Page 30 – Vaish Associates Advocates

Delhi High Court: An arbitration clause contained in a contract perishes upon its novation

The Delhi High Court (“Delhi HC”) has, in its judgement dated June 2, 2023, in the matter of B. L. Kashyap and Sons Limited v. Mist Avenue Private Limited [Commercial Arbitration 190/2019], held that an arbitration clause contained in a contract would perish with its novation if the novated contract does not contain any arbitration clause.

Facts

B. L. Kashyap and Sons Limited (“Petitioner”) and Mist Avenue Private Limited (“Respondent”) entered into an undated construction contract in August, 2014 (“Construction Contract”) for civil and structural works relating to a project known as ‘MIST’ in Uttar Pradesh. The estimated value of the Construction Contact was INR 229 Crores, to be executed on a bill of quantities (“BBQ”) on an item rate basis. The Construction Contract contained an arbitration clause which provided the parties with the right to refer any dispute arising out of or in connection with the Construction Contract to a sole arbitrator, where the parties were unable to resolve such dispute amicably by way of joint discussions.

Subsequently, certain disputes arose between the Petitioner and the Respondent which were resolved mutually and its terms were recorded in a memorandum of understanding dated October 8, 2015 (“MoU”). The MoU recorded the terms upon which the Construction Contract would stand fully satisfied towards both the parties and was also accompanied by an annexure titled ‘List of Assets Paid for’. Notably, the MoU did not contain an arbitration clause.

The Respondent breached the MoU by failing to make payments to the Petitioner in accordance with the terms of the MoU. Consequently, the Petitioner invoked the arbitration clause in the Construction Contract and an arbitrator was appointed by the Delhi HC (“Arbitrator”) under Section 11 (Appointment of arbitrators) of the Arbitration and Conciliation Act, 1996 (“Act”)..

The Petitioner lodged seven claims before the Arbitrator amounting to total of INR 35,17,69,185/-. The Respondent challenged the arbitrability of the dispute on the basis of the execution of the MoU and contended that it had paid an excess amount of INR 32,83,865/- to the Petitioner, which in fact, the Respondent was entitled to claim from the Petitioner.

The Arbitrator, while examining the claims made by the Petitioner, concluded that even though the MoU was not fully complied with, it would not lead to the conclusion that the arbitration clause in the Construction Contract stood revived. Moreover, as the parties had moved from the BBQ/item rate basis of payment to a ‘cost plus’ basis of payment as set out in the MoU, there was no question of revival of the Construction Contract, even if the terms of the MoU had been breached by the Respondent.

Relying on the judgement passed by the Hon’ble Supreme Court (“SC”) in Young Achievers v. IMS Learning Resources Private Limited [(2013) 10 SCC 535] (“Young Achievers Case”) and the judgement of the Delhi HC in Ansal Housing and Construction Limited v. Samyak Projects Private Limited [2018 SCC OnLine Del 12866], the Arbitrator in its award dated January 7, 2019 (“Impugned Award”) opined as follows:

“Once there is full and final settlement in respect of all the disputes in relation to a matter covered in the arbitration clause in the contract, such disputes or differences do not remain arbitrable and the arbitration clause cannot be invoked…Though the original contract was validly executed, the Petitioner and the Respondent had decided to put an end to it as if it never existed and substituted a new contract in its place, governing their rights and liabilities. In such a situation, the original contract is extinguished by the substituted one, the arbitration clause of the original one perishes with it.”

Aggrieved by this, the Petitioner filed a petition under Section 34 (Application for setting aside arbitral awards) of the Act, urging the Delhi HC to set aside the Impugned Award.

Issues

Whether an arbitration clause survives a supervening agreement between the parties.
Whether the Construction Contract stood novated by the MoU.

Arguments

Contentions of the Petitioner:

The Petitioner contended that the Arbitrator’s interpretation of the Construction Contract and the MoU was arbitrary and perverse, therefore rendering the Impugned Award manifestly illegal. The Petitioner submitted that as per the MoU, the Construction Contract was to stand satisfied only upon the fulfilment of conditions enumerated therein and that the Respondent had failed to make full payment of the sum of INR 132 Lakhs to the Petitioner. Therefore, the Petitioner was entitled to claim all dues under the Construction Contract. Further, the MoU contemplated execution of a new contract on ‘cost plus’ basis which was not done. For that reason, the Petitioner had submitted its claims before the Arbitrator under the Construction Contract rather than under the MoU.

The Petitioner argued that the Impugned Award would have an effect of taking away the Petitioner’s right to make claims for its dues and losses under the Construction Contract, which was contrary to the terms of the MoU.

In order to support its contention that the Construction Contract did not stand novated by the MoU and that the arbitration clause contained in the Construction Contract survived the execution of the MoU, the Petitioner sought to distinguish the judgement in the Young Achievers Case on the basis of the decision rendered in Union of India v. Kishorilal Gupta and Brothers [AIR 1959 SC 1362] wherein the SC made a distinction between a contract which stands finally determined only on payment of the agreed amount and a contract which stands determined on the date of settlement. The Petitioner submitted that a proper interpretation of the terms of the MoU would place the instant case in the first category. Thus, the Arbitrator had missed the conditional nature of cancellation of the Construction Contract. Reliance was also placed by the Petitioner on the judgement passed in Lata Construction v. Rameshchandra Ramniklal Shah [(2000) 1 SCC 586] wherein the SC opined that an original agreement would remain enforceable if the payment under a second contract was not made.

