Supreme Court: CIRP can be initiated against Corporate Debtor without proceeding against Principal Borrower

The Supreme Court (“SC”) has in its judgment dated September 6, 2022 in the matter of K. Paramasivam v. The Karur Vysya Bank Limited and Others [Civil Appeal No. 9286 of 2019] held that the Corporate Insolvency Resolution Process (“CIRP”) can be initiated against the corporate debtor without proceeding against the principal borrower.

Facts

Mr. K. Paramasivam (“Appellant”) is the promoter, shareholder and suspended director of Maharaja Theme Parks and Resorts Private Limited (“Corporate Debtor”), which had stood as guarantor for the credit facilities granted by Karur Vysya Bank (“Financial Creditor/ Respondent”) to three entities, namely, (i) Sri Maharaja Refineries, a Partnership Firm; (ii) Sri Maharaja Industries, a proprietary concern of K. Paramasivam; and (iii) Sri Maharaja Enterprises, a proprietary concern of P. Sathiyamoorthy.

Upon failure on part of the principal borrowers to repay the loan, the Financial Creditor filed an application under Section 7 (Initiation of corporate insolvency resolution process by financial creditor) of the Insolvency and Bankruptcy Code, 2016 (“IBC”) for initiation of the CIRP of the Corporate Debtor, on account of the corporate guarantee(s) extended by the Corporate Debtor to secure the loans availed by each of the above-named borrowers. In view thereof, the National Company Law Tribunal, Chennai (“NCLT/ Adjudicating Authority”) admitted the Corporate Debtor under CIRP, by order dated April 8, 2019.

Thereafter, the NCLT order dated April 8, 2019 was challenged before the National Company Law Appellate Tribunal, New Delhi (“NCLAT”), which came to be dismissed, by order dated November 18, 2019. Aggrieved by the impugned order dated November 18, 2019 passed by the NCLAT, the Appellant preferred an appeal before the SC.

Issue

Whether an action under Section 7 (Initiation of corporate insolvency resolution process by financial creditor) of the IBC can be initiated by a financial creditor, against a corporate person, in relation to a corporate guarantee, given in respect of a loan advanced to the principal borrower, who is not a corporate person?.

Arguments

Contentions raised by the Appellant:

The Appellant submitted that the Corporate Debtor does not fall within the definition of ‘corporate guarantor’ in terms of Section 5(5A) of the IBC, wherein ‘corporate guarantor’ is defined as a corporate person who is the surety in a contract of guarantee to a corporate debtor. As such, the Appellant contended that it has not stood as guarantor in respect of a loan, which was granted to a corporate person. In order to substantiate the aforesaid contention, the Appellant referred to the definition of ‘corporate person’ provided under Section 3(7) of the IBC:

“(7) “corporate person” means a company as defined in Clause (20) of Section 2 of the Companies Act, 2013 (18 of 2013), a limited liability partnership, as defined in Clause (n) of Sub-section (1) of Section 2 of the Limited Liability Partnership Act, 2008 (6 of 2009), or any other person incorporated with limited liability under any law for the time being in force but shall not include any financial service provider;”

The Appellant submitted that on a conjoint reading of Section 5(5A), Section 3(7) and Section 3(8) of the IBC, it is clear that a corporate guarantor is the surety in a contract of guarantee to a corporate debtor. However, the principal borrowers herein, not being corporate debtor; as such, the Corporate Debtor is not a corporate guarantor as defined under Section 5(5A) of the IBC.

Contentions raised by the Respondent:

The Respondent submitted that the question of law as to whether an action under Section 7 of the IBC can be initiated by a financial creditor, against a corporate person, in relation to a corporate guarantee, given by that corporate person, in respect of a loan advanced to the principal borrower, who is not a corporate person; has already been settled by the Supreme Court in the recent judgment of Laxmi Pat Surana v. Union Bank of India and Another [Civil Appeal No. 2734 of 2020] (“Laxmi Pat Surana”). Hence, the position of law is clear that CIRP can be initiated against a corporate entity who has stood as guarantor to secure the dues of a non-corporate entity as a financial debt, which accrues to the corporate person, in respect of guarantee given by it, once the borrower commits default.

Observations of the Supreme Court

The SC examined the terms “financial creditor” as defined under Section 5(7) of the IBC, “creditor” as defined under Section 3(10) of the IBC, “financial debt” as defined under Section 5(8) of the IBC, “debt” as defined under Section 3(11) of the IBC and “claim” as defined under Section 3(6) of the IBC.

