Page 30 – Vaish Associates Advocates

RBI Issues Instructions on Investments in AIFs to Prevent Evergreening of Loans

Reserve Bank of India (“RBI”), vide its notification dated December 19, 2023, has issued a circular with instructions on the procedure to be followed by the Regulated Entities (“REs”) in order to make investments in units of Alternative Investment Funds (“AIFs”), and to address concerns relating to possible evergreening through this route. REs make investments in units of AIFs as part of their regular investment operations. However, as per RBI, certain transactions of REs involving AIFs entail substitution of direct loan exposure of REs to borrowers, with indirect exposure through investments in units of AIFs.

In order to tackle these issues, RBI has issued the following instructions:

(a) REs will not be allowed to invest in any scheme of AIFs which have downstream investments, either directly or indirectly, in a debtor company of the RE. The debtor company has been defined as any company to which the RE currently has or previously had given a loan or investment exposure in the preceding 12 months.

(b) If an AIF scheme, in which an RE is already an investor, makes a downstream investment in a debtor company, then the RE is required to liquidate its investment in the AIF scheme within 30 days from the date of making such downstream investment. Further, in the event REs have already made investments in such AIF schemes, the 30-day period for liquidation shall initiate from the date of issuance of this circular.

(d) In the event, the REs are unable to liquidate their investments within the prescribed time limit, they will be required to make a 100% provision on such investments.

(e) Any investment by REs in subordinated units of any AIF scheme with a ‘priority distribution model’ will be subject to a full deduction from REs’ capital funds. The term ‘priority distribution model’ refers to a distribution waterfall structure of AIFs where one class of investors share loss more than pro rata to their holding in the AIFs with respect to the other classes of investors/ unit holders.

To read the circular click here

For any clarification, please write to:

Mr. Yatin Narang
Partner
[email protected]

SEBI Outlines the Process for Dematerialisation / Crediting of Units by AIFs Where Investors Haven’t Provided Demat Account Details

In June 2023, Securities and Exchange Board of India (“SEBI”) mandated all schemes of Alternative Investment Funds (“AIFs”) to issue or convert their units in dematerialised form within a specified timeframe.

SEBI, vide its circular dated December 11, 2023, has now laid down the process for dematerialising/ crediting the units issued by AIFs, where investors are yet to provide demat account details to AIFs.

The said circular sets out that managers of AIFs shall continue to reach out to existing investors to obtain their demat account details and credit the units issued to them to their respective demat accounts. In this regard, the AIF industry and depositories have been directed to adopt implementation standards as formulated by the pilot Standard Setting Forum for AIFs (SFA) along with the 2 depositories, in consultation with SEBI.

Further, units already issued by schemes of AIFs to existing investors who have not provided their demat account details, shall be credited to a separate demat account named ‘Aggregate Escrow Demat Account’. New units to be issued in demat form shall be allotted to such investors and credited to the Aggregate Escrow Demat Account. As and when such investors provide their demat account details to AIFs, their units held in the Aggregate Escrow Demat Account shall be transferred to the respective investors’ demat account within 5 working days.

The circular clarifies the following with respect to issuance and credit of units of AIFs in demat form:

To read the circular click here

For any clarification, please write to:

Mr. Yatin Narang
Partner
[email protected]

Legalaxy – Monthly Newsletter Series – Vol VII – December, 2023

We are pleased to share with you the link to our newsletter “Legalaxy” for December 2023, providing updates on the recent and relevant legal developments in India.

Below are the key highlights of the newsletter:

SEBI streamlines procedure for dealing with unclaimed funds
SEBI carried out regulatory changes towards fraction investing for SM REITs and index providers, fresh investment by AIFs in dematerialised form
Winter effect – SEBI done away with the freezing of folios
No more hide and seek of ownership in LLPs now – MCA notifies LLP SBO Rules
RBI notifies the master directions on information technology governance, risk, controls and assurance practices
RBI notifies the regulatory measures towards consumer credit and bank credit to NBFCs
MoEFCC notifies the Van (Sanrakshan Evam Samvardhan) Rules, 2023
MoEFCC notifies the Water Purification Rules
MoEFCC issues order specifying the terms and conditions for conducting surveys on forest lands
MoEFCC notifies the guidelines to be abided by while considering exemptions provided under the Van (Sanrakshan Evam Samvardhan) Adhiniyam, 1980
MoEFCC notifies conditions for considering proposals relating to assignment of forest land
UGC issues guidelines for foreign universities to set up campuses in India
Ministry of Commerce and Industry amends the Special Economic Zones Rules, 2006 to permit hybrid working for its employees
Central Consumer Protection Authority issued the guidelines for Prevention and Regulation of Dark Patterns, 2023
CERT-In exempted from the ambit of RTI
Implementation of DCA under Telecom Commercial Communications Customer Preference Regulations, 2018

We hope you like our publication. We look forward to your suggestions.

