New Delhi : The Supreme Court has set aside the admission of an insolvency application filed by an EPC contractor against the owner of a power project, holding that while payments due under a works contract's milestone schedule qualify as operational debt, claims for suspension, idling and demobilization charges remain in the nature of damages and cannot be treated as operational debt under the Insolvency and Bankruptcy Code, 2016, unless previously assessed and crystallized by a court or arbitral tribunal of competent jurisdiction.
A Bench of Justice J. B. Pardiwala and Justice Manoj Misra was hearing a civil appeal filed against the judgment of the National Company Law Appellate Tribunal ("NCLAT"), which had affirmed the National Company Law Tribunal's ("NCLT") admission of a Section 9 application under the IBC filed by an operational creditor seeking initiation of insolvency proceedings against the corporate debtor.
The dispute arose out of an Engineering, Procurement and Construction ("EPC") contract dated 09.02.2011 for setting up a 225 MW gas-based power station in Andhra Pradesh, awarded for a contract price of Rs. 827 crore. The contractor alleged that the owner failed to release payments due under the agreed milestone-based payment schedule, compelling it to suspend works in 2011 and eventually demobilize from the site. Despite this, neither party invoked the termination clause of the contract. Legal notices sent by the contractor in 2014 and 2015 went unanswered, and a statutory demand notice under Section 8 of the IBC was issued only in July 2018, followed by the Section 9 application in October 2018 claiming dues of over Rs. 1,292 crore.
The corporate debtor opposed the application on the grounds that the claim was hopelessly time-barred, having crystallized as far back as 2011-2012, and that a pre-existing dispute existed between the parties, both of which, it was argued, barred the application under Section 9 of the IBC. It was further submitted that despite the EPC contract providing for arbitration as the mode of dispute resolution, the contractor had chosen to file a time-barred claim under the IBC instead.
The operational creditor argued that since the EPC contract had never been terminated by either party, it continued to subsist, giving rise to a continuing cause of action that kept its claim within limitation. It was further submitted that the corporate debtor never disputed the claim at any stage prior to the filing of the Section 9 application, and that the Resolution Professional had already separated the operational debt component from the damages component of the claim.
On the question of frustration of the contract, the Court held that the EPC contract could not be said to have been frustrated by efflux of time, since frustration under Section 56 of the Indian Contract Act, 1872 requires an unforeseen supervening impossibility, and a contract cannot be treated as frustrated where the suspension resulted from the conduct of the parties themselves. Relying on the decision in Boothalinga Agencies v. V.T.C. Poriaswami Nadar, the Court observed that the doctrine of frustration cannot apply to a case of "self-induced frustration".
On the nature of the claim, the Court held that amounts payable under the EPC contract's milestone-linked payment schedule qualified as operational debt under Section 5(21) of the IBC, being consideration for goods and services rendered. However, it held that suspension, idling and demobilization charges were in the nature of damages arising from an alleged breach of contract, and that
"disputes that arise from breach of the contract cannot give rise to an operational debt till the time the debt becomes crystallized and legally enforceable", since the NCLT and NCLAT are not the appropriate forums for adjudicating such disputes on merits.
On the question of a pre-existing dispute, the Court held that the corporate debtor's consistent and total silence in response to the contractor's legal notices over nearly seven years was strong evidence that no genuine dispute existed prior to the Section 9 application, applying the principles laid down in Mobilox Innovations Pvt. Ltd. v. Kirusa Software (P) Ltd. The Court clarified that a defence raised for the first time in reply to a Section 9 application, without any anchoring in the party's prior conduct, amounts to an afterthought.
On limitation, however, the Court ruled in favour of the corporate debtor. It held that the claim crystallized in January and February 2012, when the amounts were acknowledged by the debtor, and that the three-year limitation period under Article 137 of the Limitation Act, 1963 began running from that date. The Court rejected the contractor's argument that the subsistence of the EPC contract created a continuing cause of action, holding that
"though an unpaid debt may cause continuous damage, yet it does not cause continuing legal injury", and that default under Section 3(12) of the IBC occurs at a singular point in time. It further held that the contractor's subsequent legal notices could not extend the limitation period in the absence of any written acknowledgment of liability under Section 18 of the Limitation Act.
Relying on its earlier decisions in Babulal Vardharji Gurjar v. Veer Gurjar Aluminium Industries (P) Ltd. and Sabarmati Gas Ltd. v. Shah Alloys Ltd., the Court reiterated that the IBC is not intended to give a fresh lease of life to debts that are already time-barred, and that insolvency proceedings cannot be used as a substitute for recovery of stale claims.
Holding that the Section 9 application was filed more than three years after the default had crystallized, without any application seeking condonation of delay, the Court found the admission of the application to be erroneous and set aside the orders of both the NCLT and the NCLAT.
Allowing the appeal, the Court granted the contractor liberty to pursue its claims before the appropriate dispute resolution forum, namely arbitration, as provided under the EPC contract.
Case Title: Srinivasa Reddy Velagala vs. Sravanthi Infratech Pvt. Ltd., Civil Appeal No. 876 of 2021
