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TaxBuzz | NCLT overrules applicability of GAAR in case of Panasonic Merger!

Recently, the Chandigarh Bench of National Company Law Tribunal (“NCLT”) approving the amalgamation of a loss-making company, Panasonic India Private Limited (Transferor Company) with the profit-making company, Panasonic Life Solutions India Private Limited (Transferee Company), overruled the objections raised by the Income tax Department qua the proposed merger on the ground that the proposed merger was designed for tax avoidance since – (a) the amalgamated company sought to claim benefit of carry forward losses and unabsorbed depreciation of the amalgamating company under section 72A of the Income tax Act, 1961 (“the Act”) and, (b) the shareholders of the amalgamating company stood to benefit from exemption from levy of tax on capital gains.

In that case, the ultimate ownership of both the amalgamating and amalgamated company was held by M/s Panasonic Corporation, Japan, and the Transferor company, i.e., Panasonic India Private Limited had accumulated losses of INR 14,375 million approx. in assessment year 2020–21. During the pendency of the proposed scheme of amalgamation before the NCLT, the Income tax Department filed a report alleging, inter alia, that –

the scheme of amalgamation was not at arm’s length and could not be termed as a prudent acquisition on any commercial or business terms;
the main objective of amalgamation was to take the benefit of accumulated losses which were eligible for set off in future years;
proposed amalgamation was prejudicial to the interest of the Revenue so much so that the same would cause loss of INR 3,594 Million (i.e., 25% of INR 14,375 Million plus applicable surcharge and cess) on account of possible non-payment of capital gain realisable by the shareholders of the Transferor company by selling shares of the Transferee company in the future;
the proposed merger was a vehicle to transfer accumulated losses eligible for set off by the Transferor company to the Transferee company attracting provisions of section 96(1) under Chapter X of the Act, viz, General Anti-Avoidance Rules (“GAAR”).

While contending the above, the Income tax Department placed reliance on the decision of the Mumbai Bench of NCLT in the case of Gabs Investments Pvt. Limited and Ors. in CSP No.995 of 2017 and CSP No.996 of 2017 in CSA Nos.791, 792 of 2017 decided on 30.08.2018 and the decision of the NCLAT in the case of Wiki Kids Ltd. and Ors. Vs. Regional Director, Southeast Region, and Ors. in Company Appeal (AT) No.285 of 2017 decided on 21.12.2017.

In response thereto, the Petitioner companies contended that –

the proposed amalgamation was driven by commercial rationale (in detail), viz, reduction in operating and marketing cost, economies in procurement, increased value to customers, offering holistic customer solutions, enhancing shareholders value;
no prejudice was caused to the Revenue since the conditions of section 2(1B) read with section 47 of the Act were fulfilled;
conditions laid down under section 72A read with Rule 9C of the Income Tax Rules, 1962 (“IT Rules”) would be fulfilled by the Petitioner companies in order to qualify for carry forward and set off of unabsorbed business losses and brought forward depreciation of the amalgamating company in the hands of the amalgamated company and all the pending tax litigation of the Transferor company was to continue in the hands of the Transferee company in the same manner;
there was no loss to the Revenue with respect of capital gains in the hands of the shareholders of the Transferor company upon the ultimate sale of shares in Transferee company since non-resident shareholders were in anyway not obligated to pay capital gains taxes by virtue of the relief under the India’s tax treaty with Netherlands and Singapore on transfer of shares of the Transferee company if the transaction of merger had not taken place;
value in the hands of the shareholders of the Transferor company remained the same both pre and post amalgamation.

Distinguishing the decisions in the case of Gabs Investments (supra) and Wiki Kids (supra), the NCLT observed that –

the rationale of the scheme justified the claim of the Petitioner companies that the scheme was for business consolidation and the tax arrangements were merely a consequential fallout of implementation of the scheme of amalgamation by placing reliance on the decision of the Supreme Court in the case of Hindustan Lever Employees’ Union V. Hindustan Lever Ltd. MANU/SC/0101/1995 where it was held that “unless there is some illegality or fraud involved in the scheme the court cannot decline to sanction the scheme of amalgamation”;
the provisions of section 72A read with Rule 9C and section 79 of the Act were sufficient to protect the interests of the Revenue in the case of amalgamation / demerger;
since the scheme of amalgamation approved by NCLT cannot override the existing provisions of the Act, the Revenue can examine the issues arising therefrom at the time of assessment of the Petitioner companies;
as regard GAAR, in case the assessing officer during the course of assessment/reassessment proceedings believes that GAAR should be invoked, the Income tax Department is at liberty to do so provided the case is referred to Principal Commissioner or Commissioner of Income Tax who in turn has to refer the matter to the approving panel in accordance with the provisions of section 144BA of the Act.

