Gujarat High Court: Proceedings under Section 9 of the Arbitration and Conciliation Act, 1996 cannot be used for enforcement of the conditions of a contract

The Gujarat High Court (“GHC”) has in its judgment dated June 10, 2022 (“Judgment”), in the matter of Kanhai Foods Limited v. A and HP Bakes [R/First Appeal No. 2638 of 2021], held that issues involving enforcement of the conditions of a contract cannot be the subject matter of an application for interim measures under Section 9 of the Arbitration and Conciliation Act, 1996 (“Act”).

Facts

Kanhai Foods Limited (“Appellant”), a registered company, was engaged in the business of production, marketing and selling of bakery products under its brand ‘KABHI B’ (“Appellant’s Brand”). The Appellant had started selling its bakery products in the year 2007 and started granting franchises to other persons in the State of Gujarat as its business started expanding. Amongst the 50 franchises granted by the Appellant, A and HP Bakes (“Respondent”) was granted franchisee for the Appellant’s Brand in the year 2015 at Pij Road, Nadiad (“Franchised Premises”). Consequently, a franchise agreement was entered into between the Appellant and the Respondent on November 1, 2017, which, inter alia, provided for an initial term of three years.

Subsequently, the franchise agreement was renewed and a fresh Franchise Agreement (“Franchise Agreement”) was entered into between the parties on November 1, 2020. As per the terms of the Franchise Agreement, the Respondent was obliged to sell only the bakery products of the Appellant’s Brand. Further, the Respondent was restrained from, directly or indirectly, conducting similar business during the term of the Franchise Agreement.

Following the execution of the Franchisee Agreement on November 1, 2020, it came to the knowledge of the Appellant that the Respondent had started selling other bakery products, particularly bakery products of the brand ‘G5’, in which partners of the Respondent were connected. Despite receiving a warning from the Appellant, the Respondent continued to store and sell the products of other bakery brands with a trade mark similar to that of the Appellant’s Brand so as to pass them off as the products of the Appellant’s Brand.

Thereafter, in the month of July 2021, the Respondent issued a notice to the Appellant seeking to terminate the Franchise Agreement. The Appellant not only rejected such termination by the Respondent but also stated that the Respondent had breached the terms of the Franchise Agreement by attempting to pass off its products as those of the Appellant.

In view of the above, the Appellant filed an application under Section 9 (Interim Measures, etc. by Court) of the Act (“Application”) before the Commercial Court, City Civil Court, Ahmedabad (“Commercial Court”) seeking interim measures, including a direction to the Respondent to handover the Franchised Premises to the Appellant and a direction restraining the Respondent from carrying out any activity at the Franchised Premises for a specified period as per the terms of the Franchise Agreement. The Appellant also sought a direction to restraint the Respondent from conducting a business similar to that envisaged in the Franchise Agreement.

The Respondent challenged the said Application by filing a reply contending that the termination of the Franchise Agreement by the Respondent was legal. The Respondent further contended that it could not be restrained from conducting its business as the same is violative of the provisions set out in Section 27 of the Indian Contract Act, 1872.

The Commercial Court by its order dated August 31, 2021 (“Impugned Order”) rejected the Application filed by the Appellant on the ground that the relief which was prayed for by the Appellant were of the nature in respect of which the Appellant could be compensated in terms of money.

Hence, the Appellant approached the GHC for setting aside the Impugned Order passed by the Commercial Court.

Issue

Whether issues involving enforcement of the conditions of a contract can be the subject matter of an application for interim measures under Section 9 of the Act.

Arguments

Contentions raised by the Appellant:

The Appellant submitted that the Franchise Agreement was for a fixed term of three (3) years and could not be prematurely terminated by either of the parties except in accordance with the terms stipulated in the Franchise Agreement. Further, the franchisor, that is, the Appellant had the sole right to terminate the Franchise Agreement provided that the five requisite conditions mentioned thereunder were satisfied.

Highlighting the provisions of Clause 5(22) of the Franchise Agreement, the Appellant submitted that it was the duty of the franchisee, that is, the Respondent to handover the Franchised Premises to the Appellant for a minimum period of three months in the event a dispute arose between the parties to the Franchise Agreement.

The Appellant referred to Section 14 (Contracts not specifically enforceable) of the Specific Relief Act, 1963, and submitted that in view of the nature of conditions incorporated in the Franchise Agreement, the contract between the parties was not determinable in nature and that only the Appellant could terminate the Franchise Agreement.

The Appellant, in order to support its submissions, placed reliance on DLF Homes Developers Limited v. Shipra Real Estate Limited and Others [2021 SCC Online Del 4902], wherein the Delhi High Court analysed the question on determinability of contracts in detail.

