommending minimum base level taxation. With regard to digital economy, where nexus to taxation is attributed to the concept of significant economic presence, considering the role of users, a fourth factor (i.e. user intensity) needs to be further built into the income attribution formulae.

The OECD approach for income attribution based on FAR analysis, which the Committee regards as factoring only supply side attributes (and not demand) finds favour with the Committee where no sales takes place in India. For instance, where a multinational enterprise constitutes a PE in India and compensates the PE at arm’s length basis FAR analysis and further such enterprise does not have any sales in India, no further income will be attributable to India (in absence of any play of demand side factor). However, where sales are made in India, the reading of the Committee report suggests formulae based attribution would become the rule and additional income attributable would become taxable in India (post allowance of income apportioned to supply factors and offered to tax in India).

Given the development, there will be a significant transformation to the concept and impact on income attribution to permanent establishments in India, should the proposed recommendation be formulated into mandatory rules. The demand side factors which the Committee consider as an important consideration would seemingly lead to attribution of 33 percent of the profits derived from sale in India even if no further attribution is required to be made in absence of other factors. It will be interesting to see how the courts view the principles around income attribution in light of the divergence in OECD approach and Indian tax administration position.

Supreme Court upholds constitutional validity of IBC

By Abhishek Dutta, Vineet Shrivastava and Manish Parmar, Aureus Law Partners

3 April 2019

The Supreme Court, while deciding the constitutional validity of various provisions of the Insolvency and Bankruptcy Code, 2016 (code), in the case of Swiss Ribbons Pvt Ltd v Union of India, upheld the mandate of section 29A with minor distinctions. Section 29A of the code lists persons or entities not eligible to submit a resolution application in insolvency proceedings before the National Company Law Tribunal.

The challenge to the constitutional validity of section 29A, more particularly clause (c), was made on the grounds that it restricts the speedy disposal of a resolution process, and as such is contrary to the object of the code. Clause (c) of section 29A provides that a person who exercises control and management over a corporate debtor’s non-performing asset (NPA) account or who is a promoter of the corporate debtor, and at least one year has elapsed from the date on which such account was classified as NPA. is not qualified to be a resolution applicant.

A proviso to the provision makes exceptions in casesc where (1) the applicant discharges their debt under the said NPA accounts, (2) the applicant is a financial entity and is not a related party to the corporate debtor, and (3) the applicant has the control and management of the NPA accounts and is a promoter of the corporate debtor pursuant to a resolution plan approved under the code.

Section 29A(c) was challenged on the grounds that it brings about a blanket ban on all the promoters of the corporate debtor. Also, it does not provide any mechanism to bar unscrupulous promoters responsible for the stressed state of the corporate debtor and does not allow efficient managers to revive the corporate debtor, and is manifestly arbitrary.

Vineet-V-Shrivastava-Aureus-Law-Partners — **Vineet V Shrivastava**
Partners
Aureus Law

Also, it was contended that retrospective application of the provision has erroneously restricted the former promoters who may have the best resolution plan, resulting in the maximization of value, and as such is contrary to the object of the code.

Further, the classification of an account as NPA may be due to various reasons without the person being a willful defaulter. Restricting such a person from making a resolution application otherwise valid under the code is without any basis in law and rationality. Also, restricting relatives of former promoters (clause (h)), who do not have a business connection with such promoters, from submitting a valid resolution plan may not be a rational interpretation of the mandate of the code.

The Supreme Court, in upholding the constitutional validity of section 29A, observed that the Statement of Object and Reasons of the Insolvency and Bankruptcy Code (Amendment) Ordinance, 2017, clearly stated that persons, who with their conduct have contributed to the defaults of the corporate debtor, and are otherwise undesirable, may misuse the code to participate in the resolution process, and gain or regain control of the corporate debtor.

The retrospective application of the said provision was held to be valid on the basis of the fact that an applicant has no vested right for consideration and approval of its resolution plan (ArcelorMittal India Private Limited v Satish Kumar Gupta and Ors), and no vested right is being taken away by the retrospective application of section 29A.

Further, the Supreme Court observed that restricting an efficient erstwhile manager or promoter of the corporate debtor from making a resolution application under the code is valid. The court held that such persons do not have a vested right to make an application as they are also restricted from purchasing stressed assets of a corporate debtor under liquidation.

With regard to restrictions imposed on the relatives of such ineligible resolution applicant, the Supreme Court applied the doctrine of nexus (Attorney General for India & Ors v Amratlal Prajivandas & Ors), and observed that categories of persons qualified to be relatives under the code should not be considered to be ineligible resolution applicants under section 29A in the absence of any (real) connection with the business activity of former promoters or managers.

The above ruling of the Supreme Court furthers the principle that a person, owing to whose conduct the corporate debtor has gone into insolvency, should not be allowed to regain control of the stressed enterprise at a discounted value, and is in line with its judgment in the case of State Bank of India v V Ramakrishnan.

