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Set-Offs During CIRP: Scope And Applicability

Supreme Court in its recent judgment, has given clarity on the issue of applicability of varied types of set-off during CIRP

Recently, the Supreme Court of India decided the case of Bharti Airtel Limited and Another v. Vijaykumar V Iyer and Others, settling the issue on the applicability of the varied types of set-off during CIRP. It laid down conditions/exceptions when set-off may be allowed even during CIRP. 

Facts:

The Appellants, Bharti Airtel Limited and Bharti Hexacom Limited (“Appellants” / “Airtel Entities”), entered into eight spectrum trading agreements with the Respondents, Aircel Limited and Dishnet Wireless Limited (“Respondents” / “Aircel entities”), for purchase of the right to use the spectrum allocated to the Respondents in the 2300 MHz band. The Airtel entities were to pay INR 4,022.75 Crores to the Aircel entities as consideration against such purchase.

The spectrum trading agreements were contingent on the approval of the Department of Telecommunications (“DoT”). The DoT demanded bank guarantees from the Aircel entities for certain license and spectrum dues before approving the transfer. Aircel entities challenged the direction of DoT before the Telecom Disputes Settlement and Appellate Tribunal (“TDSAT”).

In the meantime, since the Aircel entities did not have the means to furnish the bank guarantees, they asked the Airtel entities to do so on their behalf. The Airtel entities agreed to furnish the bank guarantees and deduct the amount from the consideration payable to the Aircel entities under the spectrum transfer agreements. The Airtel entities subsequently furnished the bank guarantees to the DoT as required. Thereafter, the TDSAT vide order dated 09.01.2018, held that the DoT’s demand of up to INR 298 Crores (bank guarantees) was untenable and directed the DoT to return the bank guarantees. However, the DoT did not return the same and filed Civil Appeal no. 5816 of 2018 before the Hon’ble Supreme Court of India. Aircel entities also filed Cross-appeals. The Hon’ble Supreme Court of India, vide order dated 28.11.2018, held that the TDSAT’s order should be given effect to. The DoT still did not return the bank guarantees. Hence, Airtel entities approached the Hon’ble Supreme Court of India which, vide order dated 08.01.2019, directed the cancellation of the said bank guarantees.

Consequently, The Airtel entities paid INR 341.80 Crores to the Aircel entities after receiving the bank guarantees back from the DoT, setting-off the balance amount of INR 145.20 Crores against certain interconnect charges owed by the Aircel entities to the Airtel entities.

Meanwhile, Aircel entities were admitted to Corporate Insolvency Resolution Process (“CIRP”) under the Insolvency and Bankruptcy Code, 2016 (“Code”). Bharti Airtel Limited filed a total claim of INR 203.46 Crores for interconnect charges including the claims of Telenor (India) Communications Private Limited (which had been merged with Bharti Airtel Limited). The same were admitted to the extent of INR 112.87 Crores. 

The resolution professional of the Aircel entities wrote to Airtel entities and stated that the Airtel entities should pay INR 112.87 Crores to the Aircel entities, as Airtel entities had suo moto adjusted the amount of INR 112.87 Crores from the amount of INR 453.73 Crores payable by Airtel entities to Aircel entities, consequent to the discharge and cancellation of the bank guarantees. The Airtel entities disputed the claim and asserted their right to set-off the amount due to them by the Aircel entities.

The Aircel entities’ resolution professional’s objection to the set-off was challenged by the Airtel entities before the Hon’ble National Company Law Tribunal (“NCLT”/“Adjudicating Authority”/“Tribunal”). The Hon’ble Tribunal allowed the set-off as claimed by the Airtel entities. However, the Hon’ble National Company Law Appellate Tribunal reversed the order of the Adjudicating Authority (in Aircel entities’ appeal) and held that set-off was not permissible under the Insolvency and Bankruptcy Code, 2016. Hence, the Appellants filed this appeal before the Hon’ble Supreme Court of India.

Issues under adjudication:

1.Whether the Airtel entities have a right to set-off INR 112.87 Crores from the payment due to the Aircel entities, who are undergoing Corporate Insolvency Resolution Process under the Insolvency and Bankruptcy Code, 2016.

2.Whether the set-off claimed by the Airtel entities is contractual, statutory, equitable or insolvency set-off, and what are the conditions and principles governing each type of set-off.

3.Whether the set-off claimed by the Airtel entities violates the pari passu principle, the anti-deprivation principle, or the objective of the Insolvency and Bankruptcy Code, 2016.

Arguments of the Appellants:

•Right to set-off: The Appellants claimed that they have a right to set-off INR 145.20 Crores from the amount payable to the Aircel entities under the spectrum transfer agreements, on account of the interconnect charges owed by the Aircel entities to the Appellants. They contended that the set-off is based on contractual and equitable grounds and is not affected by the commencement of the CIRP against the Aircel entities.

