The Supreme Court requests that the law clarify the validity of contractual clauses “ipso facto” in insolvency matters

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The Supreme Court observed that the absence of a legislative voice on the issue of the validity / invalidity of ipso facto insolvency clauses will lead to confusion and reduced commercial clarity. the National Company Law Tribunal which suspended the dismissal by Gujarat Urja Vikas …

The Supreme Court observed that the absence of legislative voice on the issue of the validity / invalidity of ipso facto insolvency clauses would lead to confusion and reduced commercial clarity.

The bench including Judges DY Chandrachud and MR Shah thus observed while maintaining the order of the National Company Court which suspended the dismissal by the Gujarat Urja Vikas Nigam Limited of its electricity purchase contract with Astonfield Solar (Gujarat) Private Limited.

In this case, a PPA was signed on April 30, 2010, under which the Nigam must purchase all the electricity produced by the Debtor Company. On November 20, 2018, the NCLT granted a petition filed by the debtor company under Article 10 of the IBC and began the process of resolving the corporate insolvency. In May 2019, Nigam issued termination notices in which it stated: Under Article 9.2.1 (e) of the PPA, the debtor company subject to the IBP under the IBC constitutes a ‘case of default ”(b) under article 9.2. 1 (a) of the EIA, there was a defect in the operation and maintenance of the Plant. Rejecting the response issued by the debtor company, Nigam stated that it would terminate the PPA under Articles 9.2.1 (e) and 9.3.1 since the debtor company is subject to the CIRP. Subsequently, the debtor company filed IBC Section 60 (5) claims before the NCLT with respect to the notices issued by the appellant to the debtor company and sought an injunction. prohibiting Nigam from terminating the PPA. On August 29, 2019, the NCLT issued its final order prohibiting Nigam from terminating the PPA and rescinding the first notice.

One of the issues considered by the court was whether the appellant’s right to terminate the PPA under section 9.2.1 (e) read with 9.3.1 is regulated by the IBC.

To answer it, the chamber examined the validity of the ipso facto clauses (contractual provisions which allow a party (terminating party) to terminate the contract with its counterparty (debtor) due to the occurrence of an “event of default”. in international and multilateral organizations, the judiciary has noted:

(i) Many jurisdictions follow the American model of legislative invalidation of ipso facto clauses. Interestingly, this change has been much larger over the past decade, even though the US Bankruptcy Code has taken this position since 1979;

(ii) Some of the recent jurisdictions which have followed the American model, such as Australia and Singapore, prospectively invalidate ipso facto clauses, that is to say that ipso facto clauses contained in contracts concluded before entry into force. force of laws will not be invalidated;

(iii) The United Kingdom, through CIGA, only ipso facto invalidates clauses in contracts with suppliers, which is similar to the effect of Article 14 (2) of the IBC. Other ipso facto clauses are considered valid, based on the UKSC decision in Belmont Park (supra). However, as previously stated, the UKSC decision was made in connection with the application of the anti-deprivation rule, which protects against dilution of the value of the indebted company and does not necessarily affect the status of the company. business as a going concern ‘;

(iv) Greece is one of the rare countries to have legislated ipso facto clauses;

(v) The legal situation in the Republic of Korea is unclear due to conflicting court rulings, which has prompted demands for legislative clarity. This highlights the growing commercial importance of legislative clarity in this area;

(vi) As a general rule, even where the ipso facto clauses are invalidated, this has no effect on the termination rights of the terminating party on the basis of other cases of contract default;

(vii) Some countries which invalidate clauses ipso facto, such as Austria, Canada, Singapore and the United Kingdom (limited to supplier contracts), provide an exception based on “durss” caused to the terminating party. This “ordeal” must be determined by the courts; and

(viii) Even in countries which legally invalidate clauses ipso facto, there are often contrasting court decisions regarding the scope of their invalidation. Some court decisions go beyond the legislative text to ipso facto invalidate the clause on general considerations of the object and purpose of the insolvency regimes concerned. On the other hand, there are judicial precedents, which follow a more conservative approach and strictly interpret the legislative mandate.

The tribunal also noted that in India the ipso facto clauses are invalid in: (i) any licenses, permits, registrations, quotas, concessions, authorizations or any concession or similar right granted by the central government, the government of the State, local authority, sector regulator or any other authority incorporated under any other law currently in force, as explained in Article 14 (1); and (ii) contracts in which the counterparty provides essential / critical goods and services to the debtor company, within the meaning of Articles 14 (2) and 14 (2A). However, no clear position emerges regarding the validity of ipso facto clauses in other contracts, from the plain text of the IBC, the judiciary said.

The court observed that the following complex questions will arise when deciding the issue of the validity / invalidity of the ipso facto clauses:

“(I) The extent of the invalidation of the ipso facto clauses, that is to say the termination solely on the basis of an” insolvency event “(filing of a request to open a CIRP, start of CIRP, appointment of RP, etc.) within the IBC will be invalid;
(ii) Whether the invalidation is absolute or conditional during the insolvency proceedings;
(iii) What types of contracts should be exempt from this invalidation;
(iv) What should be the nature of the exceptions to the invalidation of ipso facto clauses to preserve the interests of the terminating party;
(v) Whether invalidation is to take place prospectively or retrospectively; and (vi) What safeguard will be necessary to ensure that the parties do not circumvent the invalidation. “

Taking note of these, the Chamber observed that the question of the validity / invalidity of the ipso facto clauses is one which it should not resolve exhaustively in the present case.

“On the contrary, what we can do is seriously call on the legislator to provide concrete guidance on this issue, as the absence of a legislative voice on the issue will lead to confusion and reduced commercial clarity,” added the bench.

The court made the following observations in the judgment:

It is through the intermediary of an interinstitutional dialogue that the doctrine of the separation of powers can be operationalized in a nuanced manner.

At its heart, the Court is an institution which responds to the concrete cases submitted to it. It is not within its purview to enshrine in law its views on what constitutes good policy. It is a question which falls within the competence of the legislator. Likewise, faced with a new matter on which the Legislature has not yet made its decision, we do not believe that this Court can sit with folded hands and simply return the responsibility to the Legislature. In such a case, the Court may adopt an interpretation – a workable formula – which favors the general objectives of the legislation concerned, while leaving it to the legislature to formulate a comprehensive and well-considered solution to the underlying problem. To assist the legislature in this exercise, this Court may present its best thinking as to the relevant considerations at play, the position of the law in force in other relevant jurisdictions, and any pitfalls that may need to be avoided. It is through an inter-institutional dialogue that the doctrine of the separation of powers can be operationalized in a nuanced manner. This is how the Court can take the middle road between abdication and usurpation.

Case: Gujarat Urja Vikas Nigam Limited v Amit Gupta [CA 9241 of 2019]

Coram: judges DY Chandrachud and MR Shah

Tips: Sr. Adv Shyam Diwan, Adv Ranjitha Ramachandran, Sr. Adv CU Singh, Sr. Adv Nakul Dewan, Sr. Adv V Giri

Reference: LL 2021 SC 142

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