Saranga Aggarwal: A Normative Assessment of Penalty Bifurcation in Insolvency Law

[Kevin and Sanjana are students at National Law School of India University.]

The Insolvency and Bankruptcy Code 2016 (IBC) provides a new paradigm for dealing with insolvency in India, with a view of reconciling the rights of the creditors, with the ability of the debtor to start afresh with a clean slate. However, the treatment of regulatory penalties within the IBC’s insolvency processes, particularly for personal guarantors, reveals significant doctrinal and practical challenges. The Supreme Court of India's ruling in Saranga Aggarwal v. Union of India (Saranga Aggarwal) exemplifies these challenges by holding that penalties under the Consumer Protection Act 1986, are purely punitive and, as such, not covered by the interim moratorium envisioned under Section 96 of the IBC. Such an interpretation based on a general reading of Section 79(15) overlooks the compensatory nature of many statutory penalties, especially in consumer law, and risks undermining the IBC's objectives of ensuring fair participation among the creditors and finality of claims. 

This article aims to make three main arguments. Part I argues that the Saranga Aggarwal precedent misapplies prior rulings on interpreting the nature of proceedings that ought to be stayed. Part II demonstrates how Indian law recognizes the bifurcation of penalties into punitive and compensatory elements, and argues that exempting entire decreed amounts without distinction unfairly privileges homebuyers over other financial creditors under the IBC. Part III provides a normative analysis on the bifurcation of the penalty awarded on the basis of its nature as compensatory or punitive, to determine its applicability to the moratorium. 

Analyzing the Precedent in Saranga Aggarwal: Nature of Proceedings Stayed

In the case of Ajay Kumar Radheyshyam Goenka v. Tourism Finance Corporation of India Limited, the two-judge bench had to decide whether the moratorium imposed under Section 14 included criminal proceedings, specifically proceedings relating to Section 138 of the Negotiable Instruments Act 1881 (NIA). The court had broadly two important opinions on this issue:

[First opinion] First, the scope, and nature of proceedings under the two statutes significantly differ from each other, making it clear that criminal proceedings (and proceedings of such nature) would not be stayed by the moratorium. The court thus holds that the nature of Section 138, being a criminal proceeding and penal in character, cannot be likened to debt recovery proceedings and would not be stayed by the moratorium. 

[Second opinion] Second, the court, relying on Manish Kumar v. Union of India, held that since such liability is co-extensive with the company, such criminal proceedings against the directors etc. of the company would not extinguish merely due to the resolution process. The individuals continue to remain personally liable and the company’s dissolution doesn’t bring an end to such proceedings. 

The National Consumer Disputes Redressal Commission relies on Ajay Kumar for its second opinion but applies the logic used in the first opinion. This position itself is problematic for two reasons: 

First, the extent of applicability of the second opinion to the given facts is limited since the current case didn’t involve a plea to end criminal proceedings due to company dissolution or insolvency process but rather primarily regarding staying of such proceedings due to the moratorium under Section 96, an issue that is not particularly answered by the second opinion. 

Second, the court fails to realize that the position taken on the first opinion (by a two-judge bench) is per incuriam, directly going against the holding of the three-judge bench in P Mohanraj and Others v. Shah Brothers Ispat Private Limited, where the court held that proceedings under Section 138 of the NIA would not be allowed to continue due to the bar under Section 14 of the IBC. The reasoning of the three-judge bench is pertinent to note, as it decodes the nature of the proceedings to be quasi-criminal and the intention behind such proceedings to be to not only punish the offender [punitive aspect] but also to compensate the complainant [recovery aspect]. It notes that while the proceedings, being criminal, cannot be likened directly to a civil suit for recovery, nevertheless in practice, the direction from the court in such cases is to levy a fine based on the cheque amount and to compensate the complainant. It goes on to highlight the perspective of financial institutions viewing such proceedings primarily as proceedings for recovery of the lost amount [recovery aspect] and secondarily, as proceedings to punish the offender [punitive aspect].

