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from NSE, about the aforesaid transaction and the possibility of the trading having taken place on the basis of unpublished price sensitive information (“UPSI”), Securities and Exchange Board of India (“SEBI”) conducted a preliminary enquiry.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]

Supreme Court: In the absence of any period of time and limitation prescribed by the enactment, every authority is to exercise power within a reasonable period

The Hon’ble Supreme Court (“SC”), in Securities and Exchange Board of India v. Sunil Krishna Khaitan and Others [Civil Appeal No. 8249 of 2013], examined the question of delay and laches in initiating proceedings and held that in the absence of any period of time and limitation prescribed by the enactment, every authority is to exercise power within a reasonable period.

Facts

Khaitan Electrical Limited (“KEL”), a listed company, was founded by late Shri Krishna Khaitan, who had passed away on November 4, 2012. The promoter group consists of his family members/relatives and associate entities (collectively, “Respondents”). In the extraordinary general meeting (“EGM”) held on March 23, 2006, the shareholders of KEL had approved issuance of 10,00,000 equity share warrants on preferential basis to the Respondents. In the EGM held on November 29, 2006, the shareholders had approved issuance of 10,00,000 equity share warrants to M/s. Khaitan Lefin Limited (“Respondent No. 3”), an identified member of the promoter group.

On March 12, 2007, the Respondents acquired 13,00,000 shares in KEL in two tranches. Upon receipt of the full consideration in terms of the warrants, KEL had issued shares to the Respondents consequent to which the shareholding of the Respondents underwent a change.

The Respondents were served with the show-cause notice dated March 26, 2012 issued by the Securities and Exchange Board of India (“Board”) with respect to violation of Regulations 10 (pertaining to obligation to make an open offer) and 11(1) (pertaining to creeping acquisition limit) of the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 1997 (“Takeover Regulations, 1997”), calling upon them to show cause why suitable directions under the Securities and Exchange Board of India Act, 1992 (“SEBI Act”) and Regulations 44 and 45 of the Takeover Regulations, 1997 read with corresponding provisions of Regulations 33 and 35 of the SEBI (Substantial Acquisition of Shares and Takeover) Regulations, 2011 (“Takeover Regulations, 2011”) should not be issued against them. Violation of Regulation 10 was predicated on the ground that on March 12, 2007, shareholding of Respondent No. 3 had individually increased from 10.52% to 17.16% and thereby it was mandatory for it to make a public announcement in accordance with the provisions of Regulation 10 read with Regulation 14(1) of the Takeover Regulations, 1997 within four working days from March 12, 2007. Further, on March 12, 2007, the collective shareholding of the promoter group, including the acquirers, had increased from 25.83% to 34.21% and, therefore, the acquirers collectively were required to make a public announcement in accordance with the provisions of Regulation 11(1) read with Regulations 14(1) of the Takeover Regulations, 1997 within four working days from March 12, 2007.

The Respondents contested the show-cause notice on various grounds. The Whole-Time Member of the Board (“Whole Time Member”) did not agree with the submissions made by the Respondents and vide his order dated December 31, 2012 held that there was a violation of the Takeover Regulations, 1997 and, therefore, the Respondents shall make a combined public announcement to acquire shares of KEL.

The Respondents preferred an appeal before the Securities Appellate Tribunal (“Appellate Tribunal”), which by the impugned order was partly allowed. The Appellate Tribunal held that Regulation 10 was not violated, but Regulation 11(1) was violated albeit the direction with regard to issue of public announcement and open offer was not sustainable at a belated stage. There was a delay of about five years in issuing show-cause notice relating to acquisition/ incidents which pertain to the year 2006-07, and as the impugned order came to be passed only on December 31, 2012, the directions of the Whole Time Member for issue of public announcement and open offer were set aside. However, monetary penalty was imposed.

In this regard, the Respondents have filed the present appeals. However, the Respondents did not challenge the penalty imposed by the Appellate Tribunal for violation of Regulation 11(1) of the Takeover Regulations, 1997.