Please feel free to contact us at [email protected]

SEBI Carried Out Regulatory Changes Towards Fractional Investing for SM REITs and Index Providers, Fresh Investment by AIFs in Dematerialised Form

Securities and Exchange Board of India (“SEBI”), in its board meeting held on November 25, 2023, approved the following decisions:

Amendments to SEBI (Real Estate Investment Trusts) Regulations, 2014, so as to create a regulatory framework for facilitating Small and Medium Real Estate Investment Trusts (“SM REITs”). SM REITs with an asset value of at least INR 50 crores, shall have the ability to create separate scheme(s) for owning real estate assets through special purpose vehicle(s) constituted as companies. This is a departure from the present requirement of a minimum asset value of INR 500 crores for existing REITs.
Providing flexibility to not for profit organizations (“NPOs”) in raising funds through the social stock exchange (“SSE”) by reducing the minimum issue size in case of public issuance of zero coupon zero principal instruments by NPOs on SSE from INR 1 crore to INR 50 lakhs. The minimum application size in case of public issuance of zero coupon zero principal instruments has also been reduced from INR 2 lakhs to INR 10,000, thereby enabling wider participation of subscribers including retail.
Introducing a regulatory framework for index providers with the objective of fostering transparency and accountability in governance and administration of financial benchmarks in the securities market. The regulatory framework shall be in accordance with the International Organization of Securities Commissions (IOSCO) principles for financial benchmarks and the said regulations shall provide a framework for registration of index providers which license ‘Significant Indices’ notified by SEBI based on objective criteria.
Mandating all Alternative Investment Funds (“AIFs”) to appoint a custodian. Presently, the mandate for appointment of a custodian applied to schemes of Category III AIFs and to schemes of Category I and II AIFs with a corpus more than INR 500 crores. Further, any fresh investments made by AIFs, beyond September 2024, shall be compulsorily held in dematerialised form. These proposals have been approved towards facilitating ease of compliance and to strengthen protection of investor interest in AIFs.

To read the press release click here

For any clarification, please write to:

Mr. Yatin Narang
Partner
[email protected]

Gujarat HC: Purchaser of an asset in a liquidation process is not liable for payment of government dues which were not substantiated adequately during the CIRP and not lodged with the liquidator

The Gujarat High Court (“Gujarat HC”) has, by its judgment pronounced on September 22, 2023, in the matter of KRBL Limited v. State of Gujarat [C/SCA/19804/2022], held that the purchaser of an asset in a liquidation process of a corporate debtor is not responsible for payment of any government dues, if the claim was not adequately substantiated during the Corporate Insolvency Resolution Process (“CIRP”) and on failure to lodge the claim with the liquidator.

Facts

The Mumbai bench of National Company Law Tribunal (“NCLT”), vide its order dated January 17, 2020, admitted insolvency proceedings initiated against M/s. Gran Electronics Private Limited (“Corporate Debtor”) by Universal Digital Connect Limited. The claim of Sales Tax Department (“Respondent”) of an amount of INR 77,08,69,644 was rejected by the resolution professional on inadequacy of proof.

Thereafter, an application to liquidate the Corporate Debtor was admitted by NCLT on February 12, 2021. The Respondent failed to register its claim with the liquidator, despite a letter dated February 23, 2021 being issued by the liquidator to Assistant Commissioner of Tax. The liquidator initiated the sale of assets of Corporate Debtor by means of an e-auction. KRBL Limited (“Petitioner”) purchased a piece of land, which was a part of the liquidation corpus of the Corporate Debtor. The purchase was recorded vide sale deed dated December 17, 2021 containing an express stipulation thereunder that the Petitioner will not be responsible to pay any due amount to the government, since it will be dealt with in the manner specified in Section 53(1) of Insolvency and Bankruptcy Code, 2016 (“IBC”).

