NCLAT: Debt arising out of advance payment for supply of goods or services is an operational debt in terms of Section 5(21) of IBC

The National Company Law Appellate Tribunal, New Delhi (“NCLAT”), in its judgement dated May 6, 2024, in the matter of Sanam Fashion and Design Exchange Limited v. Ktex Nonwovens Private Limited [Company Appeal (AT) (Ins.) No. 1234 of 2023], has held that a debt arising out of an advance paid towards the supply of goods or services would constitute an operational debt in terms of Section 5(21) (Definition of operational debt) of the Insolvency and Bankruptcy Code, 2016 (“IBC”).

Facts

Sanam Fashion and Design Exchange Limited (“Appellant”) had placed an order for the supply of 10 tons of non-woven fabric by issuing a purchase order dated March 16, 2020 (“PO”) on Ktex Nonwovens Private Limited (“Respondent”). Upon sharing the PO for execution by the Respondent, the Appellant immediately issued a debit advice to its bank in India for crediting an amount of USD 200,000 (“Advance Payment”) in the Respondent’s bank account.

In terms of the PO and the invoice raised by the Respondent on the Appellant (“Invoice”), the goods were supposed to be delivered to the Appellant on March 19, 2020. However, owing to the outbreak of the Covid-19 pandemic, the export of materials from India was banned. After the lifting of the Covid-19 ban, e-mails were exchanged between the parties in relation to the supply, terms of delivery, refund of the Advance Payment and other related issues. Thereafter, the Appellant issued a demand notice under Section 8 (Insolvency resolution by operational creditor) of IBC (“Demand Notice”), demanding the repayment of the Advance Amount from the Respondent. However, the Respondent failed to respond to the Demand Notice.

Consequently, the Appellant filed a petition under Section 9 (Application for initiation of corporate insolvency resolution process by operational creditor) of IBC (“Section 9 Petition”), before the National Company Law Tribunal, Ahmedabad Bench (“NCLT”) for initiation of corporate insolvency resolution process (“CIRP”) against the Respondent.

In its Section 9 Petition, the Appellant iterated that as per the contract, the goods were supposed to be delivered at its office in Hong Kong, however, the Respondent had made available the goods for pick up at its plant situated at Rajkot, India. Hence, the goods never reached the Appellant.

The NCLT, vide its order dated August 10, 2023 (“Impugned Order”), rejected the Section 9 Petition filed by the Appellant, since in NCLT’s view, the Appellant had merely made an Advance Payment to the Respondent, which would not get covered under the definition of an ‘operational debt’ under Section 5(21) of IBC. Further, the terms of delivery of the goods under the Invoice was ‘Ex-Plant Rajkot’, however the Appellant had failed to pick up the said goods from the Respondent’s Rajkot plant.

Aggrieved by the Impugned Order, the Appellant filed the present appeal before the NCLAT.

Issues

Whether the Appellant is an operational creditor under IBC.

Whether there existed a breach of terms and conditions of the contract leading to a pre-existing dispute between the Appellant and the Respondent.

Arguments

Contentions of the Appellant:

The Appellant submitted that the finding of NCLT that the Advance Payment was not to be treated as an operational debt under Section 5(21) of IBC was erroneous. To support its submission, the Appellant relied on the judgment of the Hon’ble Supreme Court (“SC”) in the case of Consolidated Construction Consortium Limited v. Hitro Energy Solutions Private Limited [(2022) 7 SCC 164] (“Consolidated Construction Case”) wherein the SC had clarified that the definition of operational debt encompasses an amount paid in advance for the purchase of goods and services.

The Appellant relied on an e-mail dated March 14, 2020, received from the Respondent wherein the Respondent had confirmed the terms of delivery along with other relevant details, and contended that it was not the duty of the Appellant to lift the goods from the Respondent’s Rajkot plant.

The Appellant further submitted that a conjoint reading of the said e-mail and the PO made it evident that the Appellant was to receive the goods from the Respondent at Hong Kong, and that the NCLT had wrongly interpreted the words ‘Ex-plant Rajkot’ as appearing in the Invoice to mean that the goods were to be picked by the Appellant from the Rajkot plant of the Respondent.

