Breach of Settlement and Restoration of Section 9 Petition

Introduction

The relentless march of new-age commerce demands a robust legal framework. This system must prioritize transparency and the swift resolution of financial defaults to maintain market stability. A critical legal dilemma arises when a Corporate Debtor attempts to veil a default through accounting maneuvers. Specifically, the court must determine if a debtor can legally misallocate payments between past arrears and fresh transactions. This brings the issue as to whether a Corporate Debtor can mask a default by misallocating payments between past arrears and fresh transactions.

In the landmark case of Dnyaneshwar Shankar Unde, Proprietor of Swadarshan Dairy Products v. Shukla Dairy Private Limited¹, NCLT², Ahmedabad Bench, presided over by Sh. Shammi Khan (Judicial Member) and Sh. Sanjeev Sharma (Technical Member), primarily held that the IBC³ remains a potent tool for operational creditors when a debtor fails to honor settlement terms, specifically ruling that the tactical “on-account” adjustment of payments toward new supply does not extinguish a pre-existing operational debt.

The OC⁴, a MSME⁵-registered dairy proprietor, supplied milk to the CD⁶ from 2011 to 2018. Following a default in 2018, a petition was filed for an outstanding debt. During the proceedings, an MoU was signed in November 2020 to settle the principal amount in 15 installments. However, after the business relationship resumed, the CD allegedly failed to complete the settlement payments, leading the OC to seek restoration of the petition after an initial withdrawal based on the settlement.

The Tribunal Unmasks the Reality of Debt Discharge

The Applicant contended that while a settlement was reached, the Respondent failed to adhere to the payment schedule, paying only a fraction of the settled amount. They argued that subsequent payments made by the Respondent were for “fresh sales” occurring after the MoU⁷ and could not be unilaterally adjusted by the CD to claim that the old debt was discharged. They further highlighted that the dishonor of security cheques and subsequent undertakings in criminal court evidenced an admission of the continuing debt.

Conversely, the Respondent argued that the entire settled amount had been fully paid by December 2022. They maintained that the OC suppressed material facts and that the payments made “on-account” should be viewed as a total discharge of the liability. The Respondent asserted that the IBC should not be used as a recovery mechanism and that the petition was a vexatious attempt to harass a solvent, going concern with a substantial turnover.

In evaluating the merits, the Tribunal analyzed the specific clauses of the MoU and the ledger entries provided by both parties. The court scrutinized the application of Section 9 of the IBC in light of the following principles:

“The Code is not intended to be a substitute for recovery proceedings; however, where a debt is admitted and a default is established through the breach of a settlement agreement, the Adjudicating Authority must act to ensure the objectives of the IBC are met.”

The Tribunal referenced the spirit of Invent Asset Securitisation and Reconstruction Private Limited v. Girnar Fibres Limited⁸, noting that while the object is the revival of the corporate debtor, the existence of an undisputed debt is the trigger for CIRP. The Bench further examined the Respondent’s reliance on Krishna Garg v. Pioneers Fabricators⁹, distinguishing it by noting that in the present case, the liberty to revive the petition was explicitly granted by the Hon’ble NCLAT, thereby maintaining the maintainability of the Section 9 application.

The Tribunal resolved the dichotomy between “past dues” and “new supply payments” by looking at the conduct of the parties and the terms of the MoU. The clause of the agreement explicitly stated that payments for new supplies would be “in addition to” the settlement installments. The Bench observed that the Respondent’s attempt to consolidate all payments into a single ledger to project a “nil balance” was a misleading accounting tactic. By verifying that the Respondent had given an undertaking in a Section 138 NI Act proceeding for a sum that contradicted their “full payment” claim in the NCLT, the Tribunal found clear evidence of a subsisting default. Consequently, the Bench determined that the Operational Creditor had successfully proven the existence of an operational debt and a subsequent default, leading to the admission of the petition.

Conclusion

This case reinforces the sanctity of settlement agreements within the insolvency framework. The NCLT Ahmedabad Bench meticulously separated the complexities of ongoing trade from the statutory obligations of a debtor under a court-sanctioned settlement, ensuring that creditors are not left in a lurch by clever accounting.

The future ramifications of this judgment are significant for the MSME sector. It establishes a precedent that “on-account” payments cannot be used as a shield by Corporate Debtors to arbitrarily settle older debts with funds intended for new transactions, provided the agreement specifies a distinction. It provides a clear roadmap for creditors to revive dismissed petitions if settlement terms are breached, preventing debtors from using MoUs as a mere stalling tactic.Will future courts mandate specific “Allocation Clauses” in all MoUs to prevent the commingling of old debt and new trade payments? Should the IBBI¹⁰ introduce a standard protocol for the “Restoration of Petitions” to avoid multiple rounds of litigation (NCLT to NCLAT and back)? To mitigate the risk of tactical misallocation, practitioners should advise clients to include a robust ‘Payment Hierarchy’ clause in MoUs; this ensures that payments for new transactions are legally decoupled from settlement installments, providing a clear path for the restoration of Section 9 petition upon a breach of settlement.

1. Dnyaneshwar Shankar Unde, Proprietor of Swadarshan Dairy Products v. Shukla Dairy Private Limited (CP (IB) No. 239/9/AHM/2020) ↩︎
2. National Company Law Tribunal ↩︎
3. Insolvency and Bankruptcy Code, 2016 ↩︎
4. Operational Creditor ↩︎
5. Micro, Small & Medium Enterprises ↩︎
6. Corporate Debtor ↩︎
7. Memorandum of Understanding ↩︎
8. Invent Asset Securitisation and Reconstruction Private Limited v. Girnar Fibres Limited 2023 15 SCC 255 ↩︎
9. Krishna Garg v. Pioneers Fabricators, Company Appeal(AT) (Insolvency) Nos. 92 of 2021 ↩︎
10. Insolvency and Bankruptcy Board of India ↩︎

Expositor(s): Adv. Shreya Mishra