This application of bifurcating the proceeding into its respective components, i.e., punitive and recovery aspects, thus aids in highlighting the true nature of such proceedings. This distinction and focus on the components, specifically the recovery aspect, can be clearly seen in the court's analysis of such criminal proceedings. The court highlights that such quasi-criminal procedure involving compensation twice the amount of the bounced cheque would lead to depreciation of the debtor’s assets and directly influence the insolvency proceedings just like (or even more than) the continuance of a civil suit or enforcement of a decree. 

Additionally, the court erroneously dismisses the precedent set in Sheetal Gupta v. National Spot Exchange Limited and Others [Bombay High Court] (which relies on P Mohanraj) based on the dismissal of an special leave petition. While the apex court is not bound by the ruling of the High Court, a dismissal of the special leave petition would only mean that the same is good in law and need not be interfered with under Article 136. Thus, the authors argue that the apex court’s affirmation of the holding in Ajay Kumar goes against established precedent (P Mohanraj and Sheetal Gupta) and ignores the elements of bifurcating proceedings (into recovery and punitive aspects) to determine its applicability to the moratorium. 

Homebuyers’ Escape from the Waterfall Mechanism

Penalties under Indian law have consistently demonstrated this bifurcation - providing both compensatory and punitive aspects within the fine. The apex court has previously engaged in determining the nature and objective of the penalty - either to compensate for the losses incurred or punish the wrongful act and deter further such acts. This bifurcation exists even within the real estate sector (exactly the present case), where the consumer forum (District Consumer Disputes Redressal Commission, State Consumer Disputes Redressal Commission or National Consumer Disputes Redressal Commission) typically awards both compensatory remedies such as refunds and compensation for mental agony as well as punitive remedies such as fines.

Nevertheless, in the present case, the decree holders (home buyers) had filed execution proceedings before the National Consumer Disputes Redressal Commission over the entire decree, which included both the punitive and compensatory remedies. Despite the builder satisfying seven execution petitions (out of 20), the National Consumer Disputes Redressal Commission held that the entire decree amount would be considered as ‘fines’ and thus would not be kept in abeyance by the moratorium in Section 96. This, in essence, provides homebuyers [classified as financial creditors under Section 5(8)(f)] an escape from the waterfall mechanism provided under the IBC by classifying the dues owed to them as part of the fines imposed by the consumer forum. This conclusion, as seen in Saranga Aggarwal, goes against the ruling in Vishal Chelani and Others v. Debashis Nanda, where the court held that homebuyers cannot face differential treatment in comparison to other ‘financial creditors’ under the IBC solely due to the fact that they have received orders from the authority under Real Estate (Regulation and Development) Act 2016.

An Alternative Interpretation: Normatively Assessing Bifurcation of Regulatory Penalties

The current approach to penalties under the IBC raises several doctrinal and practical concerns. First, it erroneously consolidates all the penalties into a single punitive category, regardless of their distinct functions. Section 3(11) of the IBC describes 'debt' as liability which arises due to a 'claim', and numerous statutory penalties, especially in consumer law, are restitutive in nature. For instance, monetary relief awarded for delayed possession constitutes a financial claim and should be treated as a provable debt in insolvency proceedings. 

Second, the classification of penalties significantly impacts their dischargeability. While purely punitive penalties may not be amenable to resolution through insolvency, compensatory liabilities, representing creditors’ financial claims akin to debts from breaches or defaults, should be dischargeable. Excluding such liabilities from the insolvency process denies affected creditors participation in the collective resolution mechanism, compelling them to seek individual enforcement outside the IBC framework.

Third, the IBC's goal of giving the debtor a clean slate after resolution is undermined when compensatory penalties are not included. Exclusion leaves debtors open to future individual enforcement proceedings, which is against the IBC's goal of holistic claim resolution. By contrast, jurisdictions such as the UK differentiate between non-provable punitive fines and provable statutory compensation, a stance that is consistent with doctrinal clarity and includes creditors in the resolution process.

Embracing a similar test in the IBC would avert unjust denial of valid financial claims dressed only as penalties. It would further strengthen creditor participation in the committee of creditors, allowing more balanced participation in the collective settlement process. Furthermore, it would facilitate efficiency through resolution of all claims during the insolvency process, allowing the debtor to emerge with a fresh start, true to the principles of the IBC.