Under the Insolvency & Bankruptcy Code, 2016 (“the Code”), a corporate insolvency resolution process against a company can be initiated by a creditor under Section 7 or Section 9 if the debt is due and payable. Once the resolution process commences, creditors of the corporate debtor may submit “claims” based on the “liability or obligation” owed to them. Such claims have to be submitted to the IRP/RP in the form prescribed. Thus, apart from distinguishing debts as financial, operational and other, the Code consciously makes a distinction between “a claim which is due” and other claims against the corporate debtor. Such other claims may concern a future or contingent liability such as a claim by a person who has filed a suit for recovery of money which is pending or by a person who has filed a claim before an Arbitral Tribunal which is pending.
The Code itself does not seem to provide any clear indication as to the nature of contingent claims. This has resulted in resolution professionals adopting different methods to deal with the uncertainty surrounding contingent liabilities relating to pending litigations and arbitration proceedings; where the corporate debtor is a party to pending litigation and stands in a position in which it may be ordered to pay creditors pursuing the litigations. In this scenario, some of the key questions that arise for consideration are as follows:
(i) Can the resolution professional admit such claims while collating claims under Section 18 of the Code?
(ii) If the IRP/RP were to admit such claims based on the plaint/claims submitted as proof, then is there a basis or yardstick for assessing such claims or should it be admitted in its entirety only based on the suit/claim before the civil court/Arbitral Tribunal?
(iii) If the RP were to reject such claims for reason that they are yet to crystallise and a resolution plan gets approved for the corporate debtor, what remedies do contingent and future creditors have in the light of the ratio in Ghanashyam Mishra and Sons (P) Ltd. v. Edelweiss Asset Reconstruction Co. Ltd.1?
RECOGNITION OF CONTINGENT CLAIMS UNDER THE CODE
Though the definition of the term “claim” under the Code is similar to one provided in Section 101(5) of the US Bankruptcy Code, unlike the US Bankruptcy Code which specifically enumerates “contingent claims”, the Code is silent on the concept of contingent or future liabilities.2 It does, however, hint at the possibility of contingent liability being provable under it by providing that a claim would include a right to payment “whether or not … fixed, disputed, undisputed …” or a right to remedy for breach of contract giving rise to a right to payment “whether or not … fixed, matured, unmatured, disputed, undisputed …”.3 Further, Regulations 13 and 14 of the Insolvency & Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations, 2016 (“the CIRP Regulations”) explicitly acknowledge such liabilities and empower the resolution professional to “determine” to the “best estimate” claims which are “not precise due to any contingency”. NCLT and NCLAT have also on multiple occasions held that contingent liabilities may be admitted while collating claims under Section 18(1)(b) of the Code.4
Curiously, however, neither the Code nor case law provide any clear indication as to what amounts to a contingent liability and as to whether disputed liabilities pending litigation is a contingent liability. Legislations and case laws from other common law jurisdictions have tried to address this issue and may offer some guidance. In the UK, the basic principle of law of insolvency, as the Report of the Review Committee on Insolvency Law and Practice (1982)(“the Cork Report”) at para 1289 described it, is “that every debt or liability capable of being expressed in money terms should be eligible for proof … so that the insolvency administration should deal comprehensively with, and in one way or another discharge, all such debts and liabilities.” To Professor Roy Goode, the term “liability” itself is wide enough to cover a liability to pay money or money’s worth whether under an enactment or for breach of trust or contract or contingent liabilities or that arising out of an obligation to make restitution.5
Though the itself does not define the term “contingent liability”, Rule 14.1 of the states:
For the purposes of references in any provision of the Act or the Rules about winding up to a debt or liability, it is immaterial whether the debt or liability is present or future, whether it is certain or contingent …
In addition, Rule 14.14, which is similar to Regulations 13 & 14 of the CIRP Regulations, states that the office-holder must estimate the value of a debt that does not have a certain value “because it is subject to a contingency or for any other reason”. While accepting such debts, the office-holder may revise an estimate by reference to a change of circumstances or to information becoming available to him.
