Vendors, suppliers may get to try mediation before moving bankruptcy courts

New Delhi: The Insolvency and Bankruptcy Board of India (IBBI) has proposed that operational creditors such as vendors and service providers, which account for the largest number of admitted cases, should have the option of exploring mediation with a defaulting company before dragging them to overburdened tribunals.

If mediation fails, the operational creditors may approach a tribunal, the bankruptcy rule-maker said in a discussion paper brought out on Monday. A non-settlement report by the mediator should be annexed to the application seeking initiation of corporate insolvency resolution, it said.

IBBI’s suggestion is aimed at enabling businesses to settle commercial disputes outside the bankruptcy courts, reducing the burden on the judiciary and expediting cases that have already been admitted. Mediation for disputes of commercial nature must be in accordance with the provisions of the Mediation Act of 2023, IBBI said.

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Operational creditors are distinct from financial creditors. The Insolvency and Bankruptcy Code (IBC) defines operational debt as a claim for the provision of goods or services, including employment. A financial creditor means any person to whom a financial debt is owed.

Almost 48% of the over 7,800 bankruptcy petitions admitted in the National Company Law Tribunal as of the end of June 2024 under the IBC were filed by operational creditors, followed by 46% by financial creditors. The rest were initiated by the companies themselves.

A large number of cases initiated by operational creditors have a default amount of less than ₹1 crore, according to data from IBBI.

Pre-admission settlements

The board noted in its paper that bankruptcy petitions involving disputes between operational creditors and companies usually entail disagreements over the quality or performance of goods or services, contract terms, and discrepancies over the amount owed or claims of setoffs or damages. These are time-consuming issues and burden the limited judicial capacity, IBBI said.

Operational creditors are more interested in the repayment of their money claims than in getting the debtor admitted for resolution at the corporate level, IBBI said.

The regulator cited data from the tribunals to show that about 85% of the bankruptcy petitions filed by operational creditors were settled before the admission stage. Also, the settlement rate was higher at the pre-admission stage than at any other stage.

At the end of April this year, 21,466 bankruptcy petitions were disposed of in the pre-admission stage and 3,818 cases were admitted, IBBI said. The tribunals are required to conduct hearings before accepting or rejecting a bankruptcy petition and the process often becomes time-consuming, IBBI said.

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“Thus, in order to resolve disputes between the operational creditor and the corporate debtor at the earliest stage and facilitate faster admission by the adjudicating authority (tribunal), mediation as an option may be considered as an effective tool,” IBBI said.

IBBI published a draft of the amendment to its regulations proposing mediation between defaulting companies and their operational creditors in the discussion paper and sought public feedback by 24 November.

“An operational creditor may undergo mediation with the corporate debtor for resolving the disputes of commercial nature in accordance with the provisions of the Mediation Act, 2023,” the proposed amendment read.

Yogendra Aldak, a partner at law firm Lakshmikumaran & Sridharan, pointed out that IBBI’s proposal is analogous to Section 12-A of the Commercial Courts Act of 2015, which mandates pre-institution mediation for commercial disputes that do not require urgent interim relief. However, IBBI’s draft regulation provides a ‘may’ provision as opposed to the mandatory nature of pre-institution mediation under Section 12-A, Aldak explained.

“It is pertinent to note that by providing for mediation as a separate process, the regulation will significantly reduce the burden imposed upon the adjudicating authority. Considering the adjudicating authority will have to conduct fewer hearings in matters which may lead to a settlement, the regulation will have a positive impact on the timely disposal and efficiency of proceedings,” said Aldak.

Resolving the delay in getting bankruptcy petitions admitted has been a priority for the ministry of corporate affairs and IBBI because it could help early debt resolution of businesses and where liquidation is the only way out, assets could be sold with the least erosion in value.

“Operational creditors have been successful in either sending defaulting companies into successful debt resolution or in recovering their dues. Mediation is being proposed now purely as an option for them. Those operational creditors which do not want to get entangled in corporate debt resolution proceedings in tribunals can try mediation first,” said Anoop Rawat, partner (insolvency and bankruptcy), at law firm Shardul Amarchand Mangaldas & Co. “Initiation of insolvency proceedings often carries a stigma and it sometimes triggers certain contractual non-compliance or contractual defaults by certain counter parties dealing with the corporate debtor. In this context, a mediation mechanism for a disputed operational liability would allow the corporate debtor and the operational creditor to avoid the prolonged litigation by having a negotiated settlement through mediation,” he said.

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However, this is often not possible owing to complex contracts between the distressed company and multiple operational and financial creditors that have to be heard before the tribunals admit them for debt resolution. Also, the National Company Law Tribunal benches have to find time for hearing matters under the Companies Act, which they also handle.

The burden of litigation on the parties and the adjudicating authority will be greatly reduced through a consultative and collaborative process such as mediation, Aldak said.

Given that the corporate debt resolution process goes to the root of the existence of the debtor company, an additional stage statutorily providing for an opportunity for amicable settlement will yield a significant increase in settlements as it safeguards both the corporate debtor and the operational creditors, Aldak said.

In February, an expert panel set up IBBI said in its report that mediation could be a complementary mechanism for settling disputes related to bankruptcy resolution.