India: Insolvency Code: Another Look Through Rose Tinted Glasses?

Last Updated: 9 April 2018
Article by Prachi Dave and Divyata Badiani

Insolvency, explained simply, refers to an individual or an entity's inability to pay debts due from it. The recent and most illustrious enactment by the Parliament, the Insolvency and Bankruptcy Code, 2016 ("IBC") encompasses this wide-ranging arena of insolvency and bankruptcy.

Prior to the introduction of the IBC, the resolution process was governed by the Sick Industrial Companies (Special Provisions) Act, 1985 ("SICA"), Maharashtra Relief Undertaking (Special Provisions) Act, 1958 ("BRU"), Corporate Debt Restructuring ("CDR"), Joint Lenders Forum ("JLF"), etc. The CDR and its successor JLF mechanism were voluntary in nature unlike the SICA and BRU which were statutory. However the key difference between the aforesaid and the IBC remains that while the SICA and BRU applied to a specific set of borrowers, the CDR and BRU apply to specific set of lenders who have agreed to follow the said voluntary process by signing the Inter Creditor Agreement and the Debt Creditor Agreement. The IBC now seeks to include all borrowers and lenders within its fold and the insolvency resolution process under the IBC has been applauded for the attempt to revive companies in an efficient and timely manner which its predecessors failed in, due to unending delays caused by erring promoters/ borrowers leading to the ultimate failure of the resolution process in most cases.

A key question, however, which has risen in the recent cases of the insolvency resolution is whether the said process being exploited by the financial creditors. The financial creditors to several of the defaulting companies which are presently undergoing insolvency resolution process have previously entered into the erstwhile debt resolution mechanism. A classic example would similar to the case of Innoventive Industries Limited where the lenders entered into a debt resolution process prevalent under the extant laws (the BRU in the instant case). However, the lenders subsequently filed for insolvency under the IBC and one of the defenses taken by the company was that it was categorized as a "relief undertaking" under the BRU. The largely debated issue in the said case remained as to whether the stand still period under provisions of Section 4 of the BRU could override the provisions of the IBC (particularly Section 238 thereof). The NCLT inter alia held the IBC would prevail over the BRU Act as the IBC was enacted subsequent to the BRU Act and the latter law prevails over the former one. On appeal to the NCLAT, it was held that that the protection under the BRU Act cannot be extended to other legislations especially to the IBC which is a union legislation and relates to insolvency resolution. 

Another aspect of this case however requires careful consideration. Pursuant to the debt resolution process under the BRU, Innoventive and its lenders entered into a Master Restructuring Agreement ("MRA"). Typically the terms of the MRA involve waivers by the lenders of the liquidated damages, interest during the moratorium period, haircut on their returns and/or a sacrifice of the principal as the facts of the case may require ("Lenders' Waivers"). However, the NCLAT held as follows regarding the MRA:

"As far as the Master Restructuring Agreement dated 8 September 2014 (MRA) executed between the Financial Creditor and the Corporate Debtor was concerned; the Corporate Debtor cannot take advantage of the same. Even if it was presumed that fresh agreement came into existence, it does not absolve the Corporate Debtor from paying the previous debts which was due to the Financial Creditor"

Prima facie the aforementioned observation of the NCLAT seems to be perhaps in contravention of all agreed principle of Indian Contract Act, 1862 ("Contract Act").

Section 62 of the Contract Act clearly states:

"Effect of novation, rescission, and alteration of contract

If the parties to a contract agree to substitute a new contract for it, or to rescind or alter it, the original contract need not be performed.


  1. A owes money to B under a contract. It is agreed between A, B and C, that B shall thenceforth accept C as his debtor, instead of A. The old debt of A to B is at an end, and a new debt from C to B has been contracted.
  2. A owes B 10,000 rupees. A enters into an agreement with B, and gives B a mortgage of his (A's) estate for 5,000 rupees in place of the debt of 10,000 rupees. This is a new contract and extinguishes the old.
  3. A owes B 1,000 rupees under a contract, B owes C 1,000 rupees. B orders A to credit C with 1,000 rupees in his books, but C does not assent to the agreement. B still owes C 1, 000 rupees, and no new contract has been entered into."

On a bare reading of the said Section 62 it is clear that once the contractual understanding has been revised/modified, the parties are not bound to perform their original contractual obligations. In the present context, the impugned judgement of the NCLAT seems to indicate that a master restructuring agreement would not override a loan agreement which has been originally been entered into. It is relevant to note that the MRA is nothing but a subsequent contractual understanding specifically meant to override the prior understanding as contained in the original loan agreement. It is relevant to note that MRAs are based on free and unconditional consent, entered into by the parties on each side with due and legal consideration.

The question that now arises is whether the said agreement can be unilaterally terminated or rescinded. Section 37 of the Contract Act states that the parties to a contract must either perform, or offer to perform, their respective promises, unless such performance is dispensed with or excused under the provisions of this Act, or of any other law. It is therefore relevant to consider whether the IBC waives the performance of such contract by the lenders or the borrower. The IBC proceeds on the basis that the creditors have a "claim" in respect of the corporate debtor and therefore requires an underlying contractual arrangement in respect whereof a claim can be made. The loan agreement is one such arrangement. However, the question therefore which begs consideration is whether claims ought to arise under the MRA or whether the MRA has no meaning under the IBC as a contractual arrangement.

It appears that the ratio descidendi of the NCLAT appears to be in contravention of the provisions of Section 62 read with Section 37 of the Contract Act. The Supreme Court, in appeal, has upheld the judgement of the NCLAT in the Innoventive Industries. As regards whether the lenders can reclaim the dues which have been waived under the MRA once again under the IBC, the Supreme Court has not dealt with the issue since same was raised by the corporate debtor before the Supreme Court for the first time. 

If upheld, the parties may legally rescind their obligations as per their whims and fancies despite all the essentials of a contract, as under prevailing laws, being complied with and leading to utter chaos. In the meantime, this decision of the NCLAT has been widely applauded by the financial creditors as the law allow them to absolve their agreed understanding without recourse to the corporate debtor. Until the law is suitably amended and the ruling overturned, the lenders and other market players are merrily looking at the IBC through rose tinted glasses.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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