Contentions of the Respondent:

The Respondent submitted that the Arbitrator’s interpretation of the Construction Contract and the MoU was a plausible one and therefore, does not call for interference of the Delhi HC under Section 34 of the Act. Further, while the MoU permitted the Petitioner to make claims with respect to amounts that were due to it under the Construction Contract, it neither revived the Construction Contract nor resurrected the arbitration clause contained thereunder.

The Respondent further submitted that under the terms of the MoU, the Petitioner and the Respondent had arrived at a settlement by which the Construction Contract was ‘cancelled’ or ‘closed’. Further, the Respondent’s failure to make full payments to the Petitioner under the terms of the MoU was due to the Petitioner’s failure to hand over the consumables mentioned in the annexure of the MoU to the Respondent.

In order to support its submission, the Respondent relied on the judgements passed by the SC in the cases of Nathani Steels Limited v. Associated Constructions [1995 Supp (3) SCC 324] wherein it was held that a party cannot invoke an arbitration clause after having entered into a settlement and Damodar Valley Corporation v. K.K. Kar [(1974) 1 SCC 141] wherein it was held that if a contract is put to an end, the arbitration clause, which is a part of it, also perishes along with the contract. Therefore, in light of the settlement that had been arrived at between the Petitioner and the Respondent under the MoU, it was not open to the Petitioner to invoke the arbitration clause contained in the Construction Contract and seek performance based on the terms thereunder.

Observations of the Delhi HC

While dealing with the question on whether an arbitration clause would survive a supervening agreement, the Delhi HC examined the judgements relied upon by: (i) the Arbitrator; (ii) the Petitioner; and (iii) the Respondent; and observed that the principles emerging therefrom were as follows:

An arbitration clause contained in an agreement which is void ab initio cannot be enforced as the contract itself never legally came into existence.

A validly executed contract can also be extinguished by a subsequent agreement between the parties.

If the original contract remains in existence, for the purpose of disputes in connection with issues of repudiation, frustration, breach, etc., the arbitration clause contained therein continues to operate for those purposes.

Where the new contract constitutes a wholesale novation of the original contract, the arbitration clause would also stand extinguished by virtue of the new agreement.

The Delhi HC observed that an application of the above-mentioned principles would require an interpretation of the MoU in order to determine whether the arbitration clause in the Construction Contract would remain enforceable.

Further, the Delhi HC observed that interference by courts with arbitral awards on the ground of patent illegality was permitted only in limited circumstances and that the findings of the arbitral tribunal were generally to be respected, unless they are found to be irrational or perverse. Moreover, in the context of arbitral awards, it is not sufficient to show that an arbitrator has committed an error if the matter falls within the jurisdiction of the arbitrator. The courts are mandated to adopt a circumspect approach, and to uphold an award, so long as the findings of the arbitrator pass the plausibility test.

While dealing with the question on whether the Construction Contract stood novated by the MoU, the Delhi HC observed that this in itself was a question of contractual interpretation and that as per Section 34 of the Act, the Delhi HC was not required to accord its own interpretation to contractual documents but only to assess whether the provisions thereof were capable of the interpretation placed upon them in the Impugned Award.

The MoU recorded the terms upon which the Construction Contract would stand fully satisfied towards both the parties. However, this did not lead to a conclusion that the Construction Contract would stand revived, if the terms thereunder were not fulfilled. Pertinently, the MoU itself referred to the Construction Contract as a ‘closed contract’. Further, the MoU incorporated an agreement between the Petitioner and the Respondent to ‘cancel’ the Construction Contract. There was no express or implicit provision in the MoU stating that the Construction Contract would stand revived on account of any breach of the terms contained in the MoU.

Decision of the Delhi HC

The Delhi HC held that the contention of the Petitioner that the Impugned Award suffered from patent illegality was not acceptable. Further, the Arbitrator’s conclusion that the MoU constituted a novation of the Construction Contract was unimpeachable within the limited jurisdiction of the Delhi HC under Section 34 of the Act.

Therefore, the Delhi HC did not find sufficient cause to interfere with the Impugned Award passed by the Arbitrator and dismissed the petition filed by the Petitioner.

VA View:

The Delhi HC has rightly upheld the Impugned Award given that the Petitioner and the Respondent had decided to put an end to the Construction Contract and substituted it by entering into a MoU governing their respective rights and liabilities. Moreover, the MoU referred to the Construction Contract as a ‘closed contract‘. In the instant case, the Construction Contract would stand extinguished by the MoU and the arbitration clause in the Construction Contract perishes with it.

Through this judgement, the Delhi HC has yet again set the legal position straight that in instances where a former contract stands novated, that is, completed or superseded by a fresh contract, the arbitration clause contained in the former contract would perish with its novation and cannot be carried over or enforced as part of the fresh contract. The judgement also serves as a reminder on how important it is for parties entering into contracts to ensure that they understand and agree to the terms set out thereunder, especially in cases where such contracts have the effect of superseding a past contract.