Rejecting the objections raised by the Income tax Department and considering that the proposed schemer of amalgamation was in compliance with the requirements of all the relevant sections of Companies Act, 2013, the NCLT sanctioned the proposed scheme of amalgamation.

VA Comments:

The above order of NCLT provides significant relief to the industry, particularly in cases where the scheme is proposed for legitimate and bonafide commercial reasons and tax benefit, if any, is only incidental in nature. Reverse merger, i.e., merger of a profit making entity into the loss making entity, cannot, per se, be the ground to object to the scheme of amalgamation so long as there is commercial rationale for the same.
On the flip side, the Income tax Department may now seek to invoke GAAR during the assessment/ reassessment proceedings.
NCLT re-emphasized the well accepted principle of law that assessee can arrange his affairs so as to minimise his tax liability; in its commercial wisdom if the company had decided to have a particular arrangement by which there may even be benefit of saving income tax, that itself could not be a ground for coming to the conclusion that the sole object of framing the scheme is to defraud the Income Tax Department [refer: Company petition No 215/1978 between A.W. Figgis & Co Pvt Ltd decided by the High Court of Calcutta on 31st July 1978].

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For any clarification, please write to:

Mr. Rohit Jain: [email protected]

Ms. Puneeta Kundra: [email protected]

Between The Lines | NCLT: Corporate debtor cannot be sent into liquidation just because liquidation value is more than the value of the resolution plan

The National Company Law Tribunal, Kolkata (“NCLT”) has in its order dated April 6, 2022, in the matter of CFM Asset Reconstruction Private Limited v. S. S. Natural Resources Private Limited and Another [IA No. 538/KB/2021 in CP (IB) No. 349/KB/2017] held that a corporate debtor cannot be sent into liquidation just because liquidation value is more than the value of the resolution plan.

Facts
Ramsarup Industries Limited (“Corporate Debtor”) was admitted into corporate insolvency resolution process (“CIRP”) under Section 10 of the Insolvency and Bankruptcy Code, 2016 (“IBC”). Subsequently, the resolution plan submitted by S. S. Natural Resources Private Limited (“SRA/ Successful Resolution Applicant”) was approved by the committee of creditors (“CoC”) and the adjudicating authority. Upon approval of the resolution plan, nine appeals were preferred before the National Company Law Appellate Tribunal (“NCLAT”). One of the appeals was preferred by SRA on the grounds that the adjudicating authority has materially changed and altered the plan by imposing additional financial obligations on SRA.

There was another appeal of interest, filed by Vanguard Credit and Holdings Private Limited (“Vanguard”) before the Hon’ble Supreme Court (“SC”) (“Vanguard Appeal”). Vanguard was claiming to be owner of the land on which factory of the Corporate Debtor is situated. During the pendency of Vanguard’s appeal, the SRA did not take any steps for implementation of the plan and waited for the decision of the SC. The promoter of the Corporate Debtor also challenged the approval of the resolution plan.

The NCLAT by its common order dated March 4, 2021 (“NCLAT Order”) dismissed the appeals. It directed the monitoring committee to start taking steps to implement the resolution plan. It further directed that in case of failure by SRA to implement the resolution plan, an application for liquidation of the Corporate Debtor should be moved before the adjudicating authority, without any further delay.

Vanguard and SRA, both preferred a civil appeal before the SC. However, SRA’s appeal was dismissed, on May 4, 2021, on grounds of lack of substantial question of law. SRA decided to wait for the decision of the SC in Vanguard’s Appeal. However, the appeal was dismissed by order dated July 2, 2021.

Pursuant to the NCLAT Order, the chairman of the monitoring agency, which was overseeing the implementation of the resolution plan, issued a notice calling for the seventh meeting of the monitoring agency. In that meeting, SRA expressed its willingness to implement the resolution plan subject to some conditions. Further, SRA was unwilling to release the upfront payment to the monitoring agency to meet the CIRP costs and also objected to utilisation of the performance security until the Vanguard Appeal was decided by the SC.

