Clean Slate or Legal Fiction? Set-Off After Ujaas Energy

[Shivam is a student at Chanakya National Law University.]

Recently, the Supreme Court (SC) in the case of Ujaas Energy Limited v West Bengal Power Development Corporation Limited (Ujaas Energy) held that well established principle of the Insolvency and Bankruptcy Code 2016 (IBC) jurisprudence that while claims not included in an approved resolution plan under the IBC stand extinguished, but simultaneously permits limited plea of set-off can still be raised as a defence in arbitral proceedings, provided it does not result in any affirmative recovery.

The decision raises a fundamental question: can a claim be considered truly extinguished if it can still be raised in a defensive form?

This article argues that this judgment, although nuanced and possibly motivated by equitable considerations, undermines the clean slate principle, one of the fundamental pillars of the IBC framework. The court permits extinguished claims to reenter the proceedings through procedural channels. This creates uncertainty about their limited survival as defensive set-offs and, ultimately, undermines the integrity of the “clean slate” principle under the IBC.

The Clean Slate Principle under the IBC

The clean slate doctrine, as embodied in Section 31(1) of the IBC, is a cornerstone of the India’s insolvency framework. The idea behind this theory is to ensure that once a resolution plan is approved under Section 31 of the IBC, all claims not forming part of the plan are extinguished, thereby allowing the successful resolution applicant to take over the corporate debtor free from past liabilities. This principle is not merely procedural; it is foundational to the commercial viability of the insolvency process. The Supreme Court has consistently upheld this doctrine in Committee of Creditors of Essar Steel India Limited v. Satish Kumar Gupta and Ghanashyam Mishra and Sons Private Limited v. Edelweiss Asset Reconstruction Company Limited, which emphasised that Section 31(1) ensures that the resolution applicant starts running the business on a fresh slate. The court held that a successful resolution applicant cannot suddenly be faced with “undecided” claims after the resolution plan submitted by it has been accepted, as this would amount to a hydra head popping up, which would throw into uncertainty amounts payable by a prospective resolution applicant who successfully takes over the business of the corporate debtor. This judgment solidified the finality of the resolution process and reaffirmed that claims not included in the resolution plan cannot be subsequently enforced.

The reason behind the doctrine is straightforward: without certainty, no prudent investor would participate in the insolvency process. Hence, the extinguishment of claims is not merely a legal consequence; it is a commercial necessity. This principle protects resolution applicants from post-resolution liabilities, facilitates business continuity, and prevents undue legal entanglements that could hinder economic recovery. 

The Ujaas Energy Ruling: A Doctrinal Shift?

In the Ujaas Energy, the Supreme Court does not overrule the clean slate principle. It reiterates that if claims are not included in the resolution plan, they stand extinguished. However, it creates an exception by allowing such claims to be invoked as a defence in arbitral proceedings through the mechanism of set-off by limited plea.

Set-off, in a generic sense, means a financial arrangement that allows two parties, i.e., the creditor and the debtor, to offset mutual debts or obligations, resulting in a balanced transaction at the end. Set-off as a clause is also included in certain commercial contracts. However, the concept of set-off becomes vastly different when the process of insolvency and bankruptcy takes place, when one of the parties becomes bankrupt or insolvent, because it allows one creditor to set off his debts, giving it an advantage over the others, which goes against two principles:

• The pari passu principle says every creditor should receive the same treatment. A reasonable amount of the money retrieved from the bankrupt/ insolvent corporation needs to go to each person.

• The anti-deprivation principle guarantees that no one shall be denied access to funds due to unjust transfers or set-offs. 

Traditionally, set-off is viewed as a defensive right rather than an independent claim. The court relied on this reasoning to uphold that, while an extinguished claim cannot be enforced affirmatively, it may still be used defensively to resist liability. The court also clarified that the respondent shall not derive any positive or affirmative relief, and such a claim could only operate as a shield to defeat the corporate debtor’s claim. Further, it held that if the counterclaim exceeds the awarded amount, the surplus would not be recoverable. It clearly limits the scope of claims to a purely defensive function. At first glance, this distinction is legally sound, but upon closer examination, it reveals a deeper inconsistency. If a claim is extinguished,  can it continue to exist even in a limited defensive form?

