The ‘net concentrate’ of ‘preference- Key takeaways from the SC ruling regarding preferential transactions

-Sikha Bansal

(resolution@vinodkothari.com)

The Hon’ble Supreme Court’s ruling in Jaypee [Civil Appeal Nos. 8512-8527 of 2019] stands as a landmark for two reasons – first, it deals with an otherwise unexplored periphery of vulnerable transactions in the context of insolvency, and secondly, it will have far-reaching impacts on how secured transactions are structured and the manner in which the lenders lend.

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Recent Developments in Corporate Laws

In its stride to achieve transparency, good governance, and ease of doing business, the Government has time and again introduced amendments, proposed new ideas in the corporate laws. The very recent example of such changes are (a) Changes in RPTs proposed in LODR; (b) Minority Squeeze outs under Companies Act; and (c) introduction of Winding-up Rules, 2020.

In light of the these amendments/ proposed amendments, it becomes important to understand its impact on the already existing set-up. A brief analysis of the aforementioned topics has been discussed here

Limits of the Limitation Law and IBC

-Megha Mittal

(resolution@vinodkothari.com)

The law of limitation revolves around the basic concept of fixing or prescribing the time period for barring legal actions beyond that period. A concept widely acknowledged, in India, the law of limitation is governed by the Limitation Act, 1963[1]. As stated in its preamble, the Limitation Act, 1963 (“Act”) is an act to consolidate the laws for the limitation of suits and other proceedings and for purposes connected therewith.

As observed in the 89th Report of the Law Commission of India[2], the laws of limitation are ultimately based on justice and convenience. An individual should not live under the threat of possible action for an indefinite period, and at the same time, should be saved from the task of defending a stale