‘Essential Goods and Services’ under IBC: Discrepancies within the judicial interpretation

June 20, 2020

The Insolvency and Bankruptcy Code, 2016 has been passed after great deliberation and pursuant to various committee reports, the most important of which is the report of the Bankruptcy Law Reforms Committee of November, 2015. The objective of the Insolvency and Bankruptcy Code, 2015 is to consolidate and amend the laws relating to reorganization and insolvency resolution of corporate persons, partnership firms and individuals in a time bound manner for maximization of value of assets of such persons, to promote entrepreneurship, availability of credit and balance the interests of all the stakeholders including alteration in the priority of payment of government dues and to establish an Insolvency and Bankruptcy Fund, and matters connected therewith or incidental thereto.

Section 14 of IBC provides that on the insolvency commencement date, the Adjudicating Authority shall by order declare moratorium for prohibiting all of the following namely the institution of suits or continuation of pending suits or proceedings against the corporate debtor including execution of any judgment, decree or order in any court of law, tribunal, arbitration panel, or other authority.[1]

The Moratorium Period is declared by the adjudicating authority[2] after admitting the application for initiating corporate insolvency process against the corporate debtor.[3]It is a time in which all legal actions against the corporate debtor are suspended and no new litigation can be initiated. The rationale behind this provision is to maximize the corporate debtor 's value so that, as the case may be, there are no obstacles in the company's liquidation or revival.

The provision speaks of halting all legal proceedings, unless they do not contravene the following two points:

1. The supply of services be essential to the extent these services are not a direct input to the output produced/supplied by the corporate debtor

2. The mandate under Section 14(2) will come into operation only in respect of the services not terminated before declaration of moratorium under Section 14 of the Code.[4]

What constitutes “essential goods and services” is envisaged under Regulation 32of the Insolvency and Bankruptcy (Insolvency Resolution Process for Corporate Persons), Regulations, 2016 (CIRP Regulations). Regulation 32 of the CIRP Regulations states that:

The essential goods and services referred to in section 14(2) of the Code shall mean:

  • electricity;

  • water,

  • telecommunication services; and

  • information technology services, to the extent these are not a direct input to the output produced or supplied by the corporate debtor


It is pertinent to mention herein that the CIRP Regulations also specifies that these commodities are only essential to the extent that ‘they are not a direct input to the output produced or supplied by the corporate debtor’. Any business that supplies essential goods and services is prohibited from terminating, suspending or interrupting its supply until the moratorium period has ended. 

The interpretation of Essential Goods and Services has been expanded by the Amendment, 2020 wherein the Resolution Professional has been given power to include other essential goods and services needed for the business’s survival into the definition. 

There are some discrepancies regarding the content contained within such essential goods and services. Insolvency board gave an exhaustive list of products and services. There has been a case, however, in which the insolvency court has extended this description, even though such extensive reading is not endorsed,by the IBC in Canara Bank v. Deccan Chronicle Holdings Ltd.[5]If this pattern persists, the corporate debtor may claim that many other services be included within the scope of the business-dependent essential goods and services.

The Insolvency Law Committee in its report dated 26thMarch, 2018 observed that in order to help the Corporate Debtor to function as a going concern, it was pertinent that ‘the Adjudicating Authority be empowered to allow the expansion of the scope of essential goods and services beyond what is specified in CIRP Regulations on the application by the Resolution Professional’.[6]

While recommending this, the Committee noted that the scope of the concept of “essential goods and services” in Regulation 32 is restricted to supplies that are important to any corporate debtor, regardless of the company he carries out. The Committee was therefore of the opinion that there should be some flexibility in deciding the goods and services that are necessary for a particular company. The Committee therefore suggested that this flexibility could be infused by adding a provisio to section 14(2), that states that the Resolution Professional shall apply to the Adjudicating Authority for the continuation of the supply of essential goods or services other than those specified by IBBI, and the Adjudicating Authority shall make a decision in that regard on the basis of the facts and circumstances of each case. 