•No violation of moratorium: The Appellants argued that the set-off does not violate the moratorium under Section 14 of the Code, as it does not amount to recovery of any property or enforcement of any security interest or legal proceeding against the corporate debtor. They submitted that the set-off is a mode of discharging reciprocal obligations and does not involve any transfer of assets or coercive action.

•No prejudice to other creditors: The Appellants asserted that the set-off did not prejudice the interests of other creditors of the Aircel entities, as the Appellants are not claiming any preference or priority over them. They maintained that the set-off was a pre-existing right that arose before the initiation of the CIRP and did not alter the position of the parties or the distribution of the assets of the corporate debtor.

Arguments of the Respondents:

•No right to set-off during CIRP: The Respondents argued that the Appellants had no right to set-off their dues from the amount payable to the Aircel entities, as this would violate the provisions and objectives of the Code. The Code did not permit any set-off during the CIRP, which is aimed at maximizing the value of assets of the corporate debtor and balancing the interests of all stakeholders. They relied on Section 238 of the Code, which states that the Code overrides any other law that is inconsistent with it, and Section 14, which imposes a moratorium on any recovery action against the corporate debtor during the CIRP. 

•No contractual or equitable set-off: The Respondents further argued that the Appellants did not have any contractual or equitable right to set-off, as the claims of the Appellants and the Respondents arose from different and unrelated transactions. They pointed out that the Appellants’ (Airtel entities) claim was arising out of the interconnect charges that were payable by the Respondents to the Appellants, while the Respondents’ (Aircel entities) claim was based on the spectrum trading agreements. The Respondents also submitted that the Appellants did not claim any set-off before the initiation of the CIRP and had only done so after the resolution professional demanded the payment of INR 112.87 Crores from them. They asserted that the Appellants were trying to take advantage of the ongoing insolvency of the Respondents and improve their position at the expense of other creditors.

•No mutuality of dealings: At the outset, it was argued that Regulation 29 of the Insolvency and Bankruptcy Board of India (Liquidation Process) Regulations, 2016 (“Liquidation Regulations”) does not apply to the CIRP and is applicable only during liquidation. The Respondents also argued that the Appellants did not satisfy the requirement of mutuality of dealings, which is essential for insolvency set-off under Regulation 29 of the Liquidation Regulations. They contended that the Appellants’ and the Respondents’ claims were not between the same parties in same right or capacity. The Appellants’ claim was against the Aircel entities for interconnect charges as Aircel entities were a user of telecom services provided by the Appellants. Whereas, the claim of the Aircel entities against the Appellants was for the sale of the spectrum by Aircel entities to the Airtel entities. Furthermore, the Respondents’ claim was contingent on the cancellation of the bank guarantees, while the Appellants’ claim was subject to the admission by the resolution professional.

Analysis:

The 4 types of Set-off explained:

•Contractual set-off: This is a matter of agreement between the parties, rather than a separate application of set-off. The parties are free to mutually agree on the outcomes they desire, subject to legality and public policy. The contract should be within the bounds of the law of contracts. The right to set-off may be explicit or implied in the agreement. (@ Para 6)

•Statutory or legal set-off: This is created by a statute, such as Order VIII Rule 6 of the Code of Civil Procedure, 1908. It requires that both the parties should fill the same character as they fill in the plaintiff’s suit. The defendant may, at the first hearing of the suit, present the written statement containing particulars of debts sought to be set-off. For set-off in law, the obligations existing between the two parties must be debts which are for liquidated sums or money demands which can be ascertained with certainty. Both the debts must be mutual cross-obligations, that is, cross-claims between the parties in the same right. (@ Para 8)

•Equitable set-off: This is allowed in common law, as distinguished from legal set-off, which is allowed by the court only for an ascertained sum of money and is a statutory right. Equitable set-off can also be claimed in respect of an unascertained sum of money payable as damages. However, the claim for an equitable set-off must have a connection between the plaintiff’s claim for the debt and the defendant’s claim to set-off, which would make it inequitable to drive the defendant to a separate suit. The claim for set-off should arise out of the same transaction, or transactions which can be regarded as one transaction. (@ Para 9)

•Insolvency set-off: This is permitted under Regulation 29 of the Liquidation Regulations, which provides for mutual credits and set-off. The sums due mutually can be set off to arrive at the net amount payable to the corporate debtor or the other party. The expression ‘mutual dealings’ for the purpose of Regulation 29 is wider than the statutory set-off or equitable set-off. Insolvency set-off applies when demands are between the same parties. There must be commonality of identity between the person who has made the claim and the person against whom the claim exists. Even when there are several distinct and independent transactions, mutuality can exist between the same parties functioning in the same right or capacity. Mutual dealings are not so much concerned with the nature of the claims, but with the relationship and apposite identity of the parties giving rise to the respective claims, such that it would offend one’s sense of fairness or justice to allow one to be enforced without regard to the other. (@ Para 16 to 22)

Applicability of Set-off in CIRP:

The Court discussed the applicability of each type of set-off in CIRP so as to determine whether any type of Set-off can be claimed by the Airtel Entities. 

