Navigating the Legal Labyrinth: An In-Depth Analysis of Ipso Facto Clauses and Their Impact on Insolvency Proceedings in India
ABSTRACT:
The ipso facto clause, a contractual stipulation triggered by insolvency events, stands at the crossroads of contract law and insolvency proceedings. This article delves into the multifaceted nature of ipso facto clauses, examining their purpose, legal implications, and the global divergence in their treatment. It highlights the protective intent behind such clauses while scrutinizing their potential to undermine the rehabilitative objectives of insolvency law.
Through a comparative analysis, the article explores the legislative frameworks from jurisdictions like the EU, US, and India, revealing a spectrum of approaches—from stringent invalidation to cautious enforcement. The Indian legal perspective is given particular attention, considering the evolving jurisprudence and the Supreme Court’s stance on the matter. The article argues for a balanced approach that reconciles the sanctity of contracts with the overarching goals of insolvency resolution, advocating for reforms that align with international best practices while catering to the unique contours of the Indian insolvency landscape.
OVERVIEW:
Any system of contractual law must include the freedom to contract. Parties are free to engage into any kind of contract with one another under classical contract law, with the court’s intervention being minimal. Then, even in cases where the contract is unfavourable to any party, they are obligated to abide by it strictly.
The idea of contract sanctity is defined as a thread that runs through a contract from start to finish, requiring courts to always be watchful to prevent new and established doctrines from serving as a convenient way out of bad deals. deals. Laissez-faire requires the freedom and sanctity of contracts, and courts have an obligation to support and uphold these essential components.
INTRODUCTION:
The classical principle of contracts states that public policy requires that men of full age and competency should have utmost liberty of contracting and that their contracts entered freely and voluntarily must be upheld by the Courts of Justice.1 Unfortunately, a lot of factors have changed and affected this principle in modern times. A contract’s terms are no longer unassailable and can really be examined by the court. Terms that are enforced in standard-form contracts or unreasonable terms seen in consumer contracts are two examples of this.2
Because they highlight the need for a balance between contractual relationships and insolvency rules, ipso facto clauses have become a hotly debated topic. The purpose of the Insolvency and Bankruptcy Code 2016 (IBC or Code), which is to save corporate debtors (CD) through restructuring, could be thwarted by these clauses. Nonetheless, it is impossible to dispute the significance of these ipso facto terms, which give parties autonomy during the contract-drafting process. The purpose of this article is to clarify the current situation with regard to ipso facto clauses under the IBC and other legal systems. This article then attempts to present a potential course of action for India to take in order to strike the crucial balance between IBC and ipso facto clauses.
IPSO FACTO CLAUSE:
Contractual provisions called “ipso facto” give one party the right, in the event of a default, to end the agreement or change it. These defaults could include specific events like the start of bankruptcy procedures, the appointment of an administrator, or failure to pay debts or fulfil obligations under contracts, among others. It is the intention of ipso facto clauses to shield one party from financial damage in the event that the other party defaults. These clauses, however, have created circumstances where they pose an obstacle to the defaulting party’s successful bankruptcy process.
A contractual provision known as an ipso facto clause permits one party to alter or cancel the agreement in the event that a certain event relating to another party’s insolvency occurs.
The purpose of the clause is to shield the parties from the dangers posed by a counterparty’s bankruptcy. By permitting a party to withdraw its obligations, these clauses may run counter to the goals of the bankruptcy process and jeopardise the debtor’s capacity to operate as a going concern.
If the CD loses a lot of money because a contract it terminated was necessary for it to continue as a “going concern,” it is because an ipso facto clause permits one party to terminate a contract due to the bankruptcy of another party. That’s why it becomes critical that certain contracts that are fundamental to the Corporate Insolvency Resolution Process (CIRP) continue. For ipso facto provisions to be governed, clear laws are therefore required.
GLOBAL PERSPECTIVES:
- UNCITRAL: The debate is acknowledged in the UNCITRAL Legislative Guide on Insolvency Law, which suggests that such sections in the domestic insolvency regime be invalidated and that the resolution process be prioritised as a “going concern.”3
- WORLD BANK: The ipso facto provisions are void under the World Bank’s Principles for Effective Insolvency and Creditor/Debtor Regimes, subject to specific restrictions.
- THE EU DIRECTIVE: In the event that the corporate debtor restructures, the EU Directive further limits the implementation of ipso facto terms.
THE GOING CONCERN CONCEPT:
The going concern principle is the main idea at the heart of India’s corporate insolvency resolution process. Operating the firm as a going concern once the insolvency resolution process commences is a clear legislative obligation for both the interim resolution professional and the resolution professional.
All of the resources, both tangible and intangible, and assets required to carry on independently with a commercial activity—which could be all or a portion of the corporate debtor’s operations—are referred to as “going concern” when no value is placed on any particular resource or asset. The idea that a business should be regarded as though it continues to exist comes from the accounting field.4
The entire purpose of resolution under the IBC is to preserve and maximise enterprise value, which is why the resolution professional is to keep the business running as a going concern until the CoC approves a resolution plan which ensures that the business keeps going on forever.5
In addition, the judiciary has taken the initiative to make sure that the corporate debtor has enough money to continue as a going concern.
The Tribunal found that it is against the going concern principle when banks deny customers the ability to withdraw money for the purpose of paying for employee salaries and the power used in the business. Consequently, the Tribunal issued an order permitting the removal of these monies. The Tribunal instructs the resolution experts that the company must be operated as a going concern at the time of each CIRP’s acceptance.