SRA in an e-mail drew attention to the aforesaid meeting, stating that the demand by the monitoring committee to compensate the financial creditors, on account of delay in implementation of the resolution plan, is unjustified. Further, SRA also contended that it should be permitted to deposit the CIRP costs in an escrow account and its disbursement be kept on hold. The disbursement of the performance security and the interest earned thereon should also be kept on hold till disposal of the Vanguard Appeal that was pending before the SC.

CFM Asset Reconstruction Private Limited (“Applicant”) alleged that SRA had miserably delayed implementation of the resolution plan. Such delay had significantly depleted the time value of money and resulted in loss of business opportunity for the creditors and other stakeholders. Therefore, the creditors and stakeholders should be compensated adequately for such loss.

It was in this conspectus of facts that the interlocutory application was filed by the Applicant seeking (i) liquidation of the Corporate Debtor; (ii) direction against the monitoring agency to forfeit the performance security amount deposited by SRA; and (iii) seeking payment of interest by SRA from the date of approval of the resolution plan till the implementation of the resolution plan by SRA.

Issue
Whether a corporate debtor can be sent into liquidation just because liquidation value is more than the value of the resolution plan.

Arguments

Contentions raised by the Applicant:

The Applicant submitted that the adjudicating authority approved the resolution plan on September 4, 2019. Despite this, SRA went up in appeal challenging this approval. Ultimately, the NCLAT dismissed the appeal. Appeals were also preferred before the SC and the important fact is that on May 4, 2021, the SC dismissed SRA’s appeal and affirmed the order of the NCLAT. Therefore, insofar as SRA was concerned, the approved resolution plan had become final and binding.

The Applicant further submitted that after the order of the SC, there were several meetings of the monitoring committee. However, no steps had been taken. SRA put in a condition that whatever money it puts in must remain in escrow. Whatever money it puts in for day-to-day operation is subject to the monies being refunded to SRA in the event of the success of the Vanguard Appeal. This condition has been imposed after the resolution plan had been challenged right up to the SC, which appeal was dismissed. Therefore, SRA does not appear to be interested in implementation, which is why the Applicant has now applied for liquidation.

Further, various observations were noted that proved that the real intent of SRA was to wriggle out from implementation of the approved resolution plan. In spite of this, the NCLAT gave SRA a second lease of life to implement the resolution plan, with a condition that if it fails, the Corporate Debtor should be sent into liquidation.

On May 23, 2021, a mail was sent by SRA, which was squarely in breach of the approved resolution plan. Conditions were sought to be brought in apropos the implementation of the resolution plan, among which was that (i) performance security amount of INR 35 crores (provided to the resolution professional), which was encashed by the CoC in January 2020, to not be disbursed; and (ii) the entire implementation of the resolution plan was now made conditional on the result of the Vanguard Appeal. According to the Applicant, this shows that SRA had acted in breach of the resolution plan, and that it sought to impose conditions on implementation of the resolution plan after its approval by the adjudicating authority, the appellate tribunal and the SC, which is not permitted in law.

Subsequently, an interim application was filed on June 8, 2021 for liquidation of the Corporate Debtor in view of non-implementation of the resolution plan by SRA. The Applicant submitted that the breach having been committed, the Corporate Debtor should now be sent into liquidation.

It was further submitted that SRA had made incorrect statements in its reply affidavit. SRA had averred that to demonstrate its bona fide intention, payments towards workmens’ dues had been made. However, some of the items stated therein could not be treated as payments. When the breaches occurred, they were accepted as breaches by SRA.

The Applicant stated that SRA had delayed the implementation of the approved resolution plan by about 21 months, and now SRA is unwilling to implement the resolution plan unconditionally. The liquidation value in terms of the approved resolution plan was far more than the enterprise value for which the resolution plan of SRA had been approved. Since SRA had frustrated the entire exercise of the CIRP and the assets of the Corporate Debtor were depleting with time, it would leave all the stakeholders in a state of devastation.

Further, it was submitted that the resolution plan was approved in 2019 based on the valuation for the year 2018. Successive appeals by SRA should not be a ground for condonation of delay in implementation of the Resolution Plan. SRA had no reason to wait for the Vanguard Appeal to be decided by the SC.

