In Srinivasa Reddy Velagala v. Sravanthi Infratech Pvt. Ltd¹., the Hon’ble Supreme Court (“Court”) clarified that, even if the damages are liquidated, they cannot be treated as operational debt unless and until proven or assessed, adjudicated and crystallized as such by the competent authority.

The dispute was regarding the interpretation of an EPC contract between the parties wherein the respondent, in order to recover the amount due from the Appellant, had initiated the Corporate Insolvency Resolution Process (“CIRP”) by way of application to the National Company Law Tribunal (“NCLT”) under section 9 of the Insolvency and Bankruptcy Code, 2016 (“IBC”), reading the demand for payment of suspension, idling and demobilization charges as operational debt. The NCLT admitted the Respondent’s application and NCLAT approved the CIRP. However, the Appellant filed an appeal before the Court challenging the initiation of the CIRP by the NCLT and the issues framed for determination by the Court were whether the suspension and demobilization charges for alleged breach of EPC contract by the Appellant can be treated as “Operational Debts” under Section 5(21) of the IBC and whether such “unadjudicated and uncrystallized claims” can be treated as “Operational Debt” so as to initiate CIRP under section 9 of the IBC.

The Court allowed the appeal filed by Appellant partly by clarifying that, although the amount payable by the Appellant to the respondent under EPC payment schedule would be deemed to be “operational debts” as soon as they become due, the Respondent’s claims for suspension and demobilization charges for alleged breach of contract by the Appellant, being damages, could not be treated as “Operational Debts” unless and until proven or assessed, adjudicated and crystallized as such by the competent authority.

While interpreting the relevant law, the Court made a distinction between the amount owing to a party for goods and services provided and the claim for damages for breach of contract for the said services and held that a claim for damages, whether liquidated or otherwise, “cannot be treated as ‘Operational Debt’ unless and until they have been assessed, adjudicated and crystallized by a competent authority”.

Further, the Court held that “the forum like NCLT and NCLAT cannot be approached directly invoking provisions of the IBC to adjudicate upon the dispute between the parties to a commercial contract and resolve the quantum of damages payable thereunder. The very mandate of the IBC is focused on insolvency resolution process of the corporate entity so as to maximize the value of the assets thereof. Therefore, disputed claim for damages cannot be converted or treated as operational debt merely by virtue of filing of application under section 9 of the IBC.”

On the question of pre-existing dispute, the Court, while referring to Mobilox Innovations (P) Ltd v. Kirusa Software (P) Ltd² has observed that, in case of a prima facie dispute between the parties even where no suit or arbitration proceeding is pending before any forum, the said dispute can be resolved by reference to conduct of the parties.

Therefore, in this case, the Court made a distinction between an accrued debt and a disputed claim for damages for breach of EPC contract and clarified that the latter cannot be treated as “Operational Debt” merely by virtue of filing of an application under section 9 of the IBC. The Court further observed that IBC cannot be misused to avoid commercial disputes by directly approaching NCLT/NCLAT.

Thus, this judgment would have far-reaching effect on disputes regarding “operational debts” since even though IBC provides for a swift process to initiate CIRP against a defaulting company, it cannot be used as an alternate forum to determine a disputed claim for damages which can only be adjudicated by an appropriate legal proceeding before any competent forum.

By - Akarsh Pandey and Khanak Jain