From Yatin’s Desk: Non tax filing prosecution risk

The Indian tax administration is taking strict action for non compliance under the India tax laws. The authorities have been launching penalty & prosecution proceedings for failure to file a tax return within the due date. While the tax provisions provide for an extended period for filing a belated return (till the end of the assessment year), the tax authorities have been identifying non filers and late filers and initiating penalty & prosecution proceedings, even if filed within the prescribed belated period.

Where prosecution proceedings are launched, the taxpayers may unfortunately have to go through the rigour of long drawn criminal proceedings before the Criminal Court to establish that the failure was not willful and absence of culpable mental state. Tax payers impacted by such action typically attempt as a first recourse quashing of prosecution proceedings through petition before the High Court. This unfortunately is unlikely to have much success considering the courts in such matters do not dwell into fact finding to establish bonafide of the taxpayer, (a domain of the criminal court) established through evaluation of facts and examination of witnesses.

Where penalty proceedings are simultaneously launched, which would ordinarily be the case, a favourable outcome before the Appellate Tribunal, on merits, would have a direct bearing on the prosecution proceedings before the trial court. The Appellate Tribunal being a final fact finding authority, if on appreciation of facts does decided that the tax payer had bonafide reasons for not being able to comply with the filing obligation, such determination would be a significant finding for discharge from criminal proceedings or alternatively quashing of prosecution proceedings through application to the High Court. A tax payer will be better off establishing the facts and circumstance before the Tax Tribunal than the Criminal Court. Proceedings before Criminal Court can rather be intimidating for an ordinary tax payer who may just be overwhelmed by the sheer thought of seeking a bail, examination and cross-examination of witness, the longevity of proceedings, etc.

Given the serious implications of prosecution proceedings, it will be extremely important for the impacted tax payers to have a well thought through strategy to address the challenges of such proceedings.

IBC: Law of guarantees and corporate insolvency process

By Abhishek Dutta, Vineet Shrivastava and Manish Parmar, Aureus Law Partners

19 March 2019

The National Company Law Appellate Tribunal (NCLAT), in its recent ruling in the case of Vishnu Kumar Agarwal v Piramal Enterprises Ltd, while examining the validity of an application made under section 7 of the Insolvency and Bankruptcy Code, 2016 (code), against corporate guarantors, held that: (1) there is no bar on filing two simultaneous applications under section 7 against the principal borrower as well as the corporate guarantors and against both guarantors; and (2) it is not necessary to initiate a corporate insolvency resolution process (CIRP) against the principal borrower before initiating a CIRP against the corporate guarantors.

The NCLAT was hearing the appeal preferred by one of the shareholders against the order of the National Company Law Tribunal, New Delhi, initiating CIRP against the corporate guarantors.

The CIRP proceedings were initiated as the principal debtor, being a society, was not amenable to the insolvency proceedings under the code.

Moreover, two separate insolvency applications were filed by the creditor and admitted simultaneously against the two corporate guarantors for the same claim amount and default.

The NCLAT held that the liability of the corporate guarantors is coextensive with the principal debtor, and consequently there is no requirement under the code to exhaust the remedies against the principal debtor before initiating proceedings against the corporate guarantors, as laid down by the Supreme Court in the case of Bank of Bihar v Damodar Prasad and Anr (1969) and State Bank of India v Indexport Registered and Ors(1992).

Further, it held that once, for the same set of claims, an application under section 7 filed by the financial creditor is admitted against one of the corporate debtors (principal borrower or corporate guarantors, the financial creditor cannot subsequently initiate a CIRP against the other corporate debtor (the corporate guarantors or the principal borrower) for the same set of claims and default.

Vineet Shrivastava Partner Aureus Law Partners — **Vineet Shrivastava**
Partner
Aureus Law Partners

This case also follows the Supreme Court’s judgment in the case of State Bank of India v V Ramakrishnan (applicability of moratorium to the corporate guarantors), denying the corporate guarantors the option of insulating themselves from the recovery proceedings as against the default by the principal borrowers or debtors.

By upholding the principles of law of guarantee to insolvency applications made under the code, the above ruling once again provides an insight into the principles of interpretation of the provisions of the code in consonance with the provisions of the Indian Contract Act, 1872 (act).

However, the tribunal did not deal with situations where the creditor may choose to claim only a part of the debt from one of the corporate guarantors. This question is still open to interpretation. In this regard, it may be pertinent to consider sections 146 and 147 of the act, which provides for the limit of liability of the guarantors in accordance with the contract of guarantee. Hence, the validity of applications filed simultaneously in such situations remain a contentious issue.

