Analysing the Interplay between IBC Moratorium and Cheque Dishonor Proceedings

Recently, the Hon’ble Supreme Court of India has, in the matter of P. Mohanraj & Ors. Vs M/s. Shah Brothers Ispat Pvt. Ltd., and other connected matters, passed a judgement inter alia holding that the order of moratorium under Section 14 of the Insolvency and Bankruptcy Code, 2016 (‘Code’), applies even to the proceedings initiated under Section 138 of the Negotiable Instruments Act, 1881(“Act”), against the Corporate Debtor.

Before, analysing the judgement, it may be necessary to briefly look at the history of the Negotiable Instruments Act, 1881 and the amendments thereto, in order to understand the reason for introduction of Section 138 to the Act.

HISTORY OF THE NEGOTIABLE INSTRUMENTS ACT, 1881:

The Act was originally drafted in 1866 by the 3^rd Indian Law Commission and introduced in December 1867 in the Council. Thereafter, it was referred to a Select Committee and also placed in public domain for debate and views. Objections were raised by the mercantile community to the numerous deviations from English Law. The Bill was redrafted in 1877, which as well did not pass muster and was, therefore, further revised by a Select Committee. The revised Bill also was not accepted by various stakeholders as adequate. In 1880 by the Order of the Secretary of State, the Bill was referred to a new Law Commission. On the recommendation of the new Law Commission, the Bill was re-drafted and sent to a Select Committee, which adopted most of the recommendations made by the new Law Commission. The draft Bill thus prepared on the fourth attempt was introduced in the Council and was enacted as law in 1881[1].

INTRODUCTION OF CHAPTER XVII IN THE ACT:

An oft used negotiable instrument is the cheque, which arguably, even post the introduction of the electronic modes of payment, continues to remain one of the popular choices by people in commerce.  Prior to 1988, there was no provision in the Act to restrain people from issuing cheques without having sufficient funds in their account or any provision to punish them in case of dishonour of cheques. The misuse of this instrument was so rampant that a need was felt to amend the law to make it onerous for the recalcitrant drawer and at the same time provide adequate safeguards to prevent harassment of honest drawers. Accordingly, in 1988 the law was amended to reflect these changes.

Section 4 of the Banking, Public Financial Institutions and Negotiable Instruments Laws (Amendment) Act, 1988, inserted Chapter XVII in the Act, comprising of Section 138 to 142. While Section 138 deals with penalties in case of dishonour of cheques for insufficiency of funds in the accounts, in Section 139 there is a presumption that the holder of the cheque has received the cheque towards discharge of a debt or any other liability either in whole or in part. To rebut this presumption, facts are required to be adduced, which on a preponderance of probability, must be proved. According to Section 140 of the Act, it shall not be a defence in a prosecution for an offence under Section 138 that the drawer had no reason to believe when he issued the cheque that the same maybe dishonoured on being presented. Section 141 then makes the Directors and other persons statutorily liable, provided the ingredients of Section 141 are met. Section 142 lays down the procedure to be adopted while taking cognizance of the offence punishable under Section 138.

NEGOTIABLE INSTRUMENTS (AMENDMENT AND MISCELLANEOUS PROVISONS) ACT, 2002:

As the punishment prescribed under Section 138 of the Act had proved to be inadequate and the procedure, prescribed for the Courts to deal with such matters was found to be cumbersome, a need was felt to bring about certain changes to the Act. Accordingly, the Negotiable Instruments (Amendment and Miscellaneous Provisions) Act, 2002 was passed, and Sections 143 to 147 were introduced. Some of the objects that were sought to be achieved were:

1. To increase the punishment prescribed under the Act from 1 year to 2 years;
2. to prescribe procedure for service of summons to the accused or witness by Court through speed post or empanelled private couriers;
3. to provide for summary trial of the cases under the Act with a view to speed up disposal of cases;
4. to make the offence under the Act compoundable.

