4th year BBA LLB student, Shri Dharmasala Manjunatheswara Law Collage, Mangalore
Supreme Court amputates the “Related Party” within the purview of CoC
Recently, in a three bench judgment of the Supreme Court in “Phoenix ARC Pvt. Ltd. v. Spade Financial Services Limited (2021) ibclaw.in 03 SC” has clarified its view on the exclusion of related parties of the Corporate Debtor and their active involvements in forming a part of the CoC, as under section 21 of the Insolvency Bankruptcy Code (IBC). The court on examination of the legislative intent behind first proviso of Section 21(2) concluded that the realm of the code was structured to limit the approaches from the Corporate Debtor perspectives. As Corporate Insolvency Resolution Process shall be accelerated only after the collation of “Outstanding Claims “of the Financial Creditor to whom the debt is owned or has been legally transferred as defined under section 5(7). Consequently, the Code sets aside the claim of those financial creditors befitting the term of “Related Parties”, eradicating their right from participation, voting and proposition of the resolution plan. By the present post, author highlights the Supreme Court judgment and implications which follows herewith.
Factual Study
During the initiation of Corporate Insolvency Resolution Process (hereinafter referred as CIRP) against AKME Projects Limited (Corporate Debtor), the Interim Resolution Professional rejected the claims of Spade Financial Services Pvt. Ltd on the ground that the debt didn’t incorporate the features of section 5(8) Insolvency Bankruptcy Code (IBC), having no speculated time limit for repayment and the claims of AAA Landmark Pvt. Ltd (wholly owned subsidiary company of Spade) as it was time barred (hereinafter referred as Spade and AAA). Aggrieved by IRP orders of rejection, the two entities appealed to NCLT to be included as CoC. The observations on record before NCLT were that the amount given by Spade was received as deposits in the form of ICDs and would attract TDS deductions as interest. Allowing the appeal NCLT accepted the claims within the capacity of financial creditors, vide in its order on 30th May 2018. On 1st June 2018, in the meeting of CoC, other independent financial creditors Phoenix ARC Pt. Ltd. and Yes Bank contended the inclusion of AAA and Spade as related parties of the Corporate Debtor under section 5(24) of IBC. Apparently NCLT concluded by their exclusion from CoC, holding the transactions between AAA, Spade and Corporate Debtor to be Collusive in nature, as there was no actual due falling within the purview of “Financial Debt”. On further appeal, the adjudicating authority (NCLAT) reversed the vide orders of NCLT and held that AAA and Spade are “Financial Creditors” but were “Related Parties” of Corporate Debtor and thereby disqualified to be part of CoC.
The appeals before Apex Court gave rise to two sets of questions following the judgement of adjudicating Authority of whether AAA and Spade would be termed as financial creditors and labelled as “Related Parties” of the Corporate Debtor. The Supreme Court answered affirmatively and held that the observations by NCLT shall not be debarred on the ground of Res-judicata as it was passed without the hearing of other Financial Creditor. Erstwhile, this would not differentiate their stand from the previous claims about the transactions being collusive in nature. The court pronounced that there was no actual involvement of “Debt” within the meaning 5(8) of IBC.
Objective of Related Parties
The legislative intend behind Section 5(24) were entangled only from the view point of “Relations with Corporate Debtor”, necessarily capturing the commutative relations between financial creditor and Corporate Debtor. The statute highlights a similar provision under Section 2(76) of the Companies Act 2013, where director of the one company is a member of another company, would constitute “Related Party”. Under IBC section 5(24) (d) reflects a similar vision of “Related Party”, but only from the view point of the Corporate Debtor. The code has made provisions to highlight the nature of “Avoidable Transaction” hampering the nature of transaction during the initiation of CIRP.
In J. R. Agro Industries Private Limited V. Swadisht Oils Private Limited (2018) ibclaw.in 21 NCLT, NCLT ruled out related party equivalent to equity shareholders under Section 53(1) (h) of the Code. In the instant matter under the legislative UNCITRAL guide, NCLT opined that the dues of Related Parties shall not overshadow the Operational creditors’ claims, stipulated in terms of loans. Thereby, the tribunal prioritized the dues of unsecured creditors over related party, disassociating the Related Party from the participation of CoC and their influence over resolution plan.
The inter-relationship between the affairs of Corporate Debtor and financial creditors has deep entangled meaning within Section 5(24). Unlike in the present case, the financial debt was an only sham to regain its entity, as a form of backdoor option to be a part of CoC. The Supreme Court hereby blacklisted AAA and Spade for their simulation behind “Related Parties” and denied their participation under Section 21(2) of the Code.
Disqualification under first proviso of Section 21(2) of IBC
After collation of claims by the Interim Resolution Professional against the Corporate Debtor, the Committee of Creditors constituting only “Financial Creditors” shall be debarred from CoC. The intend behind the first proviso of Section 21(2) was to defeat the unnecessary claims benefiting the Corporate Debtor. Relying on provision 21(2), the Court acknowledged the liberal interpretation of the statute by excluding only such Financial Creditors who are related parties in praesenti to the Corporate Debtor. Meaning, the court shall exclude those financial creditors who are related parties at the time but prior to the initiation of CIRP. The draftsman perspective was to devoid the inclusion of those Creditors/Related Parties having business capacity, whose sole intention was to form participate in CoC. The code was formulated in order to avoid the delusion of the voting rights by those external creditors subordinate to Financial or Operational Creditor in terms of repayment, which otherwise would have manipulative their control over the Corporate debtors business.
The purpose of denying the entry of Related parties of the Corporate Debtor from the participation of CoC, were to supress the conflict of interest between various creditors forming a part of the resolution plan. Ideally, under first proviso of Section 21(2) includes not only the amount due but also the relation existing between the financial creditors and the corporate debtor in praesenti, disqualifying the “Related Parties” from forming a part of CoC.
Conclusion
The definition under Section 5(24) and 5(24A) of Insolvency Bankruptcy Code 2016 is exhaustive in nature. The legislative intent behind Section 5(24) (m) includes entities of different corporation associated with Corporate Debtor functioning under a common seal as Related Parties. The liberal interpretation of code ensures a straightjacket formula by debarring unwanted creditors from CoC. The objective behind this was to acknowledge the real nature of the transaction by lifting up the corporate veil and knowing exactly who is participating in CoC. Therefore, a set of fraudulent transactions between the financial creditors and corporate debtor is avoided under Section 21 which otherwise would have sabotaged a feasible resolution plan by distressing the smooth functioning of CIRP.
Disclaimer: The Opinions expressed in this article are that of the author(s). The facts and opinions expressed here do not reflect the views of IBC Laws (http://www.ibclaw.in). The entire contents of this document have been prepared on the basis of the information existing at the time of the preparation. The author(s) and IBC Laws (http://www.ibclaw.in) do not take responsibility of the same. Postings on this blog are for informational purposes only. Nothing herein shall be deemed or construed to constitute legal or investment advice. Discussions on, or arising out of this, blog between contributors and other persons shall not create any attorney-client relationship.
Disclaimer: The Opinions expressed in this article are that of the author(s). The facts and opinions expressed here do not reflect the views of IBC Laws (http://www.ibclaw.in). The entire contents of this document have been prepared on the basis of the information existing at the time of the preparation. The author(s) and IBC Laws (http://www.ibclaw.in) do not take responsibility of the same. Postings on this blog are for informational purposes only. Nothing herein shall be deemed or construed to constitute legal or investment advice. Discussions on, or arising out of this, blog between contributors and other persons shall not create any attorney-client relationship.