Contentions raised by the Respondent:

Placing reliance on ABP Network Private Limited v. Malika Malhotra [O.M.P. (I) (COMM) 292 of 2021], the Respondent debated as to what nature of contract could be said to be determinable in law. The Respondent averred that the Franchise Agreement entered into between the Appellant and the Respondent was determinable in nature and thus could be terminated by the Respondent.

With respect to the contention of the Appellant regarding the Respondent’s duty to handover the Franchised Premises, the Respondent submitted that the handover of the Franchised Premises to the Appellant had become infructuous in view of the passage of time.

Lastly, the Respondent submitted that the prayers made by the Appellant in its Application, did not fall within the purview of Section 9(ii) clauses (a) to (e) (application to Court for an interim measures of protection) of the Act.

Observations of the Gujarat High Court

The GHC observed that as per the law laid down by the Supreme Court in Arvind Constructions Company Private Limited v. Kalinga Mining Corporation [(2007) 6 SCC 798], the powers under Section 9 of the Act are to be exercised in accordance with the recognized principles that are applicable when a court exercises its powers under Order 39 of the Code of Civil Procedure, 1908, to grant interim injunction.

The GHC further observed that the establishment of prima facie case, balance of convenience and irreparable injury are all relevant considerations while passing orders granting interim measures under Section 9 of the Act. Moreover, interim injunction is an equitable remedy and cannot be granted in a case where it would amount to granting a principal relief.

Essentially, the interim reliefs granted by a court under Section 9 of the Act are intended to protect and preserve the subject matter of arbitration as well as balance the equitable rights of the parties, during the pendency of the arbitral proceedings.

The Appellant in its Application had sought a direction to restrain the Respondent from carrying out any activity at the Franchised Premises and to handover the Franchised Premises to the Appellant. The Appellant had also sought to restrain the Respondent from conducting a business similar to the business mentioned in the Franchise Agreement.

The GHC further observed that the Commercial Court had ruled that no irreparable loss would arise to the Appellant and that the Appellant could be compensated monetarily for the reliefs sought by it in its Application, if it finally succeeded in the arbitral proceedings.

Decision of the Gujarat High Court

The GHC ruled that the Commercial Court was justified in observing that the reliefs which were prayed for by the Appellant were of such nature in respect of which the Appellant could be compensated in terms of money.

The GHC held that granting the relief of directing the Respondent to handover the Franchised Premises to the Appellant and to restrain the Respondent from carrying out any activity at the Franchised Premises, were reliefs of a final nature. Moreover, the effect of granting such relief to the Appellant would bring the business of the Respondent to a complete halt.

Further, the issues involving enforcement of conditions of the Franchisee Agreement and the applications of the parties arising therefrom, should be decided and resolved in the arbitration proceedings. As such, the question of determinability of the Franchisee Agreement is also an arbitrable issue that is to be decided by the arbitrator and cannot be weighed for merits by the GHC.

Therefore, there being no grounds to interfere with the Impugned Order passed by the Commercial Court, the GHC dismissed the appeal filed by the Appellant.

VA View:

The GHC in this Judgment has rightly held that proceedings under Section 9 of the Act are not meant for enforcement of the conditions of a contract as the said conditions could be enforced only when the rights of the parties to such contract are finally adjudged or crystalized by the arbitrator. Besides, granting any relief in favour of the Appellant, directing the Respondent to handover the Franchised Premises to the Appellant and restraining the Respondent from carrying out any activity at the Franchised Premises, would tantamount to granting principal relief to the Appellant.

Affirming the Commercial Court’s decision, the GHC reiterated that the proceedings under Section 9 of the Act which are for interim measures, cannot be converted into proceedings where a party may seek the final relief indirectly.

Therefore, through this Judgment the GHC has clarified that the principal relief cannot be granted at the interim stage, and granting interim directions which are indirectly in the nature of final relief is not permissible in law.

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

SEBI: A company cannot abdicate its responsibility to verify a news article that has appeared in the newspaper

The Securities and Exchange Board of India (“SEBI”) has, in its order dated June 20, 2022, in the matter of M/s. Reliance Industries Limited (Adjudication Order No. ORDER/BM/LD/2022-23/17202-04) held that a company cannot abdicate its responsibility to verify a news article that has appeared in the newspaper.

Facts

SEBI conducted an investigation in the suspected insider trading activities in the scrip of Reliance Industries Limited (“Noticee 1”). Based on the findings of the investigation, adjudication proceedings were initiated against Noticee 1, Ms. Savithri Parekh, Compliance Officer (“Noticee 2”), and Mr. K. Sethuraman, Compliance Officer (“Noticee 3”) (collectively, “Noticees”) under Section 15HB (which provides for penalty for violation of the provisions of the Act) of the Securities and Exchange Board of India Act, 1992 (“SEBI Act”) for the alleged non-compliance with code of conduct for trading window closure and non-adherence to Principle no. 4 under Schedule A – Principles of Fair Disclosure for purposes of Code of Practices and Procedures for Fair Disclosure of Unpublished Price Sensitive Information (“Principles of Fair Disclosure”).

