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Shubham Gupta, Mohak Thukral

Moratorium under Insolvency and Bankruptcy Proceedings Applicable to Cheque Dishonour Cases

[Shubham and Mohak are students at Jindal Global Law School.]


The Supreme Court of India (Supreme Court), in the case of P Mohanraj & Others v. Shah Brothers Ispat Private Limited (2021), has settled the question of whether insolvency proceedings under Section 14 of the Insolvency and Bankruptcy Code 2016 (Code) would stall proceedings initiated under Section 141 of the Negotiable Instruments Act 1881 (NI Act). This article aims to examine the judgment in detail.


Background


Shah Brothers Ispat Private Limited (Shah Brothers) supplied steel products to Diamond Engineering Private Limited from 21 September 2015 to 11 November 2016, for which 51 cheques, amounting to INR 24,20,91,054 were returned as dishonored on account of insufficient funds. Shah Brothers issued demand notices under the NI Act towards the company and its directors for recovery within 15 days. The company further issued 2 cheques amounting to INR 80,00,000 which were also returned for insufficient funds, resulting in a second demand notice. Shah Brothers filed 2 criminal complaints before the Additional Chief Metropolitan Magistrate, Mumbai (ACMM), to initiate proceedings under the NI Act. Additionally, Shah Brothers issued a statutory notice under Section 8 of the Code towards the company. This was accepted by the Adjudicating Authority (NCLT), which initiated the corporate insolvency resolution process (CIRP) and declared a moratorium on all pending suits or proceedings against the company, under Section 14 of the Code. The NCLT further stayed the two criminal complaints under the NI Act, which had been filed before the ACMM. This moratorium was appealed before the National Company Law Appellate Tribunal (NCLAT), which overturned the NCLT’s order, holding those proceedings under Section 138 and 141 of the NI Act were criminal in nature and not covered under Section 14 of the Code, and approved the continuation of the criminal complaints.


The Legal Issue


The main question before the Supreme Court in the matter was whether a moratorium issued under Section 14 of the Code would cover proceedings instituted under Sections 138 and 141 of the NI Act.


The Intent behind Section 14 of the Code


Section 14 of the Code institutes a moratorium on pending suits or proceedings before “any court of law, tribunal, arbitration panel or other authority”. The ambit of this provision is very wide and includes the execution of any arbitral awards and proceedings as well. The Supreme Court, in order to analyze this provision, sought to understand whether the term “proceedings” is limited to only civil proceedings, through the principles of ejusdem generis and noscitur a sociis, which are rules of statutory construction. The legislative intent of the moratorium instituted under Section 14 of the Code was to provide a breathing space to corporate debtors while they restructured their business, and prevent coercive actions, a position which was taken by the Supreme Court in Innoventive Industries Limited v. ICICI Bank Limited (2017).


The Report of the Insolvency Law Committee (2020) in paragraph 8.2 also holds that the purpose of the Section 14 moratorium is to prevent the depletion of the corporate debtor’s assets during the CIRP. This position was further affirmed in Swiss Ribbons Private Limited v. Union of India (2019). In light of these decisions, the Supreme Court, in the present case, established that the continuation of the quasi-criminal proceeding under the NI Act would lead to depletion of the corporate debtor’s assets, which would impact the resolution process in the same fashion as the continuation of a civil suit or an arbitration proceeding.


The Purpose of Section 138/141 Proceedings under the NI Act


The object and intent of the NI Act was discussed by the Supreme Court in Rajneesh Agarwal v. Amit J Bhalla (2001), where the court held that Section 138 of the NI Act amounted to quasi-criminal proceedings, which could not be quashed on account of deposit of money. The Supreme Court held that not initiating action in proceedings concerning dishonest issuance of cheques affected the credibility of transacting business on negotiable instruments. Similarly, in another case, the Supreme Court observed that while Section 138 of the NI Act has a civil remedy, it is intended to prevent dishonesty on part of drawers who have insufficient funds. In the landmark case of CIT v. Ishwarlal Bhagwandas (1966), the Supreme Court stated that the test to distinguish civil proceedings from criminal proceedings lied in the nature of the reliefs the proceedings sought to protect.


