The Insolvency and Bankruptcy Code, 2016 (“IBC”) was enacted to address insolvency and facilitate corporate resolution, not to adjudicate complex commercial disputes or operate as a debt recovery tool. However, as Indian companies increasingly operate within global corporate structures, insolvency tribunals are required to grapple with issues that extend far beyond traditional debtor-creditor relationships.
One such emerging issue lies at the intersection of insolvency law, foreign sanctions, contract law, and cross-border compliance before the National Company Law Tribunals (“NCLT”): Can a corporate debtor be said to have committed a “default” under the IBC where payment to a creditor is allegedly prohibited by a foreign sanctions regime?
The answer may shape how Indian insolvency law interprets “default”, how far summary insolvency jurisdiction extends, and whether tribunals should recognise the practical consequences of unilateral foreign sanctions.
The issue arises from the designation of certain Indian companies on the Specially Designated Nationals (“SDN”) List maintained by the Office of Foreign Assets Control (“OFAC”) of the United States Department of the Treasury pursuant to Executive Order 13846 concerning Iran-related sanctions. An SDN designation generally blocks property and interests in property within US jurisdiction and prohibits US persons from dealing with designated persons. In practice, Indian subsidiaries of US-based multinational corporations often operate under global compliance frameworks that require adherence to not only Indian law but also to compliance obligations arising from the laws applicable to their foreign parent company. This becomes particularly significant when a creditor of such an Indian subsidiary is designated on SDN by OFAC. In terms of US sanctions regime, Indian subsidiaries of U.S. parent companies are also legally restricted from transacting or making payments to other Indian companies that are sanctioned by OFAC. Any payment to an OFAC-designated creditor may expose the Indian subsidiary and its US parent to substantial legal and commercial consequences. However, sanctioned Indian companies initiate insolvency proceedings against the Indian subsidiary of US companies, contending that the debt remains payable under Indian law and that foreign sanctions cannot defeat legitimate commercial claims arising from transactions undertaken in India. The core dispute is whether foreign regulatory restrictions can affect an Indian insolvency claim.
The controversy has already surfaced in Flint Group India Private Limited v. C J Shah & Co., where the NCLT Ahmedabad, by order dated March 26, 2026, considered whether OFAC sanctions could justify non-payment of operational dues. The Tribunal rejected the sanctions defence. However, the said order is pending consideration in appeal before the National Company Law Appellate Tribunal (“NCLAT”), which is kept in abeyance, clarifying that it should not be treated as precedent. The appeal may determine whether sanctions-related payment restrictions can defeat or at least defer an IBC proceeding.
At the heart of the debate lies the statutory definition of “default” under Section 3(12) of the IBC, which refers to non-payment of a debt when the whole or any part of the debt has become due and payable. Traditionally, tribunals have focused on whether a debt exists and whether it remains unpaid. The sanctions cases, however, force tribunals to examine a more nuanced question: Can a debt be regarded as “payable” if payment is allegedly prohibited by foreign law?
The debtor’s argument is that if payment itself becomes legally prohibited due to sanctions compliance obligations, then the debt may exist but is not immediately payable, therefore non-payment cannot automatically amount to default. This draws from a long-established principle that the law does not compel performance of legally impossible acts. However, the competing view is equally persuasive that a debt does not cease to exist merely because payment becomes inconvenient, risky or even temporarily restricted. Allowing foreign sanctions to excuse payment could undermine the enforceability of legitimate commercial claims under Indian law.
The debate between these positions reveals the absence of a settled doctrinal framework for addressing sanctions-related disputes under the IBC.
A second debate concerns institutional competence. The Supreme Court has repeatedly emphasised that insolvency proceedings are not intended to become substitutes for civil suits or commercial litigation. In Mobilox Innovations Private Limited v. Kirusa Software Private Limited, Supreme Court held that a Section 9 application must be rejected where there is a genuine pre-existing dispute that is not spurious, hypothetical or illusory. In Swiss Ribbons Private Limited v. Union of India, Supreme Court held that IBC is a resolution mechanism and not a debt recovery mechanism.
