Analysis of Supreme Court Judgment on Set-off in Corporate Insolvency Resolution
Process
Introduction:
The recent judgment by the Supreme Court of India on January 3, 2024 in the case of Bharti Airtel Limited and Another v. Vijayakumar V. Iyer and others has provided crucial insights into the applicability of set-off during the Corporate Insolvency Resolution Process (“CIRP”) under the Insolvency and Bankruptcy Code, 2016 (“IBC”). This article delves into the facts of the case, provides an overview of set-off concepts, and analyzes the Supreme Court’s interpretation of relevant provisions in the IBC.
Background and Facts:
(a) In April 2016, Bharti Airtel Limited and Bharti Hexacom Limited (collectively “Airtel”) engaged in eight spectrum trading agreements with Aircel Limited and Dishnet Wireless Limited (collectively “Aircel”) for the acquisition of spectrum rights in the 2300 MHz band. The Department of Telecommunications (“DoT”), Government of India, required bank guarantees for certain license and spectrum usage dues from Aircel entities, leading to a dispute addressed by the Telecom Disputes Settlement and Appellate Tribunal (“TDSAT”).
(b) To comply with TDSAT’s interim order, Airtel entities agreed to submit bank guarantees worth approximately Rs. 453.73 crores on behalf of Aircel entities. The spectrum transfer agreements outlined a payment of Rs. 4,022.75 crores from Airtel entities to Aircel entities. Airtel entities committed to deduct Rs. 586.37 crores from this amount, with the balance payable after the substitution of bank guarantees.
(c) TDSAT, in its January 9, 2018 order, deemed the DoT’s demand of Rs. 298 crores against Aircel entities as untenable and directed the return of bank guarantees. Despite this, the DoT did not comply. Subsequent court orders affirmed TDSAT’s decision but failed to secure the return of bank guarantees.
(d) Facing reluctance from banks to cancel the guarantees, Airtel entities sought court intervention, resulting in an order on January 8, 2019, directing the cancellation of bank guarantees. Consequently, Airtel entities made a payment of Rs. 341.80 crores to Aircel entities on January 10, 2019, offsetting the remaining Rs. 145.20 crores against Aircel entities’ outstanding operational charges.
(e) Amidst these events, Corporate Insolvency Resolution Process was initiated against Aircel entities. Claims for interconnect charges were filed by Airtel entities, totalling Rs. 203.46 crores, with Airtel entities also owing Rs. 64.11 crores in interconnect charges to Aircel entities. The Resolution Professional admitted Airtel entities’ claims
partially.
(f) In response, the Resolution Professional sought Rs. 112.87 crores from Airtel entities, adjusting it against the earlier Rs. 453.73 crores payable, leading to objections and a claim for set-off by Airtel entities. The Adjudicating Authority ruled in favor of Airtel entities’ right to set-off on May 1, 2019, but this decision was contested by the Resolution Professional at the National Company Law Appellate Tribunal. On May 17, 2019, the NCLAT overturned the decision, citing the violation of insolvency principles and the non-obstante provisions of Section 238 of the Insolvency and Bankruptcy Code.
Overview of Set-off:
Set-off is a legal concept that allows a debtor to offset a smaller claim against a larger one payable to a creditor. It has different forms, including contractual set-off, statutory (or legal) set-off, equitable set-off, and insolvency set-off. Each form serves specific purposes and operates under distinct legal principles.
1. Concept of Set-off:
➢ Set-off acknowledges a debtor’s right to offset a smaller claim against a larger one payable to the creditor.
➢ It is considered a form of payment, ensuring economic efficiency and equity in transactions.
➢ Philip R. Wood1 describes it as a payment method, and Palmer2 emphasizes a distinction between ‘set-off’ in the context of accounting, and as a defence. The former centers on the practical outcome of set-off, leading to the fulfillment of mutual obligations, whereas the latter emphasizes set-off used as a defense against a claim, though not wielded as an offensive tactic.
2. Legal Preference and Rationale: Set-off is legally preferred for reasons of economic efficiency, confidence in trade, reduction of litigation, and adherence to principles of natural equity.
3. Different meanings of Set-off:
➢ Set-off has at least five meanings, including statutory/legal set-off, common law set-off, equitable set-off, contractual set-off, and insolvency set-off.
➢ Common law and equity principles have converged in the modern era.
4. Contractual Set-off:
➢ Arises from mutual agreement and is consensual.
➢ Parties are free to agree on outcomes of contractual set-off subject to legality and public policy.
➢ legal requirements of contracts viz intention to create legal relationship, acceptance, consideration etc.,. must be met for a valid contractual set-off.
