2021 (2) TMI 91 - SC - Insolvency and Bankruptcy

CIRP Proceedings - Scope of the term related parties - Financial creditors - Corporate Debtor failed to make repayment of its dues - Exclusion form Committee of Creditors (CoC) formed in relation to the Corporate Insolvency Resolution Process (CIRP) - HELD THAT - The CoC was constituted on 22 May 2018. On 25 May 2018, the IRP rejected the claim of Spade, inter alia, on the ground that the claim was not in the nature of a financial debt in terms of Section 5(8) of IBC since there was an absence of consideration for the time value of money, i.e., the period of repayment of the claimed ICDs was not stipulated. The IRP also rejected the claim of AAA on the ground that its claim as a financial creditor in Form C was filed after the expiry of the period for filing such a claim. Proceedings before NCLT - HELD THAT - NCLAT came to the conclusion that the Adjudicating Authority had rightly excluded both Spade and AAA from participation in the CoC since Mr. Anil Nanda, in concert with Mr. Arun Anand and his family, had created a web of companies which were related parties to the Corporate Debtor, and was now trying to gain a backdoor entry into the CoC through them. Transactions of the Corporate Debtor - HELD THAT - Development Agreement dated 1 March 2012, through which the Corporate Debtor sold to 38.3% of its development rights in its real estate project, AKME RAAGA, to AAA for a consideration of ₹ 32.80 crores - Agreement to Sell dated 25 October 2012, which superseded the Development Agreement dated 1 March 2012, through which AAA bought a saleable area of 313,928 sq. ft. in AKME RAAGA at a price of ₹ 43.06 crores - Side Letter dated 25 October 2012, which was to be read as a part of the Agreement to Sell, which noted that the area bought by AAA was 38.3% of AKME RAAGA, and AAA would provide for the cost of its development accordingly. Relationship between Anil Nanda and Arun Anand - HELD THAT - Since February 2013, Mr. Arun Anand has no association with Corporate Debtor in any manner whatsoever. Whether Spade and AAA are financial creditors of the Corporate Debtor - HELD THAT - The Memorandum of Understanding is unenforceable, collusive and is merely an eye-wash. An amount of only ₹ 26.55 Crores was allegedly advanced to Spade and other companies . No Board resolution was passed by Spade approving the grant of ICDs of ₹ 26.55 Crores. In any case, the alleged claim is grossly time barred - The claim of Spade was rejected by the IRP in a letter dated 25 May 2018 on the following basis (a) The essential element of a financial debt in terms of Section 5(8) of the IBC is absent, which is the consideration for the time value of money. The exact period of repayment of the ICDs has not been stipulated in the Memorandum of Understanding; (b) The calculation sheet provided by Spade to ascertain the interest rate and payment of interest does not reflect adjustment of any part of payment against the payment of interest; (c) The ledger provided by Spade does not stipulate the interest claimed on the alleged debt; (d) ICDs were allegedly granted to the Corporate Debtor by Spade in 2013; however, no valid financial contract was entered between the Corporate Debtor and Spade to stipulate the consideration in terms of the time value of money against each transaction. A financial contract is essential for considering a debt as financial debt; (e) The calculation sheet reflects that the inflow and outflow of funds are in the nature of a running account, indicating that the debit and credit balances lack any commercial effect of borrowing, which is an essential element in terms of Section 5(8)(f) of IBC; and (f) The emails relied on by Spade dated 16/17 January 2013 mention that documents in relation to an extension of a loan of ₹ 2 Crores were to be executed. No such documents have been produced on record. Assessment of preliminary submissions - Res Judicata - HELD THAT - The order was passed without hearing financial creditors such as Phoenix and YES Bank. Hence, they were legitimately within their rights in seeking a direction for the exclusion of AAA and Spade from the CoC, if they were aggrieved by the terms of that order. The earlier order was passed without furnishing them with an opportunity of being heard. Assessment of preliminary submissions - Issues before NCLAT - HELD THAT - The application filed by Phoenix adverted to its submission that NCLT s order dated 31 May 2018 was obtained by Spade and AAA on a concealment of material facts, circumstances and the real nature of the transactions. In addition, Mr Anil Nanda, the suspended director of the Corporate Debtor, had filed an application before the NCLT alleging that Spade and AAA have not financed any amount to the Corporate Debtor. He submitted that there was no loan facility against the time value of money. In addition, he argued that the Agreement to Sell between the Corporate Debtor and AAA was a part of series of acts of fraud, and is null and void. The NCLT s order dated 19 July 2019 was passed after arguments were led on the real nature of transactions between the parties. Assessment of preliminary submissions - Remand