IPSO FACTO CLAUSES AND INSOLVENCY IN INDIA:
The idea of a going concern is fundamental to Indian insolvency and is a recurring issue throughout the Insolvency and Bankruptcy Code (IBC), as previously discussed. Support from a variety of stakeholders is necessary for the concept that a business should operate forever.
In order to guarantee that the corporate debtor’s business can be maintained and managed, the Resolution Professional and the interim Resolution Professional have been given many authority. The law mandates that every effort be made to ensure ongoing business enterprise, and protecting and preserving the value of the corporate debtor is a significant component of the Resolution Professional’s duty. Compelling a supplier to comply is impossible if their contract contains an ipso facto clause that makes the same contingent upon their insolvency.
In general, this makes it far more difficult to manage the corporate debtor as a going concern. It will be very difficult for the Resolution Professional to negotiate into new contracts with suppliers if the core material contracts expire upon insolvency. Even while the Resolution Professional has this authority, it will be challenging to quickly enter into such agreements when the corporate debtor is already going through CIRPS. Suppliers who are unwilling to cooperate can put the corporate debtor in even more difficult circumstances, which will affect all parties involved in the business’s ability to continue as a going concern.
As of yet, the Indian courts have not encountered a scenario requiring them to handle a clause of this nature in an insolvency-related case. Such a clause has been presented before the NCLT in a liquidation case.6 However, the scholars disagree, nevertheless, that a choice of this nature can be carried over into the CIRP. This is due to the fact that, should the resolution process fail, the liquidation procedure does not incorporate the fundamental tenet of the CIRP—the idea of “going concern.” It is a certain that the company identity will dissolve during the liquidation stage.
INVALIDITY OF IPSO FACTO:
The “doctrine of pro-corporate debtor as going concern bias” is introduced first, outlining the parameters of the ipso facto clause’s invalidity. This doctrine stems from the I&B Code’s provisions (specifically, Section 148) as read, with the Preamble’s stated objectives being (i) maximising asset value; (ii) maintaining the corporate debtor’s ability to continue as a going concern; and (iii) balancing the interests of all stakeholders.
The “doctrine of pro-corporate debtor as going concern bias,” it can be argued, may not be able to reconcile the conflict between a corporate debtor’s rights during the CIRP (including liquidation) and the terminating party’s contractual right and the contract’s integrity. Even though such a claim seems appealing at first glance, it should be rejected.
A moratorium is allowed by Section 14, although it is only applicable during the CIRP term. The drawback is that liquidation is not covered by the ipso facto provision, which is only declared void “till the moratorium period”. It is still applicable to maintain the corporate debtor as a going concern during the liquidation process. Second, such a moratorium does not extend to cover those important contracts7 in which the corporate debtor provides commodities and/or services; rather, it only covers transactions in which the corporate debtor obtains necessities. As a result, the overall purpose and spirit of the I&B Code are no longer being upheld.
SAFEGUARDS:
After coming to the conclusion that the ipso facto clause would be invalid, we looked into the extent of this invalidation, specifically whether it was conditional or absolute. We believe that, in order to accomplish the goal of the I&B Code, the ipso facto clause should be treated invalid with retrospective effect, regardless of the date on which it was incorporated into the contract, and that this invalidity should not be dependent upon the introduction of an amendment (which would be nothing more than a clarificatory amendment).
According to the United Nations Commissions on International Trade Law (UNCITRAL) Guide, national insolvency law supersedes such ipso facto clauses, with some exceptions, as contract performance is essential for CIRP.8 When drafting new rules and regulations or evaluating whether already-existing ones are sufficient, the UNCITRAL Guide was intended to serve as a guide.
On a similar vein, the World Bank and UNCITRAL Guidelines were also suggested in the 2005 J.J. Irani Expert Committee Report on Company Law.9 It said that maintaining a flat liability curve and increasing the value of the assets are essential. Additionally, the Committee suggested that the ipso facto clause be placed under conditional stay beginning on the day the insolvency application was admitted. Additionally, it clarified that imposing an absolute stay would violate the supplier’s contractual freedom by forcing him to fulfil commitments against his best interests as a business.
CONCLUSION:
Nations that invalidate ipso facto clauses either fully or conditionally score in the top 25 for ease of doing business, according to the Doing Business Report 202031. These nations include Singapore, the United States, Australia, and Germany. Although India is ranked sixty-third, these rankings are determined by considering a number of factors, including the degree to which contracts are enforced and the manner in which insolvency is handled in a given nation.
India is still far behind in the contract performance category, while having made considerable progress in the insolvency resolution bracket. Moreover, the aforementioned year 2020 ranking would not be maintained by insolvency resolution outside of contract performance. Consequently, it is imperative to nullify the ipso facto clause that ensures contract execution in order to facilitate business transactions in India.
Observing closely, one finds that the contract generally grants an unrestricted right to any party other than the corporate debtor to terminate, accelerate, or modify the agreement to the detriment of the corporate debtor merely on the basis of filing an application for the start of CIRP, the start of CIRP/liquidation, e.g. Similar circumstances have the potential to impair the corporate debtor’s ability to continue as a going concern, which could ultimately prevent the corporate insolvency resolution process or liquidation process from being as successful as intended by the 2016 Insolvency and Bankruptcy Code. The legislators believe that clarification is necessary, even though Section 14 of the I&B Code offers a limited moratorium to safeguard the corporate debtor in order to accomplish the code’s goal.
Written by Riddhi S Bhora
