Contractual Freedom vs. Insolvency Code: A Conundrum in View of Power Purchase Agreements

The Insolvency and Bankruptcy Code, 2016 (“Code”), has been a game-changer in the insolvency and recovery landscape as it replaces a host of overlapping legislations and simplifies the journey of the creditors seeking relief under a single umbrella mechanism. In addition to simplifying the recovery process, another noteworthy objective of the Code is maximizing the value of assets of a business undergoing insolvency. The Apex Court in Swiss Ribbons Pvt. Ltd. and Anr. vs. Union of India[1] has flagged the objective of the Code to bring back the corporate debtor into economic mainstream and efficiently run it as a going concern. The Code also has a non-obstante provision (Section 238) to enhance the efficacy and deliver on the promised objectives. In terms of the non-obstante clause, the Code has an overriding effect over any other law or an instrument, notwithstanding anything inconsistent therewith.

This article identifies the contours of contractual freedom of parties vis-à-vis the objectives of the Code, in light of the non-obstante clause and as decided by the Supreme Court in the context of a power purchase agreement.

Interplay Between the Code and Freedom Under Contractual Arrangements

As per the standard business practice in India, parties include a clause in the contracts that allows one party to terminate the contract, if an insolvency process is initiated against the other party (corporate debtor) under the relevant laws. However, if we see the practical ramification of such a contractual clause, each time a termination happens on the aforesaid ground, the corporate debtor loses its value significantly.

Now, this goes strongly against the purpose of the Code which is to prevent the corporate death of the corporate debtor and reinstate it as a ‘going concern’. But, if we have to uphold the said object of the Code and hence preclude the non-defaulting party from terminating the contract, it will lead to impairing the non-defaulting party’s rights under the contract. There needs to be a solution to this apparent tension between the object of the Code and the contractual freedom of the parties.

Supreme Court’s Approach

Recently, the Supreme Court of India had an opportunity to decide on the aforesaid issue in Gujarat Urja Vikas Nigam Limited vs. Mr. Amit Gupta & Ors.[2] (“Gujarat Urja Case”). The Gujarat Urja Vikas Nigam Limited (“GUVNL”) had entered into a power purchase agreement (“PPA”) with Astonfield Solar (Gujarat) Private Limited (“Astonfield”). Under the PPA, GUVNL had the right to terminate the PPA in the event Astonfield undergoes corporate insolvency resolution process (“CIRP”). Accordingly, when CIRP was initiated against Astonfield, GUVNL issued the notice of termination in accordance with the terms of the PPA, which was challenged by the resolution professional appointed for Astonfield before the National Company Law Tribunal (“NCLT”). The NCLT stayed the termination of the PPA on the ground that the provisions of the Code, by virtue of Section 238, shall prevail over the PPA.

GUVNL appealed against the aforesaid order passed by NCLT before the National Company Law Appellate Tribunal (“NCLAT”) which went on to dismiss the appeal by stating that if the PPA is terminated in view of CIRP being initiated against Astonfield, then Astonfield would become defunct. This led to a second appeal by GUVNL before the Supreme Court of India which took up two primary issues for determination: (i) Whether the NCLT/NCLAT can exercise jurisdiction under the Code over disputes arising from contracts such as the PPA and, (ii) whether the appellant’s right to terminate the PPA in terms of the termination clause of the PPA is regulated by the Code.

The Supreme Court took this opportunity to clear the air on the contractual rights of parties vis-à-vis the application of the Code, but only specific to the context at hand. The Court answered the first issue in the affirmative as NCLT has the jurisdiction to entertain disputes arising in relation to an insolvency proceeding, however, NCLT cannot exercise its jurisdiction over matters dehors the insolvency proceedings. With regard to the second issue, the Court while giving precedence to the object of the Code over contractual freedom in this case, opined that “…given that the terms used in Section 60(5)(c) are of wide import, as recognized in a consistent line of authority, we hold that the NCLT was empowered to restrain the appellant from terminating the PPA. However, our decision is premised upon a recognition of the centrality of the PPA in the present case to the success of the CIRP, in the factual matrix of this case, since it is the sole contract for the sale of electricity which was entered into by the Corporate Debtor.” This was premised on the fact that the PPA entered into by Astonfield was the sole contract entered into by it for generation of revenue, and hence was the elixir for running the business of Astonfield as a going concern.

The Developing Jurisprudence

The Supreme Court has tried to amply strike a balance between contractual freedom of parties (including the right to include a termination clause) and the objects of the Code, by clarifying that contractual freedom cannot be ‘generally’ interfered with, but for factual matrix like in the Gujarat Urja Case.

Most importantly, to avoid over generalisation of the Court’s decision in this case to all cases of interference with contractual freedom, a line of difference needs to be drawn between termination resulting in dilution of ‘some value’ of corporate debtor and termination endangering the ‘going concern’ status of the corporate debtor. While in the former, the Code cannot be allowed to prevail over contractual freedom and the ensuing right to terminate, in case of the latter it can.

As in the case at hand, allowing termination of the PPA, the only contract which provides monetary value to Astonfield, would have been nothing less than a nail in the coffin for Astonfield and would have defeated the raison d’tere of the Code. It can be pragmatically concluded that the decision of the Supreme Court was one of its kind considering the unprecedented factual matrix of the case. The Gujarat Urja Case through its verdict has not only upheld the sanctity of erstwhile domestic legislations and domestic committee reports on the Code but also aligned with judicial pronouncement in other countries like United Kingdom, United States of America, France, Singapore, etc. The ratio of the Gujarat Urja Case finds support in the UNCITRAL Legislative Guide on Insolvency Law with respect to ‘Treatment of Assets on Commencement of Insolvency’ (Ch. II, Part Two), as well and aligns the Indian jurisprudence on the issue with international best practices.

Concluding Remarks

With decisions of this nature by the Apex Court, India will go a long way in safeguarding the interests of the creditors and the investors (domestic and foreign alike) and encouraging them to invest in Indian power generation companies. The Apex Court’s ruling in favour of keeping a company as a ‘going concern’ also aligns India with international standards and judicial pronouncements.

The views and opinions expressed in this article belong solely to the author and do not reflect the position of Tatva Legal, Hyderabad.

[1] 2019 (4) SCC 17

[2] Civil Appeal No. 9241 of 2019, decided on March 08, 2021)