The Clean Slate Theory – IBC’s Version of Hermione’s Obliviate Spell

“This topic is covered in detail in the comments on Section 31 in the commentary titled ‘Insolvency and Bankruptcy Code: Law and Practice’ by the author of this column post. The same is available at https://www.ebcwebstore.com/product_info.php?products_id=99097372.”

In this column post, we will discuss one of the most radical provisions introduced by the Insolvency and Bankruptcy Code, 2016 (hereinafter “the IB Code”). Much similar to the spell “obliviate” that the endearing character of Hermione casts on her parents in the Harry Potter series, whereby she makes her parents forget they ever had a daughter; we have our own version of this spell in Section 31(1) of the IB Code.

The column post here discusses the (i) origins; (ii) its application; and (iii) exceptions to this theory.

A. Origins: General Discussion

Just like any popular character/series/tv show; let us discuss the origins of this theory.

The provision of Section 31(1) of the IB Code apart from bestowing the final power on the adjudicating authority in approving the resolution plan; also significantly stipulates that the approval by the adjudicating authority renders the resolution plan binding on all the stakeholders, namely,

1. corporate debtor;
2. its employees;
3. its members;
4. its creditors, including the Central Government, any State Government or any local authority to whom a debt in respect of the payment of dues arising under any law for the time being in force, such as authorities to whom statutory dues are owed;
5. its guarantors; and

6. other stakeholders involved in the resolution plan.

To borrow from the phraseology used by the Supreme Court in its ruling in Essar Steel India Ltd. v. Satish Kumar Gupta,¹ the idea behind this provision is to prevent “hydra head popping up”. This “clean slate” theory prevents any past claims from resurging and thereby “throw into uncertainty amounts payable by a prospective resolution applicant who successfully takes over the business of the corporate debtor”.²

The idea behind the resolution plan and the moratorium is to put on halt all the pending liabilities and claims for and against the ailing debtor company so that the resolution process can go smoothly and bidders can assess the balance sheet with some modicum of certainty. Even an adjudicating authority has no jurisdiction to entertain any application for rectification/alteration of a resolution plan (or on any pretext) after the completion of resolution process where a resolution plan was approved and implemented.³

The Supreme Court in Essar Steel India Ltd.⁴ had opined that all claims must be submitted to and decided by the resolution professional so that a prospective resolution applicant knows exactly what has to be paid in order that it may then take over and run the business of the corporate debtor. Explaining the rationale behind the same, it added that “this the successful resolution applicant does on a fresh slate”.

Therefore, when a Government Electricity Department objected to the resolution plan approved by the adjudicating authority and contended that it could not restore the electricity connection of the corporate debtor, the same was negated by the NCLAT. The appellant Electricity Department submitted that under the provisions of Gujarat Electricity Regulatory Commission (Electricity Supply Code and Related Matters) Regulations, 2015, no electrical connection could be restored in favour of the corporate debtor till the total amount due to the Electricity Company is paid. The NCLAT, however, held that the approval of a resolution plan means that whatever amount is allocated to the respective stakeholder, the same is binding on them; the NCLAT in view of the overriding effect of the IB Code in light of Section 238, IB Code, rejected the submission.⁵

As noted earlier, by virtue of an amendment vide Insolvency and Bankruptcy Code (Amendment) Act, 2019, Section 31(1) is further clear mandating that a resolution plan is binding on creditors that include the Central Government, any State Government or any local authority to whom a debt in respect of the payment of dues arising under any law for the time being in force, such as authorities to whom statutory dues are owed.

The Supreme Court in Ghanashyam Mishra & Sons (P) Ltd. v. Edelweiss Asset Reconstruction Co. Ltd.,⁶ while upholding the validity of the amendment to Section 31, termed it as clarificatory and declaratory in nature and therefore the same effective from the date on which IB Code came into effect.

B. Application of Essar Steel and the Clean Slate Theory

Now that we have known what is this theory, and how it came about; let us now proceed with getting acquainted with its application by the courts.

The abovementioned amended provision and the parliamentary discussion on the same was noticed by Rajasthan High Court in its ruling in Ultra Tech Nathdwara Cement Ltd v. Union of India⁷. The High Court following the law laid down by the Supreme Court in Essar⁸ gave effect to the fresh slate theory. In this case, Ultra Tech Nathdwara Cement⁹ had taken over Binani Cement after emerging as a successful resolution applicant and had paid the dues to the department in terms of the resolution plan. The High Court applying the theory of fresh slate quashed the demand notices of the Goods and Services Tax Department issued against Ultra Tech Nathdwara Cement¹⁰, which is the successor of Binani Cement (after Binani successfully underwent the resolution process).