Extinction v/s Residual Survival: A Conceptual Problem

The core issue arising from the judgment is the ambiguity between extinction and residual survival. Extinction implies the complete annihilation of a claim. However, by allowing its use as a defence, the court allowed the claim to retain a limited legal existence.

This issue creates a doctrinal grey area. The claims are neither fully subsisting nor entirely extinguished. Instead, they create a situation where they cannot be enforced but can still influence outcomes. Such a position blurs the distinction between enforceability and existence.

Moreover, the court relied on the resolution plan clause 12.4.1 to hold that claims for “payment” or “settlement” were barred; the plan did not expressly prohibit defensive set-off. The court applied the principle expressio unius est exclusio alterius,  which says that what is not expressly excluded may still be permissible.

This shift in focus of the court from the statutory principle to contractual drafting introduces variability in outcomes depending on the wording of individual resolution plans.

Distinguishing Bharti Airtel: The Importance of Timing

The court distinguished Bharti Airtel Limited v. Aircel Limited and Dishnet Wireless Limited, noting that the law laid down therein "cannot be doubted." However, we find that the ratio of such a decision may not be directly applicable in the present facts and circumstances, since Bharti Airtel dealt with the aspect of set-off at the time of the corporate insolvency resolution process (CIRP). In this case, we are called upon to decide the issue of set-off in light of the resolution plan, which alone is binding apart from the fact that the claim arose before the resolution plan was approved by the committee of creditors and the adjudicating authority.

For this reason, the distinction is crucial. During CIRP, claims are still under consideration and subject to verification. However, once the resolution plan is approved, finality attaches under Section 31 of the IBC. By allowing set-off even after this stage, does the court not extend the relevance of pre-resolution claims into the post-resolution phase?

Implications for Resolution Applicants

This judgment has significant implications for resolution applicants because every stakeholder relies on the resolution plan as a complete and final statement of liabilities. However, permitting the court to extinguish claims to operate defensively creates an element of unpredictability. Even if no direct financial liability arises, the value recoverable by the corporate debtor may be reduced through set-off. Allowing set-off reduces the net realizable value of assets, which means lower recovery to operational creditors, financial creditors, and other stakeholders. The IBC aims to realize maximum asset value by requiring all claims to be valued and settled in an orderly sequence, as opposed to individual adjustments by way of set-off.

This creates a hidden risk that may not be reflected in the resolution plan, potentially discouraging participation and affecting value maximisation.

The Floodgates Concern

A major concern arising from the judgment is that there is a possibility that creditors may not file a claim during CIRP and later attempt to use it as defensive set-offs in arbitration or litigation. Although the judgment limited its ruling to the facts and circumstances of the case, the principle may be invoked in future disputes. This could lead to increased litigation and undermine the efficiency of the insolvency process.

Balancing Equity and Finality

The court's reasoning in this case is clear and reflects an attempt to balance equity and finality. Even though it is considered that the counterclaim had been raised before the arbitral tribunal before approval of the resolution plan, and that the resolution professional was aware of it. The court appears to have been concerned that denying even a remedy would lead to unfair outcomes, particularly in cases where the corporate debtor seeks recovery without accounting for its own liabilities.

However, the IBC is a special statute designed to prioritize certainty and finality. By introducing equitable considerations, the court risks diluting the objectives of the IBC, which are effectively realised.

Conclusion

The decision in Ujaas Energy highlights the inherent tension between finality and fairness in the IBC framework. While the court preserves the core principle that extinguished claims cannot be enforced for recovery, it allows their limited defensive use, but key questions remain unanswered: 

• Should defensive set-off really be universally permitted or restricted to exceptional circumstances?

• What meaningful safeguards, if any, exist to prevent abuse of such a mechanism?

• Should the availability of such defence depend on resolution plan drafting?

This hybrid approach, though pragmatic, raises important doctrinal concerns. By allowing extinguished claims to survive in a residual form, the court arguably weakened the conceptual clarity of the “clean slate” principle.