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Between the Lines | Supreme Court: Guarantor is barred from being a resolution applicant under Section 29A(h) of the Insolvency and Bankruptcy Code, 2016 if guarantee has been invoked by any creditor, not necessarily being the creditor initiating the insolvency proceedings

The Hon’ble Supreme Court (“SC”) has in its judgment dated January 18, 2022 (“Judgement”) in the matter of Bank of Baroda and Another v MBL Infrastructures Limited and Others [Civil Appeal No. 8411 of 2019] held that once a personal guarantee is invoked by any creditor, notwithstanding the fact that the application initiating the corporate insolvency resolution process (“CIRP”) was filed by another creditor, such guarantor stands ineligible to submit a resolution plan under Section 29A(h) of the Insolvency and Bankruptcy Code, 2016 (“IBC”).

Facts
The instant case throws light on the judicial interpretation of Section 29A(h) of the IBC. M/s. MBL Infrastructures Limited (“Respondent No. 1”) was set up by Mr. Anjanee Kumar Lakhotiya (“Respondent No. 3”). Loans/ credit facilities were obtained by the Respondent No. 1 from a consortium of banks. On the failure of the Respondent No. 1 to act in tune with the terms of repayment, some of the respondents were forced to invoke the personal guarantees extended by the Respondent No. 3 for the credit facilities availed by the Respondent No. 1. M/s. RBL Bank and M/s. State Bank of Bikaner and Jaipur issued a notice under Section 13(2) of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (“SARFAESI”), after duly invoking the personal guarantee of the Respondent No. 3. Thereafter, M/s. RBL Bank filed an application under Section 7 (Initiation of CIRP by financial creditor) of the IBC before the National Company Law Tribunal, Kolkata (“NCLT”) to initiate CIRP against Respondent No. 1, which was admitted.

Two resolution plans were received by the resolution professional (“Respondent No. 2/RP”), of which, one was authored by Respondent No. 3 on June 29, 2017 (“Plan”). Thereafter, by way of the Insolvency and Bankruptcy Code (Amendment) Ordinance, 2017, Section 29A (Persons not eligible to be resolution applicant) was introduced to the IBC. At the instance of the Committee of Creditors (“CoC”), the Respondent No. 3 submitted a modified Plan. The CoC held its meeting on December 1, 2017 to deliberate upon the impact of the aforesaid amendment qua the eligibility of the Respondent No. 3 in submitting the Plan in the CIRP proceedings. In view of the lingering doubt expressed, the Respondent No. 3 filed an application praying for a declaration that he was not disqualified from submitting the Plan under Section 29A(c) and Section 29A(h) of the IBC.

The NCLT, by its order dated December 18, 2017 (“2017 Order”) held that the Respondent No. 3 was eligible to submit a resolution plan, notwithstanding the fact that he had extended his personal guarantees on behalf of the Respondent No. 1, which were duly invoked by some of the creditors. This issue was never placed and raised before the NCLT. The NCLT ruled that inasmuch as the personal guarantee having not been invoked and the Respondent No. 3 merely having extended his personal guarantee, as such there is no disqualification per se under Section 29A(h) of the IBC, as the liability under a guarantee arises only upon its invocation. As debt payable by Respondent No. 3 was not crystalized, he could not be construed as a defaulter for breach of the guarantee. With such clarification, the application filed was allowed by taking into consideration the amendment introducing Section 29A of the IBC.

Aggrieved by the 2017 Order, Punjab National Bank (“Respondent No. 10”) appealed to the National Company Law Appellate Tribunal (“NCLAT”), which passed an interim order facilitating the RP and CoC to go through with the Plan, but prohibiting the NCLT to accept the same, without prior approval of the NCLAT. Respondent No. 1, Respondent No. 2, Respondent No. 3 and Respondent No. 10 are collectively referred to as “Respondents”. The Plan was put to vote and received 68.50% vote share of the CoC. The extended 270 day period of CIRP expired on December 25, 2017. Subsequently, RBL Bank also filed an appeal against the NCLT order to the NCLAT. With the approval of Indian Overseas Bank, the Plan gathered 78.50% vote share. Section 29A(h) was further amended post which it read, “has executed an enforceable guarantee in favour of a creditor, in respect of a corporate debtor against which an application for insolvency resolution made by such creditor has been admitted under this code“. On March 23, 2018, the NCLAT allowed RBL Bank and Respondent No. 10 to withdraw their respective appeals in view of the Plan having reached the mandatory requirement of 75% as warranted under Section 30(4) of the IBC, making it clear that they did not have any grievance with the CoC decision. However, a request made by Bank of Baroda (“Appellant”) before the NCLAT seeking to be impleaded as a party to continue the lis was not considered favourably without assigning any reasons.

Thereafter, the NCLT approved the Plan by its order dated April 18, 2018 (“NCLT Order”), owing to the fact that the issue qua the eligibility under Section 29A(h) of the IBC had been decided, coupled with the Plan crossing the requisite threshold of approval by the CoC, that is, 75% vote share. A subsequent appeal was made before the NCLAT by the Appellant, which confirmed the order of the NCLT (“NCLAT Order”). Aggrieved, the Appellant filed an appeal before the SC.

