Corporate Insolvency Vs. Recovery Proceedings by SEBI
4th Year Student at University of Petroleum and Energy Studies, Dehradun
Once the Corporate Insolvency Resolution Process (“CIRP”) of the corporate debtor is initiated, the moratorium comes into effect under Section 14 of the Insolvency and Bankruptcy Code, 2016 (“IBC”). When the moratorium comes into effect, neither legal proceedings can continue or be instituted against the corporate debtor, nor any judgment decree or order of the court can be executed.
When a person fails to pay the penalty imposed by Securities Exchange Board of India (“SEBI”), recovery proceedings are initiated to recover the money by selling assets under Section 28A of the Security Exchange Board of India Act, 1992 (“SEBI Act”). In such cases where SEBI initiates recovery proceedings, and the corporate debtor is admitted into CIRP, the issue arises regarding whether recovery proceedings can continue or will be adversely affected if the corporate debtor is admitted into CIRP.
As per the settled position of law, legal proceedings cannot continue during the moratorium. However, the above question came before the National Company Law Tribunal (“NCLT”), Mumbai, in the case of Mr. Nitin Suresh Satghare and 99 Ors. v. Pancard Clubs Limited (2022) ibclaw.in 989 NCLT (“present case”). This article aims to answer the above question and analyze the decision of NCLT Mumbai in this case through different deliberations.
2. Background of the case
The Financial Debt arose concerning investments made by the investors or, in the present case, Financial Creditors (“Petitioner”) in a Collective Investment Scheme (“CIS”) operated by the Corporate Debtor (“Respondent”). The investors made these investments, and the Respondent received the same under the guise of a timeshare scheme with a motive to purchase room nights in various properties owned by the Respondent. It also discovered that the Respondent had done this act to earn returns on its investments for the time value of money.
After observing the sequence of events, SEBI passed an order directing the Respondent to refund monies to the investors constituting the CIS. In an appeal against the SEBI order, the Securities Appellate Tribunal (“SAT”) upheld the order passed by SEBI. Therefore, the Petitioners filed the present petition to retract the default created by the Respondent due to non-repayment of refund under Section 7 of IBC. The issue before the Adjudicating Authority is whether the insolvency proceedings against the Respondent would act “detrimental” against the already ongoing recovery proceedings.
3. Decision of the court
The Respondent did not represent the present case, leading the Adjudicating Authority to pass an ex parte order. The Adjudicating Authority observed a couple of judicial precedents to conclude the present case, which is as follows. The National Company Law Appellate Tribunal (“NCLAT”), in the case of Shobha Limited v. Pancard Club Ltd., had passed an order stating that the CIRP cannot be put to a halt after SEBI has passed an order. The same cannot be held as a ground to reject an application for initiation of CIRP under the concerned sections of IBC.
Justice Rohinton F Nariman had rightly stated while observing the case of M/S. Innoventive Industries Ltd v. ICICI Bank, that “A debt may not be due if it is not payable in law or fact.” In E.S. Krishnamurthy v. Bharath Hi-Tecch Builders (P) Limited, the Supreme Court has held that the role of Section 7 application under IBC is to receive admission or rejection from the Adjudicating Authority by way of an order. Apart from those mentioned above, no other course of action is available to the Adjudicating Authority. The significant purpose while initiating CIRP is to determine the default, i.e., whether a debt exists and is still pending payment.
In the present case, after investing in the CIS, the Petitioners had to receive back a specific value that must be higher than the invested figure. The bank statements and financial contracts were served to the Adjudicating Authority to prove that the financial debt exists. The unpaid amount is yet to be settled by the Respondent. The Adjudicating Authority was satisfied in admitting the said application, which is sufficient to establish the occurrence of a default. Therefore, the Adjudicating Authority held that CIRP/insolvency proceedings do not act detrimental to the recovery proceedings carried on by SEBI, and thus, the present case was admitted.
