Right to claim set-off in CIRP: A Shift in the Landscape

[By Manisha Soni]

The author is a student of Gujarat National Law University.

 

Introduction

Recently, the Supreme Court of India, in the judgment of Bharti Airtel Ltd. vs Vijaykumar V. Iyer, solidified the position of the National Company Law Appellate Tribunal (NCLAT) that the arrears can not be set off when a Corporate Debtor is going through Corporate Insolvency Resolution Proceedings (CIRP), under the Insolvency and Bankruptcy Code, 2016 (IBC).  

This provided a crucial clarification of the prevailing legal intricacies and upheld the legislative purpose of the code. Through this article, the author aims to simplify the wisdom inherent in the judgment, considering the legislative intent and the potential ramifications of permitting set-offs in the CIRP. The author proposes that set-offs are not inherently contradictory to insolvency law and can be accommodated within the framework of the IBC. 

Factual matrix 

Airtel entities were engaged in spectrum trading agreements with Aircel entities to seek the right to use spectrum. Aircel entities faced demands from DoT for bank guarantees related to license and spectrum usage dues. Upon request, Airtel agreed to furnish these guarantees on Aircel’s behalf, deducting the same from consideration payable under spectrum transfer agreements. However, the Telecom Disputes Settlement and Appellate Tribunal (TDSAT) declared DoT’s demand untenable; and the bank guarantees were asked to be returned. 

In the meanwhile CIRP was initiated against Aircel entities. Airtel entities, having paid for Aircel entities, submitted a claim to set-off, asserting it as the net amount owed by Aircel entities for operational charges. Adjudication of such claims of Airtel for set-off during CIRP against Aircel created the challenge for insolvency legislation.  

The Resolution Professional (RP) asked Airtel to pay Rs. 112 crores to Aircel, who was undergoing CIRP. This was objected to by Airtel entities in NCLT Mumbai.  

The Adjudicating Authority in Mumbai initially allowed Airtel entities the right to set off. However, the NCLAT overturned this decision, contending that such a set-off is antithetical to the objective of insolvency legislation.  

Analysis of the Judgment  

In common language, the term ‘Set-off’ is an instrument that cancels mutual financial obligations between two parties by allowing one party to reduce the amount it owes to a second party by the amount the second party owes.  

Arguments by Airtel 

Since the United Kingdom’s Insolvency legislation has served as a model for IBC law in India, the Airtel representative relied on Insolvency set-off provisions in the UK. ‘Insolvency set-off’ applies when demands are between the same parties, even when several distinct transactions exist between them. 

The pre-requisites of set-off u/s 323 of the UK Insolvency Act 1986, to claim set-off is when mutual credit and debt arise from ‘mutual dealings’ between the parties prior to the commencement of the bankruptcy. Airtel relied on the UK legislation and the case of HC of Kerela, where the judges allowed set-off and held even different, independent, transactions between parties as ‘mutual dealings’ under the Kerela Insolvency Act, 1955. 

Airtel argued that the concept of set-off was permissible in India pre-IBC. Section 529 of the Companies Act 1956 and section 325 (now omitted) of the Companies Act 2013 did allow for set-off. Section 44 of the Provincial Insolvency Act 1920, contingent on certain conditions, permitted creditors’ right against the corporate debtors to set-off. 

Order VIII Rule 6 of the Code of Civil Procedure, 1908, of India provides statutory set-off. To claim set-off under this rule, the amount should be ascertained.  

After the advent of IBC in insolvency legislation, set-offs started to derive legitimacy under section 173 of IBC, where set-offs are allowed in partnership and individual bankruptcies. Apart from that, regulation 29 of the Insolvency and Bankruptcy Board of India (Liquidation Process) Regulation, 2016 provides for set-off on account of mutual dealings.   

SC Judgment 

The SC held that the nature of corporate debtors changes after the commencement of CIRP. Hence, any claim for set-off cannot be raised after CIRP. The Hon’ble Court rejected the applicability of set-off provisions of CPC in CIRP due to the presence of section 238 of IBC, which states that provisions of IBC override all other laws.  

Regulation 29 of the Liquidation Regulations provides for mutual dealing and set-off but does not apply to Part II of the IBC, which deals with CIRP.  

