In today’s Finshots, we discuss how creditors have been misusing the Insolvency and Bankruptcy Code and why they do it.

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The Story

In 2017, an interesting court battle shook the Insolvency and Bankruptcy Code.

The case pertains to Mobilox Innovations. It used to be a tech company working as a mobile technology partner for Star TV’s reality show Nach Baliye. If you’ve ever watched Nach Baliye, you’ll know that the show chooses its winners partly on the basis of an audience vote. Viewers can pick up their phones, dial or send an SMS to a toll-free number and vote for their favourite candidates.

Now, Mobilox helped facilitate this process. It offered Nach Baliye the software it needed to make the voting process smoother. And during its contract, it also outsourced a part of the job to a company called Kirusa Software. Kirusa’s job was providing toll-free numbers and customising software that could analyse results before forwarding them to Mobilox. Mobilox in turn paid them for their services. And this deal was in force for about a year between 2013 and 2014.

A couple of months later, Kirusa went to court with a complaint. It wanted to initiate insolvency proceedings against Mobilox for not settling its payments under the Insolvency and Bankruptcy Code (IBC). The IBC meanwhile is a law that helps debtors (parties who owe money) or creditors (parties who have to receive money) resolve matters if debtors go bankrupt. So if a company isn’t able to repay its debts, a creditor can take the matter to insolvency court. Apparently, Mobilox defaulted on payments worth about ₹20 lakhs. And failed to pay Kirusa, despite payment reminders.

The matter sailed back and forth between rounds of rebuttals in the insolvency courts before finally landing at the Supreme Court. But the Supreme Court flung the case off its table! It didn’t think that Kirusa’s claim was even valid.

Okay, wait… Isn’t the IBC a law that protects creditors and their interests?

It sure is. But here’s the thing. The insolvency court only deals with debts that arise out of a company’s inability to pay. On the other hand, if it’s financially sound and still doesn’t pay up because of a dispute with its creditors, it actually becomes an invalid claim.

And the fight between Kirusa and Mobilox was exactly that. When Mobilox entered into an outsourcing agreement, it also made Kirusa sign a Non-Disclosure Agreement. That meant that Kirusa wasn’t allowed to disclose its association with Nach Baliye publicly. However, the company went ahead and flaunted working with Nach Baliye on its website just to attract more clients.

So firstly, Kirusa breached the terms of a contract. Secondly, Mobilox also wrote to it that it would hold its payments because of this violation, much before the case appeared in court. And that was enough evidence to help Mobilox win. It protected itself from being dragged into insolvency proceedings.

This is just one of the thousands of cases that go to insolvency court every year. And a lot of them end up in appeals in upper courts for a disputed debt. It’s making courts irate too. Because despite repeating the fact that the IBC isn’t just a debt recovery tool, creditors don’t seem to step back. It’s actually a misuse of the law. And wastes a lot of precious court time.

So why are creditors troubling the courts repeatedly, you ask?

Well, law is quite a hard subject to understand. You could have everything clearly written out. But different people can interpret it differently. And in the IBC, the problem is with the word ‘dispute’ itself. Before an insolvency court even admits a case filed by a creditor, it has to verify three important things ―

  1. Does the debt exceed ₹1 lakh (or ₹1 crore after March, 2020)?
  2. Is there enough evidence to prove that a debt even exists?
  3. If yes, then is there an existing dispute around this debt?

The first two conditions are pretty straightforward. But the last one can be slightly tricky. How do you tell that there actually is a debt-related dispute between two parties?

If we both have companies, and my company owes yours, you could raise a demand telling me to pay up. But if I write back saying “Hey, the quality of your service is really bad. So I’m not going to pay you.” You can still take me to court.

Because even though the IBC doesn’t mention it, I should inform you about your quality issues before you send me a payment reminder. In short, if I don’t like your service I should have told you right after it. Making you wait for a payment and then raising a dispute can actually be seen as making things up. Or what the law describes “made to believe dispute”.

Okay, so now imagine that I actually informed you about this dispute much before you sent my company a payment reminder or demand. But I didn’t clearly mention why I’m disputing this payment. That doesn’t really amount to an existing dispute. As a recent case related to Rasna puts it.

Yup! The same Rasna that’s popular for its beverages and the “I Love you Rasna” tagline is amidst an insolvency proceeding. Here’s why.

In 2019, Bharat Road Carrier took Rasna to insolvency court for failing to pay some pending dues. The carrier transported goods for the beverage maker and raised invoices for its services. But Rasna still left some payments pending. Their reason?

Improper invoices and low-quality services from Bharat Road Carrier. Now, this was something Rasna didn’t explicitly mention in its email communications earlier. Of course, it did try to delay payments by telling the transporter that there seemed to be a problem with the payments. It called it “disputed/deficient bills”, but didn’t mention clear reasons for the dispute.

So the NCLT (National Company Law Tribunal), a body that deals with company matters, put Rasna on an insolvency resolution process.

And this actually makes sense. Let’s just go back to the Mobilox versus Kirusa case for a bit to understand why. Here, Mobilox actually wrote back to Kirusa explaining why they weren’t going to settle their payments. It was only over a year later that Kirusa sent out notices to remind its debtor that they had to pay up.

But with Rasna, the chronology of events is slightly different. They didn’t raise any concerns for a long time. So the creditor was probably clueless about what went wrong. It wasn’t until it received a formal demand notice that Rasna disguised the matter as a dispute. It probably sniffed, that using the IBC to settle matters would be Bharat Road Carrier’s next move. And since disputed debts get rejected at the insolvency court right off the bat, Rasna sure played it quite smartly.

It got caught nevertheless and lost* the case. The NCLT even described Rasna’s arguments “moonshine” or simply foolish.

So you can see how things can get muddled up quickly. And this is bad because the IBC was actually created to put debt resolutions on the fast track. Before 2016, insolvency resolution in India took 4.3 years on average. As against other countries like the US and the UK which took 1.5 years and 1 year respectively. But after the introduction of the Code and its several amendments, the time courts took to provide solutions came down drastically. For instance, in FY22, it took about 2 years to resolve cases involving companies that owed more than ₹1,000 crores.

But here’s also what you should know. Over 65% of the cases under the IBC overstep the 270-day deadline. That’s 180 days plus 90 days of a grace period. And the latest data from the Insolvency & Bankruptcy Board of India shows that nearly half of over 3,000 insolvency cases get solved through liquidation. ICRA Ratings, a credit rating agency describes this as “a very slow pace of the process."

Could a lot of this burden be coming from misinterpretation of laws? Well, we don’t know. But that’s what the law is like. You could look at it one way or another. But there could be a zillion other ways to prove you wrong. And that’s exactly why creditors don’t stop taking disputed debts to insolvency court.

And trust us, this is going to continue. Until then…

* The Gujarat High Court has temporarily stayed Rasna’s insolvency since it has appealed to the National Company Law Appellate Tribunal (a tribunal above the NCLT). So until that decision arrives, Rasna gets a breather.

P. S.: In our story, we mentioned the 3 pointers that an insolvency court considers before admitting an insolvency case by creditors. These actually apply to operational creditors (those who provide goods, services, etc. to a company). When courts admit cases by financial creditors (such as banks, financial institutions, etc.) they only see if a debt exists and if there's a default on the part of a company.

We hadn't specified this in our story since our examples involved operational creditors only. But we thought it would be helpful to add clarity since one of our readers pointed this out.

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