On March 8, 2021, Hon’ble Supreme Court delivered a judgement highlighting
the need for the Legislature to provide clarity on the validity of ipso
facto clauses in India in the context of insolvency laws. The Hon’ble Court,
being well aware of its remit, adopted a ‘workable formula’, applicable only in
the given factual matrix, to address the issue in question and did not encroach
the legislature’s role in formulating a policy with respect thereto. In fact,
the Hon’ble Court has put forth a series of questions for consideration before
the lawmakers regarding the validity of ipso facto clauses.
The dispute in the matter Gujarat Urja Vikas Nigam Ltd. v. Mr. Amit Gupta & Ors.
[C.A. No. 9241/2019] (Captioned Case) revolved around the notice of termination
dated May 1, 2019 issued by Gujarat Urja Vikas Nigam Limited (Appellant) for
terminating the Power Purchase Agreement (PPA) entered into between the
Appellant and Astonfield Solar (Gujarat) Private Limited (Corporate Debtor/CD),
on account of initiation of Corporate Insolvency Resolution Process (CIRP) of
the Corporate Debtor, pursuant to the order of National Company Law Tribunal (NCLT)
dated November 20, 2018.
On May 31, 2019, NCLT restrained the Appellant from
terminating the PPA and National Company Law Appellate Tribunal (NCLAT) further
upheld NCLT’s decision and stated that the Appellant cannot terminate the PPA on
the sole ground of initiation of CIRP. An appeal was filed against this order of
the NCLAT and while arriving at the judgement, the Hon’ble Court
considered, inter alia, the issue of validity of ipso facto clauses in the
context of insolvency laws. The said issue is crucial, particularly because it
has highlighted the conflict between autonomy of the parties to
contract vis-à-vis ensuring that the corporate debtor remains as a ‘going
concern’ throughout the insolvency process.
An effective insolvency regime is central to a positive financial and business
sentiment towards an economy and focuses on plugging the gaps that hinder the
central process of keeping a corporate debtor a ‘going concern’ during the CIRP.
Maintaining the status of a corporate debtor as a going concern
especially difficult due to invocation of certain contractual obligations that
were agreed to by the corporate debtor before the initiation of CIRP.
clause being an ipso facto clause – a contractual provision, typically present
in all contracts, that allows a party to terminate the contract with its
counterparty due to the occurrence of a financial distress, which can include
filing an application for insolvency, initiation of insolvency, financial
restructuring and so on, and in the context of the Captioned Case refers to
initiation of CIRP.
Such ipso facto clauses become a contentious legal issue in light of the two
opposing considerations – on one hand, upholding ipso facto clauses make the
objective of IBC redundant by allowing the counterparty to terminate the
agreement, thus reducing the asset of the corporate debtor and making it
difficult to run the corporate debtor as a ‘going concern’; whereas, on the
other hand, restricting enforcement of such clauses forces the counter party to
continue an unviable contract with the corporate debtor, which contravenes the
sanctity of enforcing contractual remedies.
An overview of the position that various international organizations as well as
jurisdictions take on this issue will help inform our perspective on balancing
two equally important objectives. To begin with, international organizations
like the UNCITRAL and the World Bank’s recommendation are in favour of
insolvency laws overriding ipso facto clauses, and where any negative impact
must be balanced by providing compensation to the creditors who have suffered
loss for continuing performance. The supranational organization, European Union,
too is of the view that the creditors should not be allowed to terminate
contracts based on ipso facto clauses when the defaulter is undergoing
Further, in the United States, there is a statutory prohibition in
enforcing ipso facto clauses in executory contracts and unexpired leases since
1979. However, it is allowed in certain financial arrangements like swap
agreements, securities, forwarding, etc. Similar to the United States, France,
Austria, and Germany have introduced statutory provisions to invalidate
termination based on ipso facto clauses during the insolvency proceedings in the
years 2014, 2020 and 2021, respectively.
Countries like Australia and Singapore
too have introduced amendments, in the year 2018 and 2020, respectively, to its
insolvency regimes to invalidate termination based on ipso facto clauses on the
ground of insolvency; and such amendments have a prospective application.
Greece, being one of the exceptions, has a statutory provision that upholds
termination based on ipso facto clauses.
In addition to statutory provisions, common law countries like the United
Kingdom and Canada follow the principle of ‘Anti-Deprivation Rule’ (ADR), which
seeks to prevent the debtor’s asset from being reduced before it becomes subject
to the insolvency process. However, certain judgements have clarified the scope
of ADR and held that in cases of complex financial instruments and as far as
possible, ADR should not be applicable on bonafide commercial transactions; and
courts should give effect to such contractual terms, except in the case of a
blatant attempt to deprive a party of property in the event of liquidation.