The Gram Panchayat of Varsamedi intimated the Corporate Debtor to pay outstanding property tax. The liquidator informed the Panchayat that any dues other than secured, unsecured or of the workman and employees, including the dues of Respondent, will fall under operational creditors. Vide notice dated January 10, 2022, the Respondent intimated attachment of the land in question. A pencil entry bearing no. 4454 was mutated in favor of the Petitioner. On a request made by the Petitioner on February 16, 2022, to certify the entry, the Talati-cum-Mantri refused to do so on the ground of existence of a charge of the Respondent. By the impugned order dated January 5, 2022, the Respondent demanded an amount of INR 56,01,79,095 towards outstanding GST dues and mutated entry no. 6295, inter alia, recording a charge on the property of the Respondent. Hence, the Petitioner approached the Gujarat HC with a writ petition under Article 226 of the Constitution of India to certify the entry no. 4454 in revenue record and to set aside order dated January 5, 2022 and further to set aside the consequential entry no. 6295 mutated in the revenue record petition.

Issue

Whether the purchaser of an asset in an auction is liable to pay the government dues which are not lodged with the liquidator at the time of liquidation process.

Arguments

Contentions of the Petitioner:

The Petitioner submitted that IBC is a complete code which deals with solutions on a holistic perspective concerning a company and all stakeholders, including the company, creditors, purchasers start with a ‘clean slate’. The Petitioner to strengthen its arguments, placed reliance on Ghanshayam Mishra and Sons Private Limited v. Edelweiss Asset Reconstruction Company Limited [(2021)/ 9/ SCC/ 657], wherein the Supreme Court held that a successful resolution applicant cannot suddenly be faced with an undecided claim after a resolution plan submitted by him has been approved.

The Petitioner also emphasized, while relying on the Paschimanchal Vidhyut Vitran Nigam Limited v. Raman Ispat Private Limited and others [Civil Appeal No. 7976 of 212] (“Paschimanchal Case”), that Sections 52 (Secured Creditor in liquidation proceedings) and 53 (Distribution of assets) are complete and comprehensive and all rights even of secured creditors in the secured assets stands diluted and compromised. Once a property is sold by the liquidator in the public auction and on “as is where is basis,” a secured creditor cannot be allowed to assert an entry for the asset once sold.

The Petitioner further submitted that even as per Section 100 (Charges) of Transfer of Property Act, 1882 (“TPA”), a charge created by operation of law or otherwise is not mortgage, and a charge cannot be enforced against any property in the hands of the person to whom such property has been transferred for consideration and without any notice of charge. The Petitioner had no notice of pending government dues, and as such is not liable to pay the government dues.

Contentions of the Respondent:

The Respondent submitted that Section 31 (Approval of Resolution Plan) of IBC is not applicable to the facts of the present case. Since the insolvency proceedings did not materialize, the rights of the Respondent did not extinguish. The rights of the Respondent are restored, since there was a failure of insolvency resolution process.

The Respondent further submitted that since the asset was sold on “as is where is basis”, the rights of the Respondent stood secured. They do not stand relinquished even if the distribution is done after following Section 53 (Distribution of assets) of IBC. The Respondent emphasized that since the asset was sold on an “as is where is basis”, ratio laid down in Paschimanchal Case, should not be applied to present case.

Observations of the Gujarat HC

Gujarat HC analyzed the facts of the case that CIRP was undertaken and claims were invited and the Respondent failed to substantiate it and at the stage of liquidation did not lodge its claim. Gujarat HC placing reliance on judgments pronounced by Supreme Court observed that the debt of the Respondent did not form part of the resolution plan and therefore stood extinguished.

Gujarat HC examined Sections 52 and 53 of IBC and asserted that the Respondent as an operational creditor would have to fall in line as per the “waterfall mechanism”.

Gujarat HC relied upon judgments pronounced in the matter of Ghanshayam Mishra and Sons Private Limited v. Edelweiss Asset Reconstruction Company Limited [(2021)/9/SCC/657] and Paschimanchal Case and reiterated that once having relinquished its interest under Section 52, the Respondent cannot continue the insistence of maintaining the charge in the revenue records and its claim will have to stand in priority.

Thereafter, Gujarat HC discussed that the dissenting argument of the Respondent, that since the asset was sold on “as is where is basis” and the charge of the Respondent was rightly recorded, is misconceived as the sale deed already records that the purchaser shall not be liable for payment of any outstanding dues of the government.

Gujarat HC also deduced Section 100 of TPA in a manner that a charge cannot be enforced against any person who has bought the property for consideration and has no notice of such charge.

Decision of the Gujarat HC

Gujarat HC held that the Petitioner was entitled to a ‘clean slate’. The Court set aside the order dated January 5, 2022, passed by the Respondent and mutated entry no. 6295 in the revenue records. It further directed the Talati-cum-Mantri to certify entry No. 4454 in the revenue records pursuant to the sale of land in question by registered sale deed dated December 17, 2021.

VA View:

The present judgment of Gujarat HC is a significant judicial pronouncement in the realm of insolvency law.