to NCLAT - HELD THAT - Having held that the transactions between the corporate debtor on one hand and AAA and Spade on the other did not qualify as a financial debt, the Adjudicating Authority commenced its discussion on the second issue by stating that it does not require a reply in view of the finding on the first issue. However, it then noted that the first proviso to Section 21(2) has been substituted with effect from 6 June 2018, the effect of which is to exclude a financial creditor who is a related party of the corporate debtor from being represented in and from participating or voting in a meeting of the CoC. After adverting to the definition of the expression related party in Section 5(24) - On the second issue, the Adjudicating Authority was of the view that it was not really necessary for it to consider what should be the date with reference to which a related party should be determined. But it is evident that the NCLT did come to the conclusion that Mr. Arun Anand and his various companies namely AAA and Spade were related parties to the corporate debtor though after 2013, Mr Arun Anand resigned from all the companies of the Anil Nanda Group. we do not agree with the submission that NCLAT exceeded its jurisdiction by considering the second issue relating to the determination of the status of AAA and Spade as related parties. Thus, we hold that there is no reason to remand the matter to NCLAT for reconsideration. An order of remand cannot be passed in a routine manner, and it should be passed only if a re-consideration is necessary. An unwarranted order of remand does not serve the cause of justice and merely extends the life of litigation. Remands in commercial matters should not become a ruse to subserve litigation luxuries. The dispute fell into a quagmire when the NCLAT proceeded on the basis that it was an admitted position that AAA and Spade are financial creditors. The finding of fact in paragraph 11 of the decision of the NCLAT that this is the admitted position is plainly erroneous since there was an express finding of the NCLT to the contrary. The fact that it necessitated an appeal by AAA and Spade would indicate that this was not an admitted position. It is also evident from the contents of the appeal filed by Spade and AAA, and the reply filed by Phoenix before the NCLAT, that the status of Spade and AAA as financial creditors was in dispute. Having said that, the issue that now falls for our consideration is whether AAA and Spade can be considered as financial creditors. Analysis - Financial Creditor and Financial Debt - HELD THAT - The current definition of 'financial debt' Under Section 5(8) of the Code uses the words includes , thus the kinds of financial debts illustrated are not exhaustive. The phrase disbursed against the consideration for the time value of money has been the subject of interpretation only in a handful of cases under the Code. The words time value have been interpreted to mean compensation or the price paid for the length of time for which the money has been disbursed. This may be in the form of interest paid on the money, or factoring of a discount in the payment. Analysis - Collusive Transactions - HELD THAT - The IBC has made provisions for identifying, annulling or disregarding avoidable transactions which distressed companies may have undertaken to hamper recovery of creditors in the event of the initiation of CIRP. Such avoidable transactions include (i) preferential transactions under Section 43 of the IBC; (ii) undervalued transactions under Section 45(2) of the IBC; (iii) transactions defrauding creditors under Section 49 of the IBC; and (iv) extortionate transactions under Section 50 of the IBC. The IBC recognizes that for the success of an insolvency regime, the real nature of the transactions has to be unearthed in order to prevent any person from taking undue benefit of its provisions to the detriment of the rights of legitimate creditors. Analysis - Spade and AAA - HELD THAT - It appears that the parties converted the Development Agreement into an Agreement to Sell executed along with a Side Letter to circumvent the legal prohibition on splitting a development license in two parts. The transaction between AAA and the Corporate Debtor was collusive in nature - Since the commercial arrangements between Spade and AAA, and the Corporate Debtor were collusive in nature, they would not constitute a financial debt . Hence, Spade and AAA are not financial creditors of the Corporate Debtor. Whether Spade and AAA are related parties - HELD THAT - The Appellate Tribunal has affirmed the decision of the NCLT to exclude Spade and AAA from the CoC on the ground that they are related parties. As we have seen earlier, there was a specific finding in the decision of the NCLT on the close business relationship between AAA and Spade on one hand and the Corporate Debtor on the other, in terms of the provisions contained in Section 5(24). The decision of the NCLT spoke of a deep entanglement in the business affairs. The NCLT came to the specific finding that Spade and AAA were related parties of the corporate debtor but, that the relationship had ended by the time the initiation