A parallel may be drawn to a decision under the in relation to the distinction between creditors empowered to petition for winding up and other creditors who may only file claims. In Pen-y-Van Colliery Co., In re6, a petition was presented for the winding up of the company under the supervision of the court. The petitioner had commenced an action for damages against the company and its liquidator on the basis of fraudulent misrepresentation. He based his petition on the claim for damages. Sir George Jessel, MR dismissed the petition on the law and stated that the legislation drew a distinction between “claims against the company” and “debts provable on a contingency”. He stated that a disputed debt pending judgment was merely a claim against the company and not a debt. He further stated that: (Ch D p. 484)
… I do not think a claim for unliquidated damages, that is, a claim for damages for fraudulent representation, makes a man a creditor entitling him to petition under the Act either for a winding up by the court or a winding up under supervision. He must change the claim for damages into a judgment, and thus make himself creditor, before he can petition the Court.
It may be noted that the did not permit persons who were owed contingent debts to file winding up petitions whereas under the current statute in the UK it is not confined to creditors with debt due. It now extends to “any contingent or prospective creditor or creditors”.7 As mentioned above, under the Code, a financial or operational creditor can file only if the debt is due and payable.
TREATMENT OF CONTINGENT CLAIMS UNDER THE ACCOUNTING STANDARDS
In the UK, the (International Accounting Standards and Other Accounting Amendments) Regulations, SI 2004/2947, amended the prescribing companies prepare their accounts in accordance with international accounting standards. This requirement was later carried over to the in Sections [] 395-397 and 464 and SI 2008/409 and SI 2008/410.8 The International Accounting Standards provide that a company that is uncertain whether a present obligation exists should evaluate the surrounding evidence and determine whether it is likely than not that a present obligation exists. If it is more likely, then provisions have to be made.9 It has been suggested that full provision must be made for such debts relating to lawsuits, if on balance of probabilities, the debt would exist. “More likely than not”, according to PwC, would suggest a probability of more than 50%.10 If the chances are less than that the possible liability must still be disclosed.
Similarly, the Indian Accounting Standards 37 (“Ind AS 37”) states that in the case of disputed liabilities pending judicial adjudication
an entity determines whether a present obligation exists at the end of the reporting period by taking account of all available evidence, including, for example, the opinion of experts. The evidence considered includes any additional evidence provided by events after the reporting period. On the basis of such evidence:
(a) where it is more likely than not that a present obligation exists at the end of the reporting period, the entity recognises a provision (if the recognition criteria are met); and
(b) where it is more likely that no present obligation exists at the end of the reporting period, the entity discloses a contingent liability, unless the possibility of an outflow of resources embodying economic benefits is remote.
Pertinently, NCLT has placed reliance on Ind AS 37 while determining whether a contingent debt is provable as a claim.11 Thus, where there is no conflict between the accounting standards and the provisions of the Code, a claim for contingent liabilities based on a disputed debt pending litigation can be admitted as a claim under Section 18(1)(b) of the Code.12
VALUATION OF CONTINGENT CLAIMS
Just as the valuation of assets can be difficult and based on exigencies so can the valuation of liabilities—especially that of future and contingent claims. There is no clear authority available in India. The only guidance that the resolution professional is given comes in the form of Regulation 14 of the CIRP Regulations, which, as noted above, only requires him to “determine” to the “best estimate” claims which are “not precise due to any contingency”.
