‘IPSO FACTO’ TERMINATION IN INDIA: VALID OR INVALID

Introduction

An insolvency law question is often asked in what way contractual agreements between business parties can or should be disturbed because of the insolvency process between one of the parties to the contract. The difficulty lies between, on the one hand, maintaining the integrity of contractual agreements and, on the other, the necessity for insolvency legislation to enable the debtor to successfully resolve the situation. If implementing a certain contract would be a serious prejudice to the insolvent debtor’s business and would considerably impair its probability of successful resolution, may bankruptcy law provide for the failure to implement such a contract? The Supreme Court has examined this problem in its judgement of March of this year in the Gujarat Urja Vikas Nigam Limited vs. Amit Gupta and Ors. (“Gujarat Urja Vikas”). This tension is evident in the discussion on the enforcement of ipso facto provisions in contracts.

Supreme Court on insolvency validity of Ipso Facto

On 8 March 2021, Supreme Court of India in Gujarat Urja Vikas Nigam Limited v. Amit Gupta that Insolvency and Bankruptcy Code (IBC) provisions for 2016 prevailed over a corporate debtor’s (“PPA”) power purchase agreement and upheld a ruling by the National Company Law Appellate Tribunal (NCLAT) that ended the power purchase agreements.

Facts of the case

To construct solar power plants in the country of Gujarat, the Government of Gujarat released the Solar Power Policy of 2009 on 6 January 2009. Aston field Solar Gujarat Pvt. Ltd (‘Aston field’) was allocated a 25 MPG capacity on 1 August 2009 to construct and build a Solar Photovoltaic Power Plant in Gujarat by the Gujarat Urja Vikas Nigam Superior Limited (“GVNL”). GVNL agreed with Aston field the power buy a contract for 25 years with Aston field, the higher tariff rate for the first 12-15 years and the reduced tariff rate for the remaining years. The deal was inked with Aston field. The plant was nevertheless forced to close for two months because of heavy precipitation and floods in the State of Gujarat in 2015. This harmed them severely and reduced their energy production capabilities. Gujarat again was affected by floods in 2017, with the plant only operating at 10-15%. These two incidents place Aston field under a financial obligation that prevents Aston field from reimbursing its creditors in full who subsequently request that Aston field be declared an asset (“NPA”).

Aston field filed for insolvency under section 10 of the IBC, which prompted the NCLT to begin a corporate insolvency resolution procedure (‘CIRP’) in its favour and impose a moratorium order. As a result of the inclusion of an ipso facto clause, GNLV cancelled the PPA with Aston field. The NCLT-appointed resolution professional objected to this decision, and the NLCT postponed the termination of the PPA. The NCLAT likewise dismissed an appeal against the NCLT’s order. As a result, GNLV decided to file a petition with the Supreme Court.

The NCLT’s jurisdiction over the resolution of commercial issues

In the current case, the Supreme Court dealt with an important legal issue: the extent of the contracting or agreement termination jurisdiction of the NCLT. Because GVNL was the sole buyer of energy from Aston field, it tried to end the PPA by invoking a clause allowing GVNL to quit the agreement when it went bankrupt in Aston field. Following IBC Section 60(5), the resolution professional employed for Aston field requested that the GVNL termination of the PPA be challenged before NCLT, on the basis that CIRP against Aston field had been initiated. The Aston field lawyers argued that GVNL’s termination of the PPA contravened the IBC plan as it forced Aston field into insolvency and necessitated the continuation of the PPA for the whole settlement and the maintenance of Aston field. The Court found that the PPA was terminated only because of the beginning of the CIRP against Aston field, based on the circumstances of the case, and would not have been terminated if the CIRP did not begin. Consequently, an issue directly connected with IBC can be asserted and the NCLT is competent to adjudicate the dispute following IBC Section 60(5)(c).