A Show Cause Notice (“SCN”) was issued to the Noticees to show cause as to why an inquiry should not be initiated against the Noticees and why penalty, if any, should not be imposed upon Noticees under Section 15HB of the SEBI Act for the aforesaid violations alleged to have been committed by Noticees.

Issue

• Whether the Noticees have violated the Principles of Fair Disclosure read with Regulation 30(11) of the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (“LODR Regulations”) by not disclosing or clarifying to the stock exchange the Unpublished Price Sensitive Information (“UPSI”) relating to Facebook investing in Reliance Jio (“Jio-Facebook Deal”) which got disclosed through the publication in the newspaper; and
• Whether Noticee 2 has violated clause 4 of the minimum standards for code of conduct for listed companies to regulate, monitor and report trading by designated persons as specified in Schedule B read with Regulation 9(1) of SEBI (Prohibition of Insider Trading) Regulations, 2015 (“PIT Regulations”) by not closing the trading window with respect to the UPSIs.

Arguments

Contentions of SEBI:

During the investigation, SEBI gathered that there was lot of news flow around Jio-Facebook Deal in the month of March and April, 2020 prior to the corporate announcement made on April 22, 2020. It was observed that the first news about the impending Jio-Facebook deal was published in the Financial Times, London (“FT”) on March 24, 2020, post market hours and, thereafter, the said news report of FT was widely circulated in Indian media on the same day and next day. The news articles, inter-alia, stated that (i) Facebook is seeking to buy a multibillion-dollar stake in Reliance Jio; (ii) Facebook was close to signing a preliminary deal for a 10% share in Jio; and (iii) a deal with Facebook was due to be announced in March end, coinciding with the end of the Indian financial year. Post publication of said news articles, the scrip price of Noticee 1 went up by almost 15% on March 25, 2020. Various other news articles/items were published/appeared in media relating to Jio-Facebook Deal prior to its corporate announcement by Noticee 1.

It was observed that with regard to the above, the Noticees did not comply with Principle no. 4 of the Principles of Fair Disclosure. The aforesaid principle deals with prompt dissemination of UPSI that gets disclosed selectively, inadvertently or otherwise to make such information generally available. Further, Noticee 2 did not comply with the code of conduct for closure of the trading window, when the UPSI was in existence. Noticee 2 did not (i) close trading window for all designated persons and their immediate relatives for the UPSI; (ii) notify the stock exchanges about the official trading window closure; and (iii) notify the period of closure of trading window to the stock exchanges after closing the trading window during which the UPSI was in existence.

Contentions of the Noticees:

The SCN alleges, firstly, that although Noticee 1 was aware of the news reports published on March 24, 2020 and March 25, 2020, yet it did not issue any clarification, as required under Regulation 30(11) of the LODR Regulations. The Noticees contended that this allegation was wholly misplaced, which is apparent from a plain reading of the said regulation.

Regulations 30(10) and (11) of the LODR Regulations state as follows:

“(10) The listed entity shall provide specific and adequate reply to all queries raised by stock exchange(s) with respect to any events or information:

Provided that the stock exchange(s) shall disseminate information and clarification as soon as reasonably practicable.

(11) The listed entity may, on its own initiative also confirm or deny any reported event or information to stock exchange(s).”

The Noticees contended that the present case is admittedly not one to which Regulation 30(10) of the LODR Regulations applies, since no query was raised by the stock exchanges. The issue that falls for consideration therefore is whether there is any obligation imposed on a listed entity under Regulation 30(11), de hors a query from a stock exchange, to confirm or deny information contained in media reports or appearing in other public fora (such as twitter or other social media platforms). According to the Noticees, plain language of Regulation 30(11) of the LODR Regulations makes it clear that the LODR Regulations impose no such obligation. The use of the phrases “may” and “on its own initiative” occurring in Regulation 30(11) of the LODR Regulations clearly brings out that what is contemplated in this provision is suo motu action by a listed entity. It is a settled principle of statutory interpretation that the word ‘may’, in a general sense, is permissive and confers discretion. Regulation 30(11) of the LODR Regulations does not impose any obligation on a listed entity, much less a positive obligation to confirm or deny any and every reported event or information.