In Ultra Tech¹¹, the Rajasthan High Court had held that the amount specified in the approved resolution plan is final and binding on all parties, irrespective of the fact whether the claimant has been heard by the resolution professional or the Committee of Creditors. It has been argued elsewhere that in most occasions, the claims are duly collated and verified by the insolvency resolution professionals/resolution professionals.

The theory of clean slate has been applied on all the instances of pending claims,¹² disputed claims,¹³ unclaimed claims,¹⁴ and claims submitted at a belated stage¹⁵.

Similarly, the claim of a creditor that it is a secured creditor has also been declined because the contractual charge was not registered as required by Section 77¹⁶ of the Companies Act, 2013.¹⁷ The NCLAT further observed that it was only when the resolution plan was approved that the charge was registered. Taking into account the same, the NCLAT did not accept the argument of the appellant creditor to stake claim of being a secured creditor.¹⁸

The Supreme Court in Ghanashyam Mishra,¹⁹ in light of Section 31 even held that the claims of labour and workmen once considered in the resolution plan, then the grant of liberty to the workmen to raise their claims before a civil court or Labour Court, is in conflict with the provisions of IB Code.

Furthermore, when the NCLT imposed certain conditions on the approved resolution plan of the successful resolution applicant; the NCLAT had set aside the same.²⁰ The NCLT had directed that if any amount is recovered by the corporate debtor which was due from any third party but written off as bad debts or which stood in the books but had not been recovered as on the date when the resolution plan was approved, such amount is to be used to pay the balance amount to dissenting financial creditor. The NCLAT setting aside the same, held that (i) the right to receivables lies with the successful resolution applicant; (ii) if any of the subsidiaries, associate or joint venture companies have any privilege or claim or assets to which they would seek entitlement from the corporate debtor prior to approval of the resolution plan, such right of privilege, claim or rights over the assets now stood extinguished after the approval of the plan under Section 31; and (iii) if the successful resolution applicant is entitled to “carry forward losses” in terms of Section 79 of the Income Tax Act, then it may claim such benefit before the appropriate authority, who will pass appropriate order in accordance with Section 79 of the Income Tax Act, 1961 and the Rules and Regulations framed thereunder.

C. Conflict between the Clean Slate and the Provision of Section 60(6)

Now taking the story telling to its maturity, where character building takes place; our “clean slate” theory has come to realise that it is going to face resistance in its journey and evolve as a principle. The same is essential, as literary critics may assert, since the same adds layer to the character by inserting the shades of grey.

Section 60(6) of the IB Code stipulates that in calculating the period of limitation specified for any suit or application by or against a corporate debtor for which an order of moratorium has been made, the period during which such moratorium is in place shall be excluded.

This throws a proverbial wrench in our Section 31(1). In certain instances, a creditor is allowed to pursue legal remedies before other forums after the moratorium ends.²¹

While this may conflict with the clean slate theory under Section 31, it is submitted that there may be still some room (and rightly so) to manoeuvre in instances where the claims are judicially recognised to be pending²² or recognised as such in the resolution plan.²³ Only such claims may be allowed to continue post the approval of resolution plan under Section 31, IB Code.

In NTPC Ltd,²⁴ issue came up before the Supreme Court where the claim of the appellant creditor in the information memorandum was noted under the title, “list of other creditor claims”, whereas the appellant wanted their claim to be categorised under the heading of “claims of operational creditors”. The Court noted that the claim of the appellant is pending for arbitration and assuaged the fears of the appellant by holding:

7. … the claim of the appellant has been taken note of in the information memorandum and does not get extinguished as such; but it will be subject to adjudication by the arbitrator. Since it is part of the memorandum, it is obvious that the resolution applicant would take the same into account while submitting his proposal, due notice whereof will be taken by the Committee of Creditors as well, and dealt with appropriately in the final resolution plan.

(emphasis supplied)

Clearly the claim of the appellant would be accounted for and not be wiped out by the sweeping terms of Section 31 of the IB Code.

Even when the adjudicating authority, in a case, had directed the following:

37. … the resolution plan approved shall not construe any waiver to any statutory obligations/liabilities arising out of the approved resolution plan and same shall be dealt in accordance with the appropriate authorities as per relevant laws. This adjudicating authority is of the considered view that if any waiver is sought in the resolution plan, the same shall be subject to approval by the authorities concerned.

The above directions were upheld by the NCLAT.²⁵

Conclusion

The above discussion provides us with the microcosm on how the theory of clean slate theory has come to evolve. The same is essential because several times claims may get reduced to a nullity only because the could not be included in the resolution plan pending any litigation in other forums. The exceptions in Part C of this column post provides us with perfect instances to understand the desperate need to qualify the radical application of this theory.