➢ Contractual Set-off can either be express or implied.
5. Statutory or Legal Set-off:
➢ Created by statute, such as Order VIII Rule 6 of the Code of Civil Procedure,
➢ Involves mutual cross-obligations for liquidated sums within pecuniary limits.
6. Equitable Set-off:
➢ Permitted for unascertained sums or ascertained sums with a connection to the plaintiff’s claim.
➢ Requires claims to arise from the same transaction or related transactions.
7. Insolvency Set-off:
➢ Should not be equated with equitable set-off.
➢ In the United Kingdom, the law allows for insolvency set-off when there are reciprocal debts, credits, and other mutual transactions between the parties at the crucial cut-off time, typically coinciding with the commencement of the liquidation process.
Analysis of IBC Provisions and Supreme Court’s Interpretation:
The IBC’s Framework and Set-off
1. The case under consideration pertains to the CIRP outlined in Chapter II Part II of the IBC, specifically Sections 6 to 32A. However, the components of Section 53 of the IBC, a component of Chapter III Part II, which pertains to the liquidation process is discussed by the Supreme Court of India in this case to better understand the concept
of Set-off and its application in insolvency process5 as against liquidation process.
Examination of relevant IBC Provisions
2. In contrast to the provisions found in the Companies Act of 1956 or the Companies Act of 2013, the IBC does not grant indebted creditors the right to set-off against the corporate debtor during the CIRP. Earlier legislations, specifically Section 529 of the Companies Act, 1956, and Section 325 (now omitted) of the Companies Act, 2013, did allow set-off under the Provincial Insolvency Act, 1920, which has now been repealed.
Under the Companies Acts, Section 46 of the Provincial Insolvency Act, 1920, statutorily recognized the right of indebted creditors to set-off against the corporate debtor, subject to certain conditions. Notably, Section 173 of the IBC permits set-off in the case of partnerships and individual bankruptcies. Regulation 29 of the Insolvency
and Bankruptcy Board of India (Liquidation Process) Regulations, 2016 (“Liquidation Regulations”), addresses mutual credits and set-off. It’s essential to clarify that these Liquidation Regulations specifically apply to the process outlined in Chapter III Part II of the IBC and do not extend to Chapter II Part II, which deals with the CIRP.
The Supreme Court’s Interpretation of Set-off in CIRP
3. Section 36(4) in Chapter III Part II of the IBC addresses the exclusion of assets that do not form part of the liquidation estate. This section allows the Insolvency and Bankruptcy Board of India to specify assets that could be subject to set-off due to mutual dealings between the corporate debtor and the creditor. When an asset is
excluded from the liquidation estate, it is not available for distribution in the liquidation process. Consequently, if a creditor exercises and is allowed set-off, Section 36(4) of the IBC gives that creditor a preferred status over others, including secured creditors, to the extent of the set-off value.
Contractual vs. Statutory Set-off in IBC
4. The Liquidation Regulations have been established under the authority of Sections 5, 33, 34, 35, 37, 38, 39, 40, 41, 43, 45, 49, 50, 51, 52, 54, 196, and 208, read in conjunction with Section 240 of the IBC. Despite not explicitly referring to Section 36(4) of the IBC, the Liquidation Regulations permit set-off due to mutual dealings as outlined in Regulation 29. This allows for the setting off of mutually due sums to determine the net amount payable to the corporate debtor or the other party. However, the exclusion of certain assets will lead to a reduction in the liquidation estate, resulting in consequences as discussed earlier. In the context of this case, our focus is not on what is included or excluded from the liquidation estate. The expression ‘mutual dealings’ is the condition to be satisfied for insolvency set-off under Regulation 29.
International Perspectives on Insolvency Set-off
5. In the United Kingdom, insolvency set-off principles were explored in Re: Bank of Credit and Commerce International SA (No. 8)7, emphasizing that set-off should pertain to dealings preceding bankruptcy and require strict adherence to the mutuality requirement. The ruling clarified that insolvency set-off is not intended to benefit a debtor lacking mutual dealings or to prefer a creditor with secondary or no liability. The UK insolvency set-off regime, broader than statutory or equitable set-off, demands that the debt be provable in the insolvency process.
6. In the earlier case of Stein v. Blake8, it was established that bankruptcy set-off extends to all claims arising from mutual credits or dealings prior to bankruptcy, even if they were due but not payable, unascertained, or contingent at the time of bankruptcy. The UK insolvency set-off regime allows for estimating liabilities and trends, with no requirement for parties to meet and calculate each other’s liabilities at a specific time.