Issue

Whether Respondent No. 3 being the guarantor was ineligible under Section 29A(h) of the IBC to submit the Plan.

Arguments

Contentions raised by the Appellant:

The Appellant submitted that Section 29A of the IBC had to be given a holistic interpretation as the objective was to weed out undesirable persons with the intention of promoting primacy of debt, by disqualifying guarantors who had not fulfilled their co-extensive liability with the insolvent corporate debtor. It was argued that Respondent No. 3 was ineligible to submit the Plan under Section 29A(h) of the IBC, as several personal guarantees executed by the Respondent No. 3 in favour of various creditors of the Respondent No.1 stood invoked, prior to commencement of CIRP, which was suppressed by Respondent No. 2 and Respondent No. 3 before the NCLT. Therefore, the premise on which the NCLT held the Respondent No. 3 eligible to submit the Plan was ex facie false. Further, it was argued that the law which was prevailing on the date of the application had to be seen, therefore, the disqualification would be attracted on the date of filing of the application.

Lastly, it was submitted that a legal ineligibility could not be done away with by alleged estoppel and such ineligibility had to be considered by courts irrespective of any waiver by any party or creditor. It was pointed out that the approval of the Plan was made after the expiry of the CIRP period. It was submitted that owing to the clear infraction of Section 12 (Time limit for completion of insolvency resolution process) of the IBC, the orders passed should be set aside.

Contentions raised by the Respondents:

The Respondents averred that a decision made by the CoC in its commercial wisdom on being satisfied with the viability and feasibility of the resolution plan, should not be interfered with by the SC. Calling the revised plan accepted by the NCLAT an improvement to the earlier one, it was submitted that the Appellant being aware of the decision of the NCLT in the first instance, ought to have taken it further. Further, it was contended that the Appellant was estopped from questioning the eligibility of Respondent No. 3.

It was further argued that Section 29A(h) of the IBC had to be literally interpreted to the extent that a personal guarantor is barred from submitting a resolution plan only when the creditor invoking the jurisdiction of the NCLT has invoked a personal guarantee executed in favour of the said creditor by the resolution applicant. It was pointed out that no personal guarantee stood invoked by RBL Bank at the time of application to the NCLT under Section 7 of the IBC. It was further submitted that the invocation of the consortium guarantee by Allahabad Bank and State Bank of Bikaner and Jaipur under Section 13(2) of the SARFAESI was ex facie illegal in terms of the inter-se agreement executed between the members of the consortium of banks.

It was also contended that the object of the IBC is the revival of the corporate debtor, liquidation being the last resort, and any interference would have an adverse effect and militate against the very object of the IBC. The Respondents highlighted that after the approval of the Plan, several projects of national importance had been completed and various others were under execution. Further, all workmen had also been paid in full, and all current employees, operational creditors and statutory dues were being regularly paid.

Observations of the Supreme Court

The SC noted that the idea of the IBC is to facilitate a process of rehabilitation and revival of the corporate debtor with the active participation of the creditors, and that there are only two principal actors in the entire process, that is, the CoC and the corporate debtor.

The SC noted that the objective behind Section 29A of the IBC is to avoid unwarranted and unscrupulous elements to get into the resolution process while preventing their personal interests to step in and prevent certain categories of persons not in a position to lend credence to the resolution process by virtue of their disqualification. Explaining the scope of Section 29A(h) of the IBC, the SC opined that once a person executes a guarantee in favour of a creditor with respect to the credit facilities availed by a corporate debtor, and in a case where an application for insolvency resolution has been admitted, with the further fact of the said guarantee having been invoked, the bar qua eligibility would certainly come into play. The provision requires a guarantee in favour of ‘a creditor’. Once an application for insolvency resolution is admitted on behalf of ‘a creditor’, then the process would be one of rem, and therefore, all creditors of the same class would have their respective rights at par with each other.

While interpreting Section 29A(h), the SC noted that the word “such creditor” in Section 29A(h) of the IBC meant similarly placed creditors after the application for insolvency application is admitted by the adjudicating authority. The SC observed that to earn a disqualification under Section 29A(h) of the IBC, there must be a mere existence of a personal guarantee that stands invoked by a single creditor, notwithstanding the application being filed by any other creditor seeking initiation of insolvency resolution process. This is subject to further compliance of invocation of the said personal guarantee by any other creditor. Any other interpretation would lead to an absurdity striking at the very objective of Section 29A of the IBC, and in turn the IBC. Ineligibility has to be seen from the point of view of the resolution process and it can never be said that there can be ineligibility qua one creditor as against others.

The SC observed that if there is a bar at the time of submission of resolution plan by a resolution applicant, it is obviously not maintainable. However, if the submission of the plan is maintainable at the time at which it is filed, and thereafter, by the operation of the law, a person becomes ineligible, which continues either till the time of approval by the CoC, or adjudication by the authority, then the subsequent amended provision would govern the question of eligibility of resolution applicant to submit a resolution plan. The resolution applicant has no role except to facilitate the process. If there is ineligibility which in turn prohibits the other stakeholders to proceed further and the amendment being in the nature of providing a better process, and that too in the interest of the creditors and the debtor, the same is required to be followed as against the provision that stood at an earlier point of time. Thus, a mere filing of the submission of a resolution plan has got no rationale, as it does not create any right in favour of a facilitator nor can it be extinguished.