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

Legalaxy – Monthly Newsletter Series – Vol II – July, 2023

We are pleased to share with you the link to our newsletter “Legalaxy” for July 2023, providing updates on the recent and relevant legal developments in India.

Below are the key highlights of the newsletter:

SEBI LODR (Second Amendment) Regulations, 2023, notified by SEBI
SEBI tightens disclosure and ownership norms for FPIs and halves IPO listing time to 3 days
SEBI (Alternative Investment Funds) (Second Amendment) Regulations, 2023 notified by SEBI
SEBI proposes mandatory dematerialisation of units of AIFs
SEBI provides flexibility to AIFs to deal with illiquid investments during the
winding-up process
SEBI prescribes standardised approach to valuation of investment portfolio of AIFs
SEBI suggested methods to achieve minimum public shareholding in REITs and InvITs
Implementation of increased rate of TCS and classification of international credit card used overseas under LRS
RBI notifies Framework for Compromise Settlement and Technical Write-offs under Prudential Framework
RBI issues Guidelines on Default Loss Guarantee (DLG) in Digital Lending
RBI permits banking units in IFSC to deal in NDDC involving INR for resident non-retail
Payment of fees to Foreign Universities in the GIFT City permitted under the LRS UGC revised norms for Deemed University Status
EPFO extends time for employees to submit options to get pension on higher wages and for employers for uploading wage details online
MCA excludes certain transactions from the ambit of moratorium under IBC

We hope you like our publication. We look forward to your suggestions.

Please feel free to contact us at [email protected]

GST Cafe | GSTN Advisory on Form DRC-01B

We are pleased to share with you a copy of our latest publication of GST Café, a briefing on the recent advisory issued by GSTN, wherein a new functionality has been introduced i.e., to intimate the taxpayer regarding the differences between liabilities declared in GSTR 1 and GSTR 3B returns.

We trust that you will find the same useful.

Looking forward to receiving your valuable feedback

For any further information/ clarification, please feel free to write to:

Mr. Shammi Kapoor, Partner at [email protected]

Supreme Court of India reaffirms competitive neutrality principle – holds that Government Companies are not outside the preview of the Competition Act

“Competitive neutrality” meaning creating a level playing field between public and private sector is a bedrock of modern competition laws across the Globe. For instance, in Europe, there are special provisions for scrutiny of “State Aid” in the form of Article 107 of the Treaty on the Functioning of the European Union (TFEU). Unfortunately, while redesigning our competition law, India did not opt for a similar specific provision in our Competition Act, 2002. (The Act).

But it is not as if the concept does not exist in India. The concept has been discreetly introduced in the Act in the wide definition of “enterprise “ , which includes even departments of governments which may be engaged in any activity relating to production, storage, distribution, supply, acquisition or control of articles or goods or the provision of services, of any kind, or in investment or in business of acquiring, holding, underwriting shares, debentures etc. and excludes only four “sovereign” functions of the State relating to currency, defense, atomic energy and space from the ambit of the Act.

The jurisprudence on the interpretation of section 2(h) of the Act i.e., the definition of the term “enterprise” (which encompasses the concept of competitive neutrality as aforesaid in India) has matured over the years through the orders of the erstwhile Competition Appellate Tribunal (COMPAT) and the High Courts and the Supreme Court.

For a detailed analysis on how the above jurisprudence on the definition of the term “enterprise “ evolved in India through the initial judgments of the writ Courts you may refer to my seminal article on “Role of Courts in Enforcement of Competition Law in India “ published in the European Competition Law Review in July, 2019[1], and how in its latest order in October 2022, the fair market regulator, Competition Commission of India (CCI), reiterated this principle by directing investigation against Indian Rare Earth Limited, a Central Public Sector Undertaking (CPSU), for alleged abuse of dominant position.

As if furthering the same jurisprudence on the topic, the Hon’ble Supreme Court of India vide its Judgement dated 15 June 2023 assiduously examined the appeal brought forth by Coal India Limited (“CIL”), contesting the applicability of the Competition Act, 2002 (“Act”) to Government Companies /Public Sector Undertakings governed by specific statutes.

The genesis of this case stems from a preceding order passed in 2014 by the Competition Commission of India (“CCI”), wherein CIL was found CIL engaging in abusive conduct by virtue of its dominant market position. This abusive behavior predominantly revolved around the imposition of inequitable and discriminatory stipulations within Fuel Supply Agreements pertaining to the procurement of non-coking coal for thermal power producers.

Subsequently, the COMPAT upheld the CCI’s decision in the year 2016. Discontented with the verdict of the COMPAT, CIL approached the Supreme Court, interposing a preliminary objection postulating that the Act lacks jurisdiction over CIL, as the company’s monopolistic authority was conferred upon it through the enactment of the Coal Mines (Nationalization) Act, 1973 (“Nationalization Act”).

Arguments of Appellant Coal India Ltd.

Shri K. K. Venugopal, a learned Senior Counsel, ( former Attorney General of India ) put forth a compelling argument on behalf of the appellants, asserting that their coal mines, operating under the provisions of the Coal Mines (Nationalization) Act, 1973, should be considered outside the purview of the Competition Act. The Nationalization Act, according to Venugopal, established a unique and protected monopoly of coal mining operations in the hands of the Central Government and its affiliated entities, including the appellants. This monopoly, designed to secure the equitable distribution of the scarce resource of coal for the common good, was safeguarded by constitutional provisions and directives.