NEGOTIABLE INSTRUMENTS (AMENDMENT) ACT, 2015:

Although Section 142 of the Act which was introduced in 1988 specified the circumstances under which the complaints for dishonour of cheque could be filed, it did not clearly specify the territorial jurisdiction of the courts where such a complaint could be filed. Thus it was left to the Courts to decide if a complaint filed was within its territorial jurisdiction. There were conflicting decisions of various Courts, including High Courts, in this regard. This issue reached the Hon’ble Supreme Court of India in the case of Dashrath Rupsingh Rathod vs State of Maharashtra[2] wherein it was inter alia held that the territorial jurisdiction for cases relating to offence of dishonour of cheques is restricted to the court within whose jurisdiction the drawee bank is situated.

This decision still did not completely iron out the lacuna regarding territorial jurisdictions. The Complainant could still take undue advantage by depositing the cheque in a branch of the bank, which was physically distant from the actual branch of the bank where the Complainant maintained his account and drag the accused to the far corners of the country for prosecution.

In order to weed away this malaise the Negotiable Instruments (Amendment) Act, 2015[3], was promulgated. Section 142 of the Act was amended, inter alia, to provide that the cases of dishonour of cheques can be filed only in a court in whose jurisdiction the branch of the bank where the payee maintains the account, is situated.

NEGOTIABLE INSTRUMENTS (AMENDMENT) ACT, 2018:

Despite various attempts made from time to time to ensure swift, cost effective and smooth disposal of cases relating to the offence of dishonour of cheques, desired impact on the pendency of cases was not. All good intentions in bringing about the various amendments came to nought primarily on account of delay tactics adopted by unscrupulous drawers in Court proceedings. Such delays compromised the sanctity of cheque transactions.

A need was felt to address the issue of undue delay in final resolution of cheque dishonour cases and to discourage frivolous and unnecessary litigation which would save time and money. Accordingly, the Negotiable Instruments (Amendment) Act, 2018[4], was enacted and a new Section 143A was introduced to provide that the Court trying an offence under Section 138 may order the drawer of the cheque to pay interim compensation to the complainant, in a summary trial or a summons case, where he pleads not guilty to the accusations made in the complaint; and in any other case, upon framing of charge. The interim compensation so payable shall be such sum not exceeding twenty per cent of the amount of the cheque. Further, a new Section 148 was inserted to provide that in an appeal by the drawer against conviction under Section 138, the Appellate Court may order the appellant to deposit such sum which shall be a minimum of twenty per cent of the fine or compensation awarded by the trial court.

The object and intent behind the various changes in law can be summarized as:

1. To enhance the acceptability of cheques in settlement of liabilities by making the drawer liable for penalties in case of dishonour of cheques due to insufficiency of funds in the accounts.
2. To make the directors/persons in charge of the company liable for the offence of dishonour of cheques on behalf of the company.
3. To provide for summary trial of the cases under the Act with a view to speeding up disposal of cases.
4. To address the issue of undue delay in final resolution of cheque dishonour cases and discourage frivolous litigation by providing interim compensation to the complainant, pending the 138 proceedings or the Appeal as the case may be.

SECTION 14 OF THE INSOLVENCY AND BANRUPTCY CODE, 2016:

Having understood the intent of the Act, it is time to turn our attention to the Insolvency and Bankruptcy Code, 2016 (‘Code’) to understand the object that it seeks to achieve, which is intended to keep “the corporate debtor's assets together during the insolvency resolution process and facilitating orderly completion of the processes envisaged during the insolvency resolution process and ensuring that the company may continue as a going concern while the creditors take a view on resolution of default”[5]. To realise this object the Code contains Section 14 whereunder the authority, namely the National Company Law Tribunal, can impose a moratorium to ensure that there is no depletion of assets of the corporate debtor during the insolvency resolution process and at the same time it can be kept afloat as a going concern during the insolvency resolution process thereby maximizing the value for all stakeholders.

Keeping the above background in mind, including the intent and object of Section 14 of the Code, we shall now analyse the judgement rendered in the case of P. Mohanraj & Ors. vs Shah Brothers Ispat Private Limited[6] wherein a question arose whether the institution or continuation of a proceeding under Section 138 read with Section 141 of the Act, can be said to be covered by Section 14 of the Code.