However, recently UK has amended its Insolvency Act in June 2020 to introduce
provisions that are similar to the moratorium provision under Section 14 of the
Insolvency and Bankruptcy Code, 2016 (IBC). The statutory laws of Canada
invalidate ipso facto clauses in both commercial and consumer restructurings and
are intended to protect consumer debtors from the deleterious consequences of
provisions that trigger upon bankruptcy.
Looking at the global insolvency and restructuring scenario, with the exception
of Greece, it can be gauged that across foreign jurisdictions, enforcement
of ipso facto clauses on the grounds of initiation of insolvency is restricted
during an insolvency or restructuring process, with varying degree of
In India, the committee headed by J. J. Irani in 2005 took note of the UNCITRAL
guide on insolvency regime and supported the idea of invalidation of ipso
facto clauses to preserve the corporate debtor’s assets from being diluted
during the insolvency process, subject to exceptions. However, this
recommendation did not find any legislative embodiment. The Report of the
Bankruptcy Law Reforms Committee, pursuant to which IBC was enacted, recognized
the requirement of a ‘calm period’, in the form of moratorium, where interests
of the creditors are protected without disrupting the running of the enterprise.
In December 2018, invalidation of ipso facto clauses was also observed in a
report issued by Vidhi Centre for Legal Policy, which notes that IBC does
not per se prohibit operation of ipso facto clauses during insolvency
proceedings, however, Section 14 of the IBC provides for a limited exception in
prohibiting the termination, suspension or interruption of specified essential
goods or services
Recently, explanation to Section 14(1) of the IBC was introduced through the
Insolvency and Bankruptcy Code (Amendment) Act, 2020, which prohibited
termination of any license, permit, registration, quota, concession, clearance,
or any similar grant or right given by a governmental authority or statutory
regulator on the grounds of insolvency, as long as there is no default in
payment of current dues.
The legislative intent behind this amendment was looked
into in the Report of the Insolvency Law Committee (ILC) dated February 20,
2020, which observed the importance of keeping the corporate debtor as a ‘going
concern’ during the moratorium period imposed under the IBC, and how termination
of certain Government licenses and permits during CIRP based on ipso
facto clauses made the imposition of moratorium ineffective. Therefore, ILC
suggested addition of the explanation to Section 14(1) of the IBC "to avoid any
scope for ambiguity" and to make the legislative intent precise and clear.
In the Captioned Case, the Hon’ble Court upheld NCLAT’s order and held that NCLT
could exercise its residuary powers to restrict the Appellant from terminating
the PPA on the sole ground of initiation of CIRP of the Corporate Debtor. This
view was taken considering the Appellant was the only purchaser of the
electricity generated by the Corporate Debtor and how crucial the PPA was to
keep the Corporate Debtor as a ‘going concern’.
However, the Hon’ble Court
emphasized that a court cannot intervene to set aside valid terminations, which
would merely dilute the value of a corporate debtor, and the present reasoning
is limited to the unique factual matrix of the Captioned case and should not be
used as a precedent in future cases to justify a court’s interference in
enforcement of any contractual terms agreed between the parties.
It is apparent that since the inception of IBC, the courts have time and again
taken a view to uphold the objective of IBC, which is to revive the corporate
debtor and operate it as a going concern
. As observed across multiple foreign
jurisdictions, termination based on ipso facto clauses solely on the grounds of
insolvency is restricted as it is in direct contravention to the object of
Having said that, there are uncertainties that plague the insolvency process,
for instance unending delays, non-availability of assets, lack of expertise in
running the business by resolution professionals, and lack of clarity on the
classification of suppliers, a definite timeline or visibility on the process,
which create major hurdles in balancing the objectives of the IBC vis-à-vis
rights of the counterparties.
Freedom of contract
important facet of growing economy and it is extremely important to ensure that
the counterparties are not made to suffer owing to such challenges or made to
continue in an unviable proposition.
While the global precedents and the decision in the Captioned Case clearly
suggest invalidation of ipso facto clauses only in an insolvency scenario and
not when the termination is on account of deficiency of service, until the
Legislature brings in any amendment to tie in the loose ends, the question of
validity of ipso facto clauses must be decided by the judiciary based on the
facts of each case.
However, given the expertise and bandwidth of NCLT, it may
not be the appropriate forum to adjudicate on this issue. The Supreme Court’s
appeal to the Legislature to engage in a dialogue to provide its legislative
vision on the issue of validity of ipso facto clauses hints at the complexity of
this issue at hand and the need for a balanced and effective solution which can
be achieved after carefully considering not just the objectives of the IBC but
also the rights of the counterparties. Accordingly, the questions raised by the
Hon’ble Court must be answered logically and strictly in the context of the
- Mr.Ketan Mukhija, Partner, Link Legal and
- Ms.Karishma Singh,
Associate, Link Legal
The contents of this update are for general information and discussion only and
is not intended for any solicitation of work. This update should not be relied
upon as a legal advice or opinion.