Between the Lines | NCLAT: Rejects application filed under Section 7 of the Insolvency and Bankruptcy Code, 2016 on grounds of collusion between the corporate debtor and the financial creditor August 24, 2021
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The National Company Law Appellate Tribunal, Principal Bench, New Delhi (“NCLAT”) has in its judgment dated June 30, 2021 (“Judgement”), in the matter of Hytone Merchants Private Limited v. Satabadi Investment Consultants Private Limited [Company Appeal (AT) (Insolvency) No. 258 of 2021], relied on Section 65 of the Insolvency and Bankruptcy Code, 2016 (‘’IBC”), to hold that, an application can be rejected on grounds of it being filed collusively and with a malicious intent, that is, not with an intention of resolution of insolvency of the corporate debtor (irrespective of the application complying with all requirements of Section 7(5) of the IBC).
Hytone Merchants Private Limited (“Appellant”) had given an unsecured loan of INR 3 lakhs to Satabadi Investment Consultants Private Limited, the corporate debtor (“Respondent”) for a period of six months, on February 15, 2019. The Respondent had acknowledged receipt of the unsecured loan amount and also issued a demand promissory note. Subsequently, the Respondent defaulted to repay the dues. The Appellant had issued a demand notice dated October 16, 2019 recalling the unsecured loan, but the Respondent failed to clear the outstanding dues.
Thereafter, an application under Section 7 of the IBC (“Application”) was filed by the Appellant to initiate corporate insolvency resolution process (“CIRP”) against the Respondent. The Application was complete and met all requirements under the IBC and regulations thereunder. The existence of debt and default were admitted during the proceedings before the National Company Law Tribunal, Kolkata (“NCLT”). However, the NCLT rejected the Application by an order dated February 02, 2021, (“Impugned Order”). Accordingly, aggrieved by the Impugned Order, the instant appeal was filed by the Appellant before the NCLAT.
Whether the Application could be rejected by the NCLT, by relying on Section 65 of the IBC (irrespective of the Application complying with all requirements of Section 7(5) of the IBC), on grounds of it being filed collusively, and with a malicious intent, that is, not with an intention of resolution of insolvency.
Contentions raised by the Appellants:
1. The NCLT overreached and exceeded its authority and jurisdiction
In the Impugned Order, it was observed that, the Application was complete in accordance with the law, and that the Respondent was in default of a debt which was due and payable. The default amount was more than the minimum threshold stipulated in Section 4(1) of the IBC. In the said circumstances, under Section 7(5) of the IBC, the NCLT had no further discretion to exercise and ought to have admitted the Application and consequently initiated the CIRP against the Respondent. However, the NCLT, instead of following the mandate of Section 7(5) of the IBC, proceeded with an unjustified and roving enquiry to hold that the Application was filed in collusion by the Appellant and the Respondent.
The NCLT has referred the master data and the financial statements for the year 2018-19 of the Respondent to come to the finding of collusion. However, neither the master data nor the financial statements of the Respondent, as referred in the Impugned Order, were part of the records submitted in the Application. Further, it was brought to notice that master data mentioned in the Application did not show the corporate guarantee amount as mentioned in paragraph 9 of the Impugned Order. Assuming that any such guarantee exists, the same was still a liability of the Respondent. The NCLT misdirected itself and ignored the materials on record, categorically showing the existence of default. Instead, the NCLT proceeded to refer to and rely on purported documents that were not on record to arrive at a finding of collusion without giving any opportunity to the Appellant to make submissions in this regard. Therefore, the NCLT had grossly exceeded its jurisdiction and authority.
2. No scope for discretion of the NCLT
The Impugned Order has been passed in contravention of law, that is, the provisions of the IBC and the regulations thereunder. There is no discretion vested on the NCLT to reject an Application under Section 7(5) of the IBC if the default has occurred and the Application is complete. The Appellant further contended that the Hon’ble Supreme Court (“SC”) in the case of Innoventive Industries Limited v. ICICI Bank [(2018) 1 SCC 407] had held that, “the moment the NCLT is satisfied that the default has occurred, the Application must be admitted unless it is incomplete.” However, in passing the Impugned Order, the NCLT acted in derogation of the settled principles of law and, therefore, the Impugned Order deserves to be set aside. Furthermore, there were no facts on record to warrant the exercise of discretion to reject the Application. It was highlighted that, Section 7(4) of the IBC was relevant since the same categorically provided that the NCLT was required to “ascertain the existence of a default from the records of an information utility or on the basis of other evidence furnished by the Financial Creditor under Sub-section (3)”. This evidences the limited scope of an adjudication of the NCLT, that is, adjudication is to be made on the evidence disclosed and on record. The NCLT is not empowered to initiate a roving enquiry dehors the records.