FACTS OF THE CASE:

1. Respondent had supplied steel products to one M/s. Diamond Engineering Pvt. Ltd., (‘company’) for which the company had issued 53 cheques in total. Upon being presented, all the cheques were returned dishonoured on account of insufficient funds.
2. Therefore, on March 31, 2017 and May 5, 2017 respectively, the Respondent issued 2 statutory notices under Section 138 read with Section 141 of the Act, calling upon the company and its Directors to pay the amount within 15 days.
3. Since the company failed to make payment, the Respondent instituted 2 criminal complaints on May 15, 2017 and June 21, 2017 respectively, under Section 138 read with Section 141 Act, before the Ld. Additional Chief Metropolitan Magistrate, Kurla.
4. Prior to that, on March 21, 2017, the Respondent issued demand notice under Section 8 of the Code to the company followed by an Application under Section 9 of the Code before the National Company Law Tribunal, Chennai (‘NCLT, Chennai’).
5. By an order dated June 6, 2017, the Application filed under Section 9 of the Code was admitted by NCLT, Chennai and moratorium in terms of Section 14 of the Code was ordered in respect of the company.
6. On May 24, 2018, the NCLT, Chennai inter alia directed the Respondent to withdraw the complaint filed under Section 138 of Act treating it as a proceeding filed after the order of moratorium and that the same amounted to misuse of the process of law.
7. Aggrieved by the order dated May 24, 2018, an Appeal was filed by the Respondent before the National Company Law Appellate Tribunal (‘NCLAT’). The NCLAT vide its order dated 31 July 2018, set aside the order dated  May 24, 2018 inter alia holding that Section 138 being a criminal law provision, cannot be held to be a ‘proceeding’ within the meaning of Section 14 of the Code.
8. In view of the order dated July 31, 2018, the Appellants filed the present Civil Appeal before the Hon’ble Supreme Court.
9. During the pendency of the Civil Appeal, on September 30, 2019, the NCLT Chennai, approved a resolution plan submitted by the promoters of the company.

QUESTION OF LAW:

Whether institution or continuation of a proceeding under Section 138/141 of the Negotiable instruments Act can be said to be covered by the moratorium provision under Section 14 of the Code?

OBSERVATIONS & FINDINGS:

Before venturing into the observations and findings made by the Court it is important to understand the essence of the case canvassed by the Appellant before it. The submission on behalf of the Appellant was that the object of Section 14 of the Code was preservation of assets of the corporate debtor during the corporate insolvency process. As such it would be incongruous to hold that the rigours of Section 138, which though a criminal proceeding, in essence was to recover amounts under a dishonoured cheque, ought to be kept out of the term “proceedings” contained in Section 14(1)(a) of the Code.

In this background the Supreme Court held:-

(I)  Proceeding under Section 14(1)(a) of the Code:

In order to determine whether  proceedings under Section 138 of the Act would fall within the meaning of ‘proceedings’ under Section 14(1)(a) of the Code, the Court in the first instance found that barring the exceptions contained in sub-sections (2) and (3), on the insolvency date, the Adjudicating Authority has to mandatorily declare a moratorium. These exceptions in turn refer to ‘transactions’ as may be notified by the Central Government in consultation with experts in finance. The Court observed this to be of some importance since Section 14(1)(a) does not indicate as to what the ‘proceedings’ contained therein apply to. The Court found that upon consideration of sub-section 3(a) it was clear that such ‘proceedings’ related to ‘transactions’ entered into by the corporate debtor pre-imposition of the moratorium. The term ‘transaction’ stands defined in Section 3(33) and upon an analysis thereof the Court held that the term was of extremely wide import and included transaction evidencing a debt or liability. Thus, according to this analysis, the term ‘proceedings’ encompass all or any ‘transactions’ evidencing a debt or liability entered into by the corporate debtor prior to the imposition of moratorium.

Having found as above the Court then held that the sweep of Section 14(1)(a) is very wide and includes institution, continuation, judgment and execution of suit and proceedings. However, the court found that the term ‘proceeding’ is preceded by the disjunctive “or” which made it clear that proceedings against the corporate debtor would be a separate category from institution of suits or continuations of pending suits. To understand the width of the expression ‘proceedings’ the Court then considered the subsequent words and expressions in Section 14(1)(a) - “any judgment, decree or order” and “any court of law, tribunal arbitration panel or other authority”.  Since Criminal proceedings are conducted before courts mentioned in Section 6 of the Criminal Procedure Coder, 1973, the Supreme Court concluded that such proceedings would certainly be a proceeding in a court of law in respect of a transaction which relates to a debt owed by the corporate debtor.

