RATIONALITY OF “IPSO FACTO” CLAUSES IN LIGHT OF INSOLVENCY LAWS IN INDIA
This guest blog under the RFMLR-IBBI Blog Series Competition has been authored by Ms. Anjali Jain, Partner (Insolvency & Debt Restructuring), Areness Law. She was assisted by Varnit Jain, 5th-year B.A. LL.B. (Hons.) student at Rajiv Gandhi National University of Law, Punjab.
In recent times, preserving the status of a corporate debtor as a 'going concern' has become incredibly challenging due to invocation of certain contractual obligations that were agreed to by the corporate debtor before the initiation of its Corporate Insolvency Resolution Process (“CIRP”). One such obligation, which is generally reflected as the essence of almost all commercial contracts is where the party is not legally bound to oblige and honour the contractual relation in case of occurrence of certain pre-defined insolvency related event of other party. The scope of this pre-defined event varies substantially based on the jurisdiction or type of financial distress or the varying nature/type of business, but the general events include initiation of CIRP, Financial Restructuring, Creditors’ Voluntary Arrangements and so on. Such belligerent clauses now increasingly demand the intervention of the tribunals as this dilemma is often discussed in light of two contrasting contemplations – first being the upholding or enforcement of the ipso facto clauses, which will make the objective of Resolution under Insolvency and Bankruptcy Code, 2016 (“IBC”) redundant by allowing the counter party to terminate the contract and thus impede the statutory mandate of keeping the corporate debtor as a 'going concern'; whereas, the second contrast being the restricting of the enforcement of ipso facto clauses which will contravene the sanctity of contractual relations and reluctantly force the second party to sustain or continue an unviable contract with the Corporate Debtor. 2. INDIA AND IPSO FACTO: THE CASE OF "GUJRAT URJA VIKAS"
At present, there are no direct legal provisions in the domain of Indian insolvency jurisprudence that perfectly resolve the above contrasting questions and settle as to whether such contractual agreements between the parties can be or should be interrupted on account of one of the parties to the contract slipping into CIRP. Recently, this tension was manifested by the Hon’ble Supreme Court in its decision in Gujarat Urja Vikas Nigam Limited v. Mr. Amit Gupta & Ors. (“Gujarat Urja Vikas”) on March 8, 2021, where the necessity for the legislature to deliver clarity on the status of ipso facto clauses in India was brilliantly highlighted.
The dispute in Gujarat Urja Vikas pivoted around the notice of termination issued by Gujarat Urja Vikas Nigam Limited (“Appellant”) for the termination of the Power Purchase Agreement (“PPA”) arrived between the Appellant and Astonfield Solar (Gujarat) Private Limited (“Corporate Debtor”), on the reason of initiation of CIRP by the Corporate Debtor. National Company Law Tribunal (“NCLT”) restricted the Appellant from terminating the PPA and National Company Law Appellate Tribunal (“NCLAT”) further upheld NCLT's decision and directed that the Appellant cannot terminate the PPA on the sole ground of initiation of the CIRP of the Corporate Debtor. Ultimately, the case demanded the intervention of apex court and the Hon'ble Supreme Court highlighted two major issues. First issue was with regards to the question whether NCLT has the jurisdiction under Section 60(5) of the IBC to adjudicate a contractual dispute between the Corporate Debtor and the Appellant. It was held that the NCLT and NCLAT had jurisdiction under Section 60(5) of IBC to adjudicate upon a contractual dispute that arose out of, or is related to, the CIRP. The second issue was in relation to the validity of the termination of PPA. The Hon’ble Supreme Court while upholding the decision made it clear that it is not basing its ruling upon the general validity of ipso facto clauses under the IBC and instead delivered the judgment on the specific facts of the matter, and the importance of PPA to the business of the Corporate Debtor. It was pointed out that the PPA was the only contract of the Corporate Debtor and that the terms of the PPA prevented the Corporate Debtor from supplying electricity to the third parties. It observed that the termination of the PPA would instigate the death of the Corporate Debtor, which is in stark contradiction with the objective of the IBC. The Hon’ble Supreme Court, being aware of its ambit, addressed the issue without infringing the role of the legislature in framing the policy with respect to the said issue. In fact, the critical analysis was made regarding the need to consider the validity of ipso facto clauses by the legislature. 3. IPSO FACTO IN INTERNATIONAL SPACE Different jurisdictions across the globe have either validated or invalidated the ipso facto clause. There are various jurisdictions where insolvency law overrides ipso facto clauses. For instance, Article 7 of the EU Directives, categorically states that the first party will not be permitted to terminate a contract based on the ipso facto clauses in case the defaulting party/corporate debtor is undergoing restructuring/resolution. The US Bankruptcy allows