In the light of the above discussion, the resolution professional need not wait for the judgment or award to be delivered to accept the claim. He must value the claims and may revise the estimate based on change in circumstances. The Accounting Standards, as noted above, lay down a broad system that must be adopted while valuing a contingent debt. It has been suggested that full provision must be made for such debts relating to lawsuits, if on balance of probabilities, the debt would exist.9, 13
But what should the process of estimation consist of? Can a contingent claim be valued by a resolution professional at zero or at a notional value of Re 1 due to pendency of disputes, as held by the Supreme Court in Essar Steel India Ltd. Committee of Creditors v. Satish Kumar Gupta14. Again, the Code provides no answers. Equally, it is unclear if such a value can be challenged by the contingent creditor since the estimate or valuation of claim becomes critical only when the resolution applicant provides for distribution to contingent creditors in the resolution plan. As we will see, in light of Ghanashyam Mishra1, if a resolution applicant chooses not to provide for a contingent liability in the resolution plan that liability becomes extinguished. However, as a matter of principle, it may be assumed that any challenge to the value at which the contingent claims have been admitted may have to demonstrate that the exercise of discretion which took place was flawed in the sense that it was one which no reasonable resolution professional in the circumstances of this case could properly have made.15 It has been suggested that the professional may first need to “determine” and formulate a view of the contingency or future event occurring and categorise the contingency as “probable”, “reasonably possible” and “remote”. Based on the determination, he may estimate the likely amount of the claim.16
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An Australian judgment does seem to suggest that notional value may be assigned where there is little evidence from which a value can be drawn. The New South Wales Supreme Court in Selim v. McGrath17 observed:
… it seems to me Regulation 5.6.23 in requiring a just estimate of value to be made does not contemplate that the chairperson or administrator will undertake any detailed enquiry. He or she will do the best that can be done by reference to the factual material the claimant furnishes, viewed in the total context with which the decision-maker is dealing. If that material provides reasonable grounds, within that context, for ascribing a particular figure to the particular claim, the chairperson or administrator is no doubt expected to accept that position. If, on the other hand, there is little or no material from which a conclusion as to value can be drawn, a just estimate may be zero or perhaps the nominal amount of $1.00, assuming that admission is warranted at all.
Further, in the UK, there is an authority to indicate that a liquidator upon estimating the value of a contingent liability may have to distribute the amount and not retain it when the contingency is not imminent.18 The Court of Appeal, in Ricoh Europe Holdings BV v. Jeremy Spratt18, made the following observations on the duty of the liquidator to conduct such valuation: (Ch p. 523, para 43)
- 43. It seems to me that any valuation of a contingent liability must be based on a genuine and fair assessment of the chances of the liability occurring. The very concept of valuing a contingency implies the need to make an assessment of how likely are the chances of the event occurring. The liquidator must therefore use his own expertise and that of any relevant advisors to make a realistic estimate of the likelihood of the Infotec companies sustaining the tax liabilities. Where some material change in the relevant factual position occurs it must be taken into account. But the liquidator is not, in my opinion, required simply to wait and see. That is the opposite of valuation.
CLEAN SLATE THEORY, RESOLUTION PLANS AND CONTINGENT CLAIMS
As per Section 31 of the Code, once a resolution plan is approved it is “binding on the corporate debtor and its employees, members, creditors, guarantors and other stakeholders involved in the resolution plan”. The approval of a resolution plan thus gives the corporate debtor a fresh start and resolves, once and for all, the financial position of the corporate debtor as it stood on the day of approval of the resolution plan, in order to allow it to have a clean slate for the future. The Supreme Court, in its decisions in SBI v. V. Ramakrishnan19, Essar Steel India Ltd. Committee of Creditors v. Satish Kumar Gupta14, and (more recently) Lalit Kumar Jain v. Union of India20, has examined the so-called “clean slate theory” in detail and has held that a resolution plan is binding on all stakeholders including personal [] guarantors and that no party may claim any right against the corporate debtor for any dues from the earlier period thereafter.
However, the recent judgment of the Supreme Court in Ghanashyam Mishra1 held that all such claims, which are not a part of resolution plan, stand extinguished. Consequently, all the dues including the statutory dues owed to the Central Government, any State Government or any local authority, if not part of the resolution plan, would stand extinguished and no proceedings in respect of such dues for the period prior to the date on which the adjudicating authority grants its approval under Section 31 could be continued.
By holding that all claims which are not a part of resolution plan on the date of approval of resolution plan by the adjudicating authority would stand extinguished, the Supreme Court has made successful resolution applicants bound to only those pre-insolvency liabilities that he has specifically accepted under the terms of the resolution plan. The conclusions set out in SCC para 102.1. of the judgment1 that no person would be entitled to initiate or continue any proceedings in respect of a claim which is not part of the resolution plan, brings to an end all proceedings against the corporate debtor for recovery of monetary claims including any statutory proceedings for recovery. In fact, in one part of the judgment,21 the judgment observes that a party cannot be made to run from one forum to another forum in respect of the proceedings and the claims, which are not permissible in law. This is ostensibly to say that a claim, or even a part thereof, if not considered by a resolution plan, whatever the reason may be, is impermissible in law.
