The National Company Law Appellate Tribunal (“NCLAT”) has in its judgement dated May 9, 2022 (“Judgement”), in the matter of Sahara India v. Shri Nandkishor Vishnupant Deshpande and Another [Company Appeal (AT) (Insolvency) No. 368 of 2021] held that the National Company Law Tribunal (“NCLT”) does not have the power to suo-moto classify a transaction as a preferential transaction under the provisions of the Insolvency and Bankruptcy Code, 2016 (“IBC”).

Facts

Sahara India, a registered partnership firm (“Appellant”), entered into a memorandum of understanding dated March 7, 2017 (“MOU”) with Royal Refinery Private Limited (“Corporate Debtor/ Respondent No.2”), by which the Appellant advanced INR 39.95 Crores to the Corporate Debtor in various tranches commencing from April, 2018 to February, 2019 for the supply of future goods in the form of gold coins/gold ornaments (“Gold Coins”). The Gold Coins were to be supplied to the Appellant after January, 2019. As per the terms of the MOU, the advance payments made by the Appellant did not attract any interest.

The Appellant in its letter dated February 4, 2019 requested the Corporate Debtor to supply 10 kg of Gold Coins, which the Corporate Debtor confirmed to supply once the Gold Coins were manufactured. Upon the Corporate Debtor’s failure to supply the Gold Coins, the Appellant by its letter dated February 28, 2019 enquired about the supply of the Gold Coins, to which the Corporate Debtor responded that the supply would be fulfilled after three to four months time due to a lack of factory staff.

In view of the above, the Appellant by its letter dated March 5, 2019 requested for a refund of the amount advanced by it to the Corporate Debtor. However, the Corporate Debtor requested to convert the amount advanced to it by the Appellant into an unsecured loan bearing a 10% p.a. rate of interest, till full and final payment. Consequently, the MOU was substituted with a loan agreement.

On November 13, 2019, Corporate Insolvency Resolution Process (“CIRP”) was initiated against the Corporate Debtor, as a result of which Mr. Nandkishor (“Resolution Professional/Respondent No.1”) took over control of the Corporate Debtor and invited public notice and claim. The Respondent No.1 and Respondent No.2 are collectively referred to as “Respondents”.

Upon learning about initiation of CIRP against the Corporate Debtor, the Appellant, in its capacity as a financial creditor, submitted its claims amounting to a total of INR 42,61,33,333/- with the Resolution Professional. However, the Resolution Professional did not consider the claims of the Appellant as a ‘financial debt’ as a result of which, the Appellant, by way of an interlocutory application, challenged the decision of the Resolution Professional before the NCLT.

The NCLT by its order dated January 7, 2021 (“Impugned Order”) compared the facts of the Appellant’s case partially with Anuj Jain Interim Resolution v. Axis Bank Limited [(2020) 8 SCC 401] (the “Anuj Jain Case”) and not only refused to classify the claim of the Appellant as a ‘financial debt’ but also treated the transaction as a preferential transaction in terms of Section 43(2)(a) of the IBC on the ground that the loan agreement dated April 15, 2019 executed between the Corporate Debtor and the Appellant was created seven months prior to initiation of CIRP, which is well within the two years look back period as prescribed under the IBC.

Therefore, the Appellant approached the NCLAT under Section 61 (Appeals and Appellant Authority) of the IBC, for setting aside the Impugned Order.

Issue

Whether the NCLT has the power to suo-moto classify a transaction as a preferential transaction under the provisions of the IBC.

Arguments

Contentions raised by the Appellant:

Firstly, the Appellant submitted that the dues payable to it by the Corporate Debtor were purely in the nature of ‘financial debt’ and that the NCLT could not consider the transaction as a ‘preferenntial transaction’ without an avoidance application being filed by the Resolution Professional or the liquidator under Section 44 of the IBC.

The Appellant submitted that the substitution of the MOU by the loan agreement amounts to novation of the earlier agreement with an entirely new agreement as per Section 62 of the Indian Contract Act, 1872. Further, the Appellant and the Corporate Debtor are not related parties. The operational debt of the Corporate Debtor was converted to financial debt only because of its inability to supply the goods to the Appellant, despite being granted certain leverage by the Appellant.

The Appellant referred to the Hon’ble Supreme Court’s pronouncement in the Anuj Jain Case to contend that, for a transaction to fall within the mischief of Section 43 of the IBC, both the twin requirements of clauses (a) and (b) of Section 43(2) of the IBC coupled with either clause (a) or (b) of Section 43(4) of the IBC needs to be satisfied. Further, Section 44 of the IBC provides that it is the resolution professional or the liquidator, as the case may be, who is supposed to file an avoidance application with the NCLT for initiation of action under Section 43(1) of the IBC.

The Appellant submitted that Section 43 (Preferential Transactions) of the IBC, specifically deals with transactions pertaining to transfer of property or an interest thereof of a corporate debtor for the benefit of a creditor. However, in the instant case, that has not happened.

In view of the above, the Appellant prayed for setting aside the Impugned Order.

Contentions raised by the Respondents:

The Respondents submitted that since the liquidation order dated April 16, 2021 passed by the NCLT, is not under challenge and continues to remain in effect, the present appeal filed by the Appellant is infructuous and that the questions and issues raised in the appeal have become entirely academic and are of no legal consequence. Further, the Resolution Professional is no longer with the Corporate Debtor and one Mr. Arihant Nenawati has been appointed as the liquidator of the Corporate Debtor.