The Appellant further submitted that the Respondent did not raise any dispute against the Demand Notice issued by the Appellant, and that the Respondent had sent the e-mail dated April 18, 2023, as an afterthought levelling allegations against the Appellant on its inability to pick up the goods from the Respondent’s Rajkot plant. Moreover, the NCLT had overlooked the fact that the goods were not even manufactured by March 19, 2020, which should have been a sufficient ground for the Respondent to refund the Advance Payment to the Appellant.

The Appellant contended that its Section 9 Petition was dismissed by the NCLT on the very first day, without affording it a reasonable opportunity of being heard, and hence, the Impugned Order violated the principles of natural justice.

Contentions of the Respondent:

The Respondent submitted that as per the Invoice, the terms of delivery of the goods was ‘Ex-Plant Rajkot’, which was prima facie evidence that the Respondent was required to prepare and keep the goods ready for collection by the Appellant from the Respondent’s Rajkot plant.

The Respondent further submitted that it had duly manufactured the goods, prepared the consignment, and informed the Appellant about the same. This established the Respondent’s willingness to fulfil its obligations under the PO.

The Respondent contended that while the Appellant had successfully collected the goods of the second consignment after the Covid-19 ban was lifted, it had intentionally failed to pick the first lot which reflected the Appellant’s wilful failure in fulfilling its contractual obligations. The Respondent further submitted that it was under the belief that the Appellant would collect the goods from the Rajkot plant, and hence continued to store the goods for a period of 3 years as evidenced in the e-mails exchanged between the parties from March, 2020 onwards.

The Respondent submitted that the NCLT had passed the Impugned Order in its favour after duly considering the material on record, since the Appellant had failed to bring forth any evidence to prove that the parties had in fact agreed to deliver the goods in Hong Kong.

The Respondent contended that the Appellant was conveniently trying to shift its burden onto the Respondent, as a means to escape its liability and was misusing the provisions of IBC as a recovery mechanism to extract undue and unjust amounts from the Respondent, despite the lack of compliance on their part.

Observations of the NCLAT

With respect to the issue on whether the Appellant was to be considered as an operational creditor under IBC, the NCLAT observed that in the Consolidated Construction Case relied upon by the Appellant, the SC had opined that when the appellant encashed a cheque for advance payment for the supply of light fittings despite the contract being subsequently terminated, such encashment gave rise to an operational debt in favour of the appellant, and the appellant was considered to be an operational creditor under IBC.

In NCLAT’s view, the Consolidated Construction Case squarely applied to the facts of the present case as there was a clear nexus between the Advance Payment made by the Appellant and the supply of goods and services.

While deliberating on the issue on whether there existed a breach of the terms and conditions of the contract leading to a pre-existing dispute, the NCLAT observed that from the documents submitted on record, it was clear that the delivery was to be made at the Respondent’s Rajkot plant, and not at Hong Kong as claimed by the Appellant. The NCLAT observed that the Respondent on the other hand had informed the Appellant of the readiness of the goods and had requested the Appellant to pick up the goods from Respondent’s Rajkot plant after the lifting of the Covid-19 ban. These events reflected a pre-existing contractual dispute between the parties, which the Appellant was trying to settle through the IBC mechanism.

The NCLAT relied on the judgement of the SC in the case of Mobilox Innovations Private Limited v. Kirusa Software Private Limited [(2018) 1 SCC 353] (“Mobilox Innovations Case”), wherein the SC had held that once a notice is received by a corporate debtor under Section 8(2) of IBC, it is enough to prove that a dispute is pending and it is not necessary that a suit/arbitration should also be pending. The SC while pronouncing its judgment in the Mobilox Innovations Case, relied on another judgement of the SC in the case of Kay Bouvet Engineering Limited v. Overseas Infrastructure Alliance (India) Private Limited [(2021) 10 SCC 483] wherein it was held that one of the objects of IBC qua operational debts (which debts are usually smaller than financial debts) is to ensure that the amount of such operational debts do not enable the operational creditors to put the corporate debtor into CIRP prematurely or initiate the process for extraneous considerations.