of the CIRP took place. It is this aspect which now merits consideration. Mr Arun Anand, Spade and AAA were related parties of the Corporate Debtor during the relevant period when the transactions on the basis of which Spade and AAA claim their status as financial creditors took place. Interpretation of the phrase is a related party in the first proviso - submission is that Spade and AAA are no longer related parties of the Corporate Debtor (even though in terms of the earlier finding they were so during the relevant period when the transactions constituting their alleged financial debt took place) - Whether Spade and AAA can be excluded from the CoC? - HELD THAT - Since the IBC attempts to balance the interests of all stakeholders, such that some stakeholders are not able to benefit at the expense of others, related party financial creditors are disqualified from being represented, participating or voting in the CoC, so as to prevent them from controlling the CoC to unfairly benefit the corporate debtor - It is pertinent to note that disqualification of related parties from being members of the CoC, has also been recommended in the UNCITRAL Legislative Guide on Insolvency law - In interpreting the legislation, which represents a Parliamentary effort to bring about structural changes in the resolution of corporate insolvencies, the effort of the court must be to aid the fulfilment of the objects of the IBC. Amendment to First Proviso of Section 21(2) - HELD THAT - The first proviso to Section 21(2) was amended, to extend the disqualification to the specified authorised representatives, in case that these representatives happened to be related parties of the corporate debtor. The introduction of the phrase is along with related party was not a guiding factor behind the Parliamentary amendment. Related Parties - Interpretation In Praesenti - HELD THAT - The use of the simple present tense in the first proviso to Section 21(2) indicates that the disqualification applies in praesenti. Furthermore, this interpretation would also be supported by a reading of the first proviso to Section 21(2), in light of the definition of related party under Section 5(24), which uses phrases such as is accustomed to act or is associated to define a related party in the present tense. It could be stated that where a financial creditor seeks a position on the CoC on the basis of a debt which was created when it was a related party of the corporate debtor, the exclusion which is created by the first proviso to Section 21(2) must apply. For, it is on the strength of the financial debt as defined in Section 5(8) that an entity claiming as a financial creditor under Section 5(7) seeks a position on the CoC under Section 21(2). If the definition of the expression related party under section 5(24) applies at the time when the debt was created, the exclusion in the first proviso to Section 21(2) would stand attracted - However, if such an interpretation is given to the first proviso of Section 21(2), all financial creditors would stand excluded if they were a related party of the corporate debtor at the time when the financial debt was created. This may arguably lead to absurd conclusions for entities which have legitimately taken over the debt of related parties, or where the related party entity had stopped being a related party long ago. Thus, it has been clarified that the exclusion under the first proviso to Section 21(2) is related not to the debt itself but to the relationship existing between a related party financial creditor and the corporate debtor. As such, the financial creditor who in praesenti is not a related party, would not be debarred from being a member of the CoC. However, in case where the related party financial creditor divests itself of its shareholding or ceases to become a related party in a business capacity with the sole intention of participating the CoC and sabotage the CIRP, by diluting the vote share of other creditors or otherwise, it would be in keeping with the object and purpose of the first proviso to Section 21(2), to consider the former related party creditor, as one debarred under the first proviso. Hence, 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. Mr Kaul has argued, correctly in our opinion, that if this interpretation is not given to the first proviso of Section 21(2), then a related party financial creditor can devise a mechanism to remove its label of a related party before the Corporate Debtor undergoes CIRP, so as to be able to enter the CoC and influence its decision making at the cost of other financial creditors. It is evident that there existed a deeply entangled relationship between Spade, AAA and Corporate Debtor, when the alleged financial debt arose. While their status as related parties may no longer stand, we are inclined to agree with Mr Kaul that this was due to commercial contrivances through which these entities seek to now enter the CoC. The pervasive influence of Mr Anil Nanda (the promoter/director of the Corporate Debtor) over these entities is clear, and allowing them in the CoC would definitely affect the other independent financial creditors. Appeal disposed off.