In a catena of decisions before the Supreme Court, it has been held that proceedings under Section 138/141 of the NI Act are a “civil sheep in a criminal wolf’s clothing”, where the state interest is secondary to the victim’s relief. This position was clearest in the decision in Kaushalya Devi Massand v. Roopkishore Khore (2011), where the Supreme Court asserted:


“Having considered the submissions made on behalf of the parties, we are of the view that the gravity of a complaint under the Negotiable Instruments Act cannot be equated with an offence under the provisions of the Penal Code, 1860 or other criminal offences. An offence under Section 138 of the Negotiable Instruments Act, 1881, is almost in the nature of a civil wrong which has been given criminal overtones.”

The Supreme Court, in this case, further drew a parallel to contempt proceedings under the Indian Penal Code 1860 and Section 630 of the Companies Act 1956, which are both also quasi-criminal and where there is no watertight distinction between civil and criminal reliefs. Even though the offences might be criminal in nature, the action is moved by a private party to enforce a personal right and not the public interest. Upon analysis of all the above-described factors, the court held that NI Act proceedings are quasi-criminal and would be covered under the moratorium instituted under Section 14 of the Code which is instituted upon the commencement of the CIRP.


Natural Persons and Section 14 of the Code


The Supreme Court then considered the question of whether proceedings under Section 138/141 of the NI Act can be instituted against the directors of a company, without the corporate debtor itself, and answered in the negative. This was a significant departure from the status quo, where the Company was considered to be the key party to proceedings in cheque-dishonor cases. Supreme Court established that Section 141 of the NI Act speaks of the persons responsible for the conduct of the business of the company, as well as the company.


However, the corporate debtor is within the ambit of the CIRP and covered under the moratorium instituted by the Code and accordingly, no Section 138/141 proceedings can be initiated or continued against the corporate debtor due to this bar. Since private persons (including those responsible for the conduct of the company) are not included in the moratorium provision, they can continue to be held liable under Section 138 and 141 of the NI Act.


The Supreme Court, through this judgment, has finally settled the long-standing question of whether proceedings under the NI Act will be stayed due to the moratorium instituted under Section 14 of the Code, overturning the judgments rendered in Tayal Cotton v. State of Maharashtra (2018) and MBL Infrastructure Limited v. Manik Chand Somani (2019), which held that the initiation of the CIRP does not bar the initiation or continuation of cheque bounce proceedings under the NI Act.


The Supreme Court has carved a delicate balance between the corporate-debtor and the natural persons responsible for the corporate-debtor, holding that the quasi-criminal proceedings against corporate-debtor would remain stayed during the moratorium, while those responsible for the conduct of the company, including the directors and other officials linked to the issuance of the dishonored cheques, would continue to apply.


Conclusion and Suggestions


However, there are several unanswered questions that emerge from this reasoning, which are bound to open the floodgates of litigation. While the court has held that “proceedings” under NI Act will get relief under the moratorium and will not apply to the “natural persons” who are responsible for the day-to-day conduct of the entity, there is little to no reasoning for why one relief is permissible and the other is not. Even though there cannot be parallel proceedings under the moratorium, by the reasoning of this judgment, the liability for the bounced cheque would now solely fall on the persons responsible for the conduct of the company, and not the company itself.


The court, while citing the judgment in Aneeta Hada v. Godfather Travels & Tours Private Limited to justify its rationale, has failed to appreciate the reasoning of this case. In Aneeta Hada, the Supreme Court held that it is imperative that in any prosecution under Section 141 of the NI Act, the company is arraigned. The finding that only those persons who were directly responsible for the conduct of the company should be made parties emerged out of the initial finding, to ensure that vicarious liability was protected. The idea was to protect individuals in the company who were not responsible for the cheque-dishonor, and not to absolve any party of responsibility. However, upon separating the company from the proceeding, the Aneeta Hada judgment would be inapplicable to this proceeding, as the question of vicarious liability would be entirely vitiated. This finding also contradicts the judgment in Aneeta Hada, which inextricably linked any proceedings towards the directors of the company to the company itself.


In subsequent cases, where companies may be undergoing the CIRP process, cases that are brought under the NI Act will now solely pass liability to the natural persons responsible for the company, and the company will not be arraigned. This will directly contradict the findings in the Aneeta Hada case as well as the intent behind Section 14 of the Code and Sections 138 and 141of the NI Act.


Further, this could be exploited as a backdoor way for companies to discharge their debts without facing liability. If the court had fully appreciated the Aneeta Hada case, they should have reasoned that upon the enforcement of the moratorium, the NI Act proceedings ought to have been stayed in their entirety (against those responsible for the conduct of the company and the company itself), and the benefit ought not to be extended merely to the corporate entity.

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