Rule 2.85 of the Insolvency Rules, 1986, akin to the CIRPL, states that during distribution, only the net balance of the creditor’s account is provable.
Implications of the Judgment on Future Insolvency Proceedings
7. Decisions like National Westminster Bank Ltd. v. Halesowen Presswork & Assemblies Ltd. underscore the mandatory nature of insolvency set-off in the UK. The Insolvency Rules, 1986 suggest that set-off coexists with the moratorium during administration, activating when the administrator announces the intention to distribute assets. However, set-off does not automatically occur upon entering administration. Notably, the doctrine
of set-off does not apply to company voluntary arrangements under Part I of the Insolvency Act, 1986. Rory Derham observes that in the absence of an express application to company voluntary arrangements, set-off, without a contractual right, is not applicable, relying on the statute of set-off and equitable set-off. Furthermore,
claims against the corporate debtor incurred after the initiation of administration cannot be set-off against the debtor’s crossclaim due to a lack of mutuality, and such claims are not against the corporate debtor itself.
The Role of Mutual Dealings and Equitable Considerations
8. The Kerala High Court’s judgment in Gokul Chit Funds and Trades Pvt. Ltd. v.Thoundasseri Kochu Ouseph Vareed10 emphasizes that the principle of mutuality in mutual dealings under the Kerala Insolvency Act, 1955, can be satisfied even with several distinct and independent transactions between the same parties, as long as these transactions give rise to reciprocal claims and demands. This interpretation broadens the scope of ‘mutual dealings’ beyond the statutory and equitable set-offs recognized by the CPC and common law in India, highlighting that insolvency set-off requires commonality of identity between claimants and respondents, regardless of the transactions’ nature. However, upon the commencement of the Corporate Insolvency Resolution Process, the identity of the corporate debtor changes, restricting the set-off of dues pre and post-commencement. Additionally, post-notice of debt assignment, acquiring debts payable to a third party to claim set-off against the assignor creditor is seen as contrary to equity and a misuse of insolvency set-off provisions, especially in voluntary winding up cases, underscoring the need for fairness and the prevention of misuse in mutual dealings.
9. Insolvency set-off challenges the pari passu principle by allowing certain creditors, including operational creditors, to obtain priority through mutual credits, potentially diminishing the assets available for equitable distribution among all creditors and affecting the dividend payable. Critics question the argument that set-off stimulates trade, suggesting it’s rarely considered a security form. IBC implicitly supports pari passu, ensuring equitable creditor treatment within the same class, as outlined in its provisions. Moreover, UK insolvency law’s anti-deprivation principle prevents contracts that would provide a party with an advantageous position in bankruptcy, emphasizing that insolvency legislation cannot be contracted out of, aiming to preserve
the insolvent estate for all creditors’ benefit. The IBC aims to consolidate insolvency laws for corporate entities, partnerships, and individuals, focusing on asset value maximization, entrepreneurship promotion, and stakeholder interest balance, establishing itself as a comprehensive code except where external enactments are referenced, as affirmed by various judgements of the Indian judiciary.
10. Section 238 of the IBC establishes its supremacy over inconsistent laws, ensuring IBC provisions prevail. Section 243 repeals the Provincial Insolvency Act, 1920, highlighting its non-applicability to the CIRP. Consequently, statutory and insolvency set-offs, as defined by other regulations, do not generally apply during CIRP, with notable exceptions. Contractual set-offs established before or at the commencement of CIRP are honored, unaffected by the process or the accompanying moratorium that halts recovery actions and legal proceedings. This reflects the IBC’s framework for managing insolvency that respects pre-existing contractual rights, underscoring the code’s comprehensive approach to insolvency resolution while preserving certain contractual entitlements.
11. Contractual set-off, grounded in mutual agreement, and the concept of ‘transactional set-off’, akin to equitable set-off but applied to closely connected transactions, are recognized exceptions during the CIRP under IBC. The Resolution Professional inherits the debtor’s property, including existing rights and limitations, thus if a debtor’s right to sue is impeached pre-CIRP, so too is the Resolution Professional’s. Transactional set-off, treated as an equitable right when transactions are interlinked, allows for claims and counterclaims to be adjusted without the need for legal proceedings, provided the set-off is quantifiable, genuine, and justifiable. This approach respects the legal certainty and equitable principles without undermining the moratorium’s effect or the principles of pari passu and anti-deprivation, ensuring a fair and just application of insolvency set-off as mandated by law.
12. In the case involving Airtel entities and Aircel entities, the Resolution Professional allowed a contractual set-off of approximately Rs. 64 crores due under various agreements prior to the CIRP, addressing Airtel’s argument for entitlement to set-offs.
