Section 138 NI Act Is Predominantly Criminal; IBC Moratorium Stays Recovery Of Compensation But Not Prosecution: Supreme Court Refers To 3-Judge Bench

"Allowing Section 138 proceedings to enjoy the benefit of moratorium, especially in light of such express exclusion of criminal liability, is not a good law," Supreme Court, in a significant judgment dated May 27, 2026, held that a moratorium under Part III of the Insolvency and Bankruptcy Code (IBC) does not stay the criminal prosecution or the imposition of punishment under Section 138 of the Negotiable Instruments Act.

A bench comprising Justice J.B. Pardiwala and Justice K.V. Viswanathan observed that while the recovery of compensation ordered in such proceedings is stayed during the moratorium period, the criminal trial must proceed to its logical conclusion to maintain the deterrent effect of the law.

"No Stay On Criminal Prosecution During Personal Insolvency"

The court noted that the predominant nature of Section 138 is criminal, as it seeks to increase public faith in the usage of cheques for settling debts. The bench highlighted that the legislature enacted this "deemed criminal liability" as a strict liability offence to ensure greater care in commercial transactions. Consequently, the bench referred the matter to the Chief Justice of India for the constitution of a three-judge bench to provide an authoritative pronouncement on the nature of these proceedings.

The appellant, Dineshchand Surana, was the former Managing Director of Surana Power Ltd (SPL), which is currently undergoing liquidation. The appellant had provided cheques as security for credit facilities from UCO Bank, which were later dishonoured for "insufficient funds," leading to complaints under Section 138 of the NI Act. During the pendency of these trials, the National Company Law Tribunal admitted personal insolvency and bankruptcy applications against the appellant, triggering the moratorium provisions under the IBC.

The primary questions before the court were whether proceedings under Section 138 of the NI Act are intended for the recovery of money and whether such proceedings are protected by the moratorium provided under Part III of the IBC. The court was also called upon to determine if directors vicariously liable under Section 141 of the NI Act would enjoy the benefit of a moratorium while undergoing personal insolvency.

"Section 138 Is A Hybrid Provision With Criminal Overtones"

The bench undertook an extensive analysis of the "deeming fiction" in Section 138 of the NI Act. It observed that although the provision arises from a civil transaction, the act of dishonouring a cheque is statutorily designated as a criminal offence. The court held that if the Parliament’s intention had merely been to ensure the failure to discharge a debt was punished, the punitive measures would have applied to all negotiable instruments, not just cheques.

"Court Explains Tiered Nature Of Cheque Bounce Proceedings"

To resolve the conflict between the NI Act and the IBC, the court introduced a "tiered" understanding of Section 138 proceedings. Tier I pertains to the mandatory criminal aspect which culminates in punishment such as imprisonment or fine. Tier II involves the discretionary power of the court to award compensation to the complainant under Section 395 of the Bhartiya Nyaya Suraksha Sanhita (BNSS), which replaces the erstwhile Section 357 of the CrPC.

"Moratorium Applies Only To Compensatory Aspect"

The court held that the moratorium under Sections 96 and 101 of the IBC should not place an embargo on the criminal aspect of cheque bounce proceedings. However, it clarified that the compensatory aspect (Tier II) is inherently civil in nature and would result in the depletion of the debtor's assets. Therefore, while a trial can continue and lead to conviction and sentence, the actual recovery of any ordered compensation must be temporarily halted during the moratorium.

"Deterrent Effect Of Section 138 Must Be Preserved"

The bench expressed reservations regarding the description of Section 138 as a "civil sheep in a criminal wolf’s clothing," a term used by a three-judge bench in P. Mohanraj v. Shah Bros. Ispat (P) Ltd. It observed that the focus in Mohanraj was largely on procedure rather than the objective of deterrence. The court stated that the "criminal colour" given to cheque dishonour is essential for maintaining trust in commercial dealings.

"The deterrent effect of Section 138 is critical to maintain the trust in the use of negotiable instruments like cheques in business dealings."

"Analysis Of Excluded Debt Under Section 79(15) IBC"

The judges pointed out that Section 79(15) of the IBC explicitly defines "excluded debt" to include the liability to pay a fine imposed by a court or tribunal. Since a fine is a personal criminal liability, the court reasoned that the legislature never intended for such liabilities to be shielded by a moratorium. Granting such protection would tantamount to allowing the evasion of criminal responsibility under the guise of insolvency proceedings.

"Liability Of Directors Under Section 141 NI Act"

Regarding vicarious liability, the court reaffirmed that even if a corporate debtor's debt is settled through insolvency, the criminal liability of its directors survives. The bench noted that Section 141 aims to pierce the corporate veil and hold the individuals in charge accountable. It held that while directors undergoing personal insolvency can seek a stay on the recovery of compensation, they cannot escape the personal criminal trial or the potential sentence of imprisonment.

"Reference To Larger Bench For Authoritative Ruling"

The court concluded that the interplay between the NI Act and the IBC is rife with complexity and requires a balance between the objectives of both legislations. It noted that a blanket stay on all Section 138 proceedings would undermine the penal intent of the NI Act, while an absolute exclusion from the moratorium could unfairly disadvantage other creditors under the IBC.

The bench referred two specific questions to a larger bench: whether Section 138 is quasi-criminal with a tilt towards the criminal side, and whether the IBC moratorium should apply to the entire proceeding or only the compensatory aspect. The registry was directed to place the matter before the Chief Justice of India for appropriate orders to constitute a three-judge bench.

Date of Decision: 27 May 2026