Whether a Decree or an Arbitral Award or a Settlement Deed can form the Basis of a Financial or Operational Debt under IB Code

In this three – part series, I shall be discussing the if a decree or an arbitral award or a settlement deed can form the basis of a financial or operational debt under the IB Code.

 

The Insolvency and Bankruptcy Code, 2016 took effect on 1-12-2016, and the Government of India has since enforced most of the sections of the Code pertaining to corporate insolvency through numerous notifications. The Code has resulted in a paradigm shift in India’s insolvency and bankruptcy law, both for corporate entities and for individuals.

 

The IB Code differentiates between financial creditors and operational creditors. Financial creditors are those having a relationship with the corporate debtor that is purely a financial contract, such as a loan or a debt security. Whereas, operational creditors are those who have due from the debtor on account of transactions made for the operational working of the debtor.[1] In order to seeking a resolution process against a corporate debtor, therefore, a creditor must either have a claim of a financial debt or an operational debt against such debtor.

 

Now issues have arisen when such creditors have sought to base their claims on

(i) a decree by a court; or an arbitral award; or

(ii) settlement agreement between the creditor(s) and the corporate debtor.

The first part of the series shall deal with whether a decree constitutes a financial debt.

 

The jurisprudence on this issue generally has held that it is essential that the claim of a financial creditor must be based on the transaction between the debtor and creditor and not on the decree issued by a court or tribunal in any other case between the debtor and creditor.

 

A decree-holder cannot initiate a corporate insolvency resolution process by using the decree or recovery certificate issued by the Debts Recovery Tribunal or Real Estate Regulatory Authority (RERA) or any other authority under any other law.[2] The rationale is that an “amount claimed under the decree is an adjudicated amount and not a debt disbursed against the consideration for the time value of money”[3]. Resultantly, the same cannot be termed to fall within the ambit of any of the clauses enumerated under Section 5(8), IB Code.[4]

 

The NCLAT has maintained that the proceedings under the IB Code are not recovery proceedings. Therefore, when a creditor seeks indirect execution of such decrees or recovery certificates by filing an application under Section 7, IB Code, the same can tantamount to “fraudulent or malicious initiation of insolvency proceedings for a purpose other than for the resolution of insolvency” and hence, actionable under Section 65, IB Code.[5]

 

In other words, the underlying idea is that the adjudicating authority does not become an executing court wherein any petitioner who obtains a decree instead of getting the same executed before the appropriate civil courts, circumvents and seeks such execution indirectly through the proceedings under Section 7 of the IB Code.

 

Similar opinion was maintained in the matter of Akram Khan v. Bank of India Ltd.,[6] wherein the NCLAT opined that the application under Section 7 of the IB Code seems to be made for the purposes of execution of a decree passed by the Debts Recovery Tribunal in favour of the “financial creditor”. Hence, the creditor approached the adjudicating authority, for the purpose other than for the resolution of insolvency, or liquidation and resultantly falls foul of Section 65 of the IB Code. Similar view was taken in C. Shivakumar Reddy v. Dena Bank.[7]

 

One query that could certainly be posed is that why does a creditor rely on a decree or an arbitral award to establish a financial or an operational debt. One particular reason for that could be to prevent the claim being hit by the law of limitation. According to Section 238-A of the IB Code, the Limitation Act, 1963 applies to the IB Code and therefore, an application under Sections 7 or 9 or Section 10 of the IB Code has to be filed within 3 years of the date of default. Therefore, when the date of default predated the year 2013 but the creditor filed the application under Section 7 of the IB Code on 7-1-2019; the creditor sought to place reliance on the decree by the Debts Recovery Tribunal which was passed on 22-10-2016 to argue that their claim was within limitation.[8] However, the same was still rejected by the NCLAT holding that the limitation will start from the date of default and not the date when the recovery certificate was issued by the Debts Recovery Tribunal.[9]

 

However, a diverging stance was taken in Ugro Capital Ltd. v. Bangalore Dehydration and Drying Equipment Co. (P) Ltd.,[10] where specific argument was taken that the creditor had not prosecuted the judgment and decree obtained in 2015 before a civil court and instead has come before the adjudicating authority by filing an application under Section 7 of the IB Code. The NCLAT setting aside the order of the adjudicating authority, had directed the latter to admit the application under Section 7 of the IB Code. The NCLAT referring to the definition of the term “creditor” in the IB Code, in categorical terms, stated:

 

“[i]t is important to point out that the definition of creditor provided in Section 5(10) of the IB Code provides that “creditor means any person to whom a debt is owed and includes a financial creditor, an operational creditor, a secured creditor, an unsecured creditor and a decree-holder.