Factually, in the instant case, it was noted that Respondent No. 3 had executed personal guarantees which were invoked by three of the financial creditors even prior to the application filed, thereby attracting Section 29A(h) of the IBC. Thus, in the touchstone of the interpretation of Section 29A(h) of the IBC by the SC, it was held that the plan submitted by the Respondent No.3 ought not to have been entertained. The SC also agreed with the NCLT that Section 12 of the IBC would not get attracted on account of pending proceedings with interim orders.

The SC observed that the majority of the creditors had given their approval to the Plan. The SC agreed with the observation of the NCLT that the Plan was accordingly approved after taking into consideration, the techno-economic report pertaining to the viability and feasibility of the Plan. Moreover, it was observed that the Plan became operational since April 18, 2018, and the Respondent No. 1 was an on-going concern. Taking note of the interest of over 23,000 shareholders and thousands of employees of the Respondent No. 1, and of the ongoing projects of the Respondent No. 1 of public interest, it observed that the ultimate object of the IBC, was to put the corporate debtor back on the rails and no prejudice would be caused to the dissenting creditors as their interests would otherwise be secured by the Plan itself. Hence, the SC wished not to interfere with the Plan.

Decision of the Supreme Court

The SC held that the plan submitted by the Respondent No. 3 ought not to have been entertained. The SC held that the NCLT and the NCLAT were not right in rejecting the contentions of the Appellant on the ground that the earlier appeals having been withdrawn without liberty, the issue qua eligibility cannot be raised for the second time. It held that since the Appellant was not a party to the decision of the NCLT on the first occasion, in the appeal the Appellant merely filed an application for impleadment, and so the principle governing res judicata and issue estoppel would not get attracted. Thus, it was held that the reasoning rendered by the NCLAT to that extent cannot be sustained in law. However, noting the peculiar facts of the instant case the SC dismissed the appeal so as to not disturb the Plan leading to the on-going operation of the Respondent No. 1.

VA View:
Through this Judgement, the SC has in accordance with the objective of IBC, given prime importance to the revival of the corporate debtor and its working as a going concern. While the SC accepted that the orders passed by the NCLT and NCLAT were flawed, considering the commercial wisdom of the CoC and the possible adverse impact the revocation of the Plan might have on the corporate debtor, the SC, following the spirit of the IBC, did not set aside the Plan.

However, for similar cases that may arise in the future, the SC has categorically laid down that invocation of personal guarantee by any single creditor, irrespective of the fact that an application initiating CIRP has been made by another creditor, suffices to disqualify the guarantor from submitting a resolution plan.

Thus, the SC through this Judgement has struck a fine balance between clarifying the law on Section 29(A)(h) of the IBC, while also ensuring that the corporate debtor is brought back on its feet, without once again getting embroiled in the process of IBC.

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

Webinar on “Analysis of Union Budget” | Presentation and Video Link

Vaish Associates organised a Budget Webinar on 4th February, 2022 which was chaired by Mr. Ajay Vohra, Senior Advocate, the leading legal luminary and one of the most respected jurists, who lead the discussions along with Partners of Vaish Associates.

Please find below link of video and presentation analyzing threadbare, the proposals of Finance Bill 2022 and their likely impact

Click here to view the Presentation.

Click here to Watch the Video of Webinar.

GST Cafe | Entitlement of a Taxpayer is limited to the Input Tax Credit reflecting in Form GSTR-2B: CBIC

The Central Board of Indirect Taxes and Customs (‘Board’), vide Notification No.39/2021-Central Tax[1] has notified new provisions under the Finance Act, 2021 (“the Act”), seeking to amend various provisions of the Central Goods and Services Act, 2017 (“CGST Act”). These provisions, namely Section 108, 109, 115, 116 and 120, have come into force from 1^st January 2022. The Board, inter-alia has clarified that any claim of input tax credit (“ITC”) will be allowed only if the same is reflected in FORM GSTR-2B of a taxpayer. The scope of this GST Café is limited to this particular aspect of the above mentioned notification.

Background:

Section 37 of the CGST Act prescribes that a monthly or a quarterly return shall be filed for all the outward supplies made by any registered supplier under GST. This return shall include details of invoices, debit notes, credit notes and revised invoices issued in relation to all outward supplies made by such supplier during any tax period. The form and manner in which the details of the outward supply shall be furnished are outlined under Rule 59 of the Central Goods and Services Rules, 2017 (“the Rules”). According to the above mentioned rule, all the relevant details of the outward supply shall be furnished by the supplier under FORM GSTR-1.
Section 41 of the CGST Act entitles taxpayers to provisionally take the credit of eligible input tax, as self-assessed, in his return and such amount shall be credited on a provisional basis to the electronic credit ledger.
Section 42(1)(a) of the CGST Act prescribes that the details of every inward supply furnished by the recipient shall match with the corresponding details of outward supply furnished by the supplier in his valid return for the same tax period or any preceding tax period. Therefore, the provisional credit becomes final after matching and the reversal and reclaim of ITC was carried out in the manner laid down under Section 42 of the CGST Act.
According to Rule 60 of the rules, the details provided in FORM GSTR-1 shall be auto-populated and made available electronically to the recipient, for matching purposes, in FORM GSTR-2A. It is a purchase centric dynamic tax return automatically generated on the portal. Any purchases made by the taxpayer, as reflected in the seller’s FORM GSTR-1 gets auto-populated in the buyer’s FORM GSTR-2A.
FORM GSTR-2B is a system-generated (auto-populated) statement for ITC. This form reflects the ITC for a month, on the basis of the outward taxable supplies made by a taxpayer. Since FORM GSTR-2A is a dynamic return, there is no due date as per which the credit should be claimed. On the other hand, FORM GSTR-2B gets auto-populated on the 14^th of every month, and hence reflects the ITC as per invoices furnished by the supplier of the taxpayer in their FORM GSTR-1 for the particular month.
Section 16(1) of the CGST Act entitles every registered taxpayer to the credit of tax charged on the course of business, commonly referred to as the ITC where as section 16(2) of the CGST Act lays down the basic conditions to seek ITC by a registered taxpayer.
Earlier, as per Rule 36(4) of the CGST Rules, 2017, the taxpayers could claim provisional credit up to 5% of the ITC of the amount reflected in FORM GSTR 2B to file returns in FORM GSTR-1 towards outward taxable supplies made.

Overview of the amendment:

The Board has amended Rule 36(4) of the CGST Rules to now provide that the recipient would not be able to take any ITC if the same is not appearing in his FORM GSTR-2B. Earlier this was limited to 5% of the amount reflecting in FORM GSTR-2A. Therefore, the condition of the cut off date for computing eligible ITC being the due date of filing FORM GSTR 1 has been brought strictly in force by way of the above amendment.
Section 109 of the Act amends section 16 by adding another sub-clause, namely 16(aa) making it mandatory for a supplier to furnish the details of the invoice or debit note in FORM GSTR-1. Furthermore, ITC can only be claimed by a supplier once the details of such invoice or debit note have been communicated to the recipient.

VA Comments:

The above amendment has in effect nullified the effect of Rule 36(4) which prescribed a provisional credit up to 5% of the ITC reflected in FORM GSTR 2A. This means that the eligible ITC of the taxpayer will be affected because of the invoices not uploaded by the supplier of such taxpayer in their FORM GSTR-1. The concept of provisional ITC was brought into effect vide Notification No. 49/2019-Central Tax[2]. Per the said notification, the Board introduced Rule 36(4) into the Rules enabling a taxpayer to avail ITC up-to 20% of the amount of the invoices not furnished by their supplier under FORM GSTR-1 (and hence not reflecting in the taxpayer’s FORM GSTR-2A). Pursuant to the 38^th GST Council meeting, such limit was restricted by the Board to 10% with effect from 1^st January, 2020. Therefore, this amendment has wide ramifications on the working capital of the taxpayer, thereby inducing stricter compliance on the part of the taxpayers.
Furthermore, the restriction imposed as per the amended Rule 36(4) is likely to induce a due diligence check from the buyers to the sellers. However, the restriction, as introduced after almost four and a half years of introduction of GST regime, seems to disrupt the seamless flow of credit, thereby refuting one of the objectives of introduction of GST.
This amendment in effect is in contradiction to the observation of the GST Council in its 27^th meeting[3] whereby it was observed that the automatic reversal of ITC in case of default of payment of seller should be restricted to exceptional situations like missing dealer, closure of business by the supplier etc. Furthermore, the Hon’ble Supreme Court while dismissing a Special Leave Petition against the decision of Hon’ble Delhi High Court in Arise India Ltd. V. Commissioner of Trade and Taxes[4] upheld the position that ITC should be restricted only with respect to the sellers failing to deposit the tax collected by them to the government. Any condition allowing the bona-fide taxpayers to suffer at the hands of the non-compliant sellers will refute the objective of intelligible differentia enshrined under Article 14 of the Constitution of India. Therefore, even though the objective of the above amendment was to reduce litigations in respect of numerous Writ Petitions filed for challenging the provisional credit available to the taxpayers, further litigations are bound to happen challenging the above amendment.

For any further information/ clarification, please feel free to write to Mr Shammi Kapoor, Partner at [email protected]

______________________________________________________________________________

[1] F. No. CBIC-20006/26/2021-GST dated 21^st December, 2021

[2] F. No. 20/06/07/2019-GST dated 9^th October, 2019

[3] Press Release of the 27th GST Council Meeting dated May 04, 2018.

[4]TS-314-HC-2017(Del)-VAT

Between the Lines | NCLT: A foreign award is not sufficient to initiate insolvency proceedings against the corporate debtor under the Insolvency and Bankruptcy Code, 2016.

The Hon’ble National Company Law Tribunal, Cuttack Bench (“NCLT”) in the matter of Jaldhi Overseas Pte. Limited v. Steer Overseas Private Limited [TP No. L8/CTB/2019], held that a foreign award is not sufficient to initiate insolvency proceedings against the corporate debtor under the Insolvency and Bankruptcy Code, 2016 (“IBC”).

