Insolvency is a Process of Resolution and Not a Refuge from Responsibility

Introduction

The Insolvency and Bankruptcy Code, 2016¹ (IBC) was brought in to simplify and speed up the process of dealing with financially distressed companies and individuals. Its goal is to help creditors recover dues while also giving businesses a chance to revive. The IBC introduces a concept known as a moratorium which is a temporary suspension of legal actions against the debtor. For companies undergoing insolvency, Section 14² of the IBC provides that once the insolvency resolution process is initiated, no legal proceedings (including criminal complaints for dishonour of cheques) can be pursued or continued against the corporate debtor i.e. a corporate entity.

For individuals, Section 96³ provides an interim moratorium the moment an insolvency application is filed under Section 94⁴, which is typically used by personal guarantors. This effectively freezes all ongoing or new proceedings against the individual debtor, offering breathing room during the insolvency process. The Negotiable Instruments Act, 1881⁵ (NI Act) plays a crucial role in maintaining trust in commercial transactions by treating the dishonour of cheques as a punishable offence.

However, when these two laws come into play together, such as when a director of a company that has defaulted on payments also faces personal insolvency, how should the rights of the holder of the cheque be balanced with the protections available to the financially distressed individual under the IBC? Can cheque bounce proceedings under the NI Act continue even after insolvency proceedings have been initiated under the IBC?

In a significant ruling, recently delivered by the Supreme Court of India in Rakesh Bhanot v. Gurdas Agro (P) Ltd.⁶ and connected appeals, the legal conundrum surrounding the applicability of interim moratorium under Section 96 of the IBC to criminal prosecutions under Section 138⁷ of the NI Act was finally settled.

Facts of the case

The appellants, including Rakesh Bhanot and others, were facing prosecution under Section 138 of the NI Act for dishonour of cheques. Subsequently, they initiated proceedings under Section 94 of the IBC for personal insolvency and invoked Section 96, which provides for an interim moratorium against any legal action or proceeding in respect of any debt. The appellants sought to stay the proceedings under Section 138 on the basis of this interim moratorium. However, the Magistrate and the High Courts concerned dismissed these applications. The appeals were clubbed together and heard by the Supreme Court.

Contentions

The primary legal contention arises from the attempt to stay proceedings under Section 138 of the NI Act due to the interim moratorium under Section 96 of the IBC. The appellants argued that insolvency proceedings should protect debtors from criminal prosecution for dishonoured cheques, accentuating the need for a structured debt resolution process. According to the appellants, the purpose of the moratorium under the IBC is to shield the debtor from coercive recovery actions like proceedings under Section 138 of the NI Act, that could disrupt the insolvency process or worsen their financial distress. It reflects the Code’s broader objective — to ensure a fair and orderly resolution or reorganisation, rather than allowing a scramble among creditors that might deplete the debtor’s assets.

The respondents argued that the moratorium under Section 96 of the IBC is limited in scope, and it primarily halts civil proceedings related to debt recovery against individuals. It does not automatically shield a person from criminal prosecution under Section 138 of the NI Act. They argued that this distinction was crucial as proceedings under Section 138 of the NI Act are penal in nature, aimed not merely at recovering money but at upholding the credibility of cheques as negotiable instruments. They serve a broader public interest by enforcing personal accountability and deterring financial misconduct, regardless of whether the drawer is undergoing insolvency proceedings.

Judicial analysis

Through several landmark rulings, the Supreme Court has earlier clarified the boundaries of moratorium provisions under the IBC.

In SBI v. V. Ramakrishnan⁸, the Court while adjudicating on the applicability of moratorium under Section 14 of the IBC to personal guarantors, held that personal guarantors are covered by the moratorium under Section 96 of the IBC, and the protection of moratorium under these Sections 96 and 101⁹ of the IBC is far greater than the moratorium under Section 14 of the IBC.

Thereafter came the 3-Judge Bench judgment of P. Mohanraj v. Shah Brothers Ispat (P) Ltd.,¹⁰ where the Supreme Court held that the moratorium under Section 14 of the IBC applies exclusively to corporate debtors and not to individuals such as directors or signatories. The judgment further went on to state that moratorium under both Sections 14 and 96 were different. It was held that a “legal action or proceeding in respect of any debt” as mentioned in Sections 81¹¹, 85¹², 96 and 101 of the IBC, would, on its plain language, include a Section 138 of the NI Act proceeding. This is because a proceeding would be a legal proceeding “in respect of” a debt. “In respect of” is a phrase which is wide and includes anything done directly or indirectly. This, coupled with the fact that the section is not limited to “recovery” of any debt as stated under Section 14, would indicate that any legal proceeding even indirectly relatable to recovery of any debt would be covered. Thus, it was held that the protection of the moratorium under Sections 81, 85, 96 and 101 of the IBC is far greater than that of Section 14 as it stays pending legal proceedings concerning the debt, rather than the debtor.

This was followed by the Bombay High Court in Sheetal Gupta v. National Spot Exchange Ltd.¹³, wherein the High Court relying on P. Mohanraj case¹⁴, held that the proceedings under Section 138 read with 141¹⁵ of the NI Act is covered under the term “any legal action or proceeding pending in respect of any debt” appearing Section 96(1) of the IBC. It is interesting to note that this matter travelled to the Supreme Court in appeal and was not interfered with.