Further it was contended that the appellants, being part of this statutorily mandated monopoly, should be exempt from the Competition Act, as they represent a distinctive form of monopoly referred to as an “Article 39(b) monopoly.” Unlike a regular monopoly, an Article 39(b) monopoly aligns with the State’s duty to consider the principles of common good and the distribution of scarce resources. The Nationalization Act entrusted the appellants, as a State entity, with the responsibility of operating this monopoly while abiding by the Directive Principles enshrined in Article 39(b) of the Constitution.

The learned Senior Counsel highlighted that the Competition Act does not specifically address companies like the appellants. Although Section 19(4)(g) of the Act acknowledges the possibility of a statutory monopoly indicating a dominant position, there exists a subtle distinction. The appellants, as an Article 39(b) monopoly, fall outside the scope of the Act. Previous court decisions, such as Ashoka Smokeless Coal India (P) Ltd. and Others v. Union of India and Others, following the precedent set by Sanjeev Coke Mfg. Co. v. Bharat Coking Coal Ltd. and Another, were cited to reinforce this point.

Referring to Sections 3 and 11 of the Nationalization Act, Venugopal argued that the broadest interpretation should be given to the general superintendence, direction, control, and management of coal mines specified in the Act. To support this stance, the learned Senior Counsel drew parallels with judgments interpreting similar language in Article 324 of the Constitution, such as In Re Gujarat Assembly Election matter and Election Commission of India v. Ashok Kumar and Others. Furthermore, Venugopal invoked Article 31C of the Constitution, which states that laws giving effect to Article 39(b) or 39(c) cannot be challenged on grounds of inconsistency with Articles 14 and 19. Such laws are deemed reasonable, whereas actions contradicting Directive Principles may be viewed as prima facie unreasonable, as highlighted in Kasturi Lal Lakshmi Reddy and Others v. State of Jammu and Kashmir and Another.

The appellants juxtaposed the Nationalization Act with the provisions of the Competition Act, emphasizing the divergences and resulting anomalies that would arise from subjecting the appellants to the latter. They drew attention to the contrasting long titles of both acts. While the object of the Competition Act is to ensure freedom of trade, the Nationalization Act demonstrates the intent to vest ownership and control of coal mines in the State for the optimal distribution serving the common good. It was argued that the Coal India Limited (CIL), as part of its constitutional obligations, engages in coal mines where it incurs substantial losses, employs a significant workforce, and operates with welfare policies that prohibit employee layoffs.

Arguments by CCI and other Respondents

The argument put forth by the Additional Solicitor General on behalf of the Competition Commission of India (CCI) emphasizes that the Act in question applies despite any conflicting provisions in the Nationalisation Act. The objective of the Act is to bring about a paradigm shift in the nation’s economic policy, ensuring the best economic interest of the country. The argument highlighted that state monopolies should operate efficiently and within the framework of competition.

CCI asserted that there is no challenge to the validity of the Act itself and suggested that laws enacted by the state cannot claim immunity when engaging in commercial activities. The composition of the CCI is seen as a sufficient safeguard, with experts in various fields ensuring fair examination of complaints related to abuse of dominant position. The argument also discussed the filters in the Act for determining abuse of dominant position by enterprises and the objective criteria provided for arriving at such a finding.

Additionally, the argument addressed the changing status of coal as an essential commodity and the repeal of the Nationalisation Act. It highlighted the reduction in government shareholding in the first appellant (possibly a government company) and argued that it cannot claim immunity from scrutiny based on its placement in the Ninth Schedule. The argument draws on various legal precedents to support the contention that the immunity of laws placed in the Ninth Schedule is diluted and that fundamental rights are qualified.

Different counsels representing the respondents support the applicability of the Act, emphasizing the common good associated with coal supply and the regulation of power prices. They argue that the acts and omissions of the appellants affect not only private players but also public sector units. The Maharashtra Power Generation company is mentioned as an example.

Supreme Court Findings

The Supreme Court started its analysis of issue whether the Competition Act, 2002 is applicable on Coal India Limited (CIL) or not, by observing various provisions of erstwhile Monopolies and Restrictive Trade Practices Act, 1969 (“MRTP Act”), Coal Mines Nationalization Act, 1973 (“Nationalization Act”), observations and recommendation of Raghavan Committee and scheme of the Competition Act, 2002 and noted that CIL cannot seek immunity from the operation of law, which otherwise bind them.

The Supreme Court started its analysis with the question where CIL falls within the definition of ‘enterprise’, as defined in Section 2(h) of the Act. The Supreme Court after analyzing the definition of enterprise and person under the Act held that there cannot be the slightest amount of doubt that the appellant is a person, which is engaged in activity relating to production, storage, supply, distribution, and control of goods, as defined in the Act. It may also be within the ambit of Section 2(h) in regard to services it may provide, having regard to the wide words used in Section 2(h) as CIL being a Government Company within the meaning of Section 617 of the Companies Act, 1956 is a “person” as defined under Section2 (l) of the Act and is engaged in economic activity relating to production, storage, distribution, and control of goods or services.