The IBC being a complete code, especially with Sections 238 and 243, negates the applicability of statutory or insolvency set-off during CIRP, clarifying that Regulation 29 of the Liquidation Regulations does not extend to the proceedings under Chapter II Part II of the IBC. This legal stance effectively counters Airtel entities’ claims for set-
offs within the CIRP framework, emphasizing the code’s comprehensive nature in handling insolvency and bankruptcy matters.
13. In the case involving Airtel entities and Aircel entities, the Resolution Professional allowed a contractual set-off of approximately Rs. 64 crores due under various agreements prior to the CIRP, addressing Airtel’s argument for entitlement to set-offs. The IBC being a complete code, especially with Sections 238 and 243, negates the
applicability of statutory or insolvency set-off during CIRP, clarifying that Regulation 29 of the Liquidation Regulations does not extend to the proceedings under Chapter II Part II of the IBC. This legal stance effectively counters Airtel entities’ claims for set-offs within the CIRP framework, emphasizing the code’s comprehensive nature in handling insolvency and bankruptcy matters.
14. The UNCITRAL Legislative Guide on Insolvency Law underscores the importance of set-off rights in insolvency proceedings to prevent misuse and ensure commercial predictability and credit availability. It distinguishes between obligations arising before and after the commencement of insolvency proceedings, advocating for the allowance of pre-commencement set-offs to promote fairness and predictability in insolvency cases. However, in the context of the CIRP under IBC, especially concerning rehabilitation and revival of the corporate debtor, the guide’s relevance is limited. The IBC’s clear provisions on this stage of insolvency proceedings do not necessitate a purposive interpretation, focusing instead on the corporate debtor’s recovery rather than liquidation aspects, where set-off rights play a different role.
15. Regarding mutual dealings and equitable considerations, the adjustment of interconnect charges between telephone service providers, based on contractual agreements, exemplifies permitted set-offs recognized by the Resolution Professional. These adjustments are deemed necessary for operational harmony and are justified on both contractual and equitable grounds. However, transactions unrelated to these operational adjustments, such as those involving spectrum usage rights and associated bank guarantees provided by Airtel entities for Aircel entities, which became payable post-CIRP commencement, highlight the complexities of set-off claims in insolvency scenarios. The argument against allowing certain set-offs, suggesting it would create new rights or undermine the IBC’s Section 14 moratorium designed to protect the corporate debtor’s assets from being dissipated, is rejected, reinforcing the structured approach to insolvency resolution that prioritizes asset preservation and equitable treatment among creditors.
Conclusion:
In conclusion, the Supreme Court’s judgment affirms that statutory and insolvency set-offs are not applicable during the CIRP. The court emphasizes the comprehensive nature of the IBC and rejects arguments in favor of insolvency set-off, ensuring the protection of the corporate debtor’s assets during the resolution process. The decision provides clarity on the boundaries of set-off in the context of insolvency proceedings, contributing to the evolving jurisprudence on the IBC.
Implications of the Judgment on Future Cases
The Supreme Court’s judgment has several implications for future insolvency and bankruptcy cases in India:
1. Clarification on Set-off Rights: It provides a clear interpretation of the IBC regarding the non-applicability of traditional set-off mechanisms during CIRP, offering guidance for future cases.
2. Impact on Creditors’ Strategies: Creditors will need to revisit their recovery and negotiation strategies with distressed companies, potentially leading to more cautious lending and contractual practices.
3. Enhanced Predictability in Insolvency Proceedings: The judgment contributes to the predictability and uniformity of insolvency resolutions under the IBC, aiding stakeholders in better anticipating the outcomes of CIRP.
4. Strengthening the CIRP Framework: This decision underscores the comprehensive nature of the IBC in managing corporate insolvency and bankruptcy, aiming for equitable treatment of all stakeholders.
5. Influence on Future Legislation and Policy: The judgment may influence legislative and policy decisions concerning the insolvency and bankruptcy framework in India, ensuring consistency with judicial interpretations.
6. Operational Creditors’ Position: The judgment could affect the position and strategies of operational creditors in the insolvency resolution process, emphasizing the need for equitable treatment.
7. Legal Precedent for Dispute Resolution: This decision serves as a precedent for interpreting the IBC’s provisions on set-off and claims resolution, guiding future legal disputes in insolvency cases.
8. Implications for Contractual Agreements: Parties might include specific provisions related to insolvency and set-off in their contracts to mitigate risks and protect financial interests in light of this judgment.
Written by: Vidyavathi Kowshik