4. Points for consideration
4.1 CIS qualifying as financial debt vis-à-vis Section 53
The SEBI Act under Section 11AA facilitates the concept of CIS. It purports that a company collects a pool of investments from several investors under a scheme or arrangement to expect a profit return. In Mohan Lal Dhakad v. Bng Global India Ltd, NCLAT discovered that a corporate debtor had given his word to pay off a return on investment to investors under the time value of money. Therefore, the Adjudicating Authority held that the Appellant does qualify as a financial creditor, and CIS would come under the definition of financial debt.
In contrast, Section 53 of IBC states about the ‘waterfall mechanism’ wherein the distribution of money to the order of priority prescribed in the provision is done through the sale of corporate debtor’s assets. The problem lies in the money-receiving process of investors after initiating the CIRP process. During the SEBI recovery proceedings, the amount of money entitled to the investors is returned without any deductions attached. However, suppose the same investors initiate CIRP as financial creditors. In that case, the recovery of the amount against the corporate debtor gets layered and deducted as per the order of priority under Section 53. This situation may lead to a prima facie unfair deduction of the investor’s money return.
For example, the cost to be paid to the ‘ABC’ (i.e., group of investors) under CIS is Rs. 10,000. Two scenarios can arise in the present situation. First, if ABC pursues the SEBI proceedings to recover the amount put in CIS, Rs. 10,000, it would be paid to ABC by selling assets. Second, if ABC initiates CIRP to recover the amount of default, Section 53 would be invoked to distribute money by selling assets. Suppose the insolvency resolution process cost (Section 5(13) of IBC), which comes under the first order of priority as per Section 53, is Rs. 4,000. The amount received by ABC (herein ‘financial creditors’) would be Rs. 6,000 (Rs. 10,000 – Rs. 4,000), which is less than the deserving amount.
Therefore, SEBI proceedings, compared to CIRP, are more beneficial for investors w.r.t. recovery of amount as there would be no deductions in the entitled amount that needs to be returned.
4.2 Implication of Section 14(3)(a) of IBC
One of the measures through which a moratorium can be exempted from getting enforced during insolvency proceedings has been outlined under Section 14(3)(a) of IBC. This specific provision states that a moratorium would not apply to transactions the Central Government is notifying after consulting with the financial regulator or any other concerned authority. Moreover, SEBI has been established as a regulator of the financial market to protect investors’ interests under Section 3 of the SEBI Act.
This directs attention to the possibility of getting an exemption from the enforceability of a moratorium on the recovery proceedings of SEBI. As a financial regulator, the SEBI can approach the Central Government regarding a particular transaction of the corporate debtor with the investor. Suppose the Central Government is satisfied with the need to issue a notification. In that case, this consultation of the SEBI will lead to avoiding a moratorium altogether for the continuance of recovery proceedings. This may lead to ableness of investors to recover their respective amounts of monies through the sale of assets from the ongoing proceedings of SEBI after the passing of the recovery order.
Therefore, this provision enables the scope of recovery proceedings to continue without any obstacle, i.e., enforcement of moratorium after the commencement of CIRP. The judicial sphere surrounding insolvency and securities law may interpret this instance in the given manner provided that the Central Government gives its significant approval to the transaction.
4.3 IBC proceedings after passing of SEBI’s Order
The present case, as discussed above, approves that insolvency proceedings can be held even after SEBI has passed an order of recovery proceedings. The Adjudicating Authority remarked on the position of law by stating that no detrimental effect would be created by permitting the initiation of the insolvency process in the given instance.
Similarly, in the case of Bohar Singh Dhillon v. Rohit Sehgal (Interim R.P.) & Ors., the contention placed by the Appellant before NCLAT was that Section 7 application is not maintainable when action has already been taken against a corporate debtor by SEBI. The NCLT allowed the insolvency application. Further, a question of law persisted before NCLAT regarding the general nature of Section 14 of IBC over Section 28A of the SEBI Act. Although a significant aspect to focus upon is that investors approached the Adjudicating Authority only to avoid delay created by the pending recovery proceedings of SEBI.