3. Change in the financial position of the Respondent
Furthermore, the financial statements of the Respondent for the year ending March 31, 2019 were not relevant because the Application was filed in December 2019 (more than eight months after March 31, 2019). Further, the Impugned Order rejecting the Application was passed on February 2, 2021, almost two years after March 31, 2019, therefore, the NCLT had ignored the possibility that the financial position reflected on March 31, 2019 may have undergone change in the intervening two years. The Respondent in this appeal, in their affidavit in reply, disclosed its financial statement for the year 2018-19 and categorically stated that the financial condition of the Respondent had deteriorated since then. Significantly, the NCLT had failed to appreciate the meaning of the Respondent’s submission (though recorded in para 7 of the Impugned Order), that it was unable to repay dues of Appellant due to “economic recession and losses in its business” and due to Respondent “being a victim of circumstances” and “by reason of the duration of the business“.
The reason for the deterioration was that major portion of its investment was into companies that were under liquidation and CIRP (M/s Kohinoor Pulp and Paper Private Limited and M/S Kohinoor Paper and Newsprint Private Limited, respectively), the Respondent being an unsecured financial creditor therein, there was no chance of getting the said money back, and the amounts were reflected in the accounts as per the accounting standard since the same cannot be immediately written off. However, the net worth of the Respondent stood substantially eroded after March 31, 2019.
4. No collusion between the Appellant and the Respondent
The Appellant has no relation or connection with the Respondent. A finding of collusion cannot be the outcome of guesswork, as is in the Impugned Order, especially not without giving the Appellant an opportunity to make any submissions on such issue. Thus, the Impugned Order of rejection is in violation of natural justice. Without prejudice, Section 65 of the IBC also cannot apply to the facts of the case, firstly because there is no connection between the parties, secondly, the Appellant has demonstrated the existence of default and that had been recognised by the NCLT. Consequently, the scheme of the IBC has been ignored by the NCLT. Thus, the conclusion drawn by the NCLT of collusion existing between them was unwarranted, unfounded and bereft of any basis.
Contentions raised by the Respondent:
Due to business losses and economic recession, the Respondent was not able to repay the loan. The Impugned Order that alleged of existing collusion, was vehemently disputed. The Respondent had made several other commitments and investments, and it was in no current position to repay the recalled amount.
As per the order dated April 4, 2021, necessary clarifications were sought regarding the balance-sheet with regards to its mention in the order of the NCLT, dated January 04, 2021, where it is mentioned that the net worth of the Respondent was INR 15,36,39,015 as per the financial statements of 2018-2019. The Respondent contended that in the present situation, when the NCLT passed the Impugned Order, the condition of the Respondent had starkly deteriorated, and the Respondent was not in a condition to repay the same. Additionally, the Respondent had made substantial investments in companies under liquidation and CIRP as was evident from the entries in the balance sheet. The Respondent being an unsecured financial creditor, there was no chance of getting said money. As per standard accounting practices, the Respondent was bound to show said receivable in its accounts and could not write it off.
Observations of NCLAT
1. Scope for discretion of the NCLT
The NCLT had observed that, undisputedly the Application met all the requirements and that the Respondent was in default of a debt due and payable and that the default amount was more than the minimum threshold stipulated in Section 4(1) of the IBC. The NCLAT noted that, Section 7(5)(a) of the IBC provided that, “where the Adjudicating Authority is satisfied that a default has occurred and the Application under Sub-section (2) is complete, and there is no disciplinary proceedings pending against the proposed Resolution Professional, it may, by order, admit such Application.” The NCLAT observed that, the use of the phrase ‘it may’ in Section 7(5) of the IBC itself provided the scope of discretion exercised by the NCLT in rejecting the Application. The NCLAT noted that, Section 7(5)(a) of the IBC lays down parameters about general conditions to admit an application. However, in the given situation, it appeared that the Application was filed collusively, not with the purpose of insolvency resolution, but otherwise, then despite fulfilling all the conditions of Section 7(5) of the IBC, the NCLT could exercise its discretion in rejecting the Application relying on Section 65 of the IBC. The NCLAT noted that, the SC in the case of Swiss Ribbons Private Limited v. Union of India [(2019) 4 SCC 17] had observed that, “What is also of relevance is that in order to protect the Corporate Debtor from being dragged into the Corporate Insolvency Resolution Process mala fide, the Code prescribes penalties.” The NCLAT observed that, therefore, it was clear that even if the Application filed under Section 7 of the IBC met all the requirements, then also the NCLT could exercise discretion, to prevent and protect the Respondent from being dragged into CIRP mala fide. It was also noted that, Sections 65 and 75 of the IBC prescribed penalties.
2. Lifting of corporate veil
The NCLAT noted that, Section 65 of the IBC explicitly provided that if any person initiated the insolvency resolution process or liquidation proceedings fraudulently or with malicious intent for any purpose other than for resolution of insolvency or liquidation, as the case may be, the NCLT may impose a penalty. The NCLAT noted that the SC in Arcelor Mittal India Private Limited v. Satish Kumar Gupta and Others [Civil Appeal Nos.9402-9405 OF 2018] while interpreting Section 29A of the IBC, held that the corporate veil may be lifted when a statute itself contemplates lifting the veil, or improper conduct is intended to be prevented, or a taxing statute or beneficial statute is sought to be evaded or where associated companies are inextricably connected as to be, in reality, part of one concern.