The Committee in its meeting held on 29thAugust, 2019,[7]further discussed the issue and noted that the Adjudicating Authority has permitted the supply of certain items not covered by the CIRP Regulations. In order to reduce the litigation in this matter, the Committee suggested that the list of essential supplies in the Regulations be expanded to include supplies that are crucial to, and have a direct relationship with, the Corporate Debtor 's production of goods or supply of services in order to remain as a going concern. It is of the opinion that payment for such supplies during CIRP should be included in the Insolvency Resolution Process Cost, while past duties of such suppliers should continue to be regarded as operational debt as at the commencement date of insolvency.


The proposed amendment as per the Report of the Insolvency Law Committee was “for continuation of supply of essential goods or services other than as specified by IBBI, the IRP/ RP shall make an application to the NCLT and the NCLT will make a decision in this respect based on the facts and circumstances of each case”.[8]However, this recommendation was not adopted as an amendment to the Code.

For many decades, creditors have had low power when faced with default. Promoters stay in control of the company even after default. Only one element of a bankruptcy framework has been put into place: to a limited extent, banks are able to repossess fixed assets which were pledged with them.Under these conditions, the recovery rates obtained in India are among the lowest in the world. When default takes place, broadly speaking, lenders seem to recover 20% of the value of debt.[9]

Through the operation of Section 14 of the Code enables the corporate debtor to preserve critical supplies to the business during CIRP. With courts still unsettled as to the scope of the definition, it is pertinent to note that the whole idea of the Section 14 in light of the Code is that the Resolution Profession has to make every effort to run the corporate debtor as a going concern. For that reason, a resolution professional may also negotiate for the continuation of other critical supplies during the corporate resolution process.[10]

The proposed amendment would help to ensure that the Corporate Debtor undergoing Corporate Insolvency Resolution Process continues as a going concern without any destruction in its value on account of termination or interruption of certain supplies which are critical to its functioning during moratorium depending on the nature of business undertaken by it. It provides for payment against such supplies to be made and, therefore, does not put any extra burden on the suppliers. This balances the interest of the Corporate Debtor vis-à-vis the suppliers, while helping revival of the Corporate Debtor, which is the primary objective of the Code. This will relieve the Adjudicating Authority from dealing with applications for continued supply of essential services, facilitating expeditious competition of CIRPs. 


COVID-19 and the dreaded impact

In general, for creditors to claim past payments, they are to file claims as operational creditors. There is a further waiting period wherein they have to wait for the completion of the complete CIRP process and approval of the resolution plan to receive their dues under the resolution plan. An average CIRP process takes 374 days.[11]Furthermore, this timeline will be further extended due to the ongoing COVID-19 pandemic. In such a situation, it is prudent of the government to extend a relief regarding the same. However, no such notification or circular has been issued to this date.


[1]Sanjeev Shriya v. State Bank of India, 2017 SCC OnLine All 2717, ¶ 11

[2]Section 13, Insolvency and Bankruptcy Code, 2016.

[3]Section 7, Insolvency and Bankruptcy Code, 2016.

[4]Edwerse Asst Reconstruction Co. Ltd. v. Bharati Defence & Infrastructure Ltd., 2017 SCC OnLine NCLT 7180.

[5]Canara Bank v. Deccan Chronicle Holdings Ltd, 2017 SCC OnLine NCLAT.

[6]Report of the Insolvency Law Committee, Ministry of Corporate Affairs, March 26, 2018. Available at <www.mca.gov.in/Ministry/pdf/ReportInsolvencyLawCommittee_12042019.pdf>..

[7]Report of Insolvency Law Committee, Ministry of Corporate Affairs, February, 2020. Available at <http://www.mca.gov.in/Ministry/pdf/ICLReport_05032020.pdf>.

[8]Supra Note. 6, ¶ 5.14. 

[9]Vikrant Rana & Chanakya Sharma, Not every bankrupt will be a total failure, Mondaq, January 3, 2017. Available at <https://www.mondaq.com/india/insolvencybankruptcy/557074/not-every-bankrupt-will-be-a-total-failure>.

[10]Section 23(2) r/w Section 20, Insolvency and Bankruptcy Code, 2016.

[11]Radhika Merwin, 3 years of IBC: Only 6% cases resolved so far, Business Line, October 28, 2019. Available at <https://www.thehindubusinessline.com/money-and-banking/ibc-check-three-years-on-only-156-of-2542-cases-admitted-have-seen-resolution/article29813481.ece>.

 

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