Section 138 NI Act Proceedings Cannot Continue Against Ex-Director Post Moratorium: Supreme Court

Introduction

The Supreme Court of India has ruled that criminal proceedings under Section 138 of the Negotiable Instruments Act, 1881 (NI Act), cannot be continued against an ex-director if the cause of action for cheque dishonor arose after the imposition of a moratorium under the Insolvency and Bankruptcy Code, 2016 (IBC). This ruling was delivered in the case of Vishnoo Mittal v. M/S Shakti Trading Company, overturning the Punjab & Haryana High Court’s decision.

Background of the Case

The case originated from a dispute concerning a cheque dishonor under Section 138 of the NI Act. The appellant, Vishnoo Mittal, was a director of M/s Xalta Food and Beverages Pvt. Ltd., which issued eleven cheques in favor of M/S Shakti Trading Company. These cheques were dishonored on July 7, 2018, due to insufficient funds.

Legal Implications of Section 138 NI Act: Cheque Dishonor and Judicial Proceedings

Impact of IBC Moratorium on Section 138 NI Act Proceedings

• On July 25, 2018, a moratorium was imposed under Section 14 of the IBC, following the initiation of the Corporate Insolvency Resolution Process (CIRP) against the corporate debtor.

• Despite the moratorium, the operational creditor issued a demand notice under Section 138 NI Act on August 6, 2018, seeking repayment of the cheque amount.

• After the statutory 15-day period, the creditor filed a complaint under Section 138 NI Act, leading to criminal proceedings against the appellant.

Punjab & Haryana High Court’s Decision

The appellant approached the Punjab & Haryana High Court seeking to quash the criminal proceedings. However, the High Court rejected the plea, relying on the Supreme Court’s decision in P. Mohan Raj v. M/S Shah Brothers Ispat Pvt. Ltd. (2021) 6 SCC 258, which stated that the moratorium applies only to the corporate debtor and not to its directors. Aggrieved by this decision, the appellant approached the Supreme Court.

Observations of the Supreme Court

Effect of the IBC Moratorium

The Supreme Court made the following key observations:

• Section 14 of the IBC imposes a moratorium suspending all legal actions against the corporate debtor, including financial transactions.

• Once CIRP is initiated, the board of directors is suspended, and financial management is transferred to the Insolvency Resolution Professional (IRP).

• Consequently, former directors cannot be held liable for financial obligations incurred after the moratorium.

Cause of Action and Legal Liability

• The Court clarified that a cheque dishonor alone does not create liability under Section 138 NI Act.

• Liability arises only when the drawer fails to make the payment within 15 days of receiving the demand notice.

• In this case, the demand notice was issued on August 6, 2018, after the moratorium had already been imposed on July 25, 2018.

• The cause of action actually arose on August 21, 2018, during the moratorium period, making it legally impossible for the appellant to make the payment.

Distinguishing from P. Mohan Raj Case

• In P. Mohan Raj’s case, the cause of action had arisen before the moratorium, making the director personally liable.

• In contrast, in the present case, the cause of action arose after the imposition of the moratorium, stripping the ex-director of any financial control over the corporate debtor.

• The Court observed: “When the notice was issued to the appellant, he was not in charge of the corporate debtor as he was suspended from his position as the director of the corporate debtor as soon as IRP was appointed on July 25, 2018.”

Supreme Court’s Final Ruling

The Supreme Court held that continuing Section 138 NI Act proceedings against an ex-director during the moratorium would be unjust, as he had no financial control over the corporate debtor.

Final Judgment

• The Supreme Court quashed the cheque dishonor proceedings against the appellant.

• It set aside the Punjab & Haryana High Court’s order.

Conclusion

This ruling provides significant legal clarity on the scope of Section 14 of the IBC and its effect on Section 138 NI Act proceedings. It establishes that ex-directors cannot be held personally liable for financial transactions that occur after a moratorium is imposed, ensuring fairness in insolvency proceedings.

Case Reference

Vishnoo Mittal v. M/S Shakti Trading Company

SPECIAL LEAVE PETITION (CRL) NO.1104 OF 2022

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