Decision of the NCLAT

In view of the above, the NCLAT held that the Appellant would be considered as an operational creditor under IBC, since an ‘operational debt’ would include a debt arising from a contract in relation to the supply of goods or services from the Respondent.

Further, since a pre-existing dispute already existed between the Appellant and the Respondent, the Section 9 Petition filed by the Appellant could not be admitted, and accordingly, the NCLAT dismissed the petition filed by the Appellant.

VA View:

The NCLAT has rightly relied on the Consolidated Construction Case and provided much needed clarity on the scope of ‘operational debt’, by including a debt which arises out of an advance payment made to a corporate debtor for the supply of goods or services within the ambit of ‘operational debt’ under the framework of IBC.

The definition of ‘operational debt’ contained in IBC means a claim in respect of the provision of goods or services. Hence, the operative requirement is that the claim must bear some nexus with the provision of goods or services. In the instant case, since there was a clear nexus between the Advance Payment made by the Appellant and the supply of goods and services, the NCLAT has rightly categorized the Appellant as an operational creditor of the Respondent.

For any query, please write to Mr. Bomi Daruwala at [email protected]

Supreme Court: Exclusion clauses in insurance contract should be interpreted strictly as they may absolve all the liabilities of the insurer

In the matter of United India Insurance Company Limited v. M/s. Hyundai Engineering and Construction Company Limited and Others [Civil Appeal No. 1496 of 2023], decided on May 16, 2024, the Division Bench of the Supreme Court reiterated that the insurer has the burden of proving applicability of exclusionary clauses in insurance contracts and such clauses must be interpreted strictly against the insurer, as they may completely exempt the insurer of its liability.

Facts

The National Highway Authority of India (“NHAI”) awarded a contract valued at INR 213,58,76,000 for design, construction, and maintenance of a cable-stayed bridge across the river Chambal on NH-76 at Kota, Rajasthan to the joint venture of M/s. Hyundai Engineering and Construction Company Limited and M/s. Gammon India Limited (“Respondents”). As per the contract, the construction was to be completed within 40 months. United India Insurance Company Limited (“Appellant”) issued the Contractor’s Insurance Policy covering the interest of NHAI as principal and of the Respondents. Construction for the bridge was commenced in December, 2007. However, during the construction process a part of said bridge collapsed on December 24, 2009, which resulted in the tragic death 48 workers. The Ministry of Road Transport and Highways, Government of India constituted an expert committee to investigate the cause of collapse. After investigation, the final report was submitted wherein the Respondents were found liable for the loss of 48 lives due to defects in construction design. Subsequently, an FIR was lodged against the Respondents under Sections 304 (Punishment for culpable homicide not amounting to murder) and 308 (Attempt to commit culpable homicide) of the Indian Penal Code.

NHAI informed the Appellant about the said incident on December 29, 2009 and requested the appointment of the surveyor to assess the damages. The surveyor commenced his work on January 6, 2010 and issued a letter seeking additional details and clarifications from the Respondents. In response, the Respondents submitted a claim amounting to INR 151,59,94,542. Surveyor in its report recommended to repudiate the insurance claims as Respondents had violated the conditions of insurance policy and there was a net loss of INR 39,09,92,828. Based on the said reports, Appellant rejected the insurance claim vide its letter dated April 24, 2011.

By a letter dated June 17, 2011, the Respondents requested the Appellant to reconsider the repudiation, to which the Appellant agreed to reconsider. The Appellant re-considered the claim, and by a letter dated April 17, 2017 informed the Respondents that the original decision of repudiation is affirmed. After 2 years of repudiation, Respondents on January 24, 2019 filed a consumer complaint bearing no. No. 160 of 2017 before the National Consumer Disputes Redressal Commission (“NCDRC”) against the Appellant. They alleged deficiencies in services of Appellant and unfair trade practices in rejecting the claim.

