Contemporary Contours of Ipso Facto Clauses in India Under Insolvency and Bankruptcy Law

*Pranay Jaiswal

Introduction

Commercial contracts generally incorporate a principle which states that when a party to the contract is referred to an insolvency proceeding, the non-defaulting party can repudiate the contract. Nevertheless, the said position of law seems to deviate from its generic rule when it comes to the party being referred to insolvency proceedings and is set under moratorium. This piece analyses such deadlock wherein the non-defaulting party cannot sue the other party for its non-performance of the contract due to insolvency.

Ipso Facto termination Clauses in Contracts

Ipso facto clauses are profoundly used in commercial and construction contracts. These clauses lay down certain rights for the aggrieved party to enforce the termination of the contract where there is an element of an occurrence of Insolvency. It is a genuine concern of the non-defaulting party about the remedy they can resort to if the opposite party goes bankrupt.

Nonetheless, these ipso facto termination clauses become a huge hurdle when the corporate debtor is sought to be removed from the metes and bounds of insolvency. This reduces the chances of a successful recovery of the company from the insolvency as these clauses deplete the resources the corporate debtor has in order to help rescue itself from the liquidation.

Position of Indian Insolvency law with respect to termination clauses

There exists no express provision pertaining to the status of ipso facto clauses in the contract under the Insolvency Bankruptcy Code, 2016. However, Section 14 of the Insolvency and Bankruptcy Code, 2016 [the ‘Code’] lays down that contract pertaining to essential goods and services shall not be terminated or suspended during the moratorium period.

A complete stay on the ipso facto clauses would cause a serious impact on the business interest of the parties if they are compelled to perform their part without any safeguard. Hence, a partial stay on such clauses will keep the balance in the interests of both the corporate debtor and the party enforcing the ipso facto clause.

Further, under the Code, the resolution professional is also conferred with the authority to amend or modify the contracts or transactions which were entered into before the commencement of the Corporate Insolvency Resolution Process, if he deems it fit to protect and preserve the value of the property of the Corporate Debtor and maintain continuity of operations of the Corporate Debtor as a going concern.

Indian Authority on termination of the contract when the insolvent company is set under Moratorium

In Section 14(1) of the Code, provides for the implications of a moratorium when applied by the Adjudicating authority. It lays down that no action can be instituted against the corporate debtor during the subsistence of moratorium. The recent decision of the NCLAT in the matter of GRIDCO Limited v Surya Kanta Sathapathy and Others[i]encapsulates this principle where the non-defaulting party was restrained from terminating the Power Purchase Agreement (“PPA”) between itself and the corporate debtor as the moratorium was persisting towards the defaulting party’s company.

Herein, the facts of the case were that GRIDCO (Appellant), a state-owned power company, was engaged in supplying electricity after procuring from other sources, one being the corporate debtor. The corporate debtor could not comply with the contract for the supply of electricity as its solar power was disrupted due to adverse weather conditions. The corporate debtor was sued for insolvency, and consequentially moratorium was imposed on it. Despite knowing this fact, the Appellant went on to terminate the PPA existing between the parties. However, this was challenged by insolvency resolution professional, contending that such termination is not permitted when there exists moratorium. This was upheld by NCLT Calcutta as it approved the resolution by the successful applicant. Further, GRIDCO went for an appeal against the decision of NCLT restoring the PPA termination.

It is pertinent to note that when the moratorium is imposed on any corporate debtor, a legal bar is created on any institution of suit or continuation of legal proceedings against the corporate debtor. It aims to safeguard the interest of the corporate debtor and provide scope for the revival of his own business.

In the aforementioned judgment, the contention that was submitted by resolution professional was that termination of PPA would render the moratorium infructuous. As the corporate debtor was engaged in the sole business of power supply, the termination would suffocate the entire process of restructuring of the business.

Jurisprudence behind non-termination of contracts during the moratorium

The remedy laid down by the insolvency must aim to treat the unfulfilled contracts in the presence of the automatic termination of the contract as a result of reference to insolvency. There exist similar clauses in the government contracts and the implication have to be analyzed if the subject matter of the contract pertains to national importance. So, if a similar situation is viewed from the lens of the government contracts, what recourse can the State take when the contractor is on the verge of becoming insolvent.

In the case of Reliance Naval Engineering[ii], it was contemplated that the company’s major contracts were with the government as its sole business was of that of building warships and servicing as per its annual report of 2018-19. Thereafter, the company was admitted as insolvent, raising concerns for its lenders and parties who have entered into the contract. The resort the government can take is that it can continue with the contracts until the end of the assignment as the direct termination would result in a huge loss and cause substantial delay.