Following the Supreme Court judgment, NCLAT, Chennai Bench, in its judgment in EPFO v. Vandana Garg22, dismissed the appeal and held that the claims filed by creditors during the CIRP stood “frozen” upon the approval of the resolution plan. In that case, the appeal was preferred by the RPF Commissioner, Telangana seeking inclusion of the total dues towards Provident Fund from the corporate debtor. It seems that the Commissioner, after his original claim had been admitted, sought to enhance the claim as he had committed an error while calculating the amount claimed as due in the original claim.
Equally sweeping is the holding in Ghanashyam Mishra1 that no person would be entitled to initiate or continue any proceedings in respect of a claim which is not part of the resolution plan. This observation is perplexing since its logical corollary would be that a creditor, whose contingent claim relating to pending litigations or arbitration proceedings is admitted, would then be [] able to continue with such proceedings if the resolution plan itself permits it as his claim is part of the resolution plan. However, with no statutory backing and no discussion in the judgment on what a contingent liability is, this observation fails to provide the required guidance. It would also make them, borrowing a phrase from a solicitor from the UK,23 creditors in respect of unknown liabilities for unknown amounts.
The Notes to Clause 31 provide some valuable insight as to the effect of an approved resolution plan on such contingent liabilities.24 The Notes state that
the moratorium imposed under Section 14 ceases to have effect upon approval of the plan. However, it is important to note that the plan is binding on all the relevant stakeholders. Therefore, if a plan requires stakeholders to do or not do certain actions for the successful implementation of a plan, it shall be binding on all the affected parties who shall be bound to undertake the actions set out in the plan.
Going by that, a resolution plan may explicitly permit or require the creditors with contingent claims to crystallise their debts by continuing with the pending litigations or arbitration proceedings and to then stake a claim to the distribution available under Section 53 of the Code. If that were the case, can a successful resolution applicant then prescribe a cut-off date for such crystallisation beyond which the contingent debt gets extinguished?
Prior to the decision in Ghanashyam Mishra1, there are examples of approved resolution plans which provided for payments to contingent claims subjects to certain conditions. For instance, the resolution plan submitted by JSW Steel Ltd. in the insolvency resolution process of Bhushan Power & Steel Ltd., provided for the payment to “identified contingent creditors” and any other creditors of ten per cent of their claims which were contingent. The plan, however, imposed a condition that the distribution would be available only to those contingent liabilities that crystallised within a period of two years from the date of approval of the resolution plan by the CoC, subject to a maximum of Rs 35 crores.25 Similarly, in the insolvency resolution process of Empee Distilleries Ltd., the resolution applicant set aside an amount of Rs 7 crores as “contingency liability fund” in lieu of pending litigations and other contingent liabilities.26
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In other cases, successful resolution applications, who faced uncertainty and vacillating scenes of ambivalence regarding the binding nature of resolution plan on contingent creditors and third parties, have employed intuitive strategies to protect themselves from such liabilities. Some have sought for complete extinguishment of all contingent debts,27 while others have agreed to pay such debts in full.28 Some have received “waiver of all the contingent liability arising out of any acts or actions of the company done before the insolvency (CIRP) commencement date…, (Percula Shipping & Trading INC case27, SCC OnLine NCLT para 6)”29 while others have treated contingent creditors as a class distinct from other creditors.30 A plea for “waiver” or extinguishment of contingent liabilities appears to be a common demand where the amount paid under the resolution plan is less than the liquidation value of the corporate debtor.