Secondly, the Noticees contended that the charge framed by SEBI is with reference to the Principles of Fair Disclosure. In order to appreciate the substance of the obligation imposed under Principle no. 4 (“prompt dissemination of UPSI that gets disclosed selectively, inadvertently or otherwise to make such information generally available”) of the Principles of Fair Disclosure, it is necessary to read the same with Principle no. 1, which is reproduced below:

“Prompt public disclosure of unpublished price sensitive information that would impact price discovery no sooner than credible and concrete information comes into being in order to make such information generally available.”

The term “prompt dissemination” occurring in Principle no. 4 takes its colour from Principle no. 1, which requires that UPSI must be disclosed no sooner than when it has become “credible and concrete information.” Any other interpretation of these provisions would result in a conflict between the substantive obligation under Principle no. 1 to disclose only such information as is “credible and concrete” and the requirement under Principle no. 4 to undertake “prompt dissemination” of UPSI.

The Noticees contended that it is a well settled maxim that a harmonious construction must always be preferred to one that would present a conflict between provisions occurring in the same body of rules/regulations. A harmonious construction of Principle no. 1 and Principle no. 4 would yield the result that only such information as is “credible and concrete” within the meaning of Principle no. 1 is required to be promptly disseminated in accordance with Principle no. 4.

The SCN takes a position that Principle no. 4 supersedes Principle no. 1. The Noticees contended that it is an elementary legal proposition that such an interpretation, which renders one provision of the regulations redundant, is unsustainable and must be avoided.

The Noticees further contended that after securing the requisite board approvals of all involved parties, the transaction documents were executed on April 21, 2020 in the United States of America and Noticee 1 intimated the stock exchanges on April 22, 2020. Until the execution of the definitive transaction documents, there was only a non-binding arrangement between the parties to explore the transaction and there was no certainty that the proposed transaction will be consummated. In regard to each investment into Jio, the disclosure was accordingly made by Noticee 1 immediately upon execution of the transaction documents by the parties thereto.

The Noticees iterated that, in addition and without prejudice to the above, the transactions were entered into during highly uncertain times of COVID-19, and the global impact of the pandemic on business sentiment particularly in March and April, 2020. There was no certainty that the deals which were under negotiation would be signed, until the signatures of the counterparty were actually received and there was every likelihood that the then prevailing global restrictions would cause the negotiations to be deferred to an uncertain future date.

Further, with respect to the alleged violations with the code of conduct for closure of the trading window, the Noticees contended that there is no SEBI regulation or standard which requires notification of trading window closure period to the stock exchanges.

Observations of the Adjudicating Officer

It was observed by the Adjudicating Officer (“AO”) that the UPSI relating to Jio-Facebook Deal had come into existence on September 1, 2019 when the initial discussion on potential transaction with Facebook started and that it became generally available upon its publication in various newspapers and media reports on March 24, 2020. From the submission made by Noticee 1 during the investigation, it was observed that Noticee 1 was aware of all the news reports published/appearing in media on March 24 and 25, 2020 relating to Jio-Facebook Deal.

The AO observed that the Noticee 1, in its submission, stated that the allegation is wholly misplaced, which is apparent from a plain reading of Regulation 30(11) of the LODR Regulations. It noted that the present case is not one to which Regulation 30(10) of the LODR Regulations applies, since no query was raised by the stock exchange(s) with respect to any events or information pertaining to the Jio-Facebook Deal during March, 2020 and particularly with respect to the media reports.

One of the circumstances contemplated in law is that if the UPSI is somehow selectively available to someone or is being made available in bits and pieces like rumours or press articles carried in newspapers, the law provides a mechanism where company can clarify on the rumour or such articles in newspapers. This forms a major part of the task that a company would need to address from rumour verification perspective. It has been argued by the Noticees that no clarification was asked from them and thus they have not provided and that there is no compulsion under the law for them to do so. However, the AO observed that a company cannot abdicate its responsibility to verify a news article that has appeared in the newspaper. One of the issues is that the company wanted to keep the information enveloped in secrecy until made public and it clearly failed in that objective. Further, when the bits of the UPSI became selectively available, the company abdicated its responsibility to verify and come clean on the unverified information that was floating around.

The other predicament the Noticees presented was that they could not have clarified the rumour on its own because the agreement was yet to be signed, approved by the Board of the company and that it was not yet final. Here, too, the AO found it hard to be convinced that the company would respond to rumours only after finality of transactions. On a mere perusal of the announcements made by companies on the stock exchanges, there are plethora of announcements where only the memorandum of understanding has been entered, or where term sheet has been signed, or other acquisition are being scouted.

While Noticee 1 had the obligation to have enveloped the UPSI, however having come to know about the selective availability of the information, the AO noted that it was incumbent upon the Noticee 1 to provide due clarification on its own. Thus, Noticee 2 and Noticee 3, on behalf of Noticee 1, should have clarified to the stock exchanges on the news item.

