OTS Failure Cannot Create Fresh Default For CIRP, Original Debt Position Revives: NCLAT New Delhi

On 28 September, the National Company Law Appellate Tribunal (NCLAT) at New Delhi held that failure to comply with the terms of a One-Time Settlement (OTS) does not constitute a fresh default for initiating the Corporate Insolvency Resolution Process (CIRP).

A Bench comprising Judicial Member Justice Sharad Kumar Sharma and Technical Member Jatindranath Swain held:

“Under an OTS, the principal loan does not remain alive. Therefore, missing the timeline for paying OTS amount which is a proceeding in consensus will not lead to a fresh default and upon its culmination, would merely result in restoration of the original position prior to OTS.”

Uma Maheshwari, suspended director and shareholder of Sharon Solutions Limited, filed the appeal challenging the admission of the company into CIRP.

Sharon Solutions had availed credit facilities from UCO Bank and other consortium lenders in 2013. Despite restructuring in 2014, the account was classified as a Non-Performing Asset (NPA) on 31 December 2014. UCO Bank initiated SARFAESI proceedings in 2016 and obtained a Debt Recovery Certificate (DRC) from the Debt Recovery Tribunal on 6 March 2018.

In June 2020, the bank approved an OTS, but Sharon Solutions defaulted on the instalments. UCO Bank subsequently filed a Section 7 application before the NCLT, Chennai, in April 2021, seeking initiation of CIRP. The NCLT admitted the application on 18 April 2023, prompting the appeal before the NCLAT.

The appellant submitted that the Section 7 application mentioned 1 November 2020 as the date of default, which fell within the Section 10A moratorium from 25 March 2020 to 25 March 2021. He therefore argued that the application was barred.

He further submitted that the NCLT had wrongly permitted UCO Bank to alter the default date to 6 March 2018, when the DRC was issued, thereby circumventing Section 10A. He also argued that the application was defective and should have been rejected rather than permitted to be cured. The appellant contended that Sharon Solutions was a viable going concern with potential investment and that its admission into CIRP was therefore unjustified.

UCO Bank and the other respondents argued that the actual default occurred when the account was classified as an NPA in 2014 and was crystallised through the DRC in 2018. They submitted that the reference to 1 November 2020 was an error which had been corrected. The respondents also pointed to earlier winding-up proceedings and the company's failure to revive despite restructuring and the OTS.

The Tribunal held that the reference to 1 November 2020 in the Section 7 application was an error that could be rectified in accordance with law. It noted that the date represented the missed instalment under the OTS.

Further, the Bench held that a default under an OTS cannot be treated as a fresh default, as an OTS is a compromise mechanism and not a rescheduling of the debt. On failure of the OTS, the original debt position is restored.

It treated 6 March 2018, when the DRC was issued, as the operative date of default. It noted that the debt had also been acknowledged on four occasions, placing the default outside the Section 10A moratorium period.

On the plea of commercial viability, it distinguished the Supreme Court's decision in Vidarbha Industries, noting that Sharon Solutions had failed to honour its OTS commitments and had previously faced winding-up proceedings.

The Tribunal also noted that despite the NCLT granting time, the company failed to honour its commitment to bring in an investor and resolve the insolvency. It further held that the company's claim of viability did not displace the established default, which was above the statutory threshold. It found the NCLT's order reasoned and legally sustainable.

Accordingly, the NCLAT dismissed the appeal.