NCDRC rejected the preliminary objections of the Appellant and relied upon the reports of independent experts cited by the Respondents. These reports indicated no flaws in design of the project. NHAI allowed the Respondents to continue the said construction. Consequently, NCDRC held that the Appellant is obligated to pay claim of INR 39,09,92,828. Furthermore, an undated addendum to the judgment unilaterally altered the judgement, increasing the obligation to INR 151,59,94,542 from the previously specified amount.

Aggrieved by the decision of the NCDRC, the Appellant filed an appeal challenging the said decision of the commission.

Issues

Whether the Appellant is liable to pay the insurance claim.
Whether the defects in design led to the collapse of the bridge.

Arguments.

Contentions of the Appellant:

The Appellant justified its repudiation by citing the affidavit provided by Mr. S. Anantha Padmanabhan, who was examined as a witness. The said affidavit includes the surveyors report and expert committee report. The Appellant also submitted that there is sufficient evidence to justify repudiation of the claim on the basis of the exclusion clause in the insurance policy.

Contentions of the Respondents:

The Respondents relied on the judgement of the Supreme Court in Texco Marketing Private Limited v. TATA AIG General Insurance Company Limited [(2023) 1 SCC 428] (“Texco Case”) to highlight the proof of burden that an exclusionary clauses place on an insurance company.

The Respondents submitted that the findings of the independent experts’ report clearly establishes that they are not at fault regarding the design issue. Specifically, they referenced reports made by 1. Mr. Jacques Combault; 2. M/s. SETRA/CETE (French Ministry of Transportation Technical Department); 3. M/s. Halcrow Group Limited and 4. AECOM Asia Company Limited.

Furthermore, the Respondents contended that the reports of the surveyor and expert committee are inconclusive and remain open-ended; failing to hold them accountable for the negligence.

Observations of the Supreme Court

The Supreme Court observed that the Apex Court noted in the Texco Case that burden of proving the applicability of an exclusion clauses rests with the insurer. In National Insurance Company Limited v. Ishar Das Madan Lal [2007 (4) SCC 105] it was held that evidence must clearly establish that the event sought to be excluded is included in the exclusionary clauses. Further, the Apex Court noted that findings from the expert committee reports which concluded that the said bridge had collapsed due to structural instability, design flaws and poor workmanship.

The Supreme Court also noted that independent experts relied upon by the Respondents were not marked as exhibits. They were not adduced in evidence as none of these experts was examined as a witness. Given these circumstances the Supreme Court concluded that the Appellant has discharged the burden of proof as set out in the Texco Case.

Additionally, the Supreme Court also relied upon National Insurance Company Limited v. Hareshwar Enterprises Private Limited [(2021) SCC Online SC 628] and National Insurance Company Limited v. Vedic Resorts and Hotels Private Limited [2023 SCC OnLine SC 648] wherein it was held by this court that surveyor report is credible and reliable evidence. Further, the Supreme Court observed that independent experts report was on a theoretical basis while the surveyor conducted onsite inspections and the expert committee comprised of experts from the field of civil engineering. The Supreme Court observed that NCDRC failed to examine the independent experts and their reports.

Decision of the Supreme Court

In light of the above-mentioned observations, it was held that NCDRC fell in error of law in allowing the said consumer complaint. Therefore, the Supreme Court allowed the appeal and set aside the decision of NCDRC. Further, the Supreme Court held that an insurance is a contract of indemnification, being a contract for a specific purpose which is to cover defined losses and thus, exclusion clause must be construed strictly against the insurer.

VA View:

By overturning the decision of NCDRC and referencing its previous judgments in
Texco Case, the Supreme Court underscored the need for substantial evidence in such disputes.The Supreme Court’s preference for thorough onsite inspections instead of theoretical reports also highlights the importance of robust evidence in such matters.

This judgement has set a precedent for future insurance claims disputes involving such largescale construction projects by emphasizing the need to strictly comply with the contractual terms and thorough scrutiny of exclusion clauses.

For any query, please write to Mr. Bomi Daruwala at [email protected]