Answer By law4u team
When a company enters liquidation under the Insolvency and Bankruptcy Code (IBC), 2016, it has a direct impact on the company’s ongoing contracts, such as lease agreements, service agreements, supply contracts, and employment arrangements. These contracts may be continued, terminated, or disclaimed based on the liquidator’s assessment of their value and benefit to the liquidation estate.
Impact of Liquidation on Ongoing Contracts
Assessment by Liquidator
The liquidator reviews all existing contracts to determine whether continuing them would be beneficial for maximizing value.
Contracts that are burdensome, unprofitable, or unnecessary can be terminated or disclaimed.
Disclaimer of Onerous Contracts (Regulation 44, Liquidation Regulations)
The liquidator may disclaim onerous property or contracts, including:
- Unprofitable leases
- Supply agreements with penalties
- Contracts with future liabilities
A notice must be sent to all interested parties and filed with the Adjudicating Authority (NCLT).
Effect on Contractual Rights
Upon disclaimer, the contract is treated as terminated, and the counterparty may claim compensation as an unsecured creditor.
The counterparty cannot enforce specific performance of the contract after disclaimer.
Continuing Valuable Contracts
Contracts necessary for preserving the going concern value (e.g., licenses, maintenance contracts) may be continued with mutual agreement.
The liquidator may seek court approval to temporarily continue contracts during asset sales or business transfer.
Automatic Termination Clauses
Some contracts contain termination clauses triggered by insolvency or liquidation.
Such clauses are generally valid, but courts may restrict them if continuation benefits the liquidation estate.
Stay on Proceedings
Legal proceedings or claims for breach may be stayed under Section 33(5) IBC unless approved by the NCLT.
Legal Provisions Involved
- IBC Sections 35 & 37: Powers of liquidator to access, control, and manage contracts.
- Liquidation Process Regulations: Process for disclaiming contracts and handling disputes.
- Indian Contract Act, 1872: General principles for contract enforcement and damages.
- Case Law Support: Judicial precedents guide the treatment of executory contracts and disclaimer rights.
Challenges Faced
- Determining whether a contract is truly burdensome or strategically important.
- Negotiating continuation with counterparties unwilling to cooperate post-liquidation.
- Managing litigation risk if a disclaimer is contested.
- Valuing potential damages for breach or termination.
Consumer Safety Tips (for counterparties and creditors)
- Review contract terms for insolvency or liquidation clauses.
- Engage with the liquidator early to discuss continuation or compensation.
- File your claim promptly if a contract is disclaimed.
- Avoid entering new long-term contracts with companies under financial stress.
- Ensure clear documentation of payments, performance, and correspondence.
Example
A corporate debtor had an ongoing IT services agreement with a vendor costing ₹2 crore annually. After entering liquidation, the liquidator found that the service was no longer required and financially draining.
Steps taken:
The liquidator issues a notice of disclaimer to the vendor and files it with the NCLT.
The NCLT approves the disclaimer, considering it in the interest of the liquidation estate.
The contract stands terminated, and the vendor files a claim for unpaid dues and termination damages as an unsecured creditor.
The liquidator admits the claim and includes it in the distribution waterfall.
