Transfer and Assignability of Contracts in Case of Schemes

Restructuring is often used by companies to reassign rights and liabilities amongst shareholders and creditors, or with the purposes of achieving debt structuring, reducing tax liabilities, eliminating competition, business integration and customer growth.

For undertaking certain schemes of arrangement, given that such arrangements are a departure from the routine rights exercised within the company and general actions permitted under company law, approval of the courts is required. While sanctioning a scheme, the courts not only ensure that the procedural requirements for such a scheme are met, but also take into due consideration the rights, obligations and liabilities of various stakeholders to ensure that the scheme is fair and reasonable and that it does not contravene any provisions of law or violate public policy.[1]

Further, court approved schemes afford a legal sanction for transfer and devolution of the rights and liabilities of the transferor entity to the transferee entity, who is identified as a successor-in-interest. It therefore follows that as a general principle, on the scheme becoming effective, the transferee entity will become the successor to all the businesses of the transferor entity and all the rights and obligations of the transferor entity under contractual arrangements, suits and other matters shall vest in the transferring company, without requiring any further act or deed.

But how exactly do the courts in India deal with the rights and liabilities relating to the party to a scheme, arising from a contract outside of such a scheme?

It is settled law that while the rights under a contract are assignable unless the contract is personal in nature, assignment of liabilities requires the consent of the counterparty and when such consent is granted, it is really a novation resulting in substitution of liabilities.[2] The Supreme Court has, time and again, held that a court-approved scheme of arrangement cannot be used as a tool to circumvent the provisions of any statute or contract which require specific consents or which lay down specific conditions in connection with any approvals for transfer of liabilities.[3] For instance, a contractual covenant against subletting without the landlord’s prior consent was upheld and enforced, as the merger of the lessee with the resulting entity pursuant to a scheme had effectually led to transfer and subletting in contravention of the rent agreement and the provisions of the Andhra Pradesh Buildings (Lease, Rent and Eviction) Control Act, 1960.[4]

To sum up, an exception to the rule of automatic transfer of rights and liabilities in case of a court approved scheme is when the applicable law / contract provides for specific consent (statutory, contractual or otherwise) to be obtained, prior to such transfer and vesting pursuant to such scheme. Therefore, as a pre-emptive measure, it would be advisable for the parties involved in a scheme to discuss and obtain prior approval (where required) of third parties (including statutory authorities) to prevent any subsequent claims or termination / revocation by such third party.

Authors:

Pallavi Satpute, Counsel
Yashi Saraswat, Associate 

Footnotes:

[1] Miheer H. Mafatlal v. Mafatlal Industries Ltd., AIR 1997 SC 506.
[2] Khardah Company Ltd v. Raymon & Co (India) Pvt. Ltd., AIR 1962 SC 1810.
[3] Parasaram Harnand Rao v. Shanti Prasad Narinder Kumar Jain and Anr., (1980) 3 SCR 444; General Radio and Appliances Co. Ltd. and Ors. v. MA Khader (Dead) by Lrs., AIR 1986 SC 1218; Delhi Development Authority v. Nalwa Sons Investment Limited and Others, SLP (Civil) No. 29201 of 2014.
[4] General Radio and Appliances Co. Ltd. and Ors. v. MA Khader (Dead) by Lrs., AIR 1986 SC 1218.

Date: May 24, 2021