Summary

Issues Involved:
1. Whether Spade and AAA are financial creditors of the Corporate Debtor.
2. Whether Spade and AAA are related parties of the Corporate Debtor.
3. Whether Spade and AAA have to be excluded from the CoC.

Issue-Wise Detailed Analysis:

1. Whether Spade and AAA are financial creditors of the Corporate Debtor:

The judgment addresses the claims of Spade and AAA to be financial creditors based on their transactions with the Corporate Debtor. Spade's claim was based on a Memorandum of Understanding (MoU) dated 12 August 2011, which stated that Inter Corporate Deposits (ICDs) of ?26.55 crores were granted to the Corporate Debtor with an interest rate of 24%. However, the court noted several discrepancies and collusive elements in these transactions, including the late signing of the MoU, the unregistered and unstamped nature of the document, and the fact that no interest was paid on the alleged debt. Similarly, AAA's claim was based on a Development Agreement and subsequent Agreement to Sell, both of which were found to be collusive and aimed at circumventing legal prohibitions on splitting development licenses. The court concluded that these transactions did not constitute financial debt as defined under Section 5(8) of the IBC, and thus, Spade and AAA were not financial creditors.

2. Whether Spade and AAA are related parties of the Corporate Debtor:

The court examined the relationship between the key managerial personnel of the Corporate Debtor, Mr. Anil Nanda, and the director of Spade and AAA, Mr. Arun Anand. It was found that there was a deep entanglement between the entities led by Mr. Arun Anand and Mr. Anil Nanda. Mr. Arun Anand held various positions within the Anil Nanda Group of Companies, and his brother-in-law, Mr. Sonal Anand, was also closely associated with the Corporate Debtor. The court concluded that Mr. Arun Anand, Spade, and AAA were related parties of the Corporate Debtor during the relevant period when the transactions took place, falling under the definitions in Section 5(24) of the IBC.

3. Whether Spade and AAA have to be excluded from the CoC:

The court addressed the interpretation of the first proviso to Section 21(2) of the IBC, which disqualifies related parties from being part of the Committee of Creditors (CoC). The court noted that the purpose of this exclusion is to prevent conflicts of interest and ensure that the CoC is not influenced by parties related to the corporate debtor. The court held that the exclusion applies not only to financial creditors who are related parties in praesenti but also to those who were related parties at the time the financial debt was created. The court found that Spade and AAA were related parties when the alleged financial debt arose and that their subsequent disassociation was a commercial contrivance to circumvent the exclusion. Therefore, the court affirmed their exclusion from the CoC.

Conclusion:

The court concluded that:
1. Spade and AAA are not financial creditors due to the collusive nature of their transactions.
2. Spade and AAA are related parties of the Corporate Debtor.
3. Spade and AAA should be excluded from the CoC in accordance with the first proviso of Section 21(2) of the IBC.

The appeals were disposed of accordingly, and any pending applications were also disposed of.