Upon examination of the above-mentioned terms, the SC observed that undoubtedly, a right or cause of action arises on part of the lender (financial creditor) to proceed against the principal borrower, as well as the guarantor in equal measure, in case of any default in repayment of debt. Further, even if the principal borrower fails to discharge its obligation in respect of the debt, it would still be deemed as if the default was committed by the guarantor itself. In this regard, SC referred to Section 128 of the Indian Contract Act, 1872 which clearly provides that the obligation of the guarantor is coextensive and coterminous with that of the principal borrower. The SC further observed that as a consequence of such default, the status of the guarantor metamorphoses into a debtor or a corporate debtor if it happens to be a corporate person, within the meaning of Section 3(8) of IBC. Further, the term “default” as defined under Section 3(12) of the IBC would mean non-payment of debt when whole or any part or instalment of the amount of debt has become due or payable and is not paid by the debtor or the corporate debtor, as the case may be.

Hence, SC observed that this argument on part of the Appellant could not be accepted that since the principal borrower is not a corporate person, the financial creditor could not have invoked remedy under Section 7 of the IBC against the corporate person who had merely stood as a guarantor to secure such loan account. The financial creditor can still proceed against the guarantor being a corporate debtor, consequent to the default committed by the principal borrower.

SC further observed that if the contentions raised by the Appellant were to be accepted, it would lead to diluting or narrowing the purview of the term “corporate debtor” occurring in Section 7 of IBC, which means a corporate person, who owes a debt to any person. It was further observed that the term “debt” as defined under Section 3(11) of the IBC is broad enough to include liability of a corporate person on account of guarantee extended by it to secure a loan by any person including not being a corporate person in the event of default committed by the latter. It would still be a “financial debt” of the corporate person, arising from the guarantee extended by it, within the meaning of Section 5(8) of the IBC.

SC arrived at the conclusion that upon harmonious and purposive construction of the relevant definitions and provisions of the IBC, it is not possible to extricate the corporate person from the liability (of being a corporate debtor) arising on account of the guarantee extended by it in respect of loan given to a person other than corporate person. Hence, the liability of the guarantor is coextensive with that of the principal borrower.

Further, in the Laxmi Pat Surana judgment, SC had made it clear that CIRP can be initiated against the corporate guarantor without proceeding against the principal borrower.

Decision of the Supreme Court

The SC held that in view of the issues raised in the present appeal having been already settled in the Laxmi Pat Surana judgment, it is clear that liability of the guarantor is co-extensive with that of the principal borrower. Hence, Financial Creditor can proceed against the guarantor without first suing the principal borrower.

The SC held that there is no reason to interfere with the concurrent findings of the NCLT and NCLAT, and therefore dismissed the appeal.

VA View:

The SC has put this question to rest that under Section 7 of the IBC, CIRP can be initiated against a corporate entity who has given a guarantee to secure the dues of a non-corporate entity as a financial debt accrues to the corporate person in respect of the guarantee given by it once the borrower commits default. In such a scenario, the guarantor would be the corporate debtor.

Further, the SC has reiterated its recent decision in Laxmi Pat Surana, whereby it was held by a three-judge bench that the liability of the guarantor is co-extensive with that of the principal borrower and that the financial creditor can very well proceed against the guarantor without first proceeding against the principal borrower.

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

Supreme Court: The actual gain or loss is immaterial, but the motive for making a gain is essential.

The Supreme Court (“SC”) has, in its judgment dated September 19, 2022, in the case of Securities and Exchange Board of India v. Abhijit Rajan [Civil Appeal No. 563 of 2020], held that in deciding cases pertaining to insider trading, the actual gain or loss is immaterial, but the motive for making a gain is essential.

Facts

Abhijit Rajan (“Respondent”) was the chairman and managing director of Gammon Infrastructure Projects Limited (“GIPL”) till September 20, 2013. Thereafter, he ceased to be the chairman and managing director, but continued to be a director of GIPL.

In the year 2012, GIPL was awarded a contract by National Highways Authority of India (“NHAI”). For the execution of the project, GIPL set up a special purpose vehicle called Vijayawada Gundugolanu Road Project Private Limited (“VGRPPL”). Similarly, Simplex Infrastructure Limited (“SIL”) was awarded a contract by NHAI in Jharkhand and West Bengal. For the execution of the project, SIL set up a special purpose vehicle called Maa Durga Expressways Private Limited (“MDEPL”).

GIPL entered into two shareholders agreements with SIL. Under these agreements, GIPL was to invest in MDEPL and SIL was to invest in VGRPPL for their respective projects. The mutual investments were to be tuned in such a manner that GIPL and SIL would hold 49% equity interest in each other’s projects.

However, on August 9, 2013 the board of directors of GIPL passed a resolution authorizing the termination of both shareholders agreements. On August 22, 2013, the Respondent sold about 144 lakhs shares (approx.) held by him in GIPL. On August 30, 2013, GIPL made a disclosure to the National Stock Exchange of India (“NSE”) and Bombay Stock Exchange (“BSE”) regarding the termination of two shareholders agreements.

