Staying regulatory action under guise of insolvency proceedings emboldens errant developers: Supreme Court

New Delhi: The Supreme Court has said the moratorium imposed under the Insolvency and Bankruptcy Code does not extend to regulatory penalties imposed for non-compliance with consumer protection laws as those are regulatory in nature and do not constitute "debt".

"Given that the legislative intent behind the Consumer Protection Act is to ensure compliance with consumer welfare measures, staying such penalties would be contrary to public policy," a bench of Justices Vikram Nath and Prasanna B Varale said.

The court recently dismissed an appeal filed by real estate developer Saranga Anilkumar Aggarwal against the penalties imposed by the National Consumer Disputes Redressal Commission on August 10, 2018 for failing to deliver the possession of residential units to homebuyers as per the agreed timeline.

"Permitting a stay on regulatory penalties under the guise of insolvency proceedings would undermine the very purpose of the CP Act and embolden errant developers to escape liability through insolvency proceedings," the bench said.

The court pointed out homebuyers, many of whom invest their life savings in purchasing residential units, are already in a precarious position due to delays in possession and breaches of contractual obligations.

"Staying penalties that serve as deterrence against such unfair practices would render consumer protection mechanisms ineffective and erode trust in the regulatory framework," it said.

The court said, the appellant cannot invoke insolvency proceedings as a shield to evade statutory liabilities.

"The objective of the IBC is to provide a mechanism for resolving financial distress, not to nullify obligations arising under regulatory statutes," the bench said.

The bench found as "misconceived and legally untenable" the analogy drawn between the moratorium on proceedings under Section 138, Negotiable Instruments Act and Section 27 CP Act.

"If the argument is accepted, homebuyers, who have already suffered immense delays and financial hardship, would be further deprived of relief. The legislative intent behind consumer protection laws is to safeguard the interests of consumers and ensure accountability from service providers," the court said.

The bench also noted in P Mohanraj and Others Vs Shah Brothers Ispat Private Limited (2021), this court held that a moratorium under Section 14 of the IBC extends to proceedings under Section 138 of the NI Act.

However, a distinction between debt recovery proceedings and punitive actions needs to be created, and therefore all criminal liabilities do not fall within the scope of the moratorium unless explicitly covered under the IBC, it said.

The penalties by regulatory bodies in the public interest cannot be stayed merely because insolvency proceedings are ongoing, the court held.

The bench also pointed out there is a fundamental distinction between civil and criminal proceedings concerning a debt moratorium.

"While civil proceedings are generally stayed under IBC provisions, criminal proceedings, including penalty enforcement, do not automatically fall within its ambit unless explicitly stated by law," the bench said.

The court also said there existed a distinction between punitive actions and criminal proceedings.

"While a criminal proceeding is initiated by the State against an accused to determine guilt and impose penal consequences, punitive actions in the regulatory sphere, such as those imposed by the NCDRC, are meant to ensure compliance with the law and to act as a deterrent against future violations," the bench said.

These penalties do not arise from any "debt" owed to a creditor but rather from the failure to comply with the remedial mechanisms established under consumer law. Unlike a criminal prosecution, which requires the establishment of mens rea, the penalties imposed by NCDRC are regulatory in nature and aim to protect the public interest rather than to punish criminal behaviour, the bench said.

The court also said the moratorium under Section 96 of the IBC is intended to provide temporary relief to debtors by preventing certain proceedings against them during the resolution process.

"The intent behind the moratorium is to ensure that the debtor's assets are preserved for an efficient resolution process and to prevent creditors from taking unilateral actions that may frustrate the objective of insolvency proceedings," the court said.

The court also emphasised the statutory scheme of the IBC makes it clear that the protection under the moratorium does not cover all forms of liabilities, particularly those classified as "excluded debts" under Section 79(15) of the IBC.