Further, the Apex Court outlined the scheme of the Competition Act the principle of enacting the and noted that that the Law-Giver has taken care to expressly include even Departments of the Government separately within the ambit of the word ‘enterprise’. Things could not be more clear. The only activity of the Government, which has been excluded from the scope of Section 2(h) and therefore, the definition of the word ‘enterprise’ is any activity relatable to the sovereign functions of the Government. Sovereign functions would include, undoubtedly, all activities carried on by the Departments of the Central Government, dealing with atomic energy, currency, defense and space.

The Apex Court noted that Section 19(4)(g) of the Act, explicitly includes monopolies or dominant positions acquired through statutes or as government companies, public sector undertakings, or by any other means. Thus, the Court concluded that legislature intended to include the State Monopolies, Government Companies, Public Sector Units, and entities governed by statutes within the purview of the Act. Thus, CIL being a Monopoly under the Nationalisation Act, would fall within the realm of a dominant position as per Section 19(4)(g).

The Supreme Court while considering the argument of “common good” in Article 39(b) of the Constitution and acknowledging the aim of the Nationalization Act to achieve the goals outlined in Article 39(b) held that the content of common good is itself not a static concept and changes with the time and may depend upon the times, the felt necessities, the direction that the Nation wishes to take in the future, the socio-economic condition of the different classes, the legal and Fundamental Rights and also the Directive Principles themselves and therefore there is no reason to hold that a State Monopoly being run through the medium of a Government Company, even for attaining the goals in the Directive Principles, will go outside the purview of the Act.

Finally, the Supreme Court noted the wide power possessed by the CCI under the Act and held that though the action of the CIL can be challenged in judicial review and in other forums like Controller of Coal, however, this does not exempt it from the preview of the Competition Act.

Lastly the Supreme Court held that through a notification under Section 54 of the Act can exempt from the application of the Act or any provision and for any period on the ground security of the State and public interest. Therefore, if a genuine case made out by CIL for being taken outside the purview of the Act in public interest, the Government would be powerless.

COMMENT – The Apex Court vide this latest order has further strengthened the concept of competitive neutrality in the Indian competition law by rejecting the defence on ground of the archaic Nationalization Act, put forth vehemently by the Ld. Shri KK Venugopal, former AGI. The Supreme Court has reiterated that except for the four well defined sovereign functions of the State under Section 2(h) of the Act, all other economic activities of the State are covered under the Act and amenable to CCI scrutiny for any violation of the enforcement provisions of the Act. This is a very positive and healthy development for competition law jurisprudence.

————————————————–

Authored by
Mr. MM Sharma, Head – Competition Law & Policy
E: [email protected]

and

Mr. Sudhanshu Prakash Singh, Associate
E: [email protected]

NCLT: Land owners entering into joint development agreements for sharing of profits do not come within the ambit of operational creditors

The National Company Law Tribunal, Principal Bench, New Delhi (“NCLT”) has, in its order dated May 12, 2023 (“Order”), in the matter of Mrs. Jesleen Kaur Papneja v. Raheja Developers Limited [Company Petition (IB)/392(PB)/2019], held that an agreement in the nature of a joint development agreement, for sharing of profits in an agreed upon ratio, does not come within the ambit of an operational debt and that the land owners entering into such joint development agreements do not come within the ambit of operational creditors.

Facts

M/s Raheja Developers Limited (“Corporate Debtor”) was a real estate developer company engaged in the development and construction of integrated residential/ commercial plotted colonies/ group housing apartments, etc. Mrs. Jesleen Kaur Papneja (“Applicant”) along with three land owners (collectively, “Land Owners”) and the Corporate Debtor had entered into a collaboration agreement dated August 13, 2012, which was subsequently amended by a supplementary collaboration agreement dated June 25, 2013 (“Collaboration Agreement”), for the development of certain land admeasuring 24.1563 acres (“Total Land”) in which the Land Owners had an undivided share. Out of the Total Land, the Corporate Debtor had procured a license for 12.48675 acres (“Licensed Land”) from the Directorate of Town and Country Planning for the development of a residential group housing project namely ‘Raheja Vanya’ (“Project”). The balance land admeasuring 11.6695 acres remained unlicensed.

A memorandum of understanding dated October 7, 2016 (“MoU”) was entered into between the Corporate Debtor and the Land Owners wherein the Land Owners permitted the Corporate Debtor to construct, develop, maintain, and sell the Land Owners’ share, subject to the terms and conditions of the MoU. Under the MoU, the Land Owners agreed to provide the Corporate Debtor with the following:

An exclusive right to develop and construct the Licensed Land;
An exclusive and absolute right to sell the flat units and other saleable area of the Project;
The right to convey and transfer the title and interest in the Project; and
Exclusive and irrevocable rights with respect to the development of the Project.

In consideration of the abovementioned rights, the Corporate Debtor had agreed to develop the Project at its own cost and pay certain amounts to the Land Owners under various heads as agreed upon under the terms of the MoU, including ‘revenue sharing’.