The NCLAT briefed an alternative in the case of Anju Agarwal v. Bombay Stock Exchange & Ors. It was observed that if SEBI imposes any penalty, it can claim the same as an operational creditor in the CIRP.
5. Harmonious Construction: An Analysis
The meaning of harmonious construction reflects upon a notion that in case of a conflict among statutes, harmonizing the specific provisions of those statutes must be synced together on a level that one statute does not defeat the objective of the other statute. The concept purports that a statute cannot be dealt with in isolation and should be in parlance with the other conflicting provisions. The rule of law focuses on harmonizing the two comparable interpretations of statutes and their provisions, provided that the latter statute must prevail in case of direct conflicts between the said provisions.
Resort must not be to make the later statute prevail in case they are not found to be in a subject matter conflict as per the judicial authority. Both laws must coexist while recognizing the importance of implementing each statute as much as possible. Otherwise, clashes would arise, which, through one or the other notions of law, would lead to a situation of a whole statute being negated. The issue is that conflict against provisions cannot arise when the statute’s objectives are pole opposite. Therefore, if the object of both statutes differs, then the onus should be on the Supreme Court to clarify the overriding effect of IBC, especially Section 14, over statutes such as SEBI.
In the present case, the purpose of IBC is to protect corporate debtors from financial distress and facilitate the return of money to the list of creditors. However, SEBI aims to protect the investor’s money in the securities market. The Report of Insolvency Law Committee, 2018, supported harmonious construction by addressing the difference between assessing/determining and recovering the assessed/determined. The Report stated that during CIRP, where the Adjudicating Authority imposes a moratorium, SEBI must at least be allowed to assess or determine the liability required to be recovered from the corporate debtor. The reason was that no recovery of assets could be touched upon while a corporate debtor is protected under a moratorium of IBC.
In the Bohar Singh case, NCLAT stated that SEBI could neither recover any amount nor sell assets of corporate debtors. As per the Report’s analysis, even if SEBI assesses the liability of corporate debtors, the assets under the control of a Resolution Professional under IBC are still unaffected, and there is no interruption in the ongoing CIRP. This also gives a certain amount of importance to Section 28AA of the SEBI Act. Hence, even under harmonious construction, a mid-way needs to be sought where there is no overlapping regarding which statute must apply and which needs to be negated.
The noticeable aspect in the scenario of insolvency proceedings taking place while the recovery proceedings of SEBI are still in the picture is that neither can be declared null and void temporarily. Courts must understand that it would be unfair against the concept of harmonious construction to interpret laws so that one statute is given weightage and the other is declared not applicable. Although, through the analogy mentioned above, the investors can recover their rightful amount from the recovery proceedings of SEBI rather than opting for CIRP under IBC. This article has explained better the status quo of investors in CIS and how they would be in an advantageous position if they do not opt for CIRP after SEBI’s order has been passed for the recovery of assets. To conclude, the current legal standing as per Adjudicating Authority still stands valid, i.e., CIRP is allowed after SEBI passes an order for recovery proceedings, and recovery proceedings should be put on halt when a moratorium is imposed.
 Rajendra K. Bhutta v. Maharashtra Housing and Area Development Authority and Another  ibclaw.in 27 SC.
 CP (IB) 4578/MB/C-I/2018, reported at (2022) ibclaw.in 989 NCLT.
 2021 SCC OnLine NCLAT 84.
 Section 5(8) of the Insolvency and Bankruptcy Code, 2016.
 Supra Note 2.
  ibclaw.in 61 NCLAT.
  ibclaw.in 123 NCLAT.
 Kishorebhai Khamanchand Goyal v. State of Gujarat and Anr., (2003) 12 SCC 274.
 Sultana Begum v. Prem Chand Jain, (1997) 1 SCC 373.
 CIT v. M/S. Hindustan Bulk Carriers, (2003) 3 SCC 57.
 Supra Note 3.
 The Report of Insolvency Law Committee, 2018, https://www.mca.gov.in/Ministry/pdf/ReportInsolvencyLawCommittee_12042019.pdf.
 Supra Note 9.
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