The above ruling is in contrast with an earlier order of the NCLAT in the case of Export Import Bank of India v CHL Limited. In this case, the tribunal held that where the reconciliation of the claim amount is pending with the principal borrower, the creditor cannot proceed to issue proceedings against corporate guarantors.

Only when the principal borrower fails to pay the reconciled amount, would the creditor be entitled to invoke the corporate guarantee against the corporate guarantors. The connected question, however, is if there are reconciliation issues pending in relation to the claim amount, would the same qualify as a dispute under the code?

The ruling in the CHL Limited case can be distinguished from the Vishnu Agarwal case judgment in as much as the amount claimed was not settled with the principal borrower, and the reconciliation of the interest was pending.

However, leaving aside the distinction in the factual matrix it will be interesting to see how these two conflicting judgments will be applied in the future. At the time of publication, the Vishnu Agarwal judgment has been appealed in the Supreme Court and is pending admission. Hence, it would be relevant to see the Supreme Court’s view on this.

Existence of dispute under insolvency code

By Abhishek Dutta, Vineet V Shrivastava and Manish Parmar, Aureus Law Partners

2 February 2019

Under the Insolvency and Bankruptcy Code, 2016, the corporate insolvency resolution process (CIRP) can be initiated by an operational creditor if there is no dispute in relation to the default on the part of the corporate debtor.

Abhishek Dutta Aureus Law Partners — Abhishek Dutta
Aureus Law Partners

The application filed with the National Tribunal (NCLT) must be preceded, under section 8, by a demand to repay the debt. The corporate debtor should, within a period of 10 days from the date of receipt of notice, either repay the unpaid operational debt or mention the existence of a dispute or record of the pending suit or arbitration proceedings filed before the receipt of such notice or an invoice in relation to such a dispute.

While a record of a pending suit or an arbitration proceeding filed before the receipt of notice or invoice in relation to the dispute would lead to an immediate cessation of further proceedings, the stand-alone term “dispute” has lent itself to interpretation by the courts. Under section 5(6) of the code, “dispute” includes a suit or arbitration proceedings relating to (a) the existence of the amount of debt; (b) the quality of goods or service; or (c) the breach of a representation or warranty.

Evaluation of dispute: The definition clause provides that the term “dispute” shall include a suit or an arbitration proceeding. Principles of statutory interpretation provide that the word in respect of which “includes” is used, bears both its extended statutory meaning and its ordinary, popular and natural sense, whatever is properly applicable. Also, the definition in relation to which “includes” is used would have an extended meaning, and cannot be restricted to receive its ordinary, popular and natural meaning.

Further, where the word is defined to “include” something, the definition is prima facie extensive. The word “include” is generally used in interpretation clauses in order to enlarge the meaning of words or phrases occurring in the statute. It is also instructive to note that in the code as enacted, the word “includes” was substituted for the word “means”, which occurred in the Insolvency and Bankruptcy Bill.

In view of the above, the meaning of the term “dispute” as defined in the code would include other forms of dispute which have not culminated in judicial proceedings, in addition to the suit or arbitration proceedings.

According to the definition of “dispute”, suits or arbitrations are examples of dispute. However, such suits or arbitrations should be specifically related as provided under section 5(6) of the code.

As discussed, being inclusive, the definition of “dispute” can be extended. The Supreme Court, in Mobilox Innovations Pvt Ltd v Kirusa Software Pvt Ltd (2017), held that the dispute in the form of suits or arbitration proceedings must relate to one of three conditions laid down under section 5(6) of the code either directly or indirectly. Further, the Supreme Court has held that passing of an arbitral award and steps taken to challenge the arbitral award constitutes a valid dispute with regard to operational debt, as well as a pending appeal under the Arbitration and Conciliation Act, 1996.

A part settlement of the disputed amount as opposed to arbitration proceedings would not entitle the creditor to contend that a dispute did not exist.

Existence of dispute: The Supreme Court has observed that the dispute must be pre-existing prior to the receipt of the demand notice or invoice. A dispute raised after the application for CIRP cannot be a ground for rejection of such application.

Manish Parmar Aureus Law Partners — Manish Parmar
Aureus Law Partners

The true meaning of section 8(2)(a) read with section 5(6) of the code clearly brings out the intent of the code, that the corporate debtor must raise a dispute with sufficient particulars. In case a dispute is being raised by showing the records of dispute in a pending suit or arbitration, the dispute must also be relatable to the conditions provided under section 5(6). In addition, such dispute should have been raised with or brought to the notice of the creditor.

Hence, for rejection of an insolvency application, the adjudicating authority does not have to go into the merits of the dispute as to whether such a dispute would withstand judicial scrutiny. However, it is important that the authority determines two things – firstly that the dispute raised is valid in its estimation and secondly that the dispute has been brought to the notice of the creditor before the notice is served. The first of these two aspects is subjective, but the second is an objective assessment. Remedying this, in the authors’ view, would lead to better solutions under the law.