Further, the Applicant submitted that one of the objectives of the IBC is maximisation of assets. If such maximisation lies in liquidation, then no advantage is to be gained by allowing implementation of a resolution plan after more than two years.

The Applicant also submitted that Section 33(4) of the IBC enjoins the adjudicating authority to pass an order of liquidation. The issue is to determine whether there is a default or not. The mandate of the statute is that if there is a default, the liquidation order must follow.

It is an accepted fact that after March 4, 2021, SRA did not comply with the timelines of the NCLAT Order or what was provided for in the resolution plan. In fact, right from March 4, 2021 to May 4, 2021, when SRA’s appeal to the SC got dismissed, there was no step taken under the resolution plan.

SRA said that the IBC is concerned with resolution and not liquidation of the corporate debtors, on the basis that the preamble does not speak of liquidation. The Applicant conceded that this was true, but liquidation is the consequence of failure of resolution.

Section 33(4) of the IBC requires that a liquidation order shall be passed, if the adjudicating authority determines that the corporate debtor has contravened the provisions of the resolution plan. The Applicant submitted that the fundamental issue is whether the resolution plan and its implementation was resisted after the NCLAT Order. If the determination was that it was so, then that is the end of the matter. Even if the term “shall”, occurring in Section 33(4) of the IBC, was to be read as “may,” no discretion should be exercised in favour of SRA, because it did not comply with its obligations even though an appeal remained pending.

Contentions raised by SRA:

SRA submitted that Vanguard filed an appeal against the NCLAT Order, since it was the owner of the land in which the factory of the Corporate Debtor was situated. The resolution plan provided that the land will come to the Corporate Debtor. This was a key feature of the resolution plan.

SRA further submitted that in the case of Babulal Vardharji Gurjar v. Veer Gurjar Aluminium Industries Private Limited and Another (“Veer Gurjar Judgment”), the SC held that the primary focus of the IBC is to ensure revival and continuation of the corporate debtor and, as far as feasible, to save it from liquidation. The SC had reiterated that the IBC is not a mere recovery legislation for creditors. If that is the principle of the IBC, then a creditor who files an application for commencing liquidation proceeding after the resolution plan has been approved, and that too only for the purpose of realising a higher value, should be discouraged and such application ought not to be entertained by the adjudicating authority.

SRA further submitted that the Vanguard land is recognised in the NCLAT Order. Therefore, the Vanguard Appeal becomes important and central to the resolution plan, without which the implementation was in jeopardy. If Vanguard was allowed to pull out, then the resolution plan would have failed, since there would be no resolution plan to be implemented at all. Naturally, SRA waited for the Vanguard Appeal to be decided.

Furthermore, SRA submitted that when an appeal is filed from an order and the appeal is disposed of, the original order is no longer enforceable. Therefore, the enforceable order is only of March 4, 2021, since the order of the adjudicating authority had now merged in the order of the appellate tribunal. He submitted that the adjudicating authority cannot now look into the conduct of SRA. The same principle will apply once the statutory appeal is filed before the SC against the NCLAT Order. Automatically, the NCLAT Order will merge into the order of the SC. SRA submitted that if a statutory remedy is available, then the order of the appellate forum will hold the field. So, at least before the May 4, 2021 judgment of the SC in SRA’s appeal, nothing survives. At this point, at best, the order dismissing Vanguard’s Appeal survives. Hence, once an appeal is filed, the matter is no longer enforceable.

On July 2, 2021, the SC dismissed Vanguard’s Appeal. SRA addressed an e-mail on the same day to the monitoring agency. On July 7, 2021, SRA offered to implement the entire resolution plan. However, at the meeting, the Applicant stated that unless interest was paid, it would oppose implementation of the approved resolution plan. Therefore, after July 7, 2021, all delay in implementation is attributable to the Applicant, which prevented the monitoring agency and SRA from implementing the resolution plan.

SRA urged the adjudicating authority to take a holistic picture. The adjudicating authority is not a forum for creditors to come and ask for interest for delay. The adjudicating authority must look at the conduct of the creditor, just as it must look at the conduct of SRA also. It pointed out that only one creditor, that is, the Applicant, is asking for interest, and that too after preventing the monitoring agency and SRA from implementing the resolution plan. Therefore, the creditor cannot use the forum of the adjudicating authority to arm-twist SRA to part with additional interest.

