Case BriefsSupreme Court

Supreme Court: The 3-judge bench of Dr. DY Chandrachud*, Indu Malhotra and Indira Banerjee, JJ has held that collusive transactions with the Corporate Debtor would not constitute a ‘financial debt’ under Insolvency and Bankruptcy Code.

Financial Creditor and Financial Debt

Under Section 5(7) of the IBC, a person can be categorised as a financial creditor if a financial debt is owed to it. Section 5(8) of the IBC stipulates that the essential ingredient of a financial debt is disbursal against consideration for the time value of money.

As per the decision in Pioneer Urban Land and Infrastructure Ltd v. Union of India, (2019) 8 SCC 416,

“The expression “disbursed” refers to money which has been paid against consideration for the “time value of money”. In short, the “disbursal” must be money and must be against consideration for the “time value of money”, meaning thereby, the fact that such money is now no longer with the lender, but is with the borrower, who then utilises the money….”

Collusive Transactions

Money advanced as debt should be in the receipt of the borrower. The borrower is obligated to return the money or its equivalent along with the consideration for a time value of money, which is the compensation or price payable for the period of time for which the money is lent. A transaction which is sham or collusive would only create an illusion that money has been disbursed to a borrower with the object of receiving consideration in the form of time value of money, when in fact the parties have entered into the transaction with a different or an ulterior motive. In other words, the real agreement between the parties is something other than advancing a financial debt.

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.

Hence, collusive transactions with the Corporate Debtor would not constitute a ‘financial debt’.

Related Parties – Interpretation In Praesenti

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.”

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.”

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.

[Phoenix Arc Pvt. Ltd. v. Spade Financial Services Ltd., 2021 SCC OnLine SC 51, decided on 01.02.2021]


*Justice Dr. DY Chandrachud has penned this judgment 

Know Thy Judge| Justice Dr. DY Chandrachud

Appearances before the Court by

Senior Advocate K.V. Viswanathan for AAA and Spade;

Senior Advocate Neeraj Kishan Kaul for Phoenix; and

Senior Advocate Sanjiv Sen for the Resolution Professional

New releasesNews

A panel discussion on  “4 Years of IBC – The Revolution Witnessed and the Promise for Future” was held on 12th December, 2020.  The event also marked the release of Mr Akaant Kumar Mittal’s book on Insolvency and Bankruptcy: Law and Practice. It had several prominent personalities in attendance such as Justice AB Singh, Judicial Member, NCLAT, Dr MS Sahoo, President of Insolvency and Bankruptcy Board of India, Ms Mamta Binani, ex- Chairman, ICSI and others. This discussion was moderated by Ms Haripriya Padmanabhan, Advocate, Supreme Court of India.

 

After a brief introduction, Ms Padmanabhan proceeded to ask Justice Singh whether in his extensive experience as a judge of the High Court where he would have had an occasion to decide winding up cases, compared to his present office as Member of the NCLAT, does he think, that the IBC has made the process of insolvency more efficient? Listen to his answer below

To Dr Sahoo, Ms Padmanabhan asked whether that as new cases are time bound as they come under the new code, shouldn’t we consider transferring the existing winding up cases from HC to NCLT and NCLAT? She also asked his opinion on the fact that  the Code was brought in to save businesses, however it has been found that more than half the cases which are closed under the Code ended up in Liquidation and only 14.93% of the cases ended up with a Resolution Plan. Why does he think this is the case? Dr Sahoo’s reply to the question can be seen below. Kindly pardon Dr Sahoo’s video quality because of connectivity issues.

Next Ms Padmanabhan asked Dr Binani that by the time companies reach NCLT they are very sick, the amount of time available for resolution should increase or decrease depending on what is at stake? Also, What does she think are some of the biggest challenges that a Resolution Professional  faces under the Code? To see Dr Binani’s reply, watch the video below.

Ms Padmanabhan next addressed the author, Mr Mittal and asked him his opinion on the recent Supreme Court’s judgment with respect to the limitation act being applied to IBC. His answer can be seen below.

In the second round, Ms Padmanabhan proceeded to ask each panelist what measures can be introduced to make IBC more effective. See the video below for Justice Singh’s reply.

Listen to Dr Sahoo answer Justice AB Singh’s question on prepackaged insolvency and Ms Padmanabhan’s question on group insolvency and how to make IBC better. Kindly pardon the bad audio because of connectivity issues.

Ms Padmanabhan asked Dr Binani whether foreign portfolio investors are permitted to rescue companies under current IBC, the need to create a fund to facilitate the process and how to make the IBC better.

Ms Padmanabhan commented that Mr Mittal’s book contains many reports on the basis of which IBC was evolved. She asked him whether he thinks there are any lacunas in the law which can be addressed. See the video below for Mr Mittal’s reply.

Dr Padmanabhan finally ended the panel discussion by stating that the new law on insolvency has been a resounding success both in terms of reduction of time and recovery of dues and that she is very optimistic about the future of IBC. The webinar concluded with a vote of thanks to all panelists and all the people who contributed to the book in any small or big way.

The book can be bought here.


Nilufer Bhateja, Associate Editor has put this story together