Pursuant to an input received from NSE, about the aforesaid transaction and the possibility of the trading having taken place on the basis of unpublished price sensitive information (“UPSI”), Securities and Exchange Board of India (“SEBI”) conducted a preliminary enquiry. After completion of the preliminary enquiry, SEBI passed an ex parte interim order holding prima facie that the Respondent violated the provisions of The Securities and Exchange Board of India Act, 1992 (“SEBI Act”) and consequently restraining the Respondent from buying, selling or dealing in securities and accessing the security markets directly or indirectly. This ex parte interim order was also confirmed by a confirmatory order, passed after providing an opportunity of hearing to the Respondent.

In the interregnum, SEBI completed the investigation and issued certain directions on March 21, 2016, followed by a show cause notice dated March 29, 2016. The show cause notice was addressed not only to the Respondent, but also to another company ‘Consolidated Infrastructure Company Private Limited’ (“CICPL”) and two of its directors. The noticees filed their replies and after giving an opportunity of hearing to the noticees, the Whole-Time Member (“WTM”) passed an order, by which the WTM held the Respondent guilty of insider trading and hence liable to disgorge the amount of unlawful gains made by him. The show cause notices issued to the others, namely, CICPL and its directors were closed without any directions, on the ground that no case was made out against them.

Challenging the said order of the WTM, the Respondent filed a statutory appeal before the Securities Appellate Tribunal (“Tribunal”). The appeal was allowed by the Tribunal by an order and it is against the said order that SEBI has come up with the above appeal in the SC.

Issues

• Whether the information regarding the decision of the board of directors of GIPL to terminate the two shareholders’ agreements can be characterized as ‘price sensitive information’ within the meaning of Section 2(ha) of the Securities and Exchange Board of India (Prohibition of Insider Trading) Regulations, 1992 (“PIT Regulations”).
• Whether the sale by the Respondent of the equity shares held by him in GIPL, under peculiar and compelling circumstances in which he was placed, would fall within the mischief of ‘insider trading’ in terms of Regulation 3(i) read with Regulation 4 of the PIT Regulations.
• Whether SEBI should have taken into account the last trade price of the day on which information was disclosed instead of the trade price of the next day.

Arguments

Contentions by SEBI:

SEBI contended that proportionality is a dangerous and subjective ground in matters involving insider trading, especially since one-third of the total number of directors of a listed company are independent directors and even transactions involving thousands of crores might be a minor proportion to the turnover, if the company is very large in size. SEBI also contended that Regulations 3 and 4 of the PIT Regulations contain an absolute prohibition against insider trading and such a statutory prohibition cannot be diluted by arguing that the total value of the contracts terminated by the company was just a minor percentage of the order book value and the total turnover of the company. The de minimis syndicate has no application to insider trading, as it introduces an element of subjectivity.

Further, in any case the total value of the contracts terminated on both sides was nearly INR 2,600 crores and hence the information relating to the termination of the contracts was definitely likely to materially affect the price of the securities of the company under Regulation 2(ha).

It was also stated by SEBI that explanation (vi) under Section 2(ha) which speaks about “significant changes in policies, plans or operations of the company” cannot limit the scope of the main part of the definition and in this case as a matter of fact the price of the share dropped in just one day and the Respondent avoided a loss of INR 85 lakhs. SEBI argued that bona fide intentions or grounds of necessity, such as those pleaded in this case, cannot frustrate the object of strict ban on insider trading, especially when the expression “lawful excuse” as used in about 88 central statutes to justify non-compliance, is conspicuously absent in the PIT Regulations. Also, that in any case, SEBI took note of the situation in which the Respondent was placed, warranting the necessity to sell the shares and hence confined the final order only to disgorgement, which is merely in the nature of restitutionary relief.

Further, the intimation regarding the termination of the contracts was given to the BSE at 1.05 p.m. and to NSE at 2.40 p.m. on September 3, 2013 and the trading concluded at 3:30 p.m. and hence the adoption of the closing price on September 3, 2013 would not correctly determine either the gains made or the losses averted. Therefore, the question of SEBI taking the closing price as on September 3, 2013 did not arise.

Contentions by the Respondent:

The Respondent contended that the primary object of insider trading regulations anywhere in the world is to prohibit an insider from taking advantage of asymmetrical access to UPSI over others who do not have such access and that the question whether an information is price sensitive or not, would depend upon its potency to materially impact, upon publication, the price of the securities.

The Respondent also contended that by its very nature, the issue is barely a question of fact or at the most, a mixed question of fact and law which will not fall within the scope of Section 15Z (Appeal to Supreme Court) of SEBI Act warranting interference by this Court.

Further, one of the key factors which the courts take into account while interpreting the circumstances revolving around transactions such as the one in question, is the purpose for which the transaction was effected. Apart from looking into the purpose of the transaction, courts have also taken into account other circumstances such as the scale of the transaction, pattern of trading and honesty in responses during the proceedings.