Facts

Steer Overseas Private Limited (“Corporate Debtor”) engaged Jaldhi Overseas Pte. Limited (“Operational Creditor”), a company incorporated under the laws of Singapore, for availing its vessel services for carrying its cargo of iron-ore fines from Haldia and Vizag port to a port in China. In the course of transportation of goods from the vessel which was taken on hire by the Corporate Debtor from the Operational Creditor, detention and demurrage charges became payable at Vizag and China port respectively. The amount of charges to be payable became disputed between the Corporate Debtor and the Operational Creditor. Consequently, the dispute was referred to arbitration by the Operational Creditor which was duly contested by the Corporate Debtor and upon completion of hearing and pleadings, the partial foreign award was passed by the arbitrator against the Corporate Debtor on January 20, 2017 (“Foreign Award”).

The Operational Creditor thereafter applied before the High Court of the Republic of Singapore for leave of the court to enforce the Foreign Award which was duly accepted and allowed by the High Court of Singapore by judgment dated December 1, 2017. Thereafter, the Operational Creditor had raised a demand notice demanding payment in respect of the Foreign Award. However, the Corporate Debtor failed to repay the debt. Consequently, the Operational Creditor filed an application under Section 9 (Application for initiation of corporate insolvency resolution process by operational creditor) of the IBC for initiation of corporate insolvency resolution process (“CIRP”) against the Corporate Debtor.

Issue

Whether a foreign award is sufficient to initiate insolvency proceedings against the Corporate Debtor under the IBC.

Arguments

Contentions raised by the Corporate Debtor:

The Corporate Debtor contended that the enforcement of Foreign Award through NCLT is impermissible and a CIRP under the IBC cannot be initiated on the basis of a foreign award. It further contented that the NCLT is not a civil court and nor an executing court for enforcement of Foreign Award. Lastly, the Corporate Debtor contented that since there is a pre-existing dispute between both the parties, the Foreign Award cannot be enforced and the petition is not maintainable as the claim is not an “operational debt”.

Contentions raised by the Operational Creditor:

The Operational Creditor submitted that its claim is based on the Foreign Award which was passed in its favour by an arbitral tribunal based in Singapore. The High Court of the Republic of Singapore, after rejecting objections raised by the Corporate Debtor, by its judgement dated December 1, 2017, also enforced the Foreign Award in favour of the Operational Creditor. Lastly, it contended that since the Foreign Award was recognised by the High Court of Singapore against the Corporate Debtor and the Corporate Debtor failed to repay the debt, even after repeated demand notice, the Foreign Award should be recognised as an operational debt and CIRP should be initiated against the Corporate Debtor under the IBC.

Observations of the National Company Law Tribunal

The NCLT stated that foreign awards are different from domestic awards. Unlike a domestic award, a foreign award has to undergo certain test to become an enforceable award/deemed decree and cannot directly constitute debt to initiate proceedings against the corporate debtor under the IBC. The NCLT, by citing the judgment of the Hon’ble Supreme Court in Government of India v. Vedanta Limited [2020 SCC online SC 749], further elaborated this by stating that the mere production of Foreign Award is not enough to give an effect. Part II, Chapter I of Arbitration and Conciliation Act, 1996 (“1996 Act”) deals with enforcement of foreign awards in India and as per explanation to Section 47 (Evidence) of the 1996 Act, ‘the court’ refers to only High Courts. Therefore, relying on Section 47 of the 1996 Act, the NCLT stated that the High Courts in India alone have the exclusive jurisdiction to deal with enforcement of foreign awards.

The NCLT further stated that to enforce foreign awards in India, the party in whose favour award stands shall file the documents referred in Section 47 (l) and (2) of the 1996 Act, and the enforcement of foreign award is subject to the satisfaction of the concerned High Court and only after the satisfaction of the High Court, the foreign award becomes enforceable and shall be deemed to be a decree as per Section 49 (Enforcement of foreign awards) of the 1996 Act.

The NCLT concluded by stating that Section 47 of the 1996 Act makes it clear that only the concerned High Court has the exclusive jurisdiction to deal with Foreign Award and give effect to the same and in this case, the NCLT cannot act upon the Foreign Award under the presumption that an undisputed debt amount is due towards the Corporate Debtor and as such an exercise would amount to bypassing/violating the procedures laid down in Part II, Chapter I of the 1996 Act.

Decision of the National Company Law Tribunal

In view of the above, the NCLT rejected the application of the Operational Creditor.

VA View:

In this judgement, the NCLT, by analysing the provisions of the 1996 Act, rightly opined that a foreign award is insufficient to initiate insolvency proceedings against the Corporate Debtor under the IBC. As highlighted by the NCLT, a foreign award cannot be considered as an operational debt under the IBC as it is not considered as deemed decree of the court.

To enforce a foreign award, one has to follow the procedure laid down in Part II, Chapter I of the 1996 Act. A foreign award is not an automatically recognised debt under the IBC and has to undergo certain test to become enforceable award/deemed decree. This judgment brings further clarity towards treatment of foreign awards under the IBC and would be helpful to parties looking to enforce foreign awards to claim their debt from Indian debtors.