The Court further concluded that given the width of the expression ‘proceedings’, as already discussed, it was difficult to accept that it should be limited to civil suits alone.

The Court next turned its attention to the provisions of Chapter XVII of the Act together with amendments made thereto. The Court found that the proceeding under Chapter XVII of the Code, which contained Section 138 was quasi-criminal in nature, instituted with a view to recover amounts under a dishonoured cheque through summary proceeding. Having regard to the aforesaid, the Supreme Court, after having considered various decisions rendered by it on the true nature of proceedings under Chapter XVII of the Act, observed that the proceeding under Section 138 can be said to be a “civil sheep” in a “criminal wolf’s” clothing.

(II)  Whether Natural Persons are covered by Section 14 of the Code:

Having thus concluded that proceedings under Section 138 of the Act, would be covered and thus have to follow the rigours of Section 14 of the Code and that a moratorium would apply against the corporate debtor in respect of such proceedings as well, the Supreme Court then proceeded to evaluate whether the Section 138 proceedings against the Directors/ persons in management or control of the corporate debtor can be initiated or continued in view of the law laid down by the Hon’ble Supreme Court in Aneeta Hada vs Godfather Travels & Tours (P) Ltd., wherein, it has been inter alia held that the for maintaining a proceeding under Section 141 of the Act, it is imperative to arraign the company as an accused.

Reference, in particular was made to paragraphs 51 and 59in Aneeta Hada’s case wherein after analysis of various decisions, including that of Anil Hada vs Indian Acrylic Ltd. and State of Madras vs C.V. Parekh the Court concluded that Director or any other officer can be prosecuted without impleadment of the company provided there is some legal impediment in impleading the company in which case the doctrine of lex non cogit ad impossibilia gets attracted.

Having regard to the aforesaid observations in Aneeta Hada’s case, the Hon’ble Supreme Court held that the legal impediment contained in Section 14 of the Code would make it impossible for the proceedings under Section 138 of the Act to be continued or instituted against the corporate debtor. However, the proceedings against the Directors/ persons in management or control of the corporate debtor can be initiated or continued and the Directors/ persons in management or control of the corporate debtor continue to be statutorily liable.

The observations of the Hon’ble Supreme Court can thus be summarized as under:

1. Proceedings under Section 138 read with Section 141 of the Act are ‘proceedings’ within the meaning of Section 14(1)(a) of the Code.
2. An order of moratorium passed by the NCLT, would apply with equal force vis-à-vis proceedings initiated under Chapter XVII, Section 138 of the Act, qua the corporate debtor alone. The proceedings may continue after the moratorium period (330 days) comes to an end.
3. Irrespective of the moratorium in force against the corporate debtor, the proceedings under Section 138 of the Negotiable Instruments Act, 1881, against the directors/persons in management of the corporate debtor can be continued or initiated and they will be statutorily liable.

CONCLUSION AND ANALYSIS:

The decision reconciles and aligns the provisions of the Code with that of the Act. It carries forward the object and intent with which the Code was enacted and more particularly addresses the issue of preservation of assets of the corporate debtor pending the insolvency resolution process and at the same time allows the recovery proceedings under the provisions of Section 138 of the Act to continue against directors/persons in management or control of the corporate debtor. The decision draws a fine balance between the needs of the corporate debtor during the insolvency process and that of the drawee, left in the lurch on account of the dishonour of cheque, especially in those instances where the drawer (in case of a company, through natural persons then in control of its affairs) intentionally issued the instrument in spite of knowledge of lack of funds.

What remains to be seen is, whether, the Directors/persons in management and control of the corporate debtor in such cases would be directed to pay/deposit interim compensation under Section 143-A of the Act, during the subsistence of the moratorium against the corporate debtor. Should such a direction to pay/deposit interim compensation be issued to the Directors/persons in management and control of the corporate debtor, the same is likely to open a pandora’s box and whole new gamut of litigation.