Validity of the Ipso Facto Clauses under the IBC

The ruling of the Supreme Court at Gujarat Urja Vikas addresses the wider question of whether contractual obligations according to the CIRP can be enforced (or not). Section 14(2) of the IBC currently forbids third parties, after the CIRP is begun and the moratorium is enforced, from stopping to supply essential services to their corporate debtors. Furthermore, Section 14(2A) of the IBC, which was enacted in December 2019, states that vital service supply cannot be interrupted unless the borrower pays for such supplies during the current term (even if there have been payments defaults in past periods). The licenses, government grants, and permits for conducting the corporate debtor’s business that was not terminable at the time the CIRP was started if the corporate debtor has not defaulted on the payment of the current licenses or allowances required during the moratorium period are the final category mentioned in the explanation for section 14(1). This all means to raise the prospects of the resurrection of the debtor by ensuring that his enterprise can be handled during a CIRP.

The Court debated the legitimacy of ipso facto rules, noting that they are recognized or rejected in different nations throughout the world. The need for ipso facto provisions arises from the need to safeguard commercial relationships between parties and to prevent the debtor from selectively carrying out the contract. However, the Court pointed out that in countries where insolvency law takes precedence over ipso facto clauses, triggering an ipso facto clause when a debtor is in financial distress might jeopardize the debtor’s efforts to restructure. This safeguard is provided by Article 7 of the EU Directives, which stipulates that a party may not terminate a contract based on ipso facto terms if the defaulting party is a corporate debtor in the process of restructuring.

The stance of the United Kingdom (“UK”) on this issue has been decided. In Belmont Park Investments Pty Ltd v BNY Corporate Trustee Services Ltd, In 2012, the UK Supreme Court ruled that ipso facto clauses could not be used to validate contracts that did not serve a legitimate commercial purpose and were only intended to avoid unlawful bankruptcy or insolvency regulations. In addition, in 2020, the Corporate Insolvency & Governance Act 2020 amended the Insolvency Act, 1986, rendering termination of a demand-supply contract based on ipso facto clauses unlawful. Insolvency, Restructuring and Dissolution Act, 2018 section 440 stipulates that ipso facto clauses cannot be invoked to invalidate contracts in the case of insolvency.

Validity of Ipso Facto clauses

Act 2020 of the Insolvency and Bankruptcy Code clarifies Section 14(1) of the IBC, which prohibits a government authority or statutory authority from terminating a license, permit, registration, allowance, concession, clearance, or other similar grant or right for insolvency if there is no default in payment of the existing du insolvency. The legislative intent behind this amendment was examined in the ISLR report of February 20, 2020, which noted the importance of keeping a corporate debtor as a “going concern” during the IBC moratorium and the waiver of certain governmental licenses and permits during CIRPs based on ipso facto provisions. The ILC proposed adding a “scope for ambiguity” explanation to Section 14(1) of the IBC and making the legislative intention plain and accurate.

The Hon’ble Court of Cassation upheld NCLAT’s decision, noting that NCLT’s residual jurisdiction can be used to limit the terms of the PPA only to initiate the Corporate Debtor’s CIRP. The applicant was deemed the debtor’s only buyer of electricity generated by the debtor, as well as the PPA’s need to keep the debtor operating as a ‘going concern.’ This viewpoint was taken into consideration.  However, the Hon’ble Court emphasized that the court cannot intervene to set aside valid terminations that would merely dilute the value of a corporate debtor, and that the current reasoning is limited to the facts of the case at hand and should not be used to justify the Court’s interference in the implementation of any contractual terms agreed upon by the parties as a precedent in future cases.

Conclusion

IBC seeks to provide financial assistance to a corporate debtor and reorganize its assets. To achieve this goal, it is not acceptable to terminate agreements only based on insolvency under ipso facto clauses. While the IBC has yet to resolve the ipso facto problem in India, several nations, like the United Kingdom, the United States, and Singapore, have included ipso facto provisions into their bankruptcy laws. It’s perhaps past time for Parliament to add anything similar in the IBC.

Author(s) Name: Aeshita Marwah (University of Petroleum and Energy Studies, Dehradun)

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