In the case on hand, the information in question, namely, the termination of the shareholders’ agreements actually resulted in GIPL gaining total control of a larger project and that in other words what was lost by the termination was far lesser than what was gained and hence the information relating to the termination of the agreements was actually a favourable and not adverse information.

The Respondent noted that GIPL’s investments in the project of SIL represented 0.05% of GIPL’s order book and 0.7% of its turnover and that a project with a small percentage of the order book and a miniscule percentage of the turnover cannot ipso facto become material for information about it to become UPSI.

The Respondent contended that the failure of the Respondent to meet the obligation towards Corporate Debt Restructuring (“CDR”) package would have led to GIL filing for bankruptcy. Further, every penny of the sale proceeds of the shares, was transferred by the Respondent towards the implementation of CDR package, a fact that SEBI itself has accepted. Hence, it is a misconception to think that he made unlawful gains that ought to be disgorged.

Furthermore, SEBI itself exonerated the co-noticee, namely, CICPL, on the ground that its sale of shares was on account of a pressing need to meet a margin shortfall to its stock broker. Thus, SEBI applied two different yardsticks, one in respect of the Respondent and another in respect of the co-noticee in the very same proceeding, which necessitated interference by the Tribunal.

Observations of the Supreme Court

The SC noted that an appeal under Section 15Z (Appeal to Supreme Court) of SEBI Act concerns appeals with ‘any question of law arising out of the order of the Tribunal’. The focus of Section 15Z is on ‘any question of law’ and not ‘any substantial question of law’.

The SC observed that in order to find out if a person is guilty of violation of Regulation 3 of the PIT Regulations, the courts should address the following questions namely: (i) is he an insider?; (ii) did he possess or have access to any information relating to the company?; (iii) whether such information was price sensitive?; (iv) whether the information was unpublished?; and (v) whether he dealt in securities by subscribing, buying, selling or agreeing to do any of these things in any securities.

The SC noted that one important fact namely, that the price sensitivity of an information has a correlation directly to the materiality of the impact that it can have on the price of the securities of the company. An information may materially affect the price of the security of a company either positively or negatively. The effect should be material and not completely insignificant.

Keeping the above parameters in mind and coming to the facts of the case on hand, it was clear, (i) that the Respondent was certainly an insider, as he was a chairman and managing director of GIPL till September 20, 2013 and was a party to the resolution of the board of directors authorising the termination of the shareholders’ agreements; (ii) that the information relating to the termination of both the shareholders’ agreements that the Respondent had, would certainly fall under the category of “significant changes in policies, plans or operations of the Company” under Regulation 2(ha)(vii) of the PIT Regulations; (iii) that the Respondent dealt in securities by selling 144 lakhs shares, a month before his resignation as chairman and managing director; and (iv) that the termination of the shareholders’ agreements was disclosed to the NSE and BSE after the sale of the shares, which made the information relating to the termination of the agreements unpublished as on the date of the sale.

Therefore, it may appear at first blush, that the Respondent, who was an insider and who possessed information which was both unpublished and price sensitive, was guilty of the charge of insider trading as he undoubtedly dealt in securities.

While it is true that the actual gaining of profit or sufferance of loss in the transaction, may not provide an escape route for an insider against the charge of violation of Regulation 3 of the PIT Regulations, one cannot ignore normal human conduct. If a person enters into a transaction which is surely likely to result in loss, he cannot be accused of insider trading. In other words, the actual gain or loss is immaterial, but the motive for making a gain is essential.

The cancellation of the shareholders’ agreements resulted in GIPL gaining very hugely in terms of order book value. In such circumstances an ordinary man of prudence would expect an increase in the value of the shares of GIPL and would wait for the market trend to show itself up, if he actually desired to indulge in insider trading. However, the Respondent did not wait for the information about the market trend, after the information became public because he had to dispose of his shares as well as certain other properties for the purpose of honouring a CDR package.

Therefore, the Tribunal was right in thinking that the Respondent had no motive or intention to make undeserved gains by encashing on the UPSI that he possessed. As a matter of fact, the Tribunal found that the closing price of shares rose, after the disclosure of the information. This shows that the UPSI was such that it was likely to be more beneficial to the shareholders, after the disclosure was made. Any person desirous of indulging in insider trading, would have waited till the information went public, to sell his holdings. The Respondent did not do this, obviously on account of a pressing necessity.

The SC observed that the allegation of insider trading cannot be measured in terms of the value of the contracts terminated and the percentage of shares sold and that the theory of proportionality cannot be applied in such cases. The magnitude of what an insider did, in relation to the size of the company, may not have a bearing upon the question whether someone indulged in insider trading or not, but what is sought to be encashed by the insider should be an information which if published is likely to materially affect the price of the securities of the company. It is true that the de minimis rule has no application to insider trading, as it introduces an element of subjectivity. Hence, the SC did not go on the basis that GIPL’s investments in the project of SIL represented 0.05% of GIPL’s order book value and 0.7% of its turnover.