Further, the government can categorize its past debt as claims in the form of operational creditors and pending payment as the cost incurred by CIRP which has the stake of highest ranking when it comes to repayment by the bidder.

Moreover, Indian position of law lacks for definite framework wherein the government contracts can be treated into specific manner when the contractor becomes bankrupt. In the US, the concept of ‘automatic stay’ over the termination clauses prevails, which is alike to India with respect to the ordinary contracts. However, the precedent that is set forth with regards to government contracts is substantially different.

The US law lays down that when the party to a government contract goes insolvent, the federal government is vested with ‘police and regulatory power’ with respect to public health and safety. So, if the subject-matter is pertaining to public health and safety, then the government actions are exempted from the automatic stay in case the contractor goes insolvent.

Another instance is wherein the contract entered by the government involves constitutional obligations and the contractor has undergone insolvency. Now, if the government does not comply with the constitutional obligations, the public interest would be hampered. Considering the overriding effect of IBC over all the laws in force, it is to be determined whether the Supreme law of the Land i.e. the Constitution of India, remains subservient to it.

This principle of the paramountcy of constitutional obligations can be traced out in the judgment of Reliance Natural Resources Ltd. v. Reliance Industries Ltd.[iii], wherethe Apex Court laid down that exploration of natural resources and supply of natural gas becomes paramount by virtue of being is the constitutional obligation of the Union under Art. 297 of the Indian Constitution. In addition to this, it also emphasized on the doctrine of public trust, wherein the government acts as the custodian of the public, holding the natural resources and using it towards the benefit of the public. Therefore, the Union is vested with the eminent duty to give preference to the benefit of the people and keeping the private agreement on the second footing.

If such functions of the Union are being privatized, then even that private company is bound by the constitutional obligation. Also, this constitutional obligation was held to be paramount to any private agreement between the parties. Hence, the code lacks the explanation on the position that whether a moratorium imposed shall have an overriding effect on the contract backed by constitutional obligations.

Termination of Contract leading to resolution plan redundant

Further, Section 31 of Insolvency and Bankruptcy Code, 2016, envisages in itself that once the resolution plan is accepted by the committee of creditors and the Adjudicating authority it shall be binding on all the stakeholders.

It is significant to note that in the judgment of Committee of Creditors of Essar Steel India Limited through Authorised Signatory v. Satish Kumar Gupta & Ors.[iv], the Apex Court opined that once the resolution plan is approved by the committee of creditors it shall be binding on all stakeholders, including guarantors, this will help the successful resolution applicant run the business of the corporate debtor afresh. Hence, termination of the contract with a corporate debtor when the resolution plan has been approved will lead the plan so accepted to become an ineffective one.

Further, in the light of Section 238[v] of the Code and the judgment of the NCLT, Delhi, in the case of Astonfield Solar (Gujarat) Private Ltd v Gujarat Urja Vikas Nigam Limited,[vi] construed PPA as the instrument under the said section and held that its provisions, if violate IBC, then it cannot be given effect to.

Further, keeping in mind this interpretation, taking recourse of ipso facto clause to give effect to termination of the contract will violate Section 14(1), asand when an insolvency is admitted, moratorium hits and no legal suit or continuation of legal proceedings is allowed during the moratorium period.[vii]

Conclusion

NCLAT’s stand seems to be quite appreciable which is evident from the above discussion with regards to non-termination of contract in the event of contemplation of insolvency. The settled position of law will set a getaway for the companies and even the small enterprises for the revival of their business without any apprehension of losing the contracts.

 Further, the balance of business interests of both the parties is significant while getting attached to any position. Also, the Code lacks the framework for the treatment of ipso facto termination clauses and if provided with, the same would render balancing the interests of the suppliers and corporate debtors.

*The author is a student pursuing B.A., LL.B. at ILS Law College, Pune.

[i] [C.A. (AT) (Insolvency) 1271 of 2019].

[ii] IDBI Bank Limited v. Reliance Naval and Engineering Limited, C.P. (IB) No. 418/7/NCLT/AHM/2018.

[iii] (2010) 7 SCC 1.

[iv] 2019 SCC OnLine SC 1479.

[v] “provisions of the IBC shall affect, notwithstanding anything inconsistent therewith contained in any other law for the time being in force or any instrument having effect by virtue of any such law".

[vi] C.A. 700-701/ND/2019.

[vii] IBID.