A three Judge Bench of the Supreme Court comprising of Justices Dr. D. Y. Chandrachud, Indu Malhotra and Indira Banerjee while hearing an appeal challenging the orders passed by the NCLAT and the NCLT wherein two entities namely AAA Landmark Private Limited and Spade Financial Services Limited were excluded from the Committee of Creditors constituted for corporate insolvency resolution process initiated against Corporate Debtor, AKME Projects Limited; held that since the commercial arrangements between the creditor and corporate debtor is collusive in nature, the debt does not constitute as ‘financial debt’ and hence both the entities (Spade and AAA) are not financial creditors of the corporate debtor.
The applications were filed by Phoenix Arc Private Limited and YES Bank under Section 60(5)(c) of the Insolvency and Bankruptcy Code, 2016 at the NCLT and later an appeal against the same was preferred at the NCLAT. The NCLT held that both the entities cannot be termed as ‘Financial Creditors’, as the transaction between them and the corporate debtor is collusive in nature and consequently the entities cannot be included in the CoC. In the appeal, the Appellate Authority reversed the findings of the Adjudicating Authority and held that the entities are financial creditors but are still disqualified to be the part of the CoC on the ground that they are ‘Related Parties’ of the corporate debtor.
In the appeal before the Apex Court, Phoenix submitted that although the NCLAT rightly dismissed the appeal filed by Spade and AAA holding that they are related parties of the Corporate Debtor and hence cannot be included in the CoC, the finding that they are financial creditors is erroneous in nature. It challenged the finding on the following grounds:
- It is contrary to record; and
- Both AAA and Spade are not even creditors of the corporate debtor, let alone financial creditor.
Facts of the case:
Corporate insolvency resolution process (CIRP) was initiated against the Corporate Debtor on 18.04.2018 on an application filed by the Operational Creditor under section 9 of the Insolvency and Bankruptcy Code, 2016 (IBC).
Claim of Spade:
During the process, claims were invited by the Interim Resolution Professional (IRP) and Spade filed its claim as Financial Creditor for its amount on 10.05.2018 but later revised the sum and filed the claim again after a few days.
The basis for claim filed by Spade was an alleged MOU executed with the CD which stated an amount of Inter Corporate Deposits (ICDs) granted to the CD by Spade bearing interest of 24% repayable in terms of mutual agreement between the parties.
Spade submitted before the Court that it has granted ICDs of Rs. 66,00,00,000 (approx.) to the Corporate Debtor between June 2009 and January 2013. Out of this amount, Spade claimed a principal amount of Rs. 23,00,00,000. The balance amount of Rs. 43,06,00,000 was credited in the account of AAA, which is a wholly owned subsidiary of Spade. The total claim of Spade increased to Rs. 109,11,00,000 in 7 years on account of interest at the rate of 24%.
Claim of AAA:
AAA filed its claim before the IRP as a creditor for its sum on 10.05.2018. Thereafter, it filed a revised claim as a financial creditor for a revised amount on 23.05.2018. AAA said that it had entered into a Development Agreement with the CD on 01.03.2012 for a sale consideration to purchase development rights in a project. On 25.10.2012, that Development Agreement was terminated and an Agreement to Sell along with a Side Letter was executed between AAA and the CD for purchase of flats. The sale consideration amount was further enhanced in the Development Agreement. AAA further paid a certain sum as advance payment under the Agreement to Sell, which was adjusted out of the ICDs payable to Spade as noted above. The claim of AAA is with respect to the principal amount of Rs. 43,06,00,000, which along with interest at the rate of 18% increased to Rs. 109,72,00,000 in 5 years.
Constitution of COC:
The CoC was constituted on 22.05.2018. The IRP rejected the claim of Spade on the ground that the claim was not in the nature of a financial debt in terms of section 5(8) of IBC as there was an absence of consideration for the value of money, i.e., there was no stipulated time period for repayment of the claimed ICDs.
Further, the claim of AAA was also rejected on the ground that its revised claim as a financial creditor was filed after the expiry of the period for filing such a claim.
Proceedings before NCLT:
Aggrieved by the rejection, AAA and Spade filed an application to be included in CoC and the same was allowed by the NCLT. The other financial creditors- Phoenix and YES Bank were not made party to this proceeding.
The NCLT observed the following:
- AAA’s original claim was filed on time and it only amended its claim later.
- Amount given by the Spade in the form of ICDs has been received as a deposit which attracted interest as reflected in the deducted TDS on interest.
Accordingly, NCLT allowed Spade and AAA to submit their claims as financial creditors and directed the IRP to consider their claims.
Later, after a CoC meeting that was also attended by newly approved financial creditors AAA and Spade; Phoenix and YES Bank filed applications for exclusion from the CoC before the NCLT on the grounds that they are related parties.
Accordingly, NCLT held that Spade and AAA do not qualify as financial creditors. It took note of first proviso of Section 21(2) of the IBC which states that a financial creditor who is a related party of the corporate debtor shall not have the right of representation, participation or voting in the CoC.
Proceedings before NCLAT:
In an appeal before the NCLAT, it observed that ‘admittedly’ Spade and AAA ‘are financial creditors of the corporate debtor’. Further, it held that both the entities were related parties within section 5(24) of IBC on the grounds that:
- After cancellation of Development agreement, AAA and CD entered into an Agreement to Sale and Side Letter which was merely a camouflage under which they were partners in developing a residential project to be sold to a third party.
- According to Section 5(24)(f), during the transaction period 2010 to 2013, Spade led by Mr Arun Anand made multiple financial arrangements on the basis of advice provided by the CD which was led by its management and directors including Mr. Anil Nanda and Mr. Sonal Anand (relative of Mr. Arun Anand).
- Due to various reasons, it found that Mr. Arun Anand had direct relations with the day to day happenings of the corporate debtor.
- Arun Anand and Mr. Sonal Anand were directors of the Corporate Debtor till 2013. Hence, Mr. Arun Anand would be a related party under Section 5(24)(a) read with 5(24A)(a)7, being a relative of another director.
- A holding company of the Corporate Debtor, Joint Investment Private Limited (“JIPL”) holds shareholding in Spade.
Hence, NCLAT came to the conclusion that the Adjudicating Authority had rightly excluded both Spade and AAA from participation in the CoC.
The issues before the Supreme Court:
- Whether Spade and AAA are financial creditors of the Corporate Debtor;
- Whether Spade and AAA are related parties of the Corporate Debtor;
- Whether Spade and AAA have to be excluded from the CoC.
The Supreme Court held that:
- The decision of the NCLAT wherein Spade and AAA have been referred as financial creditors has been set aside. Due to collusive nature of their transactions that have been alleged to be financial debt under Section 5(8), Spade and AAA cannot be labeled as financial creditors under section 5(7).
- The decision of the NCLAT holding Spade and AAA as related parties of the Corporate Debtor under section 5(24) has been affirmed.
- The decision of the NCLAT wherein it excluded Spade and AAA from the CoC in accordance with the first proviso of section 21(2) has been affirmed.
Accordingly the appeal was dismissed by the Supreme Court with the directions that pending applications(s), if any, stand disposed of.
Another important observation made by the Apex Court that is a big take away from this judgment is “While the default rule under the first proviso to Section 21(2) is that only those financial creditors that are related parties in praesenti would be debarred from the CoC, those related party financial creditors that cease to be related parties in order to circumvent the exclusion under the first proviso to Section 21(2), should also be considered as being covered by the exclusion thereunder.” Ideally the disqualification should apply even though the default rule is that the financial creditor must be a “related party” in present, to be disqualified from being included in the CoC.