Thereafter came the 3-Judge Bench judgment of Ajay Kumar Radheyshyam Goenka v. Tourism Finance Corpn. of India Ltd.¹⁶, wherein the Supreme Court expressly observed that there is no bar contained in any of the provisions of the IBC and the NI Act from approaching the criminal court to seek penal action under Section 138 of the NI Act. The Court made it clear that Section 138 proceedings, being quasi-criminal in nature, are distinct from civil recovery mechanisms, and hence, do not fall under the protective scope of the moratorium for individuals. However, this entire judgment dealt specifically with Section 14 of the IBC.

Observations and judgment

This present matter is the first wherein the Supreme Court specifically dealt in detail regarding the interplay between Section 138 of the NI Act and Section 96 of the IBC. It observed that the legislative intent of Section 96 of the IBC was to protect debtors from civil recovery actions during insolvency resolution. However, criminal proceedings under Section 138 of the NI Act, which aim to maintain the credibility of commercial transactions through cheques, stand on a different footing. The Court relied on the statutory language and the object of both legislations to hold that the moratorium under Section 96 of the IBC does not affect criminal prosecution.

While maneuvering through P. Mohanraj case¹⁷, the Court observed that the central issue for consideration at that time was whether the institution or continuation of proceedings under Sections 138 and 141 of the NI Act could be said to be barred by the moratorium imposed under Section 14 of the IBC. The Supreme Court, after an in-depth analysis of the moratorium provisions under Sections 14, 96 and 101 of the IBC, held that the moratorium under Section 14 is applicable only to the corporate debtor and not to natural person, including directors or persons responsible for the conduct of the company’s affairs. The judgment categorically clarified that the moratorium under the IBC does not extend to criminal proceedings, including those under Chapter XVII of the NI Act. The judgment further emphasised that the objective of the IBC is to resolve the financial distress of the corporate debtor and not to shield individuals from personal criminal liability arising from statutory obligations.

It is important to bear in mind that the moratorium under the IBC is primarily meant to protect the corporate debtor which is the company. The law is clear that this protection does not automatically extend to personal guarantors or individuals facing criminal prosecution. The IBC was brought in to help resolve financial distress in a time-bound manner and give companies a chance to recover and reorganise and not to create a blanket shield from criminal consequences. When a personal guarantor files for insolvency under Section 94, the application follows a structured process, involving examination by a resolution professional, who files a report under Section 99. Once the application is admitted under Section 100, a formal moratorium begins under Section 101. But even before that, an interim moratorium under Section 96 kicks in from the date the application is filed. This interim moratorium temporarily stays any legal action or proceeding “in respect of any debt.” But that phrase needs to be read carefully. It does not mean that every type of proceeding is paused. The words “in respect of any debt” clearly limit the scope.

Thus, in the present matter the Court, using the principle of noscitur a sociis (a word is known by the company it keeps) held that the phrase “legal action or proceeding” must be read in the context of actions that relate to debt recovery and not to criminal prosecution for issuing a dishonoured cheque. It held that the law is not designed to protect individuals from penal consequences simply because they have filed for insolvency. The objective here is to give breathing space to reorganise finances and not to allow someone to escape criminal liability altogether. Even if the debt is wiped out in the course of insolvency or restructuring, that does not undo the act of issuing a cheque that bounced. Section 141 further makes directors and those in charge of the company liable. The liability under Sections 138 and 141 is personal. It attaches to the individual and not merely to the company.

The Court observed that the acceptance of a resolution plan under Section 31¹⁸ of the IBC, or even the initiation of moratorium under Section 101, has no bearing on criminal prosecutions under the NI Act. Similarly, when the application under Section 94 is admitted and the process continues, it does not, and cannot, bar the continuation of a Section 138 prosecution. The offence under Section 138 is triggered by the act of dishonour of a cheque, and the failure to make payment within 15 days after receiving statutory notice. This is a standalone offence and not dependent on the ultimate outcome of a civil suit or a debt recovery proceeding. While a civil suit may be temporarily stayed during an insolvency proceeding, a criminal case under Section 138 is different. It is not just about recovering dues, it is about penal consequences for breaching commercial trust.

Conclusion

While the IBC does provide relief to debtors by pausing certain proceedings to help them reorganise, it does not grant immunity from criminal liability for dishonoured cheques. To allow the interim moratorium to halt criminal prosecutions would defeat the entire purpose behind Section 138 of the NI Act which acts as a deterrent to wilful defaulters and dishonest drawers of cheques. Permitting accused persons to shield themselves from prosecution under the garb of the IBC moratorium would mean that wilful defaulters may intentionally file for insolvency just to avoid criminal action and creditors, especially small businesses and individuals would lose one of the few effective remedies available to them. Such an interpretation would go against the well-established legal maxim, nullus commodum capere potest de injuria sua propria i.e. no one should benefit from his own wrong.

The interim and final moratoriums under Sections 96 and 101 are not designed to be a safe haven for individuals seeking to avoid accountability under the NI Act.