Issue

Primary questions of law raised in the appeal related to the (i) interpretation of Regulation 10 of the Takeover Regulations, 1997; (ii) the power and exercise of the power by the Board under Regulations 44 read with 45 of the Takeover Regulations, 1997; and (iii) the power and jurisdiction of the Appellate Tribunal under Section 15T of the SEBI Act.

Arguments

Contentions of the Board

The Board contended that there was a violation of both Regulation 10 and Regulation 11(1) of the Takeover Regulations, 1997, as the shareholding of Respondent No. 3 increased beyond the stipulated threshold and no public announcement was made. Regulations 10 and 11(1) have to be read accordingly and in line with the objective of the Takeover Regulations, 1997 which is to ensure that an exit option is provided to the existing shareholders once any person, whether individually, and/or along with any another person acting in concert with each other, acquires shares that cross the % threshold.

The Board has been conferred with powers under the SEBI Act under Section 11 thereof to issue appropriate direction for protection of interest of the shareholders. The Board stated that the Appellate Tribunal should not have interfered with the directions to make an open offer, which are in line with the objectives of the SEBI Act read with Regulation 44 of the Takeover Regulations, 1997. The order passed by the Whole Time Member directing making of public announcement for open offer along with paying interest to the shareholders of the target company, was made with the larger objective of protecting interests of the shareholders who have a right and expectation to be provided with the opportunity to exit the company in case the shareholding/voting rights of a person and/or persons acting in concert crosses the stipulated threshold at any point of time.

Scope of power of the Appellate Tribunal enumerated in Section 15-T (pertaining to appeals) of the SEBI Act does not extend to substituting directions issued by the Board with monetary penalty. The scope of power of the Appellate Tribunal is wide but cannot be exercised in a manner which is inconsistent with the scheme of the SEBI Act. Further, the directions issued for public announcement and open offer are in line with the objectives of the SEBI Act which states that as soon as the contravention of the statutory obligation is established, penalties must follow.

The Board further contended that the Appellate Tribunal does not exercise jurisdiction under Article 226 of the Constitution of India and is a creation of the statute and, therefore, cannot pass any order inconsistent with the scheme of the SEBI Act. Thus, imposition of monetary penalty for violation of Regulation 11(1) of the Takeover Regulations, 1997, as directed by the Appellate Tribunal, is contrary to law and would also result in weakening of investor confidence in securities market as defaulters would be able to escape the obligation.

Further, the delay in issue of show-cause notice itself would not exonerate the defaulters under the SEBI Act and the relevant regulations, as has been held in Adjudicating Officer, Securities and Exchange Board of India v. Bhavesh Pabari [(2019) 5 SCC 90] (“Bhavesh Pabari Judgment”).

Observations of the Supreme Court

Regulation 10 of the Takeover Regulations, 1997 applies to the ‘acquirer’ acquiring voting rights, with reference to the existing holding as a person and in concert with other persons, because the acquisition is to be “taken together with shares or voting rights held by the acquirer himself or by person acting in concert with him”. The combined holding of the person and the ‘person acting in concert’ determines application of Regulation 10. If an ‘acquirer’ already holds more than 15 % shares or voting rights in concert with other persons, such holding is not be fragmented to calculate the shares or voting rights of the ‘acquirer’ in his personal capacity under Regulation 10. The expression ‘acquirer’, as defined in the Takeover Regulations, 1997, is broad, wide and is given an expansive definition.

The object of the wide definitions in the Takeover Regulations, 1997 is to ensure that no one is able to dribble past and defeat its objects by resorting to camouflage and subterfuge. Thus, the contention of the Board that the interpretation by the Appellate Tribunal defeats the object and purpose of the Takeover Regulations, 1997 was a feeble and evanescent argument. In the context of the present case, it is to be noted that the Board is the draftsman of the legislation having enacted the Takeover Regulations, 1997 and hence, their interpretation and understanding of the Regulations is of importance and relevance. In the context of the present case, the Board, nearly five years after the transactions, had issued the show-cause notice and then passed an order taking a view on interpretation of Regulation 10, which was contrary to the view expressed by it in several communications as also orders passed by the adjudicating authority. Past is passe and not present, and by giving ‘retroactive’ operation without good reason and ground, the direction violates fundamental notions of predictability and legal stability.

