Can IBC override existing contracts? Why giving primacy to insolvency law may set a wrong precedent

In a recent judgement which could have wide-reaching ramifications, the National Company Law Appellate Tribunal (NCLAT) upheld the order of the National Company Law Tribunal (NCLT) that set aside termination of a power purchase agreement (PPA) between the corporate debtor, Lanco and the Gujarat distribution licensee, GUVNL. It held that the Insolvency and Bankruptcy Code, 2016 (IBC) will override existing contracts during the corporate insolvency resolution process (CIRP).

The termination was set aside citing importance of the PPA for the corporate debtor’s long-term economic and financial viability, which, in turn, is necessary for maximization of the value of assets. NCLAT was of the view that the PPA converts the physical asset namely, the power project, into an economic entity and needs to be preserved during the CIRP/liquidation process to protect the economic value of the corporate debtor.

The NCLAT order posits IBC as an overarching legislation to which all other laws must yield. This could result in absurd and unintended consequences which interfere with the contractual rights of parties. To be sure, there is no bar against the termination of agreements during the moratorium period under IBC other than contracts relating to essential services such as water, telecommunications, and information technology. PPAs, and other commercial sale and supply agreements, are evidently excluded from such restrictions.

The aim of value maximization and continuing as a going concern under IBC is in the context of corporate debtors. This principle cannot, and should not, be invoked to prevent a party from exercising its right of terminating and walking away from a commercial agreement should the contract allow it. While the CIRP binds the corporate debtor, financial creditors, operational creditors, and resolution applicants, it cannot be extended to bind all parties that have contracts with the corporate debtor.

It is also debatable whether NCLT/NCLAT had jurisdiction to adjudicate on termination of the PPA. Termination of PPA being a sector-specific dispute, the jurisdiction would lie exclusively to the sectoral regulator, i.e. the relevant Electricity Regulatory Commission (ERC). This is more so since PPAs (including the provision for termination in case of insolvency) are approved by ERCs. In fact, the Supreme Court has in the past held that expert sectoral regulators are better equipped to adjudicate on such disputes in the context of TRAI and Competition Commission.

The NCLAT, contrary to the rationale laid down by the Supreme Court, failed to consider that the issue of termination of PPA, being a sector- specific matter governed by the PPA, ought to have been decided by the relevant ERC under the Electricity Act and not the NCLT. In fact, in several instances, power companies under CIRP have continued proceedings before the ERC.

The NCLAT decision places emphasis on Section 238 to hold that the provisions of the PPA must yield to statutory provisions of the IBC. However, the applicability of Section 238 in this case is debatable. For one, Section 238 applies only to the extent of inconsistency, which has been affirmed by the Supreme Court in the Macquarie Bank case. In the instant case, there is no inconsistency between the PPA and the IBC. However, were the contract in question for the supply of essential goods and services to the corporate debtor, then the concerned parties would not be entitled to terminate such agreement, given the express provisions of IBC.

Secondly, Section 238 applies only to other statutes, or subordinate legislation, having effect by virtue of such statutes. A PPA does not fall under either category. Hence, the reliance on Section 238 itself may have been incorrect.

By interpreting the contractual relationship on the principle of value maximization and continuation of the corporate debtor as a going concern, the Courts may have opened the door to similar claims against any and all major customers.

The NCLAT decision could have far-reaching implications as it compels parties to continue doing business and fulfilling contractual obligations with an entity undergoing CIRP or liquidation, thereby nullifying the contractual right to terminate in such an event. There may be a case where a competitor takes over the corporate debtor or where the financial risks involved in continuing to do business with a company under insolvency are unacceptable. Further, it incurs the risk of jurisdictional turf wars, especially in regulated sectors, which may result in protracted litigation.


Vishrov Mukerjee is Partner & Ameya Vikram Mishra is Associate at J Sagar Associates)

Can IBC override existing contracts? Why giving primacy to insolvency law may set a wrong precedent Can IBC override existing contracts? Why giving primacy to insolvency law may set a wrong precedent Reviewed by TechCO on 1/18/2021 Rating: 5

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