The SC had gone on the basis that the termination of both the agreements put GIPL in a more advantageous position, in which one would have expected the price of the securities to rise. The normal human conduct would be to wait for this event to happen. This event could have happened only after the publication of the information in question. The fact that the Respondent did not wait to take advantage of the situation, convinced the SC that the Respondent’s intention was not to indulge in insider trading.

The contention that SEBI took note of the situation in which the Respondent was placed, and the dire need that he had to sell the shares, and that therefore SEBI confined the final order only to disgorgement, is neither here nor there. The argument is actually an argument of convenience. It so happened that according to SEBI the closing price of the stock on September 3, 2013 showed favourable position for the Respondent and SEBI was able to calculate as though the Respondent made a profit.

Decision of the Supreme Court

The SC, on issue no. 1, held that the information regarding the termination of the two shareholders’ agreements can be characterized as price sensitive information, in that it was likely to place the existing shareholders in an advantageous position, once the information came into the public domain. In such circumstances, on issue no. 2, the SC held that the sale by the Respondent would not fall within the mischief of insider trading, as it was somewhat similar to a distress sale, made before the information could have a positive impact on the price of the shares.

Accordingly, there was no necessity to go into issue no. 3 and that the impugned order of the Tribunal did not call for any interference. Hence, the appeal was dismissed.

VA View:

The present appeal clearly demonstrates the complexity in adjudicating insider trading cases. Distinguishing between mens rea and profit motive, the SC held that, in respect of matters under the PIT Regulations, the test that is to be applied is of profit motive, that is, whether the insider’s actions were an attempt to gain from the UPSI in his possession. In other words, mere possession of UPSI and acting on it are not sufficient to prove insider trading.

While the actual profit or loss incurred is immaterial, the SC has clearly identified the intent behind penalizing insider trading, that is to prevent insiders from making illicit gains. However, the requirement of profit motive may involve a great deal of subjectivity. The decision in the present matter may have far-reaching effects in the manner in which insider trading cases are decided by regulators.

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

NCLAT: Re-agitating an issue which has attained finality is an abuse of the process of law.

The National Company Law Appellate Tribunal (“NCLAT”), in Vikas Dahiya v. Arrow Engineering Limited [Company Appeal (AT)(Insolvency) No. 699 of 2022] (“Appeal No. 699 of 2022”) and Oval Investment Private Limited v. Arrow Engineering Limited [Company Appeal (AT)(Insolvency) No. 812 of 2022] (“Appeal No. 812 of 2022”), held that re-agitating an issue which has attained finality is an abuse of the process of law.

Facts

Vikas Dahiya, the Appellant in Appeal No. 699 of 2022 (“Appellant No. 1”) is an ex-director of Golden Tobacco Limited (“Corporate Debtor”) and Oval Investment Private Limited, the Appellant in Appeal No. 812 of 2022 (“Appellant No. 2”) is claiming to be shareholder of the Corporate Debtor (collectively, “Appellants”).

Arrow Engineering Limited (“Financial Creditor”) filed an application bearing number 268 of 2020 before the National Company Law Tribunal, Ahmedabad (“NCLT”) to initiate Corporate Insolvency Resolution Process (“CIRP”) of the Corporate Debtor under Section 7 of Insolvency and Bankruptcy Act, 2016 (“IBC”). The aforesaid application was dismissed by the NCLT by order dated January 25, 2021 on various grounds.

Aggrieved by the order dated January 25, 2021 passed by the NCLT, the Financial Creditor preferred an appeal bearing number 183 of 2021 (“First Appeal”) before the NCLAT. By way of order dated December 2, 2021, the NCLAT set aside the aforesaid order of the NCLT dated January 25, 2021, and directed the NCLT to pass consequential orders including the order of moratorium within one month from the date of copy of the NCLAT order being produced before the NCLT, during which period it would be open to the parties to endeavour to enter into settlement.

Aggrieved by the order dated December 2, 2021 passed by the NCLAT, the Appellant No. 1 preferred a civil appeal bearing number 7715 of 2021 before the Supreme Court (“SC”). By order dated May 5, 2022, SC dismissed the appeal and declined to interfere with the order dated December 2, 2021 passed by the NCLAT.

Thereafter, the Financial Creditor approached the NCLT by way of filing an application bearing number 830 of 2021, thereby praying for initiation of CIRP of the Corporate Debtor, in light of the above-mentioned order dated May 5, 2022 passed by the SC. By way of order dated June 7, 2022, the NCLT allowed the commencement of CIRP of the Corporate Debtor and appointed an Interim Resolution Professional (“IRP”) namely Mr. Vichitra Narayan to carry out the CIRP of the Corporate Debtor.