The Noticees have bargained about the harmonious construction of regulations and the two principles – that there should be prompt disclosure of inadvertent or otherwise available information to make it generally available (Principle no. 4); and that there should be disclosure of credible and concrete information (Principle no. 1). The principle of harmonious construction is the bedrock of legislative interpretation. The harmonious interpretation principle applies to the entire regulation and its various provisions for the ultimate purposes for which the regulation has been notified. Applying this selectively only for the principles 1 and 4 will not provide the desired result sought to be achieved by law, which in this case, the Noticees are attempting to do.

Thus, the AO noted that the Noticees have violated Principle no. 4 of Principles of Fair Disclosure. In the case of Chairman, SEBI v. Shriram Mutual Fund [[2006] 5 SCC 361] (“Shriram Mutual Fund Judgment”), the Hon’ble Court had observed: “In our considered opinion, penalty is attracted as soon as the contravention of the statutory obligation as contemplated by the Act and the Regulations is established and hence the intention of the parties committing such violation becomes wholly irrelevant. A breach of civil obligation which attracts penalty in the nature of fine under the provisions of the Act and the Regulations would immediately attract the levy of penalty irrespective of the fact whether contravention made by the defaulter with guilty intention or not.” Therefore, the aforesaid violations committed by Noticees attracted monetary penalty.

Lastly, with respect to the charge of whether the compliance officer has discharged the responsibility under the PIT Regulations, the AO noted that, as per the submissions made by Noticee 2, it is evident that the code has been implemented in the manner that was intended by Noticee 1. Thus, under the company code for closure of trading window, the responsibility was cast on the relevant employees cognizant of their responsibilities.

Decision

The AO did not agree with the submissions made by the Noticees and held them liable for the violation of the provisions of Principle no. 4 of Principles of Fair Disclosure. Basis the Shriram Mutual Fund Judgment, the adjudicating officer imposed monetary penalty on the Noticees.

Further, given that the Noticee 1 had implemented the code of conduct designed by it under the PIT Regulations, the AO did not hold Noticee 2 liable for any violation of not having closed the trading window.

VA View:

Preservation of UPSI is an important duty of any company. Listed entities have the obligation to envelope UPSI. However, having come to know about the selective availability of the information, it is incumbent upon the companies to provide due clarifications on its own. The Principles of Fair Disclosure cast a fiduciary duty to make accurate and complete disclosures to all the stakeholders.

In the present case, it was observed that the Noticees did not comply with the Principles of Fair Disclosure requiring prompt dissemination of UPSI that gets disclosed selectively, inadvertently or otherwise and to make such information generally available. Keeping in view the intent of the regulations, the AO has rightly penalized the Noticees for violation of the Principles of Fair Disclosure.

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

Supreme Court: NCLT/NCLAT should not sit in appeal over commercial wisdom of the CoC to allow withdrawal of CIRP

The Hon’ble Supreme Court (“SC”) has in its judgment dated June 3, 2022, in the matter of Vallal RCK v. M/s. Siva Industries and Holdings Limited and Others [Civil Appeal Nos. 1811-1812 of 2022], held that the NCLT/NCLAT should not sit in appeal over commercial wisdom of the Committee of Creditors (“CoC”) to allow withdrawal of the Corporate Insolvency Resolution Process (“CIRP”).

Facts

IDBI Bank Limited had preferred an application under Section 7 of the Insolvency and Bankruptcy Code, 2016 (“Code”) for initiating the CIRP of M/s. Siva Industries and Holdings Limited (“Corporate Debtor”) before the National Company Law Tribunal, Chennai (“NCLT”). On July 4, 2019, the NCLT admitted the aforesaid application and the CIRP of the Corporate Debtor was initiated. M/s Royal Partners Investment Fund Limited submitted a resolution plan before the CoC of the Corporate Debtor. However, the aforesaid resolution plan could not be approved by the CoC of the Corporate Debtor as it could not meet the requirement of receiving 66% voting share.

Thereafter, the resolution professional preferred an application under Section 33(1)(a) of the Code for seeking initiation of the liquidation process of the Corporate Debtor. Further, the promoter of the Corporate Debtor (“Appellant”), preferred a settlement application before the NCLT showing willingness to offer one-time settlement plan and seeking necessary directions to the CoC to consider the terms of the settlement plan. The settlement plan was considered and deliberated by the CoC of the Corporate Debtor during the course of the 13th, 14th and 15th meetings of the CoC. After several rounds of deliberations, the final settlement plan was put up for voting in the 16th CoC meeting held on January 18, 2021 when the settlement plan received only 70.63% votes as against the minimum requirement of 90% voting share as contemplated in Section 12A of the Code.