Subsequently, an agreement dated October 25, 2016 (“Agreement”) was entered into by and amongst the Corporate Debtor, Mr. Navin M. Raheja (personal guarantor), Raheja SEZs Limited (mortgagor No. 1) and Enkay Buildwell Private Limited (mortgagor No. 2) (collectively, “Raheja Group”) and the Land Owners. Since the Project was given as cross collateral for other project loans, the Raheja Group had, agreed to ensure the payment of the Land Owners’ entitlement under the MoU by providing security/ mortgage/ hypothecation, etc., on a second charge basis certain mortgaged properties and receivables, subject to the terms and conditions of the Agreement. Under the terms of the MoU and the Agreement, the Land Owners were entitled to payments towards the Total Land purchase with development rights by the Corporate Debtor. Further, as per the MoU, the Land Owners were also entitled to 23.5% of the amounts received from the customers of the Project and such amount was to be disbursed by the Corporate Debtor in the manner provided in the MoU and the Agreement.

The total collection from the Project till September 2017 was INR 71.3 Crores, out of which the Land Owners’ share of 23.5% amounted to INR 16.7 Crores. From the total amount of INR 16.7 Crores payable by the Corporate Debtor, a balance of INR 9.10 Crores remained unpaid to the Land Owners.

Consequently, the Applicant served a demand notice dated December 7, 2018, under Section 8 (Insolvency resolution by operational creditor) of the Insolvency and Bankruptcy Code, 2016 (“IBC”) demanding the payment of INR 9.10 Crores (“Demand Notice”) as a share in contravention of Clause 5.5.1 of the MoU. The Applicant had also claimed that the default amount payable by the Corporate Debtor was approximately INR 1,51,70,000/- due as on September 30, 2018.

Owing to the above, the Applicant had filed an application under Section 9 (Application for initiation of corporate insolvency resolution process by operational creditor) of IBC read with Rule 6 (Application by operational creditor) of the Insolvency and Bankruptcy (Application to Adjudicating Authority) Rules, 2016, for initiating corporate insolvency resolution process against the Corporate Debtor (“Application”).

Issue

Whether the dues to land owners entering into joint development agreements for sharing of profits can be treated as ‘operational debt’ within the provisions of the IBC.

Arguments

Contentions of the Applicant:

The Applicant contended that the lender of the Corporate Debtor, namely L&T Financial Services, had by its e-mail dated October 24, 2018 informed the Land Owners for the first time about the total collection from the Project as on September 2017.

The Applicant further submitted that land and construction over that land was the main component for development of any real estate project. The Licensed Land and the development rights over such land were directly related to the units/ product which were being developed, marketed and sold by the Corporate Debtor for its commercial operation/ production. Moreover, real estate companies generally treated land and building as ‘stock in trade’ in their books of accounts. Therefore, the Land Owners of the Licensed Land were ought to be treated as operational creditors of the Corporate Debtor.

Contentions of the Corporate Debtor:

The Corporate Debtor denied all the averments made by the Applicant and submitted that the Application was not maintainable considering that the debt claimed by the Applicant did not fall within the purview of operational debt under the IBC. Moreover, no goods or services were supplied/ rendered to the Corporate Debtor.

The Corporate Debtor contended that the Land Owners had executed a Collaboration Agreement for the development of a residential group housing colony over the Licensed Land, wherein the parties were to make payments towards external development charges and infrastructure development charges in proportion to their respective shares. Hence, the Land Owners and the Corporate Debtor were in joint collaboration. Further, a backup security agreement dated October 25, 2016 had been executed by and amongst the Land Owners and the Corporate Debtor, under the terms of which a net amount of INR 130 Crores was payable to the Land Owners as minimum security, which was inclusive of the amounts previously paid to the Land Owners and the alleged debt of INR 9.10 Crores, that had been claimed by the Applicant in the Demand Notice.

The Corporate Debtor contended that it had made a payment of INR 3 Crores towards pass through charges in compliance with Clause 5.5.1 of the MoU, which specifically provided that the first charge on receivables was towards ‘pass through charges’ and not towards payments to Land Owners. However, the Applicant objected such payment of INR 3 Crores towards pass through charges. Consequently, the Corporate Debtor preferred an application under Section 9 (Interim measures, etc., by Court) of the Arbitration and Conciliation Act, 1996. The Corporate Debtor submitted that the said matter was taken up in arbitration by the Corporate Debtor prior to the Demand Notice. However, the arbitration application was subsequently dismissed by the adjudicating authority.

The Corporate Debtor also submitted that the Demand Notice was an afterthought, despite knowledge of the pre-existing arbitration application. The Applicant, instead of filing her reply to the arbitration application preferred by the Corporate Debtor, chose to send the Demand Notice. Moreover, the claims under the Demand Notice had jeopardised the development of the entire Project.

The Corporate Debtor concluded its arguments by stating that the Land Owners could not claim to be considered as operational creditors as they had neither supplied any goods nor rendered any services to the Corporate Debtor.

Observations of the NCLT

The NCLT observed that upon perusal of the definition of the term ‘operational debt’ under Section 5(21) of the IBC, it was clear that the definition is comprehensive in nature and has to be understood within the four corners of the IBC. Operational debt means a ‘claim in respect of the provision of goods and services’.

The NCLT perused the terms of the Collaboration Agreement, the MoU and the Agreement and observed that the transactions involved in the instant case were in the nature of a joint development agreement wherein the Corporate Debtor, being the developer, was to develop the land and the profits arising therefrom were to be shared amongst the Land Owners and the Corporate Debtor as per the agreed terms of the said Collaboration Agreement, the MoU and the Agreement.

