NCLAT Ruling on Sole Proprietorship: A Step in Right Direction but Dust Far from Being Settled – By Anirudh Agrawal

Anirudh Agrawal
NALSAR University of Law, Hyderabad

NCLAT Ruling on Sole Proprietorship: A Step in Right Direction but Dust Far from Being Settled

 

The National Company Law Appellate Tribunal (“NCLAT”) in the recent case of Neeta Saha v. Ram Niwas Gupta 191(IBC)156/2020 had the opportunity to decide upon one of the most contentious issues – Can a sole proprietor initiate Corporate Insolvency Resolution Proceedings (“CIRP”) under the Insolvency and Bankruptcy Code, 2016 (“Code”). The court answered the above proposition in affirmative and said that sole proprietorship can file and initiate CIRP proceedings but added a caveat that the application must be filed through the proprietor himself. The court also added that Section 2 of the Code will be applicable to a sole proprietorship and gave an expanded meaning to the term “persons” defined under Section 3(23) of the Code.

Position before the present case

The ruling of the NCLAT is in sharp contrast to the recent ruling by the National Complany Law Tribunal (“NCLT”), New Delhi in the case of RG Steels vs. Berry Auto Anciallaries (P) Ltd (“RG Steels”) where the Tribunal had said that sole proprietorship concern is not entitled to initiate CIRP on its own owing to the reason that Section 3(23) of the Code never intended to include sole proprietorship under the definition of “persons”. The court in RG Steels had followed the line of reasoning advanced by the same bench previously in the case of Sai Kripa Associates v. K Star Naturalle Resources Pvt Ltd [CP-IB-1438/ND/2018] (“Sai Kripa”). The bench in Sai Kripa had said that an application filed by a sole proprietorship under Section 9 of the Code is not maintainable. The rationale of the court behind such a line of reasoning was that a sole proprietorship by not being a legal entity cannot sue or be sued and therefore it cannot file an application under Section 9 of the Code.

The Kolkata bench of NCLT in the case of Kishore and Company v. Sri Balaji Metallics (P) Ltd, also concurred with the rationale of Sai Kripa and reiterated that a Section 9 application must be filed by the sole proprietor itself for it to be maintainable. A similar view was taken by NCLT, Kolkata in the case of Impact Event Management v. Garodia Automobiles Pvt Ltd, where the Tribunal said that since the sole proprietorship is an unregistered entity and cannot sue or be sued, it cannot file an application under Section 9 and the same must be filed by the proprietor himself.

But in the case of Vani Biochem v Vaayucon Greentech Pvt Ltd, the NCLT bench of Amaravathi has said that even proprietary can file an application under the Code as the definition of the term “persons” under Section 3(23) of the Code includes proprietary concern. The Tribunal while referring to the definition of “persons” said that the term includes an individual, company and any entity established by the statute and in the present case the proprietary concern would fall within the definition of the person.

The Contentious Provision- Section 3(23) of Code:

Section 3(23) of the Code defines the term “persons”. The term “persons” is said to include individuals, companies, trusts, partnerships, Hindu Undivided Families (HUFs), Legal Liability Partnership (LLPs) and “any other entity established by the statute”. Since sole proprietorship not being mentioned explicitly in the definition and the nature of sole proprietorship resembling neither of the above mentioned entities nor it being an entity capable of being registered under the statute, the courts have said that a sole proprietor cannot initiate insolvency proceedings under section 9 of the Code.

Is sole proprietorship a legal entity?

In the case of Swapn Constructions v. IDPL Employees Cooperative Group Housing Society Ltd., the Delhi High Court had held that the present petition is not maintainable owing to the fact that sole proprietorship is not a legal entity. In the present case, the court was dealing with a petition filed by the sole proprietorship concern under Section 11 of the Arbitration and Conciliation Act, 1996 for the appointment of an arbitrator. The court while dismissing the petition for maintainability added that since the sole proprietorship is not a legal entity, the petition must be filed by the sole proprietor in his name on behalf of the firm. The court further added that the proprietor must have arraigned himself as the party to the suit even if he is filing in the name of the proprietorship concern. In the present case, the court also referred to another decision of Delhi High Court in Miraj Marketing Corporation v. Vishakha Engineering where the court had said that- “a sole proprietorship is not a legal entity which can sue or be sued in its own name.  Such suit relating to or against the affairs or claims of a proprietorship concern has to be brought or made against the person who is the sole proprietor of the firm.”

Similarly in the case of Devendra Surana v Bank of Baroda, the court said that the sole proprietorship firm and the natural person, both are the same legal entity. The liability of the sole proprietorship firm is the same as that of the natural person. The owner of the sole proprietorship firm and the firm itself does not enjoy the benefits of being treated as separate legal entities. Therefore in the present case too, the court had made the sole proprietor liable for the repayment of the loan sanctioned in the name of the proprietorship.

From the above discussion, it can be safely inferred that the Indian courts do not recognize a sole proprietorship as a separate legal entity and considers them to be same legal entity. The Indian courts do not dismiss the suit solely on the basis of the fact that proprietor himself has not been arraigned as a party or the suit is filed in the name of proprietorship and allows the parties opportunity to amend the suit to make the proprietor a party to the suit.  

Recommendations of the Bankruptcy Law Reforms Committees

In November 2015, a report titled- Bankruptcy Law Reforms Committee Volume I: Rationale and Design was released by Bankruptcy Law reforms committee. One of the major tasks of the committee was creation of a uniform framework to cover the insolvency matters of all the legal entities and individuals. For this, the committee focused upon the wider problems of small and medium enterprises (SMEs), sole proprietorships and individuals. The committee recognized that SMEs play an important role in the Indian economy and many SMEs are in the form of sole proprietorships and therefore framework to bring them under the code must be sincerely contemplated. Similarly in the recent report of the Insolvency Law Committee released in February 2020, under the chapter titled- Recommendation regarding Personal Insolvency Resolution and Bankruptcy Process, the court while dealing with the definition of the term “proprietorship firms” under Section 2(e) of the Code, said that ‘proprietorship firms’ have also not been statutorily defined in many other jurisdictions. The term ‘sole proprietorship’ or ‘proprietorship firm’ is often used in common parlance and is a well-recognized form of business and therefore, concluded that it is not necessary to define ‘proprietorship firms’ in the Code. From the above discussion, it is clear that efforts have been made consistently to bring sole proprietorships under the Code.

Conclusion

The court in the present case adopted an expansive interpretation of the term “persons” which is in line with the legislative intent. Since the word “sole proprietorship” has not been mentioned explicitly in the definitions of either of the terms “persons” and “operational creditors”, the contention whether the sole proprietorship concern can initiate insolvency petition under Section 9 of the statute remains unsettled.

In January 2018, the Insolvency and Bankruptcy (Amendment) Act, 2018 was notified where Section 2 (which deals with the applicability of the Code) was amended and the term “proprietorship” was added to the list of entities to which the code will be applicable. One of the reasons for adding the term could be that the legislature intended to extend the benefits of the Code to the sole proprietorship. Also, if we read Section 2(f) of the Code which says that the Code will be applicable to proprietary concern with Section 3(23) of the Code (which deals with the definition of “persons”), it can be safely inferred that the definition of the term “persons” includes sole proprietary concern though the NCLAT hasn’t elaborated much on the contention.

The court must also interpret the provision in line with the object and purpose of the Code. One of the main objects of the Code is to reinforce the growth of the country and denying the SMEs benefit of the Code goes against such an object as SMEs constantly require funds and any delay in recovery of funds endangers the survival of their business.

 

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