However, subsequently, International Assets Reconstruction Company Private Limited (“IARCL”) holding a voting share of 23.60% decided to approve the settlement plan and informed about it to the resolution professional. Hence, pursuant to the approval of IARCL, the settlement plan came to be approved by more than 90% of the CoC in terms of their respective voting share. Accordingly, pursuant to the approval of IARCL, the resolution professional preferred an appropriate application seeking necessary directions from the NCLT. In view thereof, on March 29, 2021, NCLT directed the resolution professional to reconvene a meeting of the CoC. Subsequently, in the 17th CoC meeting held on April 1, 2021, the settlement plan was approved by the CoC with a voting percentage of 94.23%. Accordingly, the resolution professional preferred an application before the NCLT for seeking approval of the settlement plan which was already approved by the CoC.

However, on August 12, 2021, the NCLT passed an order dismissing the above-mentioned application seeking approval of the settlement plan and observed that it was not a settlement simpliciter under Section 12A of the Code but a “Business Restructuring Plan”. Further, on the same day, the NCLT passed another order thereby initiating the liquidation process of the Corporate Debtor.

Being aggrieved by both the above-mentioned orders passed by the NCLT on August 12, 2021, the Appellant preferred two appeals before the National Company Law Appellate Tribunal, Chennai (“NCLAT”). However, the NCLAT dismissed both the appeals by a common judgment pronounced on January 28, 2022.

Aggrieved by the judgment dated January 28, 2022 pronounced by NCLAT, the Appellant approached the SC. On March 11, 2022, the SC issued a notice upon the respondents and granted stay on the judgment dated January 28, 2022 pronounced by the NCLAT.

Before the SC, there was no representation made on behalf of the Corporate Debtor, whereas the resolution professional of the Corporate Debtor submitted that he does not wish to contest the matter. However, since an important question with regard to the interpretation of Section 12A of the Code arose for consideration, the SC deemed it appropriate to decide the issue involved in the matter.

Issue

Whether the adjudicating authority or appellate authority can sit in appeal over the commercial wisdom of the CoC.

Arguments

Contentions raised by the Appellant:

The Appellant submitted that it is trite law that the adjudicating authority or appellate authority cannot sit in appeal over the commercial wisdom of the CoC. As such, NCLT and NCLAT, both have grossly erred in rejecting the settlement plan and withdrawal of CIRP, considering that the settlement plan was approved by 94.23% of the CoC in terms of voting share.
The Appellant further submitted that one of the main objects of the Code is allowing the Corporate Debtor to continue operating as a going concern as well as paying the dues of the creditors to the maximum extent possible. As such, the judgment dated January 28, 2022 passed by the NCLAT and both the orders dated August 12, 2022 passed by the NCLT are against the spirit and object of the Code.

Observations of the Supreme Court

The SC made reference to the Report submitted by the Insolvency Law Committee (“Committee”) submitted on March 26, 2018, which had, inter alia, recommended for inclusion of a provision in the Code for withdrawal of application for initiation of CIRP admitted by the Adjudicating Authority, wherein it was recommended that such an exit should be allowed provided the CoC approves the same by 90% voting share. In view of such recommendation by the Committee, Section 12A was introduced in the Code by way of the Insolvency and Bankruptcy Code (Second Amendment) Act, 2018. Accordingly, Regulation 30A (which deals with “Withdrawal of application”) was introduced into the Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations, 2016 by way of notification dated July 25, 2019.

The SC further relied upon its observations made in the case of Swiss Ribbons Private Limited and Another v. Union of India and Others [(2019) 4 SCC 17] wherein it was observed that Section 12A of the Code passes the constitutional muster. Thereafter, the SC relied upon a plethora of landmark decisions passed by it in previous judgments wherein it has been consistently held that the commercial wisdom of the CoC has been given paramount status without any judicial intervention for ensuring completion of the CIRP process within the timelines prescribed by the Code, notwithstanding that majority of those decisions are in the context of approval of resolution plan. However, the underlying principle remains the same that the commercial wisdom of the CoC is paramount.

The SC further observed that in various CoC meetings of the Corporate Debtor, the members of the CoC had widely deliberated on the issue of settlement and the fact that, one of the creditors namely IARCL, who had initially opposed the settlement plan but subsequently decided to support it, substantiates that the decision of the CoC to approve the settlement plan has been taken after sufficient discussion and deliberation on the pros and cons of the settlement plan.

Decision of the Supreme Court

In view of the above-mentioned observations, the SC allowed the appeal, quashed and set aside the judgment dated January 28, 2022 passed by the NCLAT and both the orders dated August 12, 2021 passed by the NCLT and allowed the withdrawal of CIRP of the Corporate Debtor.