Observations of the NCLT

The NCLT observed that it was absolutely clear that the land standing in the name of Vanguard was the centrepiece of the entire resolution plan. It further noted that SRA had requested that the payments made by SRA towards, inter alia, workmen’s dues, be kept in an escrow account and not be distributed to the creditors because such distribution will cause irretrievable harm to SRA. The NCLT did not consider this to be an unreasonable request, or one that reflects any mala fide conduct on the part of SRA.

The NCLT further observed that, as judicially noticed by the SC in the Veer Gurjar Judgment, the preamble of the IBC lays a lot of emphasis on insolvency resolution within the timelines prescribed. Liquidation should be the last resort, when everything else has been attempted and failed. In the present case, there is a successful resolution applicant who is ready and willing to implement the approved resolution plan as it is. Although there were some delays in the insolvency resolution process of the Corporate Debtor, attributable to the fact that many appeals came to be filed right upto the SC, now there is a situation where SRA has parked the entire resolution amount in an account separately earmarked for this purpose. This amount is now ready and available for utilisation by various stakeholders.

The Applicant is admittedly pursuing its application for liquidation because the liquidation value is more than the enterprise value. That cannot be a ground for sustaining this application, nor is it in line with the objects of the IBC.

SRA was certainly at fault in not taking steps for implementation of the approved resolution plan after the NCLAT Order, coming up with the condition that until the Vanguard Appeal is decided, it is not in a position to implement the resolution plan.

Judgment

In light of the above observations, the NCLT noted that a mechanical interpretation that once a default is established, then liquidation should be the result, would not subserve the purposes of the IBC. Therefore, the NCLT directed that the management of the Corporate Debtor be transferred to SRA so that the resolution plan be completed. Accordingly, the interlocutory applications were dismissed by the NCLT.

VA View:
In this Judgement, the NCLT has very rightly interpreted and upheld the spirit of the IBC. The NCLT correctly observed that the liquidation value being more than the enterprise value cannot be a ground for sustaining the application, nor is it in line with the objects of the IBC. Sending the Corporate Debtor into liquidation just because the liquidation value is more than the enterprise value, would not be in keeping with the objectives of the IBC.

The IBC is not about maximising value at all costs if it means death of the corporate debtor. Liquidation should be the last resort, when everything else has been attempted and failed. A purposive interpretation is called for when it comes to construction of the terms used in various provisions of the IBC. The whole idea of the IBC is to put the corporate debtor back on its feet for the larger benefit of all the stakeholders and not just the creditors.

For more information please write to Mr. Bomi Daruwala at [email protected]

GST Cafe | Supreme Court holds GST on ocean freight unconstitutional, also holds GST council decisions to be not binding

CONTEXT

GST was sought to be levied vide notification no. 10/2017-Integrated Tax (Rate) read with notification no. 8/2017-Integrated Tax (Rate) on ocean freight for CIF imports. CIF transactions are such where the freight is borne by the supplier. Such CIF value is also considered for levy of customs duty.
Aggrieved by the levy of GST on ocean freight, writ petition was filed before the Gujarat High Court. Gujarat HC had allowed such petition challenging the constitutionality of two GST notifications.
Supreme Court has dismissed the appeals filed by the Revenue against such order.

Highlights

The Supreme Court held that GST on ocean freight paid in case of import of goods is unconstitutional. Primarily, Supreme Court has agreed with the view of the Gujarat HC that the import transaction cannot be split once again to collect IGST which has been already collected at the time of levy of Customs duty.
Supreme court has also held that the recommendations of the GST Council are merely recommendary and not binding on either the Union or States. It has also held that Article 246A (which gives the Union and States power to make laws with respect to GST) of the Constitution treat the Union and the States as ‘equal units’. The Hon’ble Supreme Court held the Centre and the States were ‘autonomous, independent and even competing units’ while making GST laws.

VA Comments

The Supreme Court has held that imposing tax on ocean freight is unconstitutional agreeing with the view of the Gujarat HC on double taxation. The rulings of Supreme Court on recommendations provided by the GST Council may have far reaching impact, particularly the observation that Article 246A of the Constitution of India does not come with a repugnancy clause. Hence, this may lead to divergences in law and administration between the States and the Union.