 

Based on the decree of the court this petition was filed under Section 7 of the Code. Since the definition of word creditor in IB Code includes decree-holder, therefore if a petition is filed for the realisation of decretal amount, then it cannot be dismissed on the ground that applicant should have taken steps for filing execution case in civil court.”

 

In fact, in the above-mentioned case, the NCLAT calculated the limitation for filing the application under Section 7 from the date of the decree.

 

In conclusion, it can be said that majorly the courts had taken an adverse view when an application seeking initiation of a resolution process is supported by a decree or an arbitral award[11]. The impression that the same seems to be communicated to the courts is that the creditor has approached it with a mala fide motive, which is why the provision of Section 65 IB Code[12] is referred to it.[13]

 

However, the same must now be revisited on account of the ruling of the Supreme Court in Dena Bank v. C. Shivakumar Reddy[14]. One of the issues in this case was the financial creditor had relied on the recovery certificate issued by the Debts Recovery Tribunal to establish the claim of a financial debt and to contend that the application under Section 7 was filed in the period of limitation. Setting aside the ruling of the NCLAT, the Supreme Court accepted the submission of the financial creditor, holding:

126… In this case, the appellant financial creditor had, amongst other documents, also relied upon the final judgment and order dated 27-3-2017 passed by the Debts Recovery Tribunal and the subsequent recovery certificate dated 25-5-2017 which constituted cause of action for initiation of proceedings under Section 7 of the IB Code.

Clearly, therefore, a decree can now constitute a financial debt.

Conclusion

From the foregoing discussion, it is clear that the jurisprudence of the NCLAT wherein claim based on a decree was look with skepticism as to whether the same amounts to misuse of the provision of the IB Code, needs revisiting. In light of the ruling of the Supreme Court in Dena Bank[15], a claim can most certainly be based on a decree. However, it must be mentioned here that the claim upon which a decree is rendered must satisfy the fundamental ingredients of a financial debt, since in Dena Bank[16], it was a financial creditor that had secured the decree.

 


† Akaant Kumar Mittal is an advocate at the Constitutional Courts, and National Company Law Tribunal, Delhi and Chandigarh. He is the author of the commentary “Insolvency and Bankruptcy Code – Law and Practice”.

The author gratefully acknowledges the research and assistance of Sh. Mahesh Kumar, 4th Year, B.A.LLB. (Hons.), student at Sharda University, Greater Noida, Uttar Pradesh, in writing this series.

[1] The Report of the Bankruptcy Law Reforms Committee, Volume 1: Rationale and Design (Nov. 2015), Ch. 5.2.1

[2] See, Sushil Ansal v. Ashok Tripathi, 2020 SCC OnLine NCLAT 680.

[3] 2020 SCC OnLine NCLAT 680, para 20.

[4] 2020 SCC OnLine NCLAT 680.

[5] See, G. Eswara Rao v. Stressed Assets Stabilisation Fund, 2020 SCC OnLine NCLAT 416; Sushil Ansal v. Ashok Tripathi, 2020 SCC OnLine NCLAT 680.

[6] 2019 SCC OnLine NCLAT 1427.

[7] 2019 SCC OnLine NCLAT 907.

[8] Digamber Bhondwe v. JM Financial Asset Reconstruction Co. Ltd., 2020 SCC OnLine NCLAT 399.

[9] Digamber Bhondwe v. JM Financial Asset Reconstruction Co. Ltd., 2020 SCC OnLine NCLAT 399, para 18.

[10] 2020 SCC OnLine NCLAT 149.

[11] See HDFC Bank Ltd. v. Bhagwan Das Auto Finance Ltd., 2019 SCC OnLine NCLAT 1338.

[12] IB Code, S. 65(1) states:

“65. Fraudulent or malicious initiation of proceedings.— (1) If, any person initiates the insolvency resolution process or liquidation proceedings fraudulently or with malicious intent for any purpose other than for the resolution of insolvency, or liquidation, as the case may be, the adjudicating authority may impose upon such person a penalty which shall not be less than one lakh rupees, but may extend to one crore rupees.”

[13] See HDFC Bank Ltd. v. Bhagwan Das Auto Finance Ltd., 2019 SCC OnLine NCLAT 1338; G. Eswara Rao v. Stressed Assets Stabilisation Fund, 2020 SCC OnLine NCLAT 416.

[14] 2021 SCC OnLine SC 330.

[15] (2021) 10 SCC 330.

[16] (2021) 10 SCC 330.

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