VA View:

The SC has rightly observed that when 90% or more of the creditors, in their wisdom after due deliberations, arrive at the conclusion that it will be in the interest of all the stakeholders to permit settlement and withdrawal of CIRP, the adjudicating authority or the appellate authority cannot sit in appeal over the commercial wisdom of the CoC, unless it is observed that the decision of the CoC is capricious, arbitrary, irrational and de hors the provisions of the statute or the rules.
In fact, the SC has reaffirmed the supremacy of commercial wisdom of the CoC time and again in a plethora of judgments. As such, it is high time that the adjudicating authority and the appellate authority keep minimal judicial interference and allow a company to undergo CIRP smoothly as per the commercial wisdom of the CoC.

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

NCLAT: The NCLT does not have the power to suo-moto classify a transaction as a ‘preferential transaction’.

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]

Between The Lines | NCLT: IBC and RBI Guidelines are Disjoint Sets, there is no question of one prevailing over the other.

The National Company Law Tribunal, Kolkata (“NCLT”) has in its order dated May 17, 2022 (“Order”) in the matter of Hemant Kanoria v. SREI Infrastructure Finance Limited (Through its Administrator, Mr. Rajneesh Sharma) [IA (IB) No. 75/KB/2021 in CP (IB) No. 295/KB/2021] held that the Insolvency and Bankruptcy Code, 2016 (“IBC”) and guidelines issued by the Reserve Bank of India (“RBI”) are disjoint sets and there is no question of one prevailing over the other.

Facts

SREI Infrastructure Finance Limited (“SIFL”) and SREI Equipment Finance Limited (“SEFL”) are financial service providers undergoing Corporate Insolvency Resolution Process (“CIRP”) envisaged under the provisions of the IBC.

The RBI had issued a circular titled “Master Directions on Frauds – Classification and Reporting by commercial banks and select FIs” on July 1, 2016 (Updated as on June 3, 2017) (“RBI Circular”) directing the banks to report the fraud status of the accounts in default. Clause 8.9.5 of the RBI Circular provides for completion of forensic audit within a period of three months from the date of the Joint Lenders’ Forum (“JLF”) authorizing the audit.

In the present case, two major creditors namely Axis Bank and UCO Bank had convened JLF meeting on March 24, 2021 and appointed KPMG Assurance and Consulting Services LLP (“KPMG”) to conduct the forensic audit. In view of Clause 8.9.5 of the RBI Circular, the forensic audit was supposed to be concluded by June 24, 2021.

Upon a petition filed by the RBI, on October 8, 2021, the NCLT initiated the CIRP of SIFL and SEFL and appointed Mr. Rajneesh Sharma as administrator of both the aforesaid companies. Pursuant to his appointment, the administrator appointed BDO India LLP (“BDO”) to carry out transaction audit of SIFL and SEFL and probe the vulnerable transactions as per the relevant provisions under the IBC.

Thereafter, Mr. Hemant Kanoria (“Applicant”), shareholder of SIFL and SEFL and a member of the suspended board of directors of SIFL preferred an application before the NCLT, inter alia, praying for setting aside the appointment of KPMG and restraining Axis Bank and UCO Bank from conducting and proceeding with the process of audit through KPMG.

Issues

• Whether the NCLT has the jurisdiction to stop an audit commissioned under the RBI Circular.
• Whether the IBC will prevail over the RBI guidelines.

Arguments

Contentions raised by the Applicant:

The Applicant submitted that an audit being conducted at the instance of some bankers cannot be continued after commencement of CIRP, which itself was initiated at the instance of the RBI and thereafter the administrator appointed BDO as transactional auditor to conduct investigation of vulnerable transactions.

The major contentions raised by the Applicant are briefly set out:

• The Applicant is a member of the suspended board of directors of SIFL whose subsidiary is SEFL, and therefore has the locus standi to prefer the present application.
• The KPMG report was completed on December 22, 2021, with a delay of nearly six months, and was therefore not in compliance with the timeline provided as per Clause 8.9.5 of the RBI Circular. In fact, as per Clause 8.9.6 of the RBI Circular, the entire exercise is stipulated to be completed within six months from the date when the first member bank reported the account as fraud.
• KPMG conducted an audit without consulting the erstwhile management. Further, once a transactional auditor has been appointed under the IBC, a previous audit cannot continue. There cannot be a parallel forensic audit without consulting the erstwhile management at the instance of the bankers.
• The IBC is recognized to be complete in itself and has overriding effect over any other legislation or instrument in the event / to the extent of any inconsistency whatsoever.
• Basis perusal of the caveats and limitation to access to data whilst preparing the report as clearly mentioned in the KPMG report, it is evident that KPMG report is incomplete. KPMG has stated that the comments in the report may not be considered as definitive pronouncement.
• If the purpose of the IBC is to revive or ensure continued existence of an enterprise and to maximize its value, it is imperative that the transaction audit being conducted under the IBC should get precedence.
• On the one hand, KPMG conducted audit of SIFL and SEFL at the instance of the banks, whereas on the other hand, the banks were aware of and voted in favour of the administrator appointing a transaction auditor.
• In the event if there is inconsistency between the KPMG report and the BDO report, it will give rise to a conflict situation.
• Under Section 25(2)(j) of the IBC, it is the duty of the resolution professional (administrator in the present case) to file application for avoidance of transactions.
• As the scope of investigation is common, it is the IBC and the report filed as per the provisions of the IBC, which shall prevail.
• Previously there were preliminary reports prior to issuance of final report. This raises a serious apprehension that the contents of the report would have been modified at the behest of the bankers.
• The RBI Circular is a framework laid down under which the banks have to act, and it cannot overhaul the framework of the IBC.
• There is no explanation as to why the audit procedure was not completed by KPMG within the stipulated timeframe.

Contentions raised by Axis Bank and UCO Bank:

The submissions of Axis Bank and UCO Bank are broadly set out hereunder:

• The resolution professional or liquidator who has to form an opinion about avoidance transactions are bound by numerous restrictions. For instance, if Section 43 (Preferential Transactions) of the IBC is referred to, the opinion formed by the resolution professional or liquidator will be restricted to only the limited purpose of that section, and also for a limited duration as stipulated therein.
• The report submitted by auditors appointed by the resolution professional or liquidator under the provisions of the IBC is limited in scope, with limited consequences and to be given in respect of finite time periods.
• The proceedings emanating from KPMG report before other Courts including Criminal Courts are not hit by moratorium under Section 14 of the IBC, as the moratorium pertains to the corporate debtor and not in respect of the erstwhile management or shareholders of the corporate debtor.
• The banks have no role in determination of resolution professional to file applications. This does not preclude the lenders from commissioning a separate audit and taking an action independent of the IBC.
• The Applicant wants the NCLT to assume the jurisdiction to stay the criminal aspects that have been thrown up by the audit commissioned by the lenders, and such a relief cannot be granted within the framework of the IBC. The NCLT has not been given the jurisdiction to look into matters that are beyond the IBC itself.
• The issue of breach of timeline by KPMG in submitting its report lies between the banks and the RBI, and the Applicant cannot take any advantage of the same.
• Forensic audit carried out under the Banking Regulation Act, 1949 and not under the provisions of the IBC cannot be stopped by the NCLT. In this regard, reliance was placed on BV Bhaskar Reddy v. Bank of India and Others [MANU/ND/1394/2021] decided on January 7, 2021 by NCLT, Hyderabad.

Contentions raised by KPMG:

KPMG submitted that the prayer sought by the Applicant asking KPMG to not continue the investigation is infructuous qua KPMG as the report has been submitted.

Observations and decision of the NCLT

Considering the KPMG report being submitted now, the NCLT observed that all other prayers sought by the Applicant have become infructuous and the only Prayer (b) remains to be answered, which is – seeking an Order to set aside the audit process conducted by KPMG in light of initiation of CIRP.

On the issue of jurisdiction of the NCLT, the NCLT observed that basis the powers vested under the IBC, the NCLT lacks the jurisdiction to stop an audit commissioned under the RBI Circular, the intent of which is altogether different.

Further, on the issue of whether the IBC will prevail over the RBI guidelines, the NCLT observed that the RBI circulars work in different fields and are, in a manner of speaking, disjoint sets. The adequacy or otherwise of KPMG’s audit report would no doubt be determined by the lenders. As such, the NCLT held that there is no possibility of conflict between the two and there is no question of one prevailing over the other.

VA View:

The NCLT has rightly observed that the RBI circulars and guidelines operate in a different scope and framework and not necessarily overlap with the provisions of the IBC, in which scenario the question of inconsistency and / or one prevailing over the other does not even arise. Often many applications are filed before the National Company Law Tribunals, pitting some or the other legislation or instrument against the IBC, thereby seeking prayer that the provisions of the IBC shall prevail, in complete ignorance of the fact that there exists no inconsistency in the first place.

Further, the NCLT has correctly held that it is bound by limited powers and functions as envisaged under the IBC and cannot venture into adjudication of issues beyond its jurisdiction and cannot pass orders such as stopping audit process commissioned under the framework of RBI. The implication for the banks is that they are fully entitled to conduct forensic audits of borrowers under resolution process or liquidation and take action against the management responsible for the same without being circumscribed by the strict requirements that avoidance transactions have to be met under IBC.

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