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

Between the Lines | Supreme Court: The Adjudicating Authority and the Appellate Authority can encourage, but cannot compel the parties to settle a dispute under the Insolvency and Bankruptcy Code, 2016

The Hon’ble Supreme Court (“SC”) has in its judgement dated December 14, 2021, in the matter of E S Krishnamurthy and others v. M/s Bharath Hi Tech Builders Private Limited [Civil Appeal No. 3325 of 2020], held that the National Company Law Tribunal (“Adjudicating Authority”) and the National Company Law Appellate Authority (“Appellate Authority”) can encourage, but cannot compel the parties to settle a dispute under the Insolvency and Bankruptcy Code, 2016 (“IBC”).

Facts

A master agreement (“Master Agreement”) was entered into between M/s Bharath Hi Tec Builders Private Limited (“Corporate Debtor”), IDBI Trusteeship Limited and Karvy Realty (India) Limited (“Facility Agent”) on June 22, 2014, to raise an amount of Rs.50 crores for the development of agricultural land. The terms of the Master Agreement required the Facility Agent to sell the plots to prospective purchasers and the Corporate Debtor was then required to register and convey the plots to the purchasers. However, since the requisite funds could not be generated through the Master Agreement, a Syndicate Loan Agreement (“Loan Agreement”) was entered into on November 22, 2014, for availing a term loan of Rs.18 crores from prospective lenders. As per the Loan Agreement, the prospective lenders were to lend money to the Corporate Debtor by executing a Deed of Adherence at an assured return for the development of the proposed residential layout in its project.

Thereafter, on the advice of the Facility Agent, their clients extended loans to the Corporate Debtor by executing Deeds of Adherence and through the said Loan Agreement, the Corporate Debtor raised over Rs.15 Crores from nearly 300 investors. The Corporate Debtor sought multiple extensions of the loan period, but failed to convey the plots to the purchasers and make the repayment to the investors. Hence, on April 26, 2019, being aggrieved, 83 purchasers/investors (“Petitioners”) instituted a petition under Section 7 of the IBC before the Adjudicating Authority, due to the Corporate Debtor’s default in making the re-payment of an amount of Rs.33,84,32,493.

The Adjudicating Authority on being satisfied that a settlement process was underway, disposed of the petition and directed the Corporate Debtor to settle the claims of all remaining purchasers/investors within a period of 3 months and if any party was aggrieved by the settlement process of the Corporate Debtor, they would be at liberty to approach the Adjudicating Authority, in accordance with law (“NCLT Order”). Thereafter, the Appellate Authority by way of its order dated July 30 2020, upheld the NCLT order and observed that the Adjudicating Authority by deciding to dismiss the petition under Section 7 of the IBC at the ‘pre-admission stage’, since a settlement process was underway, protected the rights of all the Petitioners by setting a time-frame of 3 months for the settlement process (“NCLAT Order/Impugned Order”). Aggrieved by the NCLAT Order, few of the Petitioners, along with others (“Appellants”) preferred the present appeal before the SC under Section 62 of the IBC. (“Appeal”).

Issue

Whether the Adjudicating Authority can without applying its mind to the merits of the petition under Section 7 of the IBC, dismiss the petition on the basis that the Corporate Debtor initiated the process of settlement.

Arguments

Contentions raised by the Appellants:

1. The NCLT Order and the NCLAT Order were contrary to the mandate of Section 7 of the IBC

As per the scope of Section 7 of the IBC, the Adjudicating Authority merely has to satisfy itself whether a default has occurred or not. Section 7(5) of the IBC only provides the Adjudicating Authority with two options-to pass an admission order under Section 7(5)(a) of the IBC or reject the petition under Section 7(5)(b) of the IBC.
The Appellate Authority had also erred in observing that the petition under Section 7 of the IBC was disposed of at a ‘pre-admission stage’ by the Adjudicating Authority. In the event that the Adjudicating Authority is not satisfied that the financial debt is owed and a default has occurred, Section 7(5)(b) of the IBC provides that it shall reject the application. Thus, an option to dispose at a ‘pre-admission stage’ was not available to the Adjudicating Authority.

2. The Adjudicating Authority and the Appellate Authority acted beyond the scope of their jurisdiction under the IBC

Once there is an admitted default, the Adjudicating Authority was statutorily bound to admit the petition and had acted patently beyond its jurisdiction in not entertaining it on the ground that there was a possibility of a settlement. Further, out of the 83 Petitioners before the Adjudicating Authority, only 13 had entered into a settlement. As a result, there was no settlement with the remaining 70 Petitioners.
The direction by the Adjudicating Authority to the Corporate Debtor to settle all individual claims was beyond its jurisdiction, as a judicial authority cannot dispose of a petition with a direction to settle a dispute. At the highest, a proceeding may be adjourned in order to enable the parties to explore the possibility of a settlement.

Contentions raised by the Corporate Debtor:

1. Since the settlement process was progressive, it was in this backdrop that the Adjudicating Authority disposed of the petition, with specific directions that the Appellants could approach it if the Corporate Debtor did not settle their claims within three months.