The court, however, permitted contractual set-off if the date of such set-off was before the CIRP was initiated. A contractual set-off is a mutual agreement to permit set-off and adjustment. The CIRP does not preclude it.  

Set-offs are contrary to the common law doctrine of pari passu and anti-deprivation. Though the doctrine of pari passu is not explicitly mentioned in the IBC, an interpretation of the existence of the doctrine can be drawn from section 53 r/w section 52 of the IBC, as these provisions provide for the hierarchy of creditors during the distribution of value arising out of liquidation. This arrangement gives primacy to an operational creditor over a financial creditor should the operational creditors claim of set-off be permitted. 

Due to the set-off, the liquidation estate’s value gets depleted, consequently affecting the dividend distribution among the rest of the creditors. The doctrine of anti-deprivation discourages this. This doctrine enumerates that a creditor can not obtain a better position than the law explicitly provides during bankruptcy. SC applied the essence of both doctrines in this matter.  

The provisions related to CIRP do not provide for insolvency set-off, and the court refuses to extend it through implication. Unlike contractual set-off, Insolvency set-off is not self-executing in nature. 

The creditor who wants to exercise set-off can do so from the assets excluded from the liquidation estate to the extent of the set-off value, u/s 36(4) of IBC. Such creditors are often given preferred status in assets statutorily excluded from the liquidation estate.  

No new rights are created due to the rejection of rights to claim set-off, and the moratorium will be operative on the corporate debtor’s assets.  

Author’s remarks 

Set-off is a globally recognised and widely practised concept. Set-off should not be equated with the recovery of dues, as unlike debt recovery, set-off doesn’t strain a company’s assets since both parties are mutual creditors and debtors. Debt recovery, on the other hand, creates a liability for the debtor, worsening its financial condition. On the flip side, a set-off resembles secured debt and benefits all creditors by enhancing the shared pool of assets in the liquidation estate. Set-off acts as a mechanism to alleviate the debtor’s burden by reducing or eliminating the outstanding amount. 

The SC could have conducted a more comprehensive examination by revisiting the fundamentals of a moratorium. The chief objective of the moratorium is to prevent transactions that would burden an already overburdened Corporate Debtor. On the other hand, if a mutual transaction holds the potential for a refund to the Corporate Debtor, it should not be disallowed. Notably, the term “proceedings” u/s 14(1)(a) of IBC only encompasses those proceedings that may exert coercive action against the Corporate Debtor. 

The SC, in lieu of outrightly repudiating set-off, ought to have fairly considered the Corporate debtor’s situation. If permitting set-off does not result in further squandering of the debtor’s assets and enhances its financial footing, the parties ought to be permitted to execute the set-off. 

The potential conflict between insolvency set-offs and the fundamental pari passu principle in modern insolvency law can be reconciled. For instance, the UNCITRAL legislative guide acknowledges the right of set-off as an exception to the doctrine of pari passu. Similarly, Article 9 of the European Union Insolvency Regulations treats set-off as a legally guaranteed right for the insolvent debtor’s claim to safeguard creditors’ set-off rights. 

While there is no prohibition on providing additional benefits to a creditor, an imbalance arises if such benefits cause harm to another more entitled creditor. Therefore, in cases where both the creditor and debtor have mutual obligations, allowing a set-off would prevent such lopsidedness. In the present case, the SC’s denial of set-off has left Airtel in a precarious situation, where the recovery of the amount post the culmination of CIRP remains uncertain. 

Conclusion 

The transformation in the treatment of set-off rights in Indian insolvency law following the introduction of the IBC has largely gone unnoticed. The Adjudicating Authorities have consistently denied creditors the right to assert set-off during the moratorium u/s 14; resultantly, the deposits held by a creditor subject to set-off must be surrendered to the liquidation estate, putting the creditors at subpar standing.  

It is now vital for the IBBI to incorporate set-offs by utilising their authority under section 36 or by amending the Liquidation Regulations to mitigate the exposure of unsecured creditors. Significantly, acknowledging the right to set-off within the liquidation framework would not compromise the debtor’s access to the rehabilitative process offered by the IBC. Creditors would still have the chance to contemplate resolution plans for the debtor’s rehabilitation, with liquidation remaining the last resort. 

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