The NCLAT further analysed the well-established doctrines such as doctrine of “piercing the corporate veil” which stands as an exception to the principle that the company is a “separate legal entity” and distinct from a shareholder with its own legal rights and obligations. It seems to disregard the separate personality of company and attribute the acts of the company to those who are allegedly in direct control of its operation. The concept of a corporate entity was evolved to encourage and promote trade and commerce but not to commit illegalities or to defraud people. Therefore, the NCLAT noted that, where the corporate character is employed for the purpose of committing illegality or for defrauding others, the courts would ignore the corporate character and will look at the reality behind the corporate veil so as to enable it to pass appropriate orders to do justice between the parties concerned.
The NCLAT observed that, the expression “acting jointly” in the opening sentence of Section 29-A of the IBC cannot be confused with “joint venture agreements”. All that is to be seen by the expression “acting jointly” is whether certain persons have got together and are acting “jointly” in the sense of acting together. If this is made out on the facts, no superadded element of “joint venture” as is understood in law is to be seen. The other important phrase is “in concert”. The NCLAT noted that, under Section 3(37) of the IBC, words and expressions used but not defined in the Code but defined, inter alia, by the Securities Exchange Board of India Act, 1992, and the Companies Act, 2013, shall have the meanings respectively assigned to them under those acts. The NCLAT observed that, thus, it was clear that the SC in Arcelor Mittal (supra) while interpreting the statutory provision of Section 29 A of the IBC, had recognised the principle of lifting the corporate veil in matters relating to insolvency under the IBC. Therefore, Section 65 of the IBC provides for punishment for fraudulent or malicious initiation of proceedings. The NCLAT observed that, it does not mean that Section 65 of the IBC will not be applicable to prevent such fraudulent or malicious initiation of proceedings. When a statute makes a provision for punishment for any wrong, it also contains deemed power to prevent it. Therefore, it cannot be said that Section 65 of the IBC will be applicable only after initiation of the CIRP fraudulently or with malicious intent. Thus, NCLAT observed that even if the Application complied with all requirements of Section 7 of the IBC, it was filed collusively, not with the intention of resolution of insolvency but otherwise. Therefore, it was not mandatory for the NCLT to admit the Application so as to save the Respondent from being dragged into CIRP mala fide.
3. The collusion between the Appellant and the Respondent
The NCLAT noted that, in the instant case, the NCLT in the Impugned Order had observed that, “on perusal of the master debt of the Corporate Debtor it is seen that the Corporate Debtor has given a corporate guarantee of ₹ 482,42,00,000. On further enquiry and perusal of the financial statements for the Financial Year 2018-19 of the Corporate Debtor, it has come to light that the networth of the Corporate Debtor is ₹ 15,36,39,015. It is hard to convince oneself that the Company having a networth of ₹ 15,36,39,015 is not able to make a payment of ₹ 3 lakhs. It appears that the petition at hand has been filed in collusion with the Corporate Debtor.”
The NCLAT noted that, in the circumstances, the NCLT decided that the Application was filed in collusion with the Respondent and thereby rejected the Application filed under Section 7 of the IBC. There was a plausible contention to form such an opinion of collusion with the financial creditor that a company with a net worth of INR 15,36,39,015 has already given a corporate guarantee worth INR 482,42,00,000, was unable to repay a loan of INR 3 lakhs only. The NCLAT noted that, the Respondent, in its reply, did not dispute that it has extended the corporate guarantee. Since the master data of the Respondent reflected that the Respondent was also a corporate guarantor and has extended the corporate guarantee of a considerable amount worth INR 482,42,00,000, therefore, such plausible contention cannot be ruled out that the Respondent colluded with the Appellant to escape its liability as a corporate guarantor.
Decision of the NCLAT
The NCLAT relied on Section 65 of the IBC, to hold that, an application can be rejected on grounds of it being filed collusively and with a malicious intent, that is, not with an intention of resolution of insolvency of the corporate debtor (irrespective of the application complying with all requirements of Section 7(5) of the IBC). Consequently, the NCLAT held that the appeal sans merit and dismissed it.
Based on precedents, the NCLAT clarified that, the legislature, consciously has provided the NCLT with powers to exercise discretion and scope to enquire into the motive of the applicant before adjudicating on the application for initiation of CIRP against the corporate debtor, irrespective of the existence of debt and default and completeness of such an application, being in accordance with law. The NCLAT, through this Judgement, has rightly upheld the integral principles of the IBC, that is, value maximization of the assets of the corporate debtor, and insolvency resolution, unlike admission of an application with a mala fide intent/collusion.
The NCLAT reiterated that, before admitting any application, every precaution is necessary to be exercised so that the insolvency process is not misused for any purposes other than the resolution of insolvency of a corporate debtor. In other words, discretion must be used by the NCLT to prevent and protect a corporate debtor from being dragged into a mala fide corporate insolvency resolution process.
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