Gujarat HC has protected the rights of the purchaser of an asset in the liquidation process against claims that are not substantially proved during the CIRP and are not lodged with the liquidator at the time of liquidation process. This decision strengthens the enforcement mechanism of IBC. Gujarat HC has clarified the position of law that the purchaser of an asset under IBC is not liable to pay any dues to any government authority, since all dues, claims and debts will be dealt as per the “waterfall mechanism”. The government authorities cannot insist on the payment of dues, if the claim has not been lodged with the liquidator within the stipulated time. Gujarat HC also clarified the law under TPA that charge cannot be enforced against any person who has bought the property for consideration and has no notice of such charge.

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

NCLAT: No bar on the initiation of CIRP, if default is committed prior to Section 10A Period and continues during the Section 10A Period.

National Company Law Appellate Tribunal, New Delhi (“NCLAT”) in the case of Beetel Teletech Limited v. Arcelia IT Services Private Limited [Company Appeal (AT)(Insolvency) No. 1459 of 2022], vide its order dated September 11, 2023, held that there is no bar on the initiation of Corporate Insolvency Resolution Process (“CIRP”) if a default is committed prior to period when Covid-19 pandemic was prevailing and continues during the period when Covid-19 pandemic was prevailing (“Section 10A Period”), since initiation of CIRP during Section 10A Period was suspended by introduction of Section 10A (Suspension of initiation of corporate insolvency resolution process) of the Insolvency and Bankruptcy Code, 2016 (“IBC”) and not prior to Section 10A Period.

Facts

A channel partner registration form was executed between M/s. Beetel Teletech Limited (“Operational Creditor/ Appellant”) and M/s. Arcelia IT Services Private Limited (“Corporate Debtor/ Respondent”), wherein both parties had agreed to work on mutually accepted terms and conditions. A purchase order dated October 25, 2019, was raised by the Corporate Debtor pursuant to which an invoice no. RV1927813879 dated December 31, 2019 of an amount of INR 1,32,45,904.84 (“Service Invoice”), was raised by the Operational Creditor for suppling goods and services. However, the payment by Corporate Debtor towards Service Invoice remained unpaid.

To recover the dues, ample reminders were made by the Operational Creditor and several meetings were held between the Corporate Debtor and the Operational Creditor. Further, the Operational Creditor issued a demand notice under Section 8 (Insolvency resolution by operational creditor) of IBC for recovering the dues. However, no reply to the demand notice was filed by the Corporate Debtor. As a result of which, an application for initiation of CIRP was filed under Section 9 (Application for initiation of corporate insolvency resolution process by operational creditor) of IBC on December 15, 2021 by the Operational Creditor against the Corporate Debtor (“Application”) and a reply to the Application was filed by the Corporate Debtor.

However, the Application was dismissed by National Company Law Tribunal, New Delhi (“NCLT”) as not maintainable, on the grounds that the interest claimed by the Operational Creditor falls during the period March 25, 2020 to March 24, 2021, for which no CIRP could have been initiated as per Section 10A of IBC and has also failed to establish beyond doubt that the unpaid operational debt was above the minimum threshold limit of INR 1 crore. Additionally, NCLT opined that part payments made by the Corporate Debtor was adjusted by the Operational Creditor towards other debts and not against the unpaid invoice which is claimed in the Application and there was no consistency in the treatment accorded to the part payments. Aggrieved by the said order, an appeal was filed before the NCLAT against the order of NCLT by the Operational Creditor.

Issues

Whether the interest accrued during Section 10A Period can be included while computing the INR 1 crore threshold limit.

Whether the part-payment received from the Corporate Debtor can be adjusted by the Operational Creditor towards other debts.

Arguments

Contentions of the Appellant:

It was contended by the Appellant that in terms of payment conditions followed by the two parties, the payments were to be made by the Corporate Debtor within 60 days from the date of invoice and the Corporate Debtor was liable to pay interest at the rate of 18% per annum if payment was not cleared within a time period of 60 days. The Service Invoice fell due for payment on February 29, 2020, for which certain payments were received from the Corporate Debtor, which were adjusted against the Service Invoice and other outstanding invoices. Despite these adjustments, certain payments remained outstanding towards the Service Invoice. Although the Appellant took up the matter with the Corporate Debtor for release of the outstanding debt, only part payments were made against the said invoice by the Corporate Debtor.