The Respondents submitted that the liquidator had issued a public announcement dated April 27, 2021 calling for claims from the stakeholders of the Corporate Debtor. However, the Appellant had not filed its proof of claim before the liquidator. The proof of claims submitted by the Appellant on March 3, 2020, to the Resolution Professional, cannot be categorized in any way as financial debt under Section 5(8) of the IBC.

The Respondents categorically stated that the money advanced to the Corporate Debtor under the terms of the MOU was towards future supply of Gold Coins. Hence, the disbursement of the advance amount was not against the consideration of time value of money as required under Section 5(8) of the IBC. It was at best an advance payment for supply of goods and hence is in the nature of an operational debt in terms of Section 5(21) of the IBC. Moreover, Section 5(8) of the IBC does not qualify a financial debt resulting from conversion of operational debt into a financial debt at a later date.

Furthermore, in light of the overriding provision in Section 238 of the IBC and the judgment of the Hon’ble Supreme Court in Gujarat Urja Vikas Nigam Limited v. Amit Gupta, [(2021) SCC Online SC 194], it becomes evidently clear that the provisions of the IBC can override a bilateral commercial contract, such as a loan agreement. Additionally, the terms of the loan agreement neither provided for a clear repayment schedule for the purported loan amount nor did it provide for consequences upon default on the part of the Corporate Debtor.

Therefore, the loan agreement was a sham and a collusive document to give fraudulent preference to the Appellant and the contention of the Appellant that the NCLT could not suo motu hold the transaction to be preferential as it was not one of the reasons provided by the Resolution Professional, is clearly erroneous and devoid of merit.

Observations of the NCLAT

The NCLAT observed that it was an undisputed fact that the money was received by the Corporate Debtor in different tranches in order to fulfill the supply of Gold Coins to the Appellant at a future date. It was also clear that the said advance payment did not attract any interest. Further, at the time of ‘origination of transactions’ from April 2018 to February, 2019, the money advanced was in the nature of operational debt and met the criteria of operational debt as enunciated in Section 5(21) of the IBC.

Neither of the parties during their respective submissions, stated that the Appellant and the Corporate Debtor are related parties. If they were not related parties, then the lookout period is a period of one year preceeding the insolvency commencement date as per Section 43(4)(b) of the IBC. Therefore, considering that the CIRP commenced in November 2019, the payments released from April 1, 2018 to June 30, 2018, in any way would not get covered under the ambit of Section 43 of the IBC and hence only two payments amounting to INR 2.5 Crore and INR 2.04 Crore, respectively, could be treated as preferential payment from the total advance payment of INR 39.95 Crore.

Stating the provisions of the IBC, the NCLAT observed that it is abundantly clear that transfers made in the ordinary course of business or financial affairs of the Corporate Debtor shall not be covered under preferential transactions.

The NCLAT observed that the MOU entered into in the year 2017 was meant for the supply of goods in the form of gold coins/gold ornaments and the order of initiation of CIRP reflects that the Corporate Debtor was in regular business of buying and selling gold bars. Therefore, the transaction between the Appellant and the Corporate Debtor was ‘in the ordinary course of business’. Moreover, the parties not being related parties, only the transactions falling within a period of one year from initiation of CIRP could be covered under preferential transaction and not the entire advance amount.

Decision of the NCLAT

The NCLAT came to a conclusion that the NCLT in its Impugned Order has exceeded its jurisdiction while recording the finding to the effect that the Appellant and the Corporate Debtor are related parties, which is beyond the scope of the petition filed before the NCLT. That is to say that, the NCLT on its own accord, classified the parties as related parties, which is beyond the provisions of the IBC.

Drawing reference to the single judge order in the case of Mahender Singh Gill v. Chief Election Commissioner [(1978) 1 SCC 405], the NCLAT held that when a statutory functionary such as a resolution professional, has not filed an avoidance application for initiation of proceedings under Section 43 of the IBC, the NCLT by treating the transaction as a preferential transaction, has supplemented its order by a fresh reason through affidavit or otherwise and that the same is not acceptable under the provisions of the IBC.

The NCLAT, setting aside the Impugned Order, directed the NCLT to reconsider the instant case afresh and to decide the matter on its merits in accordance with law.

VA View:

The NCLAT in this Judgement has correctly observed that the NCLT cannot suo-moto classify a transaction as a preferential transaction. This Judgement adds to the development of the jurisprudence in the legislation, especially in relation to Section 43 (Preferential Transactions and Relevant Time) and its validity.

Further, the NCLAT emphasized that when a statutory functionary such as a resolution professional makes an order on certain grounds, its validity must be judged by the reasons mentioned therein and cannot be supplemented by fresh reasons in the shape of an affidavit or otherwise.

Therefore, setting aside the NCLT’s decision, the NCLAT rightly held that the NCLT has exceeded its jurisdiction by firstly, considering the parties as related parties and further, by classifying the transaction between them as a preferential transaction without an avoidance application being filed by the Resolution Professional or the liquidator under Section 44 of the IBC.

For any query, please write to Mr. Bomi Daruwala at [email protected]

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