The NCLT observed that it had been reiterated in several cases, both by the NCLT and the National Company Law Appellate Tribunal, that joint development agreements do not come within the ambit of ‘financial debt’ as defined under the IBC, and therefore, the question to be deliberated upon was whether such agreements and claims arising therefrom could be characterised as a ‘operational debt’.

The NCLT observed that the Applicant in her submissions before the NCLT was suggesting that there was a direct nexus between the units sold by the Corporate Debtor and the Licensed Land, the ownership of which belonged to the Land Owners and so, the Land Owners were to come within the ambit of operational creditors. The NCLT further observed that the Applicant was attempting to give a very wide interpretation to Section 5(21) of the IBC which was not the legislative intent of the IBC.

Reasonably, while the Land Owners and the Corporate Debtor had, by way of entering into various agreements, shared a legal and binding relationship with mutual financial obligations towards each other, the transactions were not in the nature of ‘operational debt’. Therefore, the agreements entered into between the Corporate Debtor and the Land Owners could neither be considered within the ambit of ‘operational debt’ under Section 5(21) of the IBC, nor could the Land Owners be treated as ‘operational creditors’ under Section 5(20) of the IBC and thereby under Section 9 of the IBC.

Decision of the NCLT

The NCLT opined that the nature of the agreement entered into between the Corporate Debtor and the Land Owners was that of a joint development agreement for development of the Project with the motive of sharing profits in an agreed upon ratio.

Therefore, the agreements were not to be read in isolation and were rather to be seen collectively as a whole, and since the joint development agreements were entered into with a motive for the development of the Project and sharing of the proceeds therefrom, rather than as a provision of goods or services, there was no case for the Application to be covered and admitted under Section 9 of the IBC. The NCLT did not find any merit in the Application and therefore dismissed the same.

VA View:

It has been observed in several judicial precedents that the rights of land owners under joint development agreements have not been favoured and such land owners have not been regarded as operational or financial creditors within the provisions of the IBC. The NCLT, through this Order has clarified that the legislative intent of the IBC is to safeguard the interests of legitimate third-party creditors who must not be affected by inter-se disputes between the land owners and the developer.

The NCLT has reiterated that in order to be considered as an operational creditor under Section 5(20) of the IBC, one must be entitled to an ‘operational debt’, that is, claims relating to the provision of goods or services. Since a joint development agreement is entered into with the intent of sharing profits and not for the provision of goods or services, land owners who enter into such joint development agreements cannot be considered as operational creditors within the ambit of the IBC.

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

NCLAT upholds the insolvency proceedings against Go First

The National Company Law Appellate Tribunal (“NCLAT”), collectively in the matters of:

SMBC Aviation Capital Limited v. Interim Resolution Professional of Go Airlines (India) Limited, Abhilash Lal [Company Appeal (AT) (Insolvency) No. 593 of 2023],

SFV Aircraft Holdings IRE 9 DAC v. Interim Resolution Professional of Go Airlines (India) Limited, Abhilash Lal [Company Appeal (AT) (Insolvency) No. 603 of 2023],

GY Aviation Lease 1731 Company Limited and Others v. Interim Resolution Professional of Go Airlines (India) Limited, Abhilash Lal [Company Appeal (AT) (Insolvency) No. 604 of 2023],

Engine Leasing Finance B.V. v. Interim Resolution Professional of Go Airlines (India) Limited, Abhilash Lal [Company Appeal (AT) (Insolvency) No. 615 of 2023],

upheld the initiation of Corporate Insolvency Resolution Process (“CIRP”) of Go Airlines (India) Limited (“Corporate Applicant/ Respondent”) under the Insolvency and Bankruptcy Code, 2016 (“IBC”).

Facts

Pratt & Whitney (“P&W”) supplied faulty engines to the Corporate Applicant, owing to which the Corporate Applicant suffered losses and had to cancel several flights. After multiple attempts to resolve the issue amicably with P&W, an emergency arbitration was filed before the Singapore International Arbitration Centre against P&W, wherein the arbitrator passed arbitration awards requiring P&W to provide replacement engines which were not complied by P&W. Consequently, Corporate Applicant initiated enforcement proceedings against P&W in Delaware, U.S. and other relevant jurisdictions where engines were located.

The Corporate Applicant had committed a default of INR 2,660 Crores toward aircraft lessors, INR 1,202 Crores towards operational creditors (including dues towards its vendors) and default of INR 11.03 Crores (towards interest dues of the Financial Creditors, which did not exist on the date of filing the application). SMBC Aviation Capital Limited, GY Aviation, SFV Aircraft Holdings and Engine Leasing Finance B.V. (“Lessors/ Appellants”) had leased aircraft(s) to the Corporate Applicant.