Sanctions disputes, however, often require interpretation of foreign legislation, regulatory guidance, compliance risks and consideration of cross-border corporate structures – matters better suited for commercial courts and arbitral tribunals than summary insolvency proceedings. Thus, if correspondence before the demand notice records sanctions concerns, banking refusal or licence requirements, the NCLT may only need to decide whether the dispute pre-existed and is plausible, not whether it will ultimately succeed.
The issue also intersects with contract law. Many commercial contracts contain force majeure or change-in-law clauses covering governmental action or regulatory restrictions. A party may argue that sanctions suspend payment obligations or render performance legally impossible. Whether such a clause applies or not requires contractual interpretation. That exercise may itself support the existence of a dispute, particularly in operational creditor proceedings under Section 9.
The analysis has been affected by the recent OFAC’s temporary Iran-related general licence, reportedly permitting certain transactions involving Iranian-origin crude oil, petroleum products and petrochemical products until 21 August 2026. If a lawful route for payment exists, the argument of impossibility may weaken. However, the licence appears limited in scope and may not automatically authorise every payment to every sanctioned Indian entity. In any event, the relevant inquiry in a Section 9 case is usually whether a default and a bona fide dispute existed when the demand notice was issued and the application was filed. A subsequent relaxation may enable settlement or payment, but it may not retrospectively erase a pre-existing dispute. Companies may still require legal opinions, bank clearances and internal approvals before processing payments involving sanctioned counterparties.
A larger issue is whether Indian insolvency law should recognise unilateral foreign sanctions at all. Unlike UN-mandated sanctions or domestic legislation, unilateral sanctions do not automatically acquire legal force in India. Indian courts are therefore cautious in allowing foreign public laws to dictate domestic rights and obligations. However, the practical reality is that multinational entities structure their conduct around global compliance obligations, irrespective of whether those obligations are formally incorporated into Indian law. Foreign subsidiaries often face significant regulatory consequences if they engage in transactions involving sanctioned entities. Thus, foreign sanctions influence commercial conduct even without formally constituting part of Indian law. The challenge lies in balancing commercial reality without allowing sanctions to become a blanket excuse for non-payment.
This also raises a policy concern. If payment restrictions are temporary or capable of being addressed through licences, approvals or alternative mechanisms, insolvency may be an inappropriate remedy. This concern becomes particularly pronounced when the corporate debtor remains commercially solvent and the dispute revolves around the legality of payment rather than the financial inability to pay.
The pending NCLAT appeal is likely to provide much-needed clarity on key questions: whether sanctions-related restrictions affect “default” under Section 3(12), whether they constitute a pre-existing dispute under Mobilox, how far tribunals should examine foreign regulatory regimes, and whether later authorisations can affect pending proceedings.
The sanctions-related insolvency disputes underscore the challenge of aligning domestic insolvency principles with cross-border regulatory obligations. The forthcoming decisions may determine whether sanctions-related payment restrictions are treated as a defence to default, a pre-existing dispute, or merely a collateral commercial concern. With the Ahmedabad ruling pending under challenge before the NCLAT and OFAC having granted temporary sanctions relief until 21 August 2026, the legal and commercial landscape continues to evolve.
Whatever position ultimately prevails, one conclusion is evident: the meaning of “default” under the IBC is likely to be tested in ways that were unimaginable when the Code was first enacted. The central question “whether a debtor can be said to have defaulted when payment is allegedly restricted by law” will shape the future of insolvency law in a sanctions-sensitive global economy.
About the authors: Yogendra Aldak is an Executive Partner and Tamanna Sharma is a Senior Associate at Lakshmikumaran & Sridharan attorneys.
Disclaimer: The opinions expressed in this article are those of the author(s). The opinions presented do not necessarily reflect the views of Bar & Bench.
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