This article has been written by Nikita Pant pursuing a Diploma in International Contract Negotiation, Drafting and Enforcement from LawSikho.
This article has been edited and published by Shashwat Kaushik.
Table of Contents
Introduction
On November 17, 2021, the Hon’ble National Company Law Appellate Tribunal (hereinafter referred to as NCLAT) passed a judgement highlighting the mandatory nature of the existence of a dispute prior to the issuance of the demand notice under Section 8(1) of the
Insolvency and Bankruptcy Code, 2016 (hereinafter referred to as the ‘I&B Code’). The
Hon’ble NCLAT clarified that a pre-existing dispute, which can be used to challenge an application under Section 9 for commencing the corporate insolvency resolution process by the operational creditor, must be a genuine and substantive dispute. The dispute must reflect a real conflict or controversy where a conflict of claims or rights is clear, as stipulated under Section 8(2) of the I&B Code. Furthermore, any such pre-existing dispute must be conveyed within the stipulated period after the issuance of the demand notice under Section 8 of the I&B Code.
The author discusses the ruling of Henan Boom Gelatin v. Sunil Healthcare Ltd. (2017) in a detailed manner. The article starts with a brief overview of the case facts, followed by an outline of the key issue adjudicated in the ruling. It then highlights the significant legal provisions discussed and presents the contentions from both sides. Afterward, it provides a concise examination of the judgement and the ratio decidendi followed by a conclusion.
Facts of the case
The appellant, ‘Operational Creditor’ is a manufacturer and exporter of Gelatine & Collagen products. The respondent, ‘Operational Debtor’,’ is a company involved in the business of manufacturing man-made fibres. The appellant and respondent entered into an agreement for the supply of Pharmaceutical Grade Gelatine. Subsequently, they entered into three sales contracts, following which the supply was made and the appellant raised invoices. The respondent failed to make the payments, and after some correspondence, a meeting was held in Shanghai between the parties, where they reached an understanding as per the minutes dated July 27, 2017. The respondent admitted and acknowledged the unpaid operational debt of USD 3,77,392.00 and undertook to complete the payment in three installments.
The respondent failed to make due payments, and consequently, the appellant issued a demand notice dated February 1, 2019 under Section 8 of the I&B Code. Upon the expiry of the notice period, the appellant filed an application under Section 9 read with Rule
6 of the Insolvency and Bankruptcy (Application to Adjudicating Authority) Rules, 2016 against the Respondent. The adjudicating authority issued a notice on the application. In its three replies to the notice, the respondent stated that there was a pre-existing dispute between the parties and referred to a previous email correspondence between the parties wherein the respondent raised concerns about the quality of some gelatine supplied.
The adjudicating authority heard the parties and, by impugned order dated 19.02.2021 rejected the application of the operational creditor filed under Section 9 of the I&B Code on the grounds that there was a pre-existing dispute between the parties. The adjudicating authority held that the email sent to the appellant raising the issue regarding the quality of the gelatine demonstrates a pre-existing dispute. The present appeal has been filed challenging the said order.
Issues
Whether there was a pre-existing dispute when notice under Section 8 was issued.
Law involved in Henan Boom Gelatin vs. Sunil Healthcare Limited
Insurance and Bankruptcy Code, 2016
Section 8: Section 8 outlines the procedure for issuing a demand notice by the operational creditor to initiate the insolvency resolution process. Section 8(1) states that if there is a default in payment by the operational debtor, the operational creditor may deliver a demand notice or a copy of an invoice demanding payment of the defaulted amount. Section 8(2) further specifies that within 10 days of receiving the demand notice or copy of the invoice, the corporate debtor must inform the operational creditor of the following circumstances:
- Existence of a dispute: If there is any record of the pendency of the suit or arbitration proceedings filed before the receipt of such notice or invoice in relation to such dispute.
- Obligation of payment fulfilled: That the operational debt has been paid by sending an attested copy of the record of electronic transfer of the unpaid amount from the bank account of the corporate debtor or an attested copy of the record that the operational creditor has encashed a cheque issued by the corporate debtor.
The explanation of the Section provides that a demand notice for the purpose of this Section, means a notice served by an operational creditor to the operational debtor demanding the payment of the operational debt that has been defaulted.
Section 9: Section 9 lays down the process of application for initiation of the corporate insolvency resolution process by the operational creditor. Section 9(1) states that after the expiry of the 10-day notice period as mentioned in Section 8(1), if the operational creditor does not receive payment or notice of the dispute under Section 8(2), the operational creditor may file an application before the adjudicating authority for initiating a corporate insolvency resolution process.
Section 9(5) states that within fourteen days of receiving an application under Section 9(2), the adjudicating authority shall:
- Admit the application and notify the operational creditor and corporate debtor if:
- The application is complete;
- The debt remains unpaid;
- The invoice or payment notice has been delivered;
- No dispute notice has been received, and there is no record of dispute;
- No disciplinary proceeding is pending against the proposed resolution professional.
