[The Viewpoint] Effect of breach of settlement agreement under Insolvency & Bankruptcy Code

The Insolvency and Bankruptcy Code, 2016 (IBC) being a relatively new legislation, has witnessed inconsistent interpretation of its various provisions, especially in respect of certain legal issues which are not specifically dealt with under its existing provisions.

One such interesting legal issue is the effect of breach of settlement agreements entered into between two parties, where one party promises to pay a certain amount to the other party. This article makes an attempt to deal with the impact of breach of a settlement agreement signed between two parties and the applicability of IBC, in the following circumstances:

1. Breach of a settlement agreement entered during the pendency of IBC proceedings;

2. Maintainability of IBC proceedings against breach of a Settlement Agreement

The above issue assumed relevance on account of conflicting judgments passed by different benches of the National Company Law Tribunal (NCLT) across the country. Can a petition initiating the Corporate Insolvency Resolution Process (CIRP) against a Corporate Debtor, which is withdrawn under Section 12A of IBC pursuant to a settlement agreement executed between the parties, be revived, in the event of breach of provisions of such settlement agreement by the Corporate Debtor? Since there were conflicting judgments on this issue, there was no uniformity, resulting in total confusion regarding the rights of creditors in this situation. The following question thus arose for consideration:

“Whether, the CIRP shall revive automatically in case of breach of settlement agreement or whether the creditor shall be required to file a fresh application under the IBC?”

In the judgment of Vaishno Industries Pvt Ltd v. Horizon Global Ltd, NCLT Delhi rejected the application seeking revival of the application and instead granted liberty to the Operational Creditor to file a fresh application. However, in the matter of JFE Shoji Steel India Private Limited v. Danke Technoelectro Pvt Ltd, NCLT Ahmedabad allowed the Operational Creditor to revive and restore the application in case of any default committed by the Corporate Debtor in adhering the terms of the settlement agreement.

However, the above controversy has been settled in the recent judgment of M/s ICICI Bank Limited v. M/s OPTO Circuits (India) Limited, whereby the National Company Law Appellate Tribunal (NCLAT) Chennai Bench has held that the CIRP can be revived in case of failure to abide by the terms of the settlement agreement executed between the parties.

Factual Background

In this case, the appellant bank (Financial Creditor) had extended some credit facilities to the Corporate Debtor, who defaulted and a debt to the tune of ₹1,07,85,59,340.96/- fell due against the Corporate Debtor. Pursuant to such default, the appellant bank initiated proceedings under Section 7 of IBC, before NCLT Bengaluru. Consequently, NCLT Bengaluru admitted the application filed by the appellant bank vide order dated March 18, 2020 and initiated CIRP against the Corporate Debtor.

The Corporate Debtor challenged the above order by filing a writ petition before High Court of Karnataka and the order admitting the above application was stayed by the High Court. During the pendency of the writ petition, on April 22, 2020, the Corporate Debtor approached the appellant bank with one-time settlement (OTS) proposal, agreeing to pay a sum of ₹22.7 crore as full and final settlement, which was accepted by the appellant bank vide OTS letter dated July 10, 2020.

Subsequently, an application under Section 12A of the IBC was filed by the Corporate Debtor before NCLT, Bengaluru, seeking termination of CIRP, in view of the settlement agreement signed between the parties. During the course of the hearing, the appellant bank filed a memo seeking liberty to revive/restore the order dated March 18, 2020, in the event of failure of the Corporate Debtor to adhere to the terms of settlement. However, the NCLT Bengaluru, vide order dated August 17, 2020, refused to allow the request made in the memo and instead granted liberty to the appellant to file a fresh application in accordance with the provisions of the IBC. Feeling aggrieved by such order, an appeal was preferred by the appellant bank before NCLAT.

Findings of NCLAT

The NCLAT, while setting aside the order of NCLT, Bengaluru, observed the following:

• The NCLAT relied upon the decision passed by NCLAT Delhi in the matter of Vivek Bansal v/s Bruda Druck India Pvt Ltd which was in respect of proceedings initiated by an operational creditor under IBC. It was held that in the event of default by the Corporate Debtor and not adhering to the terms of settlement agreement with respect to outstanding instalments, the Operational Creditor shall be at liberty to seek revival/restoration of the CIRP.

• While relying upon the above judgment, it was held that NCLT, Bengaluru committed a grave error by ignoring the precedent settled in the judgment of Vivek Bansal and by refusing to give liberty to the appellant to revive/resume the CIRP. It was specifically held that in case, the Corporate Debtor failed to adhere the terms of settlement in a strict sense as agreed with the appellant bank. It was also observed that the decision of NCLT Bengaluru was erroneous, and against the principles of natural justice.

Though the position with respect to Operational Creditors was settled some time ago in the matter of Vivek Bansal, insofar as Financial Creditors are concerned, this judgment settles a very important question of law.

Maintainability of IBC proceedings against breach of a settlement agreement

The issue whether one can maintain proceedings under IBC for failure to comply with the terms of a settlement agreement, whereby one party has agreed to pay some amount to another party, is another significant legal issue. Insofar as this issue is concerned, once again, various benches of the NCLT differ in their opinion. The NCLT Hyderabad Bench, in the matter of SEW & Prasad, Joint Venture v. Gati Infrastructure Private Limited, admitted an application filed under Section 9 of the IBC on the basis of a breach of settlement agreement executed between the parties. Whereas the NCLT Allahabad Bench, in the matter of Delhi Control Devices (P) Limited vs. Fedders Electric and Engineering Ltd, held,

“unpaid instalment as per the settlement agreement cannot be treated as operational debt as per section 5(21) of IB Code. The failure or Breach of settlement agreement can't be a ground to trigger CIRP against Corporate Debtor under the provision of IBC 2016 and remedy may lie elsewhere not necessarily before the Adjudicating Authority.”

The above decision of the Allahabad Bench has been relied upon and followed in many matters by different benches of NCLT.

The above controversy was resolved by the judgment of NCLAT, Delhi in Amrit Kumar Agrawal v. Tempo Appliances Pvt. Ltd, wherein while discussing this issue, it was observed that a mere obligation to pay does not bring the liability within the ambit of ‘financial debt’ as defined under IBC. The debt, along with interest, if any, should be disbursed against the consideration for the time value of money. Mere breach of terms of any agreement including a settlement agreement by a party, whereby some payment was due, would not fall within the scope of Section 5(8) of IBC, so as to constitute a financial debt.

Accordingly, it was observed that mere obligation to pay under a settlement agreement would not amount to disbursal of amount for consideration against the time value of money. Thus, breach of such obligation would not entitle a party to invoke CIRP against the other party. It was also observed that dishonour of cheques handed over pursuant to the settlement agreement cannot be termed as a financial debt.

Considering the abovementioned judgments, the position with respect to settlement agreement entered into between the parties and the effect of IBC on such settlement agreement has become crystal clear. It can be concluded that in a case where, after the initiation of IBC proceedings, parties entered into a settlement agreement and there is a breach by the debtor, the creditor - whether a financial creditor or an operational creditor - has the liberty to revive the IBC proceedings. However, in a case, where a party wishes to avail the remedy under IBC for breach of the terms of a settlement agreement, an application under IBC shall not be maintainable.

Abhishek Kumar and Aditi Tayal are Partner and Associate respectively at Singhania & Partners