Is Set-Off Permissible in IBC Liquidation? Supreme Court Defines Scope of Mutual Dealings

This Supreme Court judgment addresses critical issues surrounding the application of set-off principles under the Insolvency and Bankruptcy Code (IBC), particularly in the context of corporate insolvency resolution and liquidation processes. The case examines the permissibility of setting off mutual debts between a corporate debtor and a creditor, focusing on the interpretation of Regulation 29 of the Liquidation Regulations and its interaction with Section 36(4) of the IBC. The dispute likely arose from a situation where parties sought to offset mutual obligations to determine a net payable amount, raising significant questions about the legal framework governing set-off in insolvency proceedings.

The primary legal question was whether set-off for mutual dealings, as permitted under Regulation 29 of the Liquidation Regulations, is consistent with the IBC’s framework, particularly Section 36(4), which excludes certain assets from the liquidation estate. The parties’ arguments centered on the definition and scope of “mutual dealings,” with one side likely contending that multiple, distinct transactions between the same parties, acting in the same capacity, qualify for set-off, even if not arising from a single transaction. The opposing argument may have emphasized that allowing set-off could reduce the liquidation estate, potentially undermining the IBC’s objective of maximizing creditor recovery. References to international precedents, such as British Eagle International Air Lines Ltd. v. Compagnie Nationale Air France (1975) 1 WLR 758 (HL), and scholarly works like Rory Derham’s The Law of Set-Off (4th Edn., 2010) were likely invoked to argue the commercial necessity and equitable basis of set-off. The distinction between legal set-off (a statutory right for ascertained sums) and equitable set-off (based on common law principles to avoid injustice) was also a key point of contention, with parties debating whether the transactions met the criteria for equitable set-off.

The Supreme Court’s interpretation clarified that mutual dealings under Regulation 29 encompass connected transactions between parties acting in the same capacity, not limited to a single transaction, thereby permitting set-off to achieve a net payable amount. The Court emphasized that set-off is essential to prevent strategic misuse of insolvency proceedings and to promote commercial predictability, as supported by the UNCITRAL Legislative Guide on Insolvency Law. It distinguished between pre-commencement set-off obligations, which are generally permissible, and post-commencement obligations, which are restricted to maintain fairness. The Court further noted that equitable set-off could be denied if it defeats justice, as stated in Paragraph 48, reinforcing the need to balance creditor rights with the protection of the corporate debtor’s assets. The judgment also addressed the role of the resolution professional under Section 25 of the IBC, noting that their duty to preserve assets is subject to pre-existing clogs, such as contractual set-off agreements. This ruling is significant as it provides authoritative guidance on the application of set-off in insolvency proceedings, ensuring clarity in the interpretation of mutual dealings and equitable principles under the IBC, thereby shaping future insolvency resolutions in India.