gave Madras High Court Bench of Justice N Sesha Sai held that an MSME corporate creditor cannot exploit the clean slate theory by withholding information, particularly when its management, which remains in control, undertakes to disclose such information.

Background Facts:

National Sewing Thread Company Limited (the petitioner), a public limited company registered under the MSME Act, 2006, had received financial assistance from the Indian Overseas Bank (‘IOB’). Due to substantial business losses, the petitioner was unable to service its loan, resulting in its classification as a non-performing asset by the IOB. On 24.03.2017, IOB transferred the said loan to Alchemist Asset Reconstruction Company Ltd. Assigned to (Financial Creditor).

The financial lender initiated Corporate Insolvency Resolution Process (‘CIRP’) against the petitioner before the National Company Law Tribunal (NCLT) under Section 7 of the Insolvency and Bankruptcy Code, 2017 (IBC). An Interim Resolution Professional (‘IRP’) was appointed, and a Committee of Creditors (‘CoC’) was constituted with IOB as the sole financial creditor.

The CoC approved the resolution plan, which was further approved by the NCLT on 06.12.2021. Under the said plan, the financial lender was partially compensated, as the value of the applicant’s assets was significantly less than its liabilities. Operational debtors were to be paid appropriately at 1% of their claim value. By approving the resolution plan, the petitioner relieved himself from the debt situation.

However, on 19.01.2022, the Tamil Nadu Generation and Distribution Corporation Limited (‘TANGEDCO’) issued a demand notice claiming Rs. 32 lakhs as unpaid electricity charges due to the petitioner from June 2019 onwards.

The petitioner replied that all outstanding dues, even those not covered by the plan, were liquidated after the NCLT approved the resolution plan and relying on the judgment of the Supreme Court. Ghanshyam Mishra & Sons (P) Ltd., v. Edelweiss Asset Reconstruction Co. Ltd. Nevertheless, TANGEDCO disconnected the electricity service of the petitioner. On 24.02.2022 the petitioner applied for temporary LT Energy connection, which was rejected by TANGEDCO, insisting the petitioner to pay the electricity arrears.

The petitioner filed a writ of certiorari and mandamus before the Madras High Court to quash the demand notice issued by TANGEDCO and further direct it to provide electricity connection.

Defendant’s Objections:

The respondent contended that although TANGEDCO could be considered an operational creditor under the IBC framework, its operations were governed by the Electricity Act, 2003, and the Electricity Supply Code, which precluded it from pursuing its claim. Is. Further, as per these regulations, the owner or occupier of the premises with supplied electricity is liable for all arrears, notwithstanding the approval of any IBC proceedings or resolution plan.

The respondent also referred to the Ghanshyam Mishra case, as cited therein. State Tax Officer v. Rainbow Papers Ltdwhere the Supreme Court held that a resolution plan ignoring certain liabilities of state apparatus was invalid.

Observations of the High Court:

The Madras High Court observed that the applicant cannot exploit the clean slate theory by withholding information, particularly when its management, which remains in control, undertakes to disclose such information.

The court pointed out that the petitioner, as an MSME, participated in the resolution process and successfully proposed a resolution plan, which was approved by the NCLT. Further, the same promoters continued to manage the company and failed to disclose the liability of the petitioner for the electricity arrears to TANGEDCO during the resolution process. Therefore, when the suspended board had an opportunity to disclose all its creditors during the resolution process, the petitioner cannot ignore the rights of the undisclosed creditors.

The High Court also questioned why the financial lender chose the IBC route despite having SARFAESI as an option and what it gained as it was promised payment only through sale of assets. He observed a possible collusion between the petitioner and his sole financial lender.

He commented:

“The issue is not about the financial debtor’s choice of remedy – either under the SARFAESI Act or under the IBC, or about his right to invoke them, but the intention behind exercising his power. This is more prominently expected when reviewing the reality of the resolution plan as there is an obligation on the CoC to protect the interests of the operational creditors.

He noted that currently, an MSME is in a debt trap with a secured financial lender and possibly many operational lenders, none of which include TANGEDCO. The purpose of IBC is to protect MSMEs as going concerns, but if the financial lender really wanted to support the cause without liquidating the applicant, they would have to take over the applicant under the SARFAESI Act, esp. but could invoke section 13(4)(b). From a management and perspective point of view both the petitioner and its operational creditors would have been protected.

The court held that the petitioner and the financial creditor could have reached a solution by mutual agreement to sell the non-core assets to pay off the financial creditor. However, the IBC was used because it appealed to the clean estate theory which extinguished the claims of all other creditors, unlike the SARFAESI Act.

Finally, the Madras High Court dismissed the writ petition observing that the petitioner could not avoid its liability to pay the unpaid electricity dues of TANGEDCO.

Case Title: National Sewing Thread Company Ltd. v. Superintending Engineer, TANGEDCO and Anr.

Case Number: WP No. 29845 of 2022 and WMP No. 29233 of 2022

Petitioner’s Counsel: Mr. E. Om Prakash, Senior Counsel Mr. Amayavaramban assisted for M/s Ramalingam & Associates.

Counsel for the Respondents: Ms. Keertana R. Shenoy for Mr. V. Venkata Sheshaiah, Standing Counsel of TANGEDCO

Date of Judgment: 07Th June, 2024

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