limited protection against such ipso facto clauses, only in case of lease or a contract termination but, permits swap agreements and securities agreements to be terminated based on ipso facto clauses. The Supreme Court of UK in Belmont Park Investments Private Limited vs BNY Corporate Trustee Services Limited, held that ipso facto clauses should not help in validating contracts that did not fulfil a legitimate commercial intent and were present only to evade an illegitimate bankruptcy or insolvency law. Besides this, Amendments have been introduced by introduction of Section 233B by virtue of the Corporate Insolvency & Governance Act, 2020 which makes termination of a demand-supply contract unenforceable on the basis of ipso facto clauses. Furthermore, Singapore’s insolvency law via Insolvency, Restructuring and Dissolution Act has settled that ipso facto clauses cannot invalidate agreements in cases of insolvency. Considering the absence of such direct nexus in India, legislature should bring the essential modifications in the IBC regarding the validity or qualified validity of such ipso facto clauses during the CIRP in harmony with multiple other jurisdictions where ipso facto clauses have already been expressly invalidated. 4. ANALYSIS OF INDIAN CONTRACT ACT, 1872 Though it is well settled that the terms of the contract shall govern the relationship between parties, however, as discussed in Gujarat Urja Vikas by the Supreme Court, the IBC has a predominantly overriding effect over other laws, each contract needs to be considered in light of the essential nature of the contract in the Corporate Debtor being run as a ‘going concern’ during CIRP and even post resolution. In an effort to analyse the impact of a specific clause or term in an Agreement for termination of an Agreement upon a Corporate Debtor turning insolvent, a cursory look at the Indian Contract Act, 1872 indicates that as per Section 35, such an Agreement can be termed as a Contingent contract which may become voidable on happening of an event which shall be Insolvency in this matter. However, if we move ahead in the same law, Section 37 binds the representatives of the promisors in case of the death of such promisors before performance, unless a contrary intention appears from the contract, hence if we consider a Corporate Debtor as an artificial/ juristic person, we can deduce that even in event of liquidation, parties may be bound to fulfil their obligations arising out of a contract, subject to any terms contrary to it in the Contract. At the same time, we cannot lose sight of the fact that cases where due to commencement of CIRP,
fulfilment of obligations at the end of the Corporate Debtor are almost impossible, the other contracting party shall be deemed to be waived off from its obligations as well. 5. ANALYSIS OF COMPANIES ACT, 2013 & IBC VIS-A-VIS CONTRACTS
While the IBC is completely silent on impact on Agreements with third parties in the event of commencement of CIRP or liquidation of a Corporate Debtor, it does empower the Resolution Professional to enter into contracts on behalf of the Corporate Debtor or to modify the contracts which were entered into before the commencement of CIRP. However, besides Section 20 of IBC, the Code is predominantly silent on contracts with third parties. On the other hand, when we look at the Companies Act, 2013, Sections 242-243 give powers to the Tribunals to terminate, modify or set aside any agreements in events of oppression, mismanagement, etc. Surprisingly, the Companies Act mandates the Company Liquidator to include details of subsisting contracts in his report to the Tribunal within sixty days from the date of order for winding up. 6. CONCLUDING REMARKS There is an urgent need for an Expert Committee to recommended the legislature for the need to invalidate the status of ipso facto clauses during insolvency proceedings to smoothen the process of insolvency of the Corporate Debtor and settle the position of liabilities of a Corporate Debtor in such clauses. The IBC was introduced to provide the financial relief to a Corporate Debtor and to provide the Corporate Debtor a new chapter of life. Keeping in view the objective of IBC, such termination of contracts on the grounds of initiation of CIRP through the ipso facto clauses cannot be held as legally admissible. Such alike clauses in the PPAs have always been a concern for the investors that if a debtor goes under insolvency proceedings, this clause will make things tougher. By now, the IBC has established itself as an uber law on preservation of the business and estate of a Corporate Debtor till it is given a new life by a Resolution Applicant or it meets its systematic step-wise end, thereby ensuring that the interests of all stakeholders are safeguarded till the end. Depending on the sector, nature and scale of business, a Corporate Debtor may have entered into most of the starter agreements with its employees and travelling across the poles, it may have multi-national contracts with third parties. It may have leases and licenses such as in Gujarat Urja Vikas which may be the core for the business or on similar lines, there may be licenses such as Spectrums for Telecom companies. In such events, it is quintessential that the Resolution professional prepares a preliminary report or negotiates with the contracting third
party which may also include the Committee of Creditors or even seek an approval or direction from the Tribunal. Since we need to balance the stakes of all interested parties, preference in payment to parties which continue to perform their obligations or fair opportunity to terminate the Agreement in event of liquidation, or opportunities such as novation, assignments or negotiations are suggested to be introduced. However, all being said, since the IBC is completely aimed at maximisation of resources, each case shall have to be dealt with keeping in consideration the intent and spirit of IBC. Though the Insolvency and Bankruptcy Board of India has supplemented the role of legislature through prompt regulations and guidelines to the Resolution Professionals and other stakeholders, it is time that this void in the Indian Insolvency sphere is also addressed by the Ministry of Corporate Affairs or the Board itself.