The Appellant also submitted that a demand notice was issued pursuant to Section 8 of IBC by the Appellant as a cheque issued by the Corporate Debtor got dishonoured for which the Corporate Debtor did not file any reply. After the demand notice was issued, two cheques amounting to INR 5 lakhs were issued by the Corporate Debtor which were adjusted by the Appellant against other pending invoices. However, the operational debt pertaining to the Service Invoice subsisted, resultantly an application under Section 9 of IBC was filed. As per the Appellant, the operational debt claimed is confined to the Service Invoice for an amount of INR 1,15,11,486 inclusive of principal amount of INR 1,01,80,986 along with an interest amount of INR 13,30,500 at the rate of 18% per annum. Therefore, the Appellant submitted that the default in payment arose before March 25, 2020 and the interest accruing on the principal amount should also be treated as a part of the operational debt and taken into consideration while computing the minimum threshold limit.

The Appellant contended that NCLT erroneously dismissed the application by the Appellant under Section 9 of IBC on the ground that the threshold limit of INR 1 crore is not fulfilled.

Contentions of the Respondent:

Despite the notice being served by NCLAT, there was no appearance made by anyone on behalf of the Corporate Debtor before the NCLAT since the first date of hearing which was on December 13, 2022.

Observations of NCLAT

NCLAT relied upon the judgement of the Supreme Court in the case of Ramesh Kymal v. Siemens Gamesa [Civil Appeal No. 4050 of 2020] wherein the Apex Court observed the object and intent underlying the insertion of Section 10A of IBC. It was held by NCLAT that Section 10A of IBC signifies that no application/ proceedings under Sections 7, 9 and 10 can be initiated for any default in payment which is committed during Section 10A Period. However, the said bar for initiation of CIRP is not applicable in respect of those defaults which are committed prior to the Section 10A Period and continues in the Section 10A Period. It was observed by NCLAT that the aim and objective of Section 10A of IBC was to protect a corporate debtor from any insolvency application against it for any default committed during the period when Covid-19 pandemic was prevailing. It was never intended to cover any default which occurred before Section 10A Period and continuing thereafter.

NCLAT noted that in the present case, the default has been committed by the Corporate Debtor since February 29, 2020, which is prior to commencement of Section 10A Period. Hence, the default was committed before the bar of Section 10A of IBC came into play and the Corporate Debtor is not entitled to claim the benefit of Section 10A Period. Furthermore, NCLAT held that since the default was committed prior to Section 10A Period and the liability for payment of interest having clocked prior to Section 10A Period, the opinion of NCLT that the liability of interest which accrued during Section 10A Period should be ignored or should not be computed for triggering CIRP, is misconceived.

In respect of the issue that whether the Operational Creditor can adjust part-payments which it has received from the Corporate Debtor towards other debts, NCLAT relied upon Section 60 (Application of payment where debt to be discharged is not indicated) of the Indian Contract Act 1872, and observed that if a debtor makes any payment without any appropriation, then the creditor can use his discretion to wipe out any of the remaining debt(s) which is/are due. Hence, if the debtor has not indicated the manner in which the debt is to be discharged, the creditor has the right of appropriation and therefore, the creditor has the scope to exercise his right in such a manner which puts him in the most advantageous position. Additionally, NCLAT held that it is a well settled business practice that in a debt where the principal amount is outstanding and interest has also accrued on the debt, sums paid by the debtor is applied by the creditor first to the interest.

NCLAT observed that payments received by the Operational Creditor have been duly adjusted against invoices in addition to the Service Invoice which were all pending for payment. Additionally, NCLAT observed that NCLT was unreasonable to hold that there is inconsistency in the pattern adopted by the Operational Creditor while adjusting payments received against outstanding dues as NCLT passed the order without any explanation as to how the action of adjusting the payments received by the Operational Creditor has contravened any provision contained in the Indian Contract Act, 1872.

Decision of NCLAT

NCLAT held that the order of NCLT is not tenable. Therefore, NCLAT allowed the appeal of the Operational Creditor and set aside the order of NCLT.

Further, NCLAT revived the application for CIRP filed by the Operational Creditor under Section 9 of IBC and remanded it back to NCLT for its consideration as per the law.

VA View:

The observation of NCLAT has brought into light the significance of the aims and objective of Section 10A of IBC which was to grant protection to a corporate debtor from any insolvency application against it for any default committed during the period when Covid-19 pandemic was prevailing and not to cover any default which occurred before Section 10A Period and continuing thereafter.

NCLAT has also emphasized on the fact that there must be no conflict between the provisions of the Indian Contract Act, 1872 and the spirit of IBC; and gave remarkable significance to both the provisions of the Indian Contract Act, 1872 as well as IBC and thus observed that neither of the statutes should not encroach upon the sphere of the other legislation.

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