The SC observed that the principle of doubtful penalisation would be applicable in the present case. The SC, in the case of Tolaram Relumal and Another v. State of Bombay [(1955) 1 SCR 15] had held that it is a well settled rule of construction of penal statutes that if two views and reasonable constructions can be put on a provision, the court must lean in favour of construction which exempts the subject from penalty rather than one which imposes penalty.

Regulation 10 of the Takeover Regulations 1997, as interpreted and applied by the Board for over ten years, was sought to be overturned by the Board, thereby, creating penal consequences. The SC noted that this should not be permitted and is hardly acceptable if the principle of good governance is applied. Further, the argument of the Board that Takeover Regulations, 2011 are retrospective was rejected. It is a general rule of law of interpretation that unless explicitly mentioned, a law cannot be presumed to be retrospective.

Regulation 44 states that the Board, without prejudice to their rights to initiate action under Chapter VI-A and Section 24 of the SEBI Act, may in the interest of the securities market or for protection of the interests of the investors, issue such directions as it may deem fit. Thereafter, it specifies certain directions in clauses (a) to (i), using the word ‘including’, which implies that the directions issued by the Board can include the directions given in clauses (a) to (i), albeit the Board may issue directions even beyond what is stated in clauses (a) to (i). Thus, the Board’s power to give directions is wide. Regulation 44 states that the Board while issuing directions, has to keep in mind the interest of the securities market and its role as a protector of interest of investors.

The SC agreed with the reasoning given by the Appellate Tribunal for setting aside the directions given in the order passed by the Whole Time Member. The violation alleged relates to the years 2006-07. The order issuing the directions was passed on December 31, 2012, several years after the alleged violation. The direction given is that the shareholders should be given an option to sell the shares held by them on June 16, 2007 by directing the respondents to make a public announcement to acquire the shares. Direction has also been given to pay interest @ 10% per annum from June 16, 2007 till shares have been accepted in the open offer.

The SC observed that, though this direction can be issued, the exercise of discretion to issue the said direction has to be predicated and based upon good grounds and reasons. The directions of such nature are not automatic and are to be issued only when they are warranted and justified. The directions were for the reason that the acquirer had failed to comply with Regulation 10 of the Takeover Regulations, 1997 in the remote past, that is, in the year 2006 and 2007. It is whimsical and arbitrary exercise of discretion by the Board.

The SC, in the Bhavesh Pabari Judgment, had examined the question of delay and laches in initiating proceedings under Chapter VI-A of the SEBI Act and the principle of law that when no limitation period is prescribed proceedings should be initiated within a reasonable time and what would be reasonable time would depend upon facts and circumstances of each case. Whenever a question with regard to inordinate delay in issuance of a show-cause notice is made, it is open to the noticee to contend that the show-cause notice is bad on the ground of delay and it is the duty of the authority/officer to consider the question objectively, fairly and in a rational manner.

Further, in the present appeal, it is to be noted that an order in the form of directions was issued. It was this order which was made subject matter of challenge before the Appellate Tribunal. The SC did not accept the contention of the Board that the Appellate Tribunal while exercising appellate power could not have set aside and quashed the directions given in the appeal.

Decision of the Supreme Court

The SC upheld the order of the Appellate Tribunal, setting aside the directions of public announcement with open offer, given by the Whole Time Member for violation of Regulation 11(1) of the Takeover Regulations, 1997.

However, the SC disagreed with the Appellate Tribunal on the aspect of the power of Appellate Tribunal under Section 15T (pertaining to appeals) of the SEBI Act. It clarified that the power of the Appellate Tribunal under Section 15T of Chapter VI-A of the SEBI Act is confined to examination of correctness and legality of the order under challenge.

VA View:
The SC has rightly upheld the Bhavesh Pabari Judgment and observed that in the absence of any period of time and limitation prescribed by the enactment, every authority is to exercise power within a reasonable period. What would be the reasonable period would depend upon facts and circumstances of each case. As there is public interest involved, regulatory authorities should take actions and exercise their powers in a timely manner. When no limitation period is specified, they should endeavor to take actions within reasonable time.

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