Contributed by Smeet Sanghvi and Sashank Saravanan

Introduction

In 2016, the primary objective towards bringing about the Insolvency and Bankruptcy Code (“IBC”) was to promote a culture of a time-bound and efficient process for transparently resolving insolvency and bankruptcy in India and facilitate the reorganisation, restoration, and resolution of the corporate debtor rather than its liquidation. The process of liquidation ensures a systematic distribution of the liquidated assets to each creditor in a proportional manner. However, the regulated application of set-off in the Corporate Insolvency and Corporate Insolvency Resolution Process (“CIIRP”) process have been muddled by ambiguity with many creditors exploiting the process to receive preference over other creditors. In Corporate Insolvency the debtor has a right to adjust the smaller claim owed to him against the larger claim payable to the creditor. However, in light of this, the Supreme Court on 4 January 2024 in the case of Bharti Airtel Ltd. v. Vijay K. Aiyer provided clarity on whether statutory set-off or insolvency set-off may be applied to the CIRP process. This article aims to critically analyse the SC’s ruling while comparing it to the objectives of the IBC.

Background on Bharti Airtel Limited & Another v. Vijaykumar V. Iyer and others

In 2016, Bharti Airtel Limited and Bharti Hexacom Limited entered into a significant agreement involving eight spectrum trading agreements with Aircel Limited and Dishnet Wireless Limited. The crux of these agreements was the acquisition by Airtel entities of the right to use spectrum in the 2300 MHz band from Aircel entities, amounting to a substantial consideration of Rs. 4,022.75 crores. However, the execution of this transaction was subject to the crucial approval of the Department of Telecommunications (“DoT”), which mandated Aircel entities to provide bank guarantees, in lieu of certain pending dues of the Aircel entities to DoT. Responding to this requirement, Airtel’s subsidiaries stepped in, furnishing the necessary bank guarantees to DoT on behalf of Aircel entities. As the process unfolded, the bank guarantees were eventually returned, triggering Airtel entities’ responsibility to settle the remaining balance, as specified in the letters of understanding with Aircel entities.

In 2018, Aircel Ltd. and Dishnet Wireless Ltd. entered the Corporate Insolvency Resolution Process under the IBC due to a decision by the National COmpany Law Tribunal (“NCLT”). Subsequently, in 2019, Airtel entities initiated payments to Aircel entities, disbursing Rs. 341.80 crores. Notably, the residual Rs. 145.20 crores was offset against outstanding operational charges, SMS charges, and interconnect usage charges owed by Aircel entities to Airtel entities.

Amidst the Corporate Insolvency Resolution Process, Airtel entities submitted a claim of Rs. 203.46 crores, of which the Resolution Professional acknowledged Rs. 112 crores. However, a twist emerged when it was revealed that Airtel entities also held liabilities of Rs. 64.11 crores in interconnect charges payable to Aircel entities.

The ensuing legal tussle unfolded when the Resolution Professional unilaterally adjusted Rs. 112.87 crores from the amount payable by Airtel entities to Aircel entities, citing the discharge and cancellation of bank guarantees. While the NCLT sanctioned this set-off on May 1, 2019, the National Company Law Appellate Tribunal (“NCLAT”) overturned the decision on May 17, 2019. NCLAT argued that set-off contradicts the IBC’s objectives, emphasising the applicability of the moratorium until the completion of CIRP, and deeming the claimed set-off impermissible due to its association with distinct and unrelated transactions. In response to the NCLAT’s ruling, Airtel entities approached the Supreme Court, filing an appeal on May 17, 2019, to contest the decision.

Unpacking the ruling in line with the scheme of IBC

The Supreme Court, in Bharti Airtel Ltd. Vs. Vijaykumar Iyer, determined that during the Corporate Insolvency Resolution Process (CIRP), creditors cannot assert set-off claims under Section 25 to safeguard assets. The CIRP under Chapter II Part II of IBC controls the liquidation process of mutual credits and set-offs. However, Order VII Rule 6 of CPC or Regulation 29 of the Liquidation Regulations does not apply to CIRP, unlike Section 325 of the Provincial Insolvency Act, 1920.

Understanding the difference between Insolvency set-off and contractual, statutory, and equitable set-off requires examining judgments from different jurisdictions. The UK Court’s Ruling in Bank of Credit and Commercial International SA sets two conditions: mutuality must precede bankruptcy, emphasised in Stein Blake Rule 2.85 Insolvency Rules,1986, stating that at the time of distribution, only the balance (if any) of the account held by the creditor is provable in the administration similar to CIRP. As the Australian jurisprudence exemplified in Gye Mcintyre, defines mutuality based on parties’ status, not the nature of the claim therefore, a debt arising out of a contract can be settled against an instrument bearing obligation. The Singapore Jurisprudence in the BP Singapore case clarifies equitable set-off where there exists no compulsion for the claim and cross-claim to arise out of the same contract as long as there exists a close relationship or linking between the communications and the dealings, stressing a close relationship between claims.