Consequently, the Corporate Applicant sought for initiation of CIRP against itself and filed an application under Section 10 (Initiation of corporate insolvency resolution process by corporate applicant) of the IBC (“Application”). The New Delhi Special Bench of the National Company Law Tribunal (“NCLT”) admitted the Application by its order dated May 10, 2023 and initiated CIRP against the Corporate Applicant which resulted in a moratorium (“Impugned Order”) owing to which, the possession of the aircraft could not be taken by the lessors. NCLT also passed an order for suspension of the Corporate Applicant’s board of directors and ex-management. Mr. Abhilash Lal was appointed as an Interim Resolution Professional (“IRP”) by NCLT to keep the Corporate Applicant as a going concern and run its services smoothly and to check that retrenchment of employees is not resorted to.

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

Issues

Whether issuance of a notice to the creditors is necessary for granting hearing or opportunity of hearing, before admission of Application.
Whether the adjudicating authority is required to give an opportunity to the creditor to file an application under Section 65 (Fraudulent or malicious initiation of proceedings) of the IBC before admitting the application under Section 10 of the IBC, where the creditors have an objection to the said application for being filed fraudulently with malicious intent.
Whether moratorium will be applicable to the assets in case where the Lessors have terminated the lease agreement prior to the admission of Application.
Whether the Appellants are entitled to claim possession of the aircraft(s) and export the aircraft(s) as per the lease agreement where the Appellants have terminated the lease agreement prior to admission of the CIRP.

Arguments

Contentions of the Appellants:

The Appellants contended that the Impugned Order violates the principles of natural justice, since NCLT did not take into consideration the time period sought by the Appellants for filing an application under Section 65 of the IBC. Additionally, the Impugned Order has been passed without serving the copy of Application on the Appellants.

The Appellants also contended that there were objections raised against the Corporate Applicant’s fraudulent and malicious intent and it should have been taken into consideration and an opportunity to file an application under Section 65 of the IBC ought to have been granted before the admission of the Application.

The Appellants placed reliance on judgment of the NCLAT in Wave Megacity Centre Private Limited v. Rakesh Taneja and Others [Company Appeal (AT) (INS.) No. 918 of 2022], wherein the order of the adjudicating authority was challenged by the corporate applicant, as a result of which the application under Section 10 of the IBC was rejected and the application under Section 65 of the IBC was allowed.

Additionally, the Appellants contended that the lease agreement executed in favour of the Corporate Applicant was terminated prior to the admission of the Application. Therefore, the Corporate Applicant has no legal right in respect to the aircraft’s possession, therefore moratorium under Section 14 (Moratorium) of the IBC is not applicable on the assets of the Appellants.

Contentions of the Respondent:

The Respondent contended that the moratorium has been imposed under Section 14 of the IBC by which the Appellants are prohibited from recovering the assets. Consequently, the Appellants cannot recover any property, which is in possession of the Corporate Applicant. As the Corporate Applicant has the possession of the aircraft(s), it is also registered in their name and the said registration has not yet been cancelled, the Corporate Applicant is entitled to retain the possession.

The Respondent contended that the termination of lease took place after the Application. It was also contended by the Respondent that the principles of natural justice are not violated by the Impugned Order as there exists no requirement that the creditors should be heard before admission of an application under Section 10 of the IBC.

The Respondent submitted that there is no mandatory requirement to issue a notice to the creditors at the pre-admission stage under Section 10 of the IBC. It is a discretion which is exercised on a case-to-case basis on valid grounds. Here, in this case, the Application was accepted by the NCLT. Further, no application under Section 65 of the IBC was filed or put forth before the NCLT for consideration. Filing and decision of an application under Section 65 of the IBC can take place even after the admission of application under Section 10 of the IBC.

Observations of the NCLAT

It was observed by the NCLAT that there is no obligation on the Corporate Applicant to issue a prior notice to the creditors for initiation of the CIRP under IBC. However, during the admission proceedings NCLT must hear the objectors and accordingly take an appropriate decision. Further, NCLAT observed that the Corporate Applicant has not violated the principles of natural justice in the present case by merely not issuing a notice to the creditors, more so when objectors were heard by NCLT. Furthermore, NCLAT held that the application by the Corporate Applicant was not fraudulent with malicious intent and Appellants have the liberty to file an application under Section 65 of the IBC even after Application has been admitted.

NCLAT also granted liberty to the IRP and the Appellants for advancing appropriate application before NCLT for the purpose of declaring the applicability of the moratorium on the aircraft(s) regarding which leases in favour of the Corporate Applicant were terminated prior to admission of Application and it would to be decided by NCLT as per the provisions of law.

Decision of the NCLAT

The NCLAT disposed of the appeal filed by the Lessors and upheld the Impugned Order. Further, the NCLAT ordered the Lessors to file applications before the NCLT for the purpose of declaration on the moratorium’s applicability and make claims regarding the leased aircraft(s).

VA View:

It can be observed that this is a landmark case where a creditor did not file the application for insolvency, rather the CIRP commenced due to an application of the Corporate Applicant filed directly with the NCLT. The Application was a move to prevent the lessors from seizing the aircraft’s possession from the hands of the Corporate Applicant and an attempt by the Corporate Applicant to safeguard itself from further financial distress thereby resulting in a breach of its obligations towards the creditors.

This case may establish a new trend for further insolvency cases against the legislative intent wherein the Corporate Applicant may follow the similar shorter roadmap for obtaining a temporary monetary ease by directly approaching NCLT and filing an application for its insolvency to dispose of its liabilities in the event of business downturns.

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