CONCLUSION
As the law stands today, the position of a contingent creditor with pending litigation is extremely precarious. While a resolution professional may consider such claims during collation, it is still unclear if a contingent creditor whose claim is admitted can become a part of the committee of creditors and vote if his claim is a financial debt or if his claim is based on an operational debt and, on admission of his claim, the operational debt would constitute 10% of the total debt.31 Further, there are contradicting judgments from the National Company Law Tribunal on whether contingent creditors are to be treated as a class distinct from financial and operational creditors.32
While the judgment in Ghanashyam Mishra1 has interpreted the provisions of Section 31 of the Code and focused on finality of a resolution plan, there is a need to deal with certainty the rights of contingent creditors and assess/value their claims although they are contingent in nature. Hence, clear provisions for dealing with the scope of contingent liabilities, their assessment and treatment while submitting resolution plans, are necessary and hopefully will be addressed by the evolving insolvency legislation in India.
**The article has been published with kind permission of Eastern Book Company. Cite as (2021) 7 SCC J-51
† Advocate, Madras High Court.
‡ Advocate, Madras High Court.
1 (2021) 9 SCC 657 : 2021 SCC OnLine SC 313.
2 Wadhwa Law Chambers, Guide to Insolvency & Bankruptcy Code, (2nd Edn. 2021), p. 66.
3 IBBI Board Meeting dated 15-3-2018 on “Amendments to Corporate Insolvency Resolution Process Regulations”. Available at <https://ibbi.gov.in/Agenda_04C_150318.pdf> (last accessed 16-6-2021).
4 Export Import Bank of India v. JEKPL (P) Ltd. Resolution Professional, 2018 SCC OnLine NCLAT 465 (hereinafter “Export Import Bank of India”); Cerestra Advisors (P) Ltd. v. MN Takshila Industries (P) Ltd., 2020 SCC OnLine NCLT 1440. See, Rule 14.14 of the for the corelative provision under the UK insolvency regime.
5 Kristin Van Zwieten (Ed.), Goode on Principles of Corporate Insolvency, (5th Edn.) p. 334, para 8-45.
6 [1877] 6 Ch.D. 477.
7 The scheme under the 1862 Act was later modified by the , which, under Section 28, allowed contingent and prospective creditors to present a winding up application. Presently, Rule 14.1. of the provides that “(f)or the purposes of” the “it is immaterial whether the debt or liability is present or future, whether it is certain or contingent….”. Also see, A Company, In re, (1973) 1 WLR 1566; Lee Beng Tat, “Claiming a pound of flesh as a contingent or prospective creditor under the Companies Act”, 1993 Singapore Journal of Legal Studies pp. 144-186.
8 Clive Wolman, “The expanding definition of contingent debts and its impact on winding up petitions” (2021) 1 JIBFL 17; R. Bax and P. Athanassiou, “Contingent debt instruments and their challenges: some insights” (2011) 1 JIBFL 20.
9 PwC (PricewaterhouseCoopers), IFRS manual of accounting (London 2011).
10 Ibid. Also see, Eloise de Jager, “IFRS 3 ‘grey area’ regarding contingent liabilities” South African Journal of Accounting Research, (2015) 29: 1, pp. 71-83.
11 Esspee Sarees (P) Ltd. v. Skipper Textile (P) Ltd., 2019 SCC OnLine NCLT 18701 (where the NCLT Kolkata Bench observed that the accounting standard AS 29 and Ind AS 37 do not recognise un-invoked corporate guarantee as a debt due or ascertained liability as on a particular date). The decision in Esspee Sarees, 2019 SCC OnLine NCLT 18701 was later followed by the Ahmedabad Bench in Intec Capital Ltd. v. Arvind Gaudana, 2021 SCC OnLine NCLT 166.
12 See, Vijay Kumar V. Iyer v. Bharti Airtel Ltd., 2020 SCC OnLine NCLAT 584 (where the NCLAT Bench at New Delhi held that no dues can be set-off when the moratorium is in force and that accounting conventions cannot supersede express provisions of the Code).
9 PwC (PricewaterhouseCoopers), IFRS manual of accounting, (London 2011).
13 Also see, Eloise de Jager, “IFRS 3 ‘grey area’ regarding contingent liabilities”, South African Journal of Accounting Research, (2015) 29: 1, pp. 71-83.
14 (2020) 8 SCC 531.