- Reject the application and notify both parties if:
- The application is incomplete;
- The debt has been paid;
- The invoice or payment notice has not been delivered;
- A dispute notice has been received, or there is a record of dispute;
There is a disciplinary proceeding against the proposed resolution professional.
The proviso further lays down that before rejecting an application due to incompleteness, the authority must give the applicant seven days to rectify the defect.
Arguments or contents of the parties
Appellant
The counsel for the appellant argued that the adjudicating authority wrongly assumed the existence of a pre-existing dispute. He contended that in its reply to the demand notice sent under Section 8(2) of the I&B Code, the respondent admitted the defaulted amount without making any claim about the existence of a dispute. Additionally, the counsel asserted that the respondent, in subsequent correspondence before the adjudicating authority, attempted to fabricate a dispute that never existed initially. He also argued that the email regarding the quality of the gelatine supplied, cited to demonstrate the existence of a dispute, was irrelevant, as a subsequent meeting between the parties in Shanghai resulted in the respondent proposing a payment plan without raising any dispute. Additionally, in subsequent emails, there is no mention of the dispute.
He also contended that the four debit notes were never acknowledged by the appellant and were created by the respondent after the filing of the application under Section 9 of the I&B Code. Thus, there was no pre-existing dispute.
Respondent
The counsel for the respondent argued that the emails in which the respondent raised concerns about the quality of the gelatine supplied by the appellant show the existence of a pre-existing dispute. Additionally, he relied on four debit notes, asserting that the invoices issued by the respondent have been settled, and the appellant has acknowledged these debit notes. In response to the allegation that the debit notes were manufactured along with the email acknowledging them, the counsel highlighted that the appellant has not lodged any complaint of forgery thus far.
Observations by the Hon’ble NCLAT
The Hon’ble NCLAT observed that following the issuance of invoices by the appellant demanding a total amount of USD 3,77,392.00, a meeting between the parties took place in Shanghai. During this meeting, it was unequivocally recorded that the respondent acknowledged the debt and committed to making the due payments in three installments. However, when no payment was forthcoming, the appellant issued a demand notice under Section 8 of the I&B Code.
In response to this demand notice, the respondent acknowledged the defaulted amount while simultaneously requesting approval of a revised payment plan. Notably, Section 8(2) stipulates that the corporate debtor, in its reply to the demand notice, must highlight the
‘existence of a dispute’. Yet, the reply from the respondent conspicuously omitted any mention of such a dispute.
Subsequently, in their three replies to the application under Section 9, the respondent introduced the notion of a pre-existing dispute between the parties. Upon careful examination of the substance of these replies, the Hon’ble NCLAT found no evidence supporting the existence of the alleged pre-existing dispute. The email correspondence cited by the respondent pertained solely to the quality of certain wooden chips/particles found in the supplied goods, with an expressed need for improvement in subsequent deliveries. This communication did not constitute a dispute between the parties.
As there was no genuine pre-existing dispute between the parties, the Hon’ble NCLAT concluded that the adjudicating authority made a mistake in rejecting the application. Consequently, the authority should have admitted the application and proceeded with the corporate insolvency resolution process.
Regarding the four debit notes, the Hon’ble NCLAT deemed them irrelevant for adjudication, as the central point of contention—the existence of a dispute—was absent. The authority’s decision was primarily anchored on the presence of a dispute, which, as established, did not exist. Hence, the Hon’ble NCLAT set aside the impugned order of the adjudicating authority.
Ratio
The Hon’ble NCLAT underscored the statutory purpose behind requiring a corporate debtor to notify the operational creditor about the existence of a dispute in its reply to a demand notice issued under Section 8(1) of the I&B Code. This requirement serves the vital function of ensuring that if a dispute does indeed exist, it is promptly communicated to the operational creditor, enabling them to determine their next course of action. In cases where the corporate debtor fails to mention any dispute, the operational creditor is entitled to proceed immediately with filing an application under Section 9 of the I&B Code, as has been done in the present case.
The concept of a pre-existing dispute, which may serve as grounds to challenge an application under Section 9, must be a genuine conflict or controversy, as clearly evident from the reply as stipulated by Section 8(2). The corporate debtor is not permitted to merely raise the spectre of disputes; there must be a substantive and real dispute present. It is incumbent upon the adjudicating authority to examine the reply and its contents, without delving into the adjudication of the dispute itself. Their role is solely to ascertain whether a genuine dispute is discernible from the reply’s substance.
Conclusion
The judgement delivered by the Hon’ble National Company Law Appellate Tribunal (NCLAT) on 17th November 2021 emphasises the importance of a genuine and substantive dispute prior to the issuance of a demand notice under Section 8(1) of the I&B Code. The ruling clarifies that a pre-existing dispute, if invoked to challenge an application under Section 9 for initiating the Corporate Insolvency Resolution Process, must reflect a tangible conflict or controversy, as mandated by Section 8(2) of the I&B Code.
This judgement reaffirms the importance of adherence to procedural requirements and the need for a bona fide dispute to obstruct insolvency proceedings, thereby upholding the integrity and efficacy of the insolvency resolution framework outlined in the I&B Code.
References