Going forward, it would also be interesting to see the views of the Supreme Court in the context of levy of service tax on ocean freight. Revenue appeal against the Gujarat HC decision holding such service tax levy unconstitutional is currently pending.

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For any clarification, please write to:

Mr. Shammi Kapoor at [email protected]

Mr. Arnab Roy at [email protected]

Competition News Bulletin – May 2022 – Newsletter January

We are glad to share the May 2022 edition of our newsletter – Competition News Bulletin.

Some highlights of this issue are as under:

Competition Commission of India (CCI) directs investigation against Zomato and Swiggy
CCI directs investigation against Star TV
CCI directs investigation against Google
CCI finds NECC guilty of distorting the egg market in India

The Bulletin, now in the 12th year of publication, is amongst India’s first comprehensive Newsletter on the subject published by Vaish Associates Advocates with an aim to supplement CCI’s efforts towards competition advocacy.

For more information please write to Mr. MM Sharma at [email protected]

TaxBuzz | Demystifying the decision of Supreme Court on reassessment notices

The Hon’ble Supreme Court has on 04.05.2022 pronounced much awaited decision in the case of Union of India v. Ashish Agarwal: C. A. No. 3005/2022. The said decision of the Hon’ble Supreme Court will give rise to numerous issues and litigation will not be put to rest.

In this Tax Buzz, we have analyzed, repercussion of the Judgment and have also given some general defences that may be available to the assessees.

To read the TaxBuzz, click at the ‘Download Newsletter.

We trust that you will find the same useful.

Between the Lines | NCLT: No insolvency proceedings can be initiated under the Insolvency and Bankruptcy Code, 2016, against personal guarantors of Non-Banking Financial Companies unless threshold of asset of INR 500 Crores is satisfied

The Hon’ble National Company Law Tribunal, Jaipur (“NCLT”) has by its order dated February 22, 2022, in the matter of Shapoorji Pallonji Finance Private Limited v. Rekha Singh [IA No. 229/JPR/2021 in C.P. No. (IB) – 25/95/JPR/2021] held that no insolvency proceedings can be initiated under the Insolvency and Bankruptcy Code, 2016 (“IBC”) against personal guarantors of Non-Banking Financial Companies (“NBFCs”) unless threshold of asset size of INR 500 Crores is satisfied.

Facts

The present interim application was filed by Rekha Singh, the personal guarantor (“Applicant/ Personal Guarantor”) against Shapoorji Pallonji Finance Private Limited (“Petitioner/ Financial Creditor”) seeking dismissal of company petition filed under Section 95 of the IBC against the Applicant (“Petition”) on account of being non-maintainable.

The Petition was filed by the Financial Creditor to initiate insolvency resolution process in the case of the Applicant under Sections 60 and 95 of the IBC read with Rule 7(2) of Insolvency and Bankruptcy (Application to Adjudicating Authority for Insolvency Resolution Process for Personal Guarantors to Corporate Debtor) Rules, 2019.

The Personal Guarantor had, through a personal guarantee, secured repayment of a term loan advanced by the Petitioner to Jumbo Finvest (India) Limited (“Jumbo Finvest”), a NBFC, under a facility agreement. However, Jumbo Finvest had failed to make payment of interest amounts for the months of September, 2020 and October, 2020 and also failed to repay the principal amount instalment for the quarter ending in September, 2020.

The Petitioner was heard on June 17, 2021, and the following order was passed:
“[…] The Petitioner shall file a short affidavit with regard to the page reference of; the relevant demand notice, acknowledgement of the receipt of the said demand notice and the relevant emails within two weeks. The Petitioner shall also file copy of the master data of the Corporate Debtor for which the Respondent is a personal guarantor along with the affidavit…”.

On July 12, 2021, the Applicant filed an interim application to set aside the aforesaid order on the basic premise that the same had been passed without hearing the Applicant. The said interim application was heard on July 20, 2021 and dismissed on the anvil.

Subsequently, after receipt of notice in the main Petition, the Applicant filed the present interim application seeking dismissal of the Petition.