2. The Corporate Debtor should not be pushed to insolvency merely because a few of its alleged creditors are not willing to settle and reiterated its commitment to settle with the proposed purchasers, despite the real-estate industry being severely affected due to the COVID-19 pandemic.

Observations of the Supreme Court:

The SC on its careful perusal of the criteria set out under Section 7, Section 3(11) and Section 3(12) of the IBC, which provide for the initiation of corporate insolvency resolution process (“CIRP”) by a financial creditor, the definition of debt and the definition of default, respectively, opined that the Adjudicating Authority had clearly acted outside the terms of its jurisdiction under Section 7(5) of the IBC, as being an Adjudicating Authority, it is empowered only to verify whether a default has occurred or if a default has not occurred. Thereafter, the Adjudicating Authority must either admit or reject an application, as these are the only two courses of action which are open to the Adjudicating Authority in accordance with Section 7(5) of the IBC.

The SC noted that no settlement was arrived at by all the original Petitioners who had instituted the proceedings and the Adjudicating Authority disposed of the petition under Section 7 of the IBC on the ground that the settlement process was progressing. Hence, the SC observed that the Adjudicating Authority cannot compel a party to the proceedings before it to settle a dispute and that the Adjudicating Authority and the Appellate Authority, in the present case, abdicated their jurisdiction to decide a petition under Section 7 of the IBC by directing the Corporate Debtor to settle the remaining claims within three months and leaving it open to the original Petitioners, who are aggrieved by the settlement process, to move fresh proceedings in accordance with law, the course of action of which is not contemplated under the IBC.

Decision of the Supreme Court:

In view of the above, the SC held that the NCLT Order and the NCLAT Order suffered from an abdication of jurisdiction and thus set aside the Impugned Order. Accordingly, the petition under Section 7 of the IBC was restored to the Adjudicating Authority for disposal afresh.

VA View:

The IBC is a complete code in itself and the Adjudicating Authority and the Appellate Authority are creatures of the statute. The provisions of the IBC do provide for settlements even after a petition under Section 7 of the IBC is admitted, and before the Committee of Creditors (“CoC”) is formed the parties can settle the dispute. Further, even after the CoC is formed, Section 12A of the IBC does provide for a mechanism through which the petition can be withdrawn in the event that the parties were to reach a settlement.

The powers of the Adjudicating Authority under the ambit of Section 7 of the IBC are limited to determining whether a default under Section 3(12) of the IBC has occurred and if it is of the opinion that a default has occurred, it has to admit the application as per the IBC. Thus, the Adjudicating Authority cannot act like a court of equity and its jurisdiction is limited by the provisions of the IBC.

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

Between the Lines | NCLT: The shareholders are different from lenders

The National Company Law Tribunal, Mumbai (“NCLT”) has in its judgment dated November 29, 2021 (“Judgement”), in the matter of Hubtown Limited v. GVFL Trustee Company Private Limited [M.A. 2411/2019 IN C.P. 4128/I&B/MB/2018 and others], held that shareholders are different from lenders.

Facts

Hubtown Limited (“Corporate Debtor”) was earlier known as Ackruti City Limited. The Corporate Debtor was a shareholder in a company called Hubtown Bus Terminal (Mehsana) Private Limited (“HBT Mehsana”), which was a special purpose vehicle incorporated to, inter alia, undertake and complete reconstruction and development of commercial and residential property at Mehsana, Gujarat by the Corporate Debtor. GVFL Trustee Company Private Limited (“GVFL”) filed a petition under Section 7 of the Insolvency and Bankruptcy Code, 2016 (“IBC”) against the Corporate Debtor for a debt by way of equity investment in shares of HBT Mehsana for a total amount of Rs.4,30,54,200/- as principal and Rs.9,96,95,800/- as Internal Rate of Return (“IRR”) calculated at 26% of the principal up to August 31, 2018.

Earlier, a Share Subscription and Shareholders Agreement dated September 24, 2010 (“SHA”) was signed between IL&FS Trust Company Limited (“ILFS”), IIRF India Realty XVIII Limited (“IIRF”) and the Corporate Debtor and two other promoters of HBT Mehsana. Consequent to the SHA, IL&FS and IIRF invested in HBT Mehsana by subscribing to Class ‘A’ equity shares, Class ‘B’ equity shares and Class ‘D’ equity shares. On May 29, 2013 a Share Purchase Agreement (“SPA”) was executed between GVFL, the ILFS group, the Corporate Debtor and two other promoters of HBT Mehsana. In terms of this SPA, GVFL purchased the shares (Class ‘D’ shares) of HBT Mehsana from the ILFS group for a total amount of Rs.4,30,54,200/-. These shares were reclassified as Class ‘E’ and Class ‘F’ equity shares as under.

Under the SHA, GVFL was provided with shareholders’ rights like right to nominate one director on the board of HBT Mehsana, right to vote in annual general meeting (“AGM”)/ extraordinary general meeting (“EGM”), special veto power, etc. Other shareholders’ right which accrued to GVFL included giving various exit options under the SHA which has been enumerated at Clause 13.1 of the SHA, which reads as under:

“13.1. The Investor No.3 shall have the following rights which the Investor No.3 shall be free to exercise at any time in the manner specified in the said clauses:
13.2. Annual Put Option;
13.3. Listing;
13.4. Buy-back of all shares held by the Investors No.3 in the Company;
13.5 Accelerated Put; and
16 – Strategic Sale and Withholding of Sale of Project Assets.”