1 Ghanashyam Mishra and Sons (P) Ltd. v. Edelweiss Asset Reconstruction Co. Ltd., (2021) 9 SCC 657 : 2021 SCC OnLine SC 313.
15 Edennote Ltd., In re, (1996) 2 BCLC 389 at p. 394.
16 Keith Bennetts, “Dealing with the claims of contingent creditors in insolvency administrators” Australian Insolvency Journal, April-June 2014, p. 18.
17 2003 NSWSC 927.
18 Ricoh Europe Holdings BV v. Jeremy Spratt, [2013] Ch. 506 : 2013 EWCA Civ 92.
14 (2020) 8 SCC 531.
20 (2021) 9 SCC 321 : 2021 SCC OnLine SC 396.
1 Ghanashyam Mishra and Sons (P) Ltd. v. Edelweiss Asset Reconstruction Co. Ltd., (2021) 9 SCC 657 : 2021 SCC OnLine SC 313.
21 Id., para 139.
23 Alistair Hill, “Schemes of Arrangement: Binding unknown creditors in respect of unknown liabilities for unknown amounts” (2006) 8 JIBFL 341.
24 Notes on Clauses to the Insolvency & Bankruptcy Code, 2015 (as introduced in the Lok Sabha).
1 Ghanashyam Mishra and Sons (P) Ltd. v. Edelweiss Asset Reconstruction Co. Ltd., (2021) 9 SCC 657 : 2021 SCC OnLine SC 313.
25 Punjab National Bank v. Bhushan Power & Steel Ltd., 2019 SCC OnLine NCLT 18702.
26 Shaji Purushothaman v. S. Rajendran, 2020 SCC OnLine NCLAT 651. See also, Parwincharan P. Dwari v. Nijinoy Trading (P) Ltd., 2021 SCC OnLine NCLT 12.
27 Percula Shipping & Trading INC v. Dadi Impex (P) Ltd., 2019 SCC OnLine NCLT 9558; Karad Urban Co-operative Bank Ltd. v. Khandoba Prasanna Sakhar Karkhana Ltd., 2019 SCC OnLine NCLT 748.
28 Sreeram E. Techno School (P) Ltd. v. Beans and More Hospitality (P) Ltd., 2019 SCC OnLine NCLAT 1148.
29 Sunil G. Nanal, In re, 2019 SCC OnLine NCLT 9793; Manoj Kumar Agarwal, In re, 2019 SCC OnLine NCLT 7154; SBI v. Calyx Chemicals & Pharmaceuticals Ltd., 2019 SCC OnLine NCLT 3854; Tourism Finance Corpn. of India Ltd. v. Rainbow Papers Ltd., 2019 SCC OnLine NCLAT 910; Edelweiss Asset Reconstruction Co. Ltd. v. Euro Pallets (P) Ltd., 2019 SCC OnLine NCLT 18700.
30 JSW Steel Ltd. v. Mahender Kumar Khandelwal, 2020 SCC OnLine NCLAT 431; Agarwal Coal Corpn. (P) Ltd. v. Danalakshmi Paper Mills (P) Ltd., 2019 SCC OnLine NCLT 3985; GAIL India Ltd. v. Ajay Joshi, 2019 SCC OnLine NCLT 6643; Canara Bank v. IVRCL Ltd., 2019 SCC OnLine NCLT 5327.
31 Insolvency and Bankruptcy Code, 2006, S. 24.
32 Export Import Bank of India v. JEKPL (P) Ltd. Resolution Professional, 2018 SCC OnLine NCLAT 465; GAIL India Ltd. v. Ajay Joshi, 2019 SCC OnLine NCLT 6643; Canara Bank v. IVRCL Ltd., 2019 SCC OnLine NCLT 5327; Agarwal Coal Corpn. (P) Ltd. v. Danalakshmi Paper Mills (P) Ltd., 2019 SCC OnLine NCLT 3985.
1 Ghanashyam Mishra and Sons (P) Ltd. v. Edelweiss Asset Reconstruction Co. Ltd., (2021) 9 SCC 657 : 2021 SCC OnLine SC 313.