Issue

Whether insolvency resolution process can be initiated against any personal guarantor of Jumbo Finvest, which is a NBFC and a financial services provider (“FSP”), by the Petitioner/ Financial Creditor under Section 95 of the IBC, particularly in absence of any corporate insolvency resolution process (“CIRP”) against the NBFC.

Arguments

Contentions raised by the Applicant:

Firstly, Jumbo Finvest is a NBFC registered with the Reserve Bank of India (“RBI”). As per the provisions of Section 3(7) of the IBC, the provisions of the IBC are not applicable to a NBFC. Secondly, there is no on-going insolvency process with respect to Jumbo Finvest and, therefore, the Petition filed by the Petitioner is not maintainable. Thirdly, as per Section 60 of the IBC, insolvency of a personal guarantor can be filed before the Hon’ble Adjudicatory Authority only if either CIRP or liquidation proceedings are pending against the corporate debtor before the National Company Law Tribunal. Therefore, no insolvency application can be filed against the personal guarantor of a NBFC and, hence, the Petition which had been filed by the Financial Creditor, under Section 95 of the IBC against the Applicant is not admissible.

The Applicant further submitted that a bare perusal of Section 60(2) of the IBC would go to show that it is necessary that CIRP has already been initiated against the corporate debtor prior to the filing of the insolvency application against the personal guarantor. As far as Section 60(1) of the IBC is concerned, the same does not deal with the situation as to when an insolvency resolution or bankruptcy against the personal guarantor can be initiated. It merely deals with the territorial jurisdiction with the NCLT for dealing with insolvency application.

The Applicant submitted that the notification no. S.O. 4139(E) dated November 18, 2019, issued by Ministry of Corporate Affairs (“FSP Threshold Notification”) would go to show that CIRP can only be initiated against FSPs by the RBI, where the asset size of the NBFC is INR 500 Crores or more as per the last audited balance sheet. In this regard, it was submitted that as per the last audited balance sheet of Jumbo Finvest, the asset size as per the balance sheet as at March 31, 2020, is approximately INR 487 Crores and, therefore, the FSP Threshold Notification is not applicable in the present facts and circumstances. Further, even for the balance sheet as ending on March 31, 2021, as per the unaudited figures, the total asset size of Jumbo Finvest is approximately INR 407 Crores, which is far below the threshold limit as specified in the FSP Threshold Notification. In view of the aforesaid, it was clear that even the RBI is not empowered to initiate CIRP against Jumbo Finvest and accordingly, no personal insolvency application can be filed against the Personal Guarantor. Furthermore, even assuming though not admitting that CIRP can be initiated against Jumbo Finvest, even then, since no application either under Section 7 or 9 of the IBC is pending against Jumbo Finvest, the present application filed by the Petitioner is not maintainable and the same is required to be dismissed.

Lastly, it was submitted that the provisions of the Indian Contract Act, 1872 (“ICA”) had nothing to do with the initiation of the insolvency against the Applicant.

Contentions raised by the Petitioner/ Financial Creditor:

The Petitioner contended that Section 60(1) of the IBC provides that insolvency resolution or liquidation of personal guarantors of corporate persons will go before the same National Company Law Tribunal having territorial jurisdiction where the registered office of the corporate person is located. Further, Section 60(1) of the IBC makes it clear that there is no necessity for a CIRP to exist against a corporate person for a CIRP to be entertained against the personal guarantor of such corporate person. It shows that Section 60(1) of the IBC would include in its ambit an individual covered by Section 95 of the IBC, if being sued in his capacity as a personal guarantor.

Furthermore, the contention of the Petitioner stating that in light of changes made to the IBC read with the Insolvency and Bankruptcy (Insolvency and Bankruptcy Proceedings of Financial Service Providers and Application to Adjudicating Authority) Rules, 2019 (“FSP Rules”), the Petitioner, being barred by law from initiating CIRP against a NBFC like Jumbo Finvest, can in no way mean that no CIRP can be initiated against personal guarantors of NBFCs till the RBI has initiated CIRP against the requisite NBFC.

The Financial Creditor further submitted that in addition to the provisions of the IBC, the contract of guarantee provided by the Applicant is also covered under the ICA. Section 128 of the ICA stipulates that the liability of the surety is co-extensive with that of the principal debtor, unless it is otherwise provided by the contract. In the present case, the liability of the Applicant is as if she herself was a co-obliger along with Jumbo Finvest. Thus, the Applicant can be proceeded against even under the ICA.