•Contractual set-off: The court accepted that contractual set-offs are a matter of agreement between the parties, and held that they could be exercised if the normal requirements of the law of contracts, i.e. intention to create legal relationship, acceptance, consideration etc are established. (@ Para 6, 7)

•Statutory/legal set-off: The court rejected statutory set-offs under Order VIII Rule 6 of CPC, as not being applicable to a CIRP under the Code. The court also observed that the Code does not recognize the principle of statutory set-off under CPC. (@ Para 8, 9)

•Equitable/transactional set-off: The court observed that equitable set-off may be allowed during CIRP as an exception, when the claim and the counterclaim are linked and connected on account of one or more transactions that can be treated as one. The court also borrowed the term ‘transactional set-off’ to describe this exception and laid down the conditions for its exercise. (@ Para 9, 32, 33)

•Insolvency set-off: This is permitted during liquidation under Regulation 29 of the Liquidation Regulations, when there are mutual dealings between the corporate debtor and another party, and the sums due from one party are set off against the sums due from the other to arrive at the net amount payable. The court held that insolvency set-off was not applicable in the present case, as the Liquidation Regulations are not applicable to the CIRP, but only liquidation process. It further held that there was no mutuality of dealings between the parties, as the amounts became payable after the commencement of the CIRP. (@ Para 13, 22, 23, 24)

The Balance between Set-offs and Anti-Deprivation / Pari Passu doctrine:

The anti-deprivation principle states that parties cannot contract out of an insolvency legislation and deprive the insolvent estate of its assets. The pari passu principle states that creditors of the same class should be treated equally and get their proportional dues (@ para 24, 25). Allowing set-offs during CIRP could invariably violate the Anti-Deprivation doctrine or the Pari Passu doctrine. The Hon’ble Supreme Court of India stipulated the conditions under which set-offs could be entertained as under:

•The court accepted contractual and transactional set-off on certain conditions, such as the set-off being genuine, clearly established, quantifiable, and arising out of the same or connected transactions. The court held that this would not contradict the moratorium, as the transactions are treated as singular and one. (@ para 31-34) 

•The court rejected the insolvency set-off under Regulation 29 of the Liquidation Regulations, as it was not applicable during the CIRP but only during the liquidation process. The court noted that otherwise allowing insolvency set-off during CIRP would give primacy and preferential treatment to a creditor who claims entitlement to set-off mutual credits. This would deplete the assets available for distribution among the general body of creditors. This would be contrary to the pari passu principle and the objective of the Code. (@ para 24, 34).

Verdict:

After examination of each type of set-off, as analyzed above, the Court came to the conclusion that Statutory Set-off and Insolvency Set-off were not applicable at all at this stage. Further, the conditions for Contractual or Equitable/Transactional set-offs also did not meet in the present facts and circumstances. Therefore, no set-off was allowed by the Hon’ble Supreme Court. The appeal was dismissed and the Hon’ble NCLAT’s verdict was upheld.

Conclusion:

This judgment emphasizes that the Code does not envisage the statutory set-off or insolvency set-off during the CIRP of a corporate debtor, except in two situations: (1) when the set-off is expressly provided for in the contract between the parties, and (2) when the set-off is based on closely connected transactions that can be treated as one. Thus, mutuality of dealings is an important foundation to seek set-off. This judgment has settled the law on set-off during CIRP, as it clarifies the scope and applicability of the doctrine of set-off in the context of IBC. The judgment also strikes a balance with the pari passu doctrine, which requires equal treatment of the same class of creditors, and the anti-deprivation doctrine, which prevents parties from contracting out of the insolvency legislation. Hence, this judgment protects the legitimate expectations of the parties and provides more certainty regarding the applicability of the set-offs during CIRP.

Case Details:

Bharti Airtel Limited and Another v. Vijaykumar V Iyer and Others

CIVIL APPEAL NOS. 3088-3089 OF 2020

Supreme Court of India

Pronounced by:  Justice Sanjiv Khanna; & Justice SVN Bhatti

Pronounced on: 03.01.2024

This article has been authored by:

  1. Shriraj Khambete, Senior Associate, Saraf and Partners
  2. Naman Jain,Associate, Saraf and Partners



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