Settlement Breach Before CIRP Admission Cannot Sustain Section 9 Insolvency Proceedings: NCLT New Delhi

The New Delhi National Company Law Tribunal (NCLT) has held that once parties enter into a settlement agreement before admission of a Corporate Insolvency Resolution Process (CIRP) under Section 9 of the Insolvency and Bankruptcy Code, 2016, any subsequent default arising from such settlement does not give rise to an “operational debt” and cannot sustain insolvency proceedings.

A Bench comprising Judicial Member Mahendra Khandelwal and Technical Member Anu Jagmohan Singh noted that such disputed must be pursued before the appropriate civil forum and dismissed a petition filed by Silver Collections Private Limited against Paragon Knits Limited. It observed:

“…… we are of a considered view that pursuant to the execution of Settlement Deed between the Corporate Debtor and Operational Creditor, pending the initiation of CIRP under Section 9 of the Code, the claim of the default amount does not constitute as Operational Debt as per Section 5(21) of the Code. Further, in view of settled position, if any default arises out of the Settlement Agreement, the same shall be recovered before an appropriate forum as this Adjudicating Authority is not a recovery forum.”

Silver Collections had supplied yarn to Paragon Knits between May and November 2023 and claimed outstanding dues of Rs. 2.33 Cr. After alleging non-payment, it issued a demand notice and filed a Section 9 application seeking initiation of CIRP.

During the pendency of proceedings, the parties executed a settlement deed under which Paragon Knits agreed to discharge the liability by issuing 24 post-dated cheques of Rs. 10 lakhs each. The operational creditor later alleged breach of settlement after 14 cheques were dishonoured and sought continuation of insolvency proceedings, citing a clause preserving its legal remedies.

Paragon Knits, however, contended that the execution of the settlement deed extinguished the original operational debt and that the creditor was bound to withdraw the insolvency proceedings upon receipt of the cheques.

The NCLT held that while the original supply transaction did constitute an operational debt under Section 5(21) of the IBC, the legal character of the claim changed once the settlement was executed prior to admission of CIRP. It noted that a default arising from a settlement agreement cannot be treated as operational debt for the purposes of Section 9 proceedings.

It referred to the decision in Trafigura India Private Limited v. TDT Copper Limited, where the NCLAT held that settlement-based obligations do not fall within the ambit of operational debt under the Code. It also relied on Basant Kumar Upadhyay v. Kuber Shree Construction Company, which held that no operational debt survives where disputes are settled prior to CIRP initiation.

Further, citing Suwarna Buildcon Pvt. Ltd. v. Sadbhav Engineering Ltd., the Members observed that once parties substitute the original contractual relationship with a structured settlement arrangement, the original cause of action arising from supply of goods or services does not survive independently.

Lastly, the Bench also examined Clause 2 of the settlement deed, which required withdrawal of the pending Section 9 proceedings upon receipt of signed cheques. It held that the parties thereafter became bound by the terms of the settlement alone.

Accordingly, the NCLT dismissed the Section 9 application filed by Silver Collections Private Limited.