The NCLT noted that these options are part of a shareholder’s right. The claim of GVFL was that the payments by GVFL were made to purchase shareholding in HBT Mehsana. GVFL had sought to exercise its right under the “put option” for the first time in December 2013 and the said Section 7 petition under the IBC was filed by them in November 2018 purportedly for a debt amount of Rs. 4,30,54,200/- along with return calculated at IRR of 26% till August 31, 2018.

There were three other projects for which three more special purpose vehicle companies were separately incorporated by the Corporate Debtor and were a subject matter of CP No. CP(IB)-4128/2018 (HBT Vadodara), CP No. CP(IB)-4130/2018 (HBT Ahmedabad) and CP No. CP(IB)-4131/2018 (HBT Adajan) filed under Section 7 of the IBC (“Other Company Petitions”). For these Other Company Petitions, miscellaneous applications had been filed by the Corporate Debtor challenging their maintainability. The NCLT noted that, the outcome of the instant maintainability application in the said case will also be applicable to other aforementioned miscellaneous applications filed under Other Company Petitions.

Issue

Whether shareholders are lenders, that is, whether GVFL is a financial creditor and, thus, whether the debt claimed is a financial debt.

Arguments

Contentions raised by GVFL:

GVFL contended that, the Corporate Debtor had defaulted as required for admission of a petition under Section 7 of the IBC, as its “put option” was not entertained when the demand notice dated January 02, 2018 was sent to the Corporate Debtor demanding exit by way of “put option”.

Observations of the NCLT

The NCLT noted that, it had to analyze whether the claim of GVFL as a shareholder of HBT Mehsana in exercise of its ‘put option’ tantamounts to a financial debt. The NCLT noted the relevant definitions under the IBC to analyse the said issue were of the “financial creditor” and “financial debt”. The NCLT noted that the IBC defines financial creditor under Section 5(7) of the IBC to mean any person to whom a financial debt is owed and includes a person to whom such debt has been legally assigned or transferred to. The NCLT further noted that, financial debt as defined under Section 5(8) of the IBC meant a debt along with interest, if any, which is disbursed against the consideration for the time value of money.

The NCLT further noted that as per the SHA, GVFL invested in HBT Mehsana by purchasing the shares of ILFS group and, therefore, observed that, this cannot be termed as an investment of GVFL by way of a loan. The money paid by GVFL to acquire the shares of HBT Mehsana cannot be construed as a consideration for time value of money and it was solely for the purchase of shares of HBT Mehsana held by ILFS group to become a shareholder in the said company.

The NCLT also noted that the SPA and SHA are both contracts in relation to GVFL’s acquisition of equity shareholding in HBT Mehsana. Further, as per the SHA, GVFL had acquired various rights as mentioned above. It was abundantly clear to NCLT that no voting rights ever accrue to a “Financial Creditor” under the IBC in any AGM/ EGM. Therefore, the rights enjoyed by GVFL in HBT Mehsana, like exercising votes in the AGM/ EGM, are typically the rights of a shareholder and not a “Financial Creditor” since equity is not a debt.

The NCLT was of the view that the SPA entered into for the share purchase in HBT Mehsana by GVFL, with exit option of, inter alia, “Annual Put Option”, cannot be considered as a debt which is disbursed against consideration of time value for money. The NCLT also noted that IRR cannot be equated with interest payments.

The NCLT was of the view that GVFL may be entitled to this claim under the SHA as a shareholder of HBT Mehsana, however, the NCLT had no doubt that the claim of GVFL cannot be termed as a “Financial Debt” as contemplated under the IBC. The NCLT observed that a shareholder is different from a lender.

Decision of the NCLT

Therefore, the NCLT allowed the miscellaneous application challenging the maintainability of the petition filed under Section 7 of the IBC. As a corollary, the NCLT dismissed the Section 7 application stating the same to not be maintainable as per the provisions of the IBC. Similarly, based on the above observations, other miscellaneous applications as mentioned above regarding maintainability of Other Company Petitions were also allowed and as a corollary, the Other Company Petitions were dismissed as not maintainable.

VA View:

The NCLT in this Judgement was of the view that a shareholder is different from a lender. The NCLT correctly observed that, any contract for acquisition of shareholding in a body corporate can never result in the formation of a debt. The NCLT was of the view that the SPA entered into for the share purchase in HBT Mehsana by GVFL with exit option of, inter alia, “Annual Put Option”, cannot be considered as a debt which is disbursed against consideration of time value for money.

The said observation of NCLT was deduced by analysing the fact that, a shareholder undertakes the risk by investing in shares and derives its return by way of profits in the form of dividends and appreciation in the value of shareholding, that is, capital gains. However, in contrast, a lender gives loans for which the profit is earned on repayment made along with Interest. It was also clarified that, the relevance of IRR for an investor in shares is in relation to expected profit and dividend payout and capital appreciation of the shares, which is totally different from the interest which is return for any investment by way of loan.

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