The Supreme Court of India has ruled that an operational creditor who endured a substantial financial haircut during the Corporate Insolvency Resolution Process (CIRP) may raise a counterclaim for set-off in post-resolution arbitration proceedings. In the judgment delivered by the bench of Justice J. B. Pardiwala and Justice K. Vinod Chandran, the Court clarified that while the "clean slate" principle under the Insolvency and Bankruptcy Code (IBC), 2016, prevents an operational creditor from seeking fresh recovery against a Successful Resolution Applicant (SRA), it does not categorically bar the use of extinguished claims as a defensive measure.

The case centered on a contract for civil and structural work on an office building, originally valued at ₹133.68 crore, between the appellant, Modern Asset, and the respondent, KNK Construction Private Limited. Following the admission of KNK Construction into the CIRP in December 2019, Modern Asset terminated the contract and lodged a claim with the Resolution Professional (RP) for over ₹12.26 crore. Under the resolution plan, which saw the erstwhile promoters regain control of the firm by leveraging its status as a Micro, Small and Medium Enterprise (MSME) under Section 240A(1) of the IBC, Modern Asset’s claim was drastically reduced, receiving only 0.72% of the total amount. When the SRA subsequently initiated arbitration to recover payments allegedly owed to the corporate debtor under the same contract, Modern Asset challenged the equity of the proceedings, arguing that it should not be left empty-handed while the SRA pursued its own claims.

Equitable Set-Off in Post-CIRP Disputes

The Supreme Court’s decision emphasizes the need for procedural fairness when both parties to a contract possess conflicting claims arising from the same transaction. The Court observed that the erstwhile promoters, now operating as the SRA, were fully cognizant of Modern Asset’s claim during the CIRP period but failed to incorporate a counterclaim into the resolution plan. By allowing the SRA to pursue its claims in arbitration while simultaneously asserting that the creditor’s claims were extinguished, the insolvency process risked becoming an instrument of inequity.

Addressing this imbalance, the Court held that while the " clean slate " doctrine is fundamental to the stability of insolvency resolution, it must not preclude a party from raising a defense of set-off in arbitration. The justices noted: "The ‘ clean slate ’ principle as coming forth from Section 31(1) of the IBC , is too well entrenched by the decisions of this Court for us to attempt to upset it." Nevertheless, the Court found that the specific circumstances—wherein the erstwhile management returned as the SRA—warranted a measured approach to prevent a "one-way street" in legal recovery.

The Limits of the Clean Slate Principle

The ruling establishes a clear boundary for such claims. While an operational creditor can now use its previously submitted and settled claim as a basis for set-off, this does not grant the creditor an independent right to recover any excess amount or obtain positive relief. The Court was careful to ensure that the "clean slate" doctrine remains intact for all other purposes. The judgment dictates that the counterclaim is strictly limited to offsetting amounts that the Arbitration Tribunal might find due and payable to the SRA.

Furthermore, the Court clarified the scope of the Arbitration Tribunal’s jurisdiction under Section 16 of the Arbitration and Conciliation Act, 1996. The Tribunal is tasked with determining whether the SRA is entitled to the amounts it claims and, in the event of a favorable finding for the SRA, must apply a set-off to the extent of the claim previously settled during the CIRP. If the SRA’s claim is found to be entirely without merit, the operational creditor is not entitled to use its counterclaim to extract any payment from the SRA, as its debt remains legally extinguished under the approved resolution plan.

Contractual Claims and Corporate Governance

The judicial reasoning for this outcome draws upon the principle that the RP acts as an administrative officer on behalf of the corporate debtor. In the case of KNK Construction, the failure of the RP to include a counterclaim in the Information Memorandum—despite clear evidence of a dispute—meant that the resolution plan was essentially incomplete regarding the firm’s total liabilities and receivables. The Court noted that in such instances, the equity of the arbitration process relies on the Tribunal’s ability to view the contractual relationship in its entirety, including the history of the CIRP settlement.

"The appellant should be permitted to raise a counterclaim for the sole purpose of claiming set-off and the appellant would not derive any positive or affirmative relief of recovery," the Court stated. This decision serves as a significant guidance for the Bengaluru International Arbitration and Conciliation Centre and other arbitral bodies currently grappling with similar post-CIRP disputes. It reinforces the mandate that while the insolvency regime prioritizes the revival of the corporate debtor and the finality of the resolution plan , it does not mandate the total abandonment of equitable defenses in subsequent bilateral arbitrations.

The matter will now proceed before the Arbitral Tribunal as directed by the Karnataka High Court, with the added instruction that the Tribunal must consider the propriety of the bank guarantee encashment as part of its final assessment of the parties' contractual rights. By disposing of the appeal with this specific modification, the Supreme Court has provided a framework that safeguards the SRA's ability to preserve the corporate debtor’s assets while providing a mechanism for creditors to avoid the perceived unfairness of asymmetric litigation. This ruling underscores that even within the rigid statutory framework of the IBC, the principles of equity remain relevant in determining the scope of arbitral jurisdiction.