Observations of the NCLT

The NCLT observed that Jumbo Finvest is a FSP in terms of the FSP Rules. The FSP Threshold Notification clarified that insolvency resolution and liquidation proceedings of NBFCs with asset size of INR 500 Crores or more, as per last audited balance sheet, shall be undertaken in accordance with the provisions of the IBC read together with the FSP Rules. As per the last audited balance sheet of Jumbo Finvest for year ending on March 31, 2020, and as per unaudited figures for the year ending March 31, 2021, Jumbo Finvest is excluded from the ambit of the FSP Threshold Notification.

In view of the above, Jumbo Finvest, the principal borrower, does not stricto sensu qualify within the tight definition of corporate person under the IBC, as the said definition excludes FSP. Further, the FSP Threshold Notification does not sweep it back into inclusion as a corporate person. So, as per debt being carried, such NBFC does not qualify as a corporate debtor.

Moreover, even if Jumbo Finvest is excluded by virtue of the FSP Threshold Notification, the generic inclusion by virtue of Rule 4 of the FSP Rules enunciates that in all the provisions relating to insolvency and liquidation proceedings under the IBC, the expression “corporate debtor” wherever it occurs, shall mean “FSP”. This cannot lead to a situation that the phrase corporate debtor in IBC is contextually read as FSP, while the FSP Threshold Notification excludes certain FSPs. The FSP Rules are applicable only to the extent that the concerned NBFC/ Housing Finance Company qualifies under FSP Threshold Notification of asset size of INR 500 Crores or more. In the present case, as stated earlier, Jumbo Finvest does not fall within the ambit of the category of NBFC having asset size of INR 500 Crores or more and, therefore, the FSP Rules shall not be applicable to it. It is clear that Jumbo Finvest is not a corporate debtor in the present case.

Further, personal guarantor means an individual who is a surety in a contract of guarantee to a corporate debtor. Therefore, in order for an individual to be a personal guarantor, all the following pre-requisites are required to be fulfilled: (a) the individual has to be a surety; (b) there has to be a contract of guarantee; and (c) the individual has to be a guarantor to a corporate debtor. In this case, the guarantors to Jumbo Finvest do not strictly fall within the definition of personal guarantors and have existence as individuals only.

Insolvency resolution process can be initiated against the personal guarantor of a NBFC/ FSP irrespective of CIRP against the NBFC, provided that the concerned NBFC falls within the category of those FSPs having assets size of INR 500 Crores or more. The definition of personal guarantors under Section 5(22) of the IBC cogently implies that they can be recognised as personal guarantors under the IBC, subject to the condition, and only if, the person or entity for whom they have given guarantee is a corporate debtor. Therefore, as it is amply clear that Jumbo Finvest is not a corporate debtor, the guarantors of the aforesaid company cannot be considered as personal guarantors under provisions of the IBC. Since consequences of CIRP are drastic and almost penal for any entity, whether corporate or individual, definitions must be strictly construed.

Decision of the NCLT

In view of entirety of the foregoing, the NCLT held that, since Jumbo Finvest does not fall within the ambit of the category of NBFC having asset size of INR 500 Crores or more, it is not a corporate debtor, and hence the guarantors of Jumbo Finvest cannot be considered as personal guarantors under provisions of the IBC. Therefore, no insolvency proceedings can be initiated against them. The interim application filed by the Applicant was allowed and accordingly disposed of. The Petition by the Financial Creditor against the Applicant was not maintainable and was accordingly dismissed.

VA View:

The NCLT has, through this judgment, answered two critical questions pertaining to initiation of CIRP under the IBC. Firstly, application(s) for insolvency resolution process can be initiated against any personal guarantor to a corporate debtor irrespective of CIRP against the corporate debtor. Secondly, insolvency resolution process can be initiated against the personal guarantors of NBFCs/ FSPs, provided the concerned NBFC meets the criteria specified in the FSP Threshold Notification. In light of the above, financial creditors shall, before initiating any insolvency proceedings against personal guarantors, ensure that the NBFC falls within the category of those FSPs having asset size of INR 500 crores or more, and thus being included in the definition of corporate debtor under the IBC.

For more information please write to Mr. Bomi Daruwala at [email protected]