Indian law opposes this stance. Indian Courts require Insolvency set-off to involve the same parties in the same capacity and possessing the same rights. With the commencement of CIRP, the corporate debtor’s identity and nature change, rendering set-off claims impermissible. The Pari Passu and Anti-Deprivation principles stem from the idea that parties cannot circumvent insolvency laws. This contrasts with the doctrine of Pari Passu, outlined in Section 53 r/w Section 52 IBC, 2016, ensuring equal treatment of creditors. This principle ensures that creditors within the same class are treated equally in insolvency proceedings. It aims to prevent any creditor from receiving more than their fair share of assets during distribution, maintaining fairness among creditors. Insolvency set-off, by prioritising certain creditors, can reduce the overall dividend payable to creditors. On the other hand, the UK insolvency law incorporates the anti-deprivation principle, which prevents parties from making agreements that would give them an unfair advantage in bankruptcy proceedings. The principle of anti-deprivation prohibits parties from entering into agreements that would unfairly benefit them in the event of bankruptcy. It prevents individuals from circumventing insolvency laws by attempting to preserve assets or advantages for themselves at the expense of other creditors thereby invalidating contracts that attempt to secure a better position in bankruptcy, aligning with Pari Passu to prevent circumvention of insolvency laws.

Decoding the Exception to SC’s Ruling

Examining Section 238 IBC, 2016 states that provisions of the law override all other laws, however, two exceptions remain viable – the equitable/transactional set-off and the contractual set-off. The basis for contractual set-off aligns with that of equitable set-off, both hinging on the challenge to the title, albeit contractual set-off emerges through a mutual agreement allowing for set-off and adjustment. The understanding of it is as follows-

1. Contractual Set-off – This exception allows for set-off if there was a pre-existing contractual agreement before the CIRP began. During the CIRP, the terms of existing contracts remain valid, and actions related to those contracts can continue. So, if there was a contractual set-off arrangement in place before the CIRP, it can still be enforced. Notably, during the moratorium period of CIRP, the initiation or enforcement of recovery and legal proceedings is restricted. Importantly, existing contract terms, including those permitting set-offs, persist unaltered and maintain their binding nature.

2. Equitable Set-off – This exception applies when there are linked claims and counterclaims arising from closely connected transactions. Here, the set-off is justified based on fairness and equity, even if not explicitly provided for by law. It prevents unjust enrichment of one party at the expense of the other, especially when transactions are closely intertwined. The adjusted amount should be a clear, quantifiable, and undisputed monetary claim, considering the time-sensitive nature of the CIRP, which is different from the normal legal procedure followed under CPC operating as an erstwhile summary procedure.

The crux of the discussion revolves around the Resolution Professional’s decision to permit set-off. This set-off, amounting to approximately Rs. 64 crores, pertained to dues owed by the corporate debtor Aircel entities to the Airtel entities under various agreements. In the present case, these exceptions address the argument raised by the appellant. Airtel entities argue for the recognition of a set-off based on contractual and equitable grounds of the dues owed by the Aircel entities to them. The Resolution Professional allowed this set-off, which occurred before the commencement of the CIRP. This aligns with the contractual set-off exception, as there was a pre-existing agreement. Additionally, the transactional set-off exception might also apply if the claims and counterclaims are closely linked, ensuring fairness and equity in the resolution process. The primary concern was to determine the compatibility of this set-off with established legal principles and exceptions, especially in light of the specific circumstances surrounding the initiation of the CIRP.

Conclusion

The Supreme Court’s decision strikes a balance between the protection of creditors’ rights and the overarching objectives of the IBC. The Supreme Court deemed the arguments of Airtel Entities fallacious. The contention that Section 30(2)(b)(ii) supports insolvency set-off is rejected. The court refuted the argument of equitable and contractual set off by applying the principle the Pari Passu and Anti-Deprivation.  It acknowledges the need for limited exceptions to accommodate pre-existing contractual arrangements while ensuring that the CIRP process remains focused on the fair resolution and reorganisation of distressed corporate entities. By rejecting the arguments put forth by the Airtel entities, the court reaffirms the integrity of the CIRP and ensures that the resolution process remains consistent with the objectives and provisions of the IBC.