Aggrieved by the aforesaid order dated June 7, 2022 passed by the NCLT, the Appellants filed Appeal No. 699 of 2022 and Appeal No. 812 of 2022 before the NCLAT, which were decided by a common order dated August 5, 2022.

Issues

• Whether the Appellants in both the appeals, that is, Appeal No. 699 of 2022 and Appeal No. 812 of 2022 are competent to challenge the order dated June 7, 2022 passed by the NCLT when the findings recorded by the NCLAT by order dated December 2, 2021 in the First Appeal had attained finality in view of the judgment passed by the SC.
• Whether the order passed by the NCLT suffers from any illegality or irregularity warranting interference of the NCLAT while exercising power under Section 61 of the IBC. If so, whether the order passed by the NCLT in I.A. No. 830 of 2021 commencing CIRP of the Corporate Debtor is liable to be set aside.

Arguments

Contentions raised by the Appellants:

The Appellants contended that the order of the NCLT is silent as to the pleas raised by the Appellants regarding relationship of the Financial Creditor and Corporate Debtor, limitation and acknowledgement of any debt, etc. In absence of any specific findings on the issues raised by the Appellant No. 1 in the Appeal No. 699 of 2022, the order passed by the NCLT is ex facie erroneous.

It was also contended that a civil appeal was preferred before the SC, only challenging the order of remand and not against the findings recorded by the NCLAT in the First Appeal. Therefore, the question of application of principle of res judicata does not arise.

Specific contention of the Appellants was that there was no operational or financial debt and the claim of the Financial Creditor does not fall within the definition of ‘financial creditor’ or ‘financial debt’ as defined under sections 5(7) and 5(8) of the IBC respectively. The Appellants also contended that there was no acknowledgment of debt and statement of accounts, particularly, balance sheet of the Corporate Debtor mentioning debt of the Financial Creditor does not amount to acknowledgment of debt. These aspects were not considered in detail by the NCLT and it simply passed an order admitting application under Section 7 of IBC and appointing the IRP to carry out the CIRP of the Corporate Debtor. Therefore, the Appellants contended that the admission of application of Financial Creditor is illegal and requested to set aside the same.

The Appellants contended that in the absence of any findings recorded by the NCLT as to the subsisting legally enforceable Financial Debt and its acknowledgment by the Appellants herein, the order is illegal. Apart from that, the adjudicating authority did not consider the question of limitation. Therefore, the order of the adjudicating authority is ex facie erroneous and deserves to be set aside.

The Appellant No. 2 in Appeal No. 812 of 2022 contended that the Appellant No. 2 is a shareholder of the Corporate Debtor and merely because there is no appeal against the findings of the NCLAT, the Appellant No. 2 is not debarred from challenging the legality of the order as it would seriously affect the rights of the shareholder in the Corporate Debtor. It was further contended that as the Appellant No. 2 was not a party to the First Appeal and before the SC, the Appellant No. 2 is entitled to assail the findings recorded by the NCLT by filing an appeal under Section 61 of IBC in collateral or incidental proceedings. The judgment in an application for initiation of insolvency resolution process is a judgment-in-rem and the third party whose interests are affected may file appeal at any time.

In the written submissions, the Appellant No. 1 contended that application under Section 7 of the IBC is not maintainable as the debt cannot be construed as financial debt as defined under Section 5(8) of IBC. The basis for this contention is that the MOU was signed by the Corporate Debtor and the Financial Creditor which clearly states that there was an arrangement between the Corporate Debtor and Financial Creditor to carry on joint venture and development of project, while the Corporate Debtor agreed to provide land to the Financial Creditor who was to provide financial assistance for the development of project. There was no relationship between the Corporate Debtor and Financial Creditor and in the absence of proof that the debt due was a financial debt, as defined in Section 5(8) of IBC, the application is not maintainable.

Contentions raised by the Financial Creditor:

The Financial Creditor contended that the NCLAT recorded its findings and considering that all contentions raised in the First Appeal were answered and the order attained finality in view of the judgment of the SC, the Appellants are debarred from raising similar contention which attained finality.

Observations of the NCLAT

The Appellant No. 1 in the earlier round, contested the application before the NCLT, which after considering entire material, dismissed the application filed by the Financial Creditor. The same was assailed in the First Appeal, where the NCLAT reversed the order passed by the NCLT and allowed the appeal, thereby directing the NCLT to initiate CIRP of the Corporate Debtor, appoint IRP and impose moratorium. The order of the First Appeal attained finality in view of the judgment delivered by the SC. The NCLAT recorded its findings as to the acknowledgment of debt and concluded that the debt due to the Financial Creditor, that is, the Respondent No. 1 in both the present Appeals, is a financial debt within the meaning of Section 5(8) of the IBC and the claim of the Financial Creditor is within limitation and that the default is within the period of limitation. These findings were assailed by an appeal before the SC and the SC affirmed the judgment of the NCLAT.

The judgment of the NCLAT in the First Appeal cannot be held to be erroneous as the same was affirmed by the SC. If, for any reason the judgment of the NCLAT in the First Appeal is held to be erroneous, it would amount to reviewing not only the judgment of the NCLAT but also the judgment of the SC. The NCLAT is incompetent to exercise a jurisdiction to review its own judgment or judgement of the SC. Hence, the NCLAT is unable to accede to the request of the Appellants.

The NCLAT referred to the judgment in Satyadhyan Ghosal v. Deorajin Debi [(1960) 3 SCR 590]. In view of the principle laid down in the aforesaid judgment, it was observed that the doctrine of res judicata is applicable even to the proceedings under the IBC and challenge to the findings in incidental or collateral proceedings amounts to an abuse of process of Court. In any view of the matter, when the Appellant No. 1 raised a specific ground before the NCLT and before the NCLAT in the First Appeal, then raising similar grounds again against the order passed by the NCLAT in the First Appeal and subsequently affirmed by the SC, is nothing but an abuse of process of Court.

The Appellant No. 1 contended that the appeal before the SC only challenged the order of remand to the NCLT passed by the NCLAT in the First Appeal. However, the NCLAT observed that, assuming that such was the case, still the findings recorded by the NCLAT on various other contentions raised by the Appellant No. 1 became final. In fact, the Appellant No. 1 did not place on record the grounds of appeal before the SC and in absence of the appeal grounds, the NCLAT has no other alternative except to reject the contention that the Appellant No. 1 only challenged the remand order.

Decision of the NCLAT

The NCLAT held that the contentions of the Appellants were liable to be rejected. The findings recorded by the NCLAT in the First Appeal attained finality. Those findings cannot be challenged in incidental or collateral proceedings. The claim of Appellants is hit by doctrine of res judicata and abuse of process of law, as the NCLAT had adverted to all the contentions of both the parties and recorded specific findings.

VA View:

This judgment will provide much needed clarity in adjudication of similar litigations before the adjudicating authority that the doctrine of res judicata is not merely a technical doctrine confined to the procedural laws, that is, the Code of Civil Procedure, 1908; but it is a fundamental doctrine that all Courts should follow so as to put an end to litigations.

It is in immense public interest that the Appellate Authority, that is, the NCLAT, has reiterated that re-agitating an issue which has attained finality is an abuse of the process of law.

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

NCLAT: Moratorium under Section 14 of Insolvency and Bankruptcy Code, 2016 is no bar for initiation of proceedings under Section 66 of the IBC

The National Company Law Appellate Tribunal, Principal Bench, New Delhi (“NCLAT”) has in its judgment dated August 4, 2022 in the matter of Rakesh Kumar Jain v. Jagdish Singh Nain and Others [Company Appeal (AT) (Ins.) No. 425 of 2022] held that the moratorium imposed under Section 14 (Moratorium) of the Insolvency and Bankruptcy Code, 2016 (“IBC”) is not a bar for initiation of proceedings against the resolution professional of a company undergoing Corporate Insolvency Resolution Process (“CIRP”) under Section 66 (Fraudulent trading or wrongful trading) of IBC.

Facts

Mr. Rakesh Kumar Jain (“Appellant”) is the resolution professional of HBN Homes Colonizers Limited, a company undergoing CIRP. Mr. Jagdish Singh Nain (“Respondent”) is the resolution professional of HBN Foods Limited, a company which is also undergoing CIRP.

Respondent had preferred an application bearing number IA/2844/2020 before the National Company Law Tribunal, New Delhi (“NCLT”) under Section 66, 68, 69, 70 and other relevant provisions of the IBC, whereby the Appellant was one of the respondents. In IA/2844/2020, Respondent had, inter alia, sought the reliefs as set out herein below:

“…
a. Allow the present Application;

b. Declare the transactions entered by/with the Corporate Debtor with the Non-Applicants/ Respondent from the period 01.03.2013 and 21.10.2019 as sham and fraudulent transactions, therefore null and void;

c. Direct the respective Non-Applicants/Respondents to contribute to the assets of the Corporate Debtor in terms of Section 66 of the Code by reimbursing/refunding the amount with an interest @12% as mentioned in ANNEXURE A-4 (Colly) till the date of payment; …”

During the lockdown imposed on account of Covid-19 pandemic, the Appellant was served with a copy of IA/2844/2020, but he could not keep track of the aforesaid application and represent himself during the proceeding. By virtue of order dated July 13, 2021, the NCLT forfeited the right of the Appellant to file reply to the aforesaid application.

Thereafter, by virtue of order dated December 13, 2021, the NCLT allowed IA/2844/2020 and inter alia held that the respondents in IA/2844/2020 (including the Appellant herein) have misappropriated INR 2687.27 Lakhs and they are jointly and severally liable to make such contribution to the assets of HBN Foods Limited. The NCLT further directed Respondent to institute criminal prosecution against the respondents (including the Appellant herein) in IA/2844/2020 under Section 69 (Punishment for transactions defrauding creditors) of the IBC.

Aggrieved by the impugned order dated December 13, 2021 passed by the NCLT, the Appellant preferred an appeal before the NCLAT.

Issue

Whether the adjudicating authority is competent to pass order under Section 66 (Fraudulent trading or wrongful trading) of IBC during subsistence of moratorium under Section 14 (Moratorium) of IBC.

Arguments

Contentions raised by the Appellant:

The Appellant submitted that HBN Homes Colonizers Limited is undergoing CIRP and is under the protection of moratorium as envisaged under Section 14 (Moratorium) of the IBC. In view of the aforesaid, it was further submitted that no proceeding could be initiated against HBN Homes Colonizers Limited and hence, NCLT committed a serious error in passing the impugned order, inter alia, against HBN Homes Colonizers Limited in IA/2844/2020 filed under Section 66 (Fraudulent trading or wrongful trading) of the IBC, which is ex-facie erroneous and bad in law.

Contentions raised by the Respondent:

The Respondent contended that HBN Homes Colonizers Limited entered into fraudulent transactions which is against the interests of the creditors.

The Respondent further submitted that Section 14(1)(a) of the IBC has no application to the facts and circumstances of the present case, whereas Section 60(5) of the IBC provides for adjudication of issues pertaining to corporate debtor during the course of the CIRP or liquidation process. Hence, the Respondent contended that Section 14(1)(a) is not a bar to pass an appropriate order under Section 66 (Fraudulent trading or wrongful trading) of the IBC, and therefore, the impugned order passed by NCLT while exercising power under Section 60(5) of the IBC requires no interference.

Observations of the NCLAT

The NCLAT observed that the Appellant has not challenged the impugned order dated December 13, 2021 passed by the NCLT on merits, but has limited his contentions to the issue of legality of the order passed under Section 66 (Fraudulent trading or wrongful trading) of the IBC against a company which is undergoing CIRP and is under the protection of moratorium envisaged under Section 14 (Moratorium) of the IBC.

The NCLAT observed that Section 14(1)(a) of the IBC prohibits institution and continuation of adjudication of suits or proceedings including execution of any judgment, decree or order in any court of law, tribunal, arbitration panel or other authority against the corporate debtor. However, it does not prohibit passing any order by the NCLT during CIRP or liquidation process against resolution professional and its suspended directors and related parties.

The NCLAT further observed that Section 66 of the IBC empowers the NCLT to pass appropriate orders in case of fraudulent transactions against the suspended board of directors or resolution professional and related parties.

The NCLAT further observed that the contention of the Appellant that, the prohibition under Section 14(1)(a) of the IBC is applicable to Section 66 of the IBC, cannot be accepted because these two provisions are independent of each other and incorporated for different purposes. Section 14 of the IBC is intended to prevent claims by third parties to realize an amount from the corporate debtor by execution of orders, decrees etc., whereas Section 66 of the IBC is intended to prevent fraudulent trading or business by the corporate debtor. In view thereof, the NCLAT observed that Section 14(1)(a) and Section 66 of the IBC should be construed harmoniously in order to give effect to the intendment of the IBC and to make it workable.

Hence, the NCLAT arrived at the conclusion that the contention raised by the Appellant that during the course of moratorium, the NCLT shall not pass any order under Section 66 of the IBC, is not sustainable. The NCLAT further observed that Section 60(5)(a) of IBC permits the NCLT to pass any order on any application or proceeding by or against the corporate debtor or corporate person notwithstanding anything to the contrary contained in any other law for the time being in force.

Decision of the NCLAT

The NCLAT held that the impugned order dated December 13, 2021 passed by the NCLT deserves no interference and the appeal is liable to be dismissed.

VA View:

The NCLAT has rightly held that upon a harmonious construction of Section 14(1)(a), Section 60(5) and Section 66 of the IBC, it can be inferred that NCLT is not precluded from passing an appropriate order or direction under Section 66 of the IBC against a company undergoing CIRP since the protection of moratorium does not apply to an application filed before NCLT under Section 60(5) of the IBC with allegations of fraudulent transactions in terms of Section 66 of the IBC.

This judgment will provide much needed clarity in adjudication of many such applications pertaining to fraudulent avoidance transactions filed by the resolution professional or liquidator of a company against another company or its resolution professional or liquidator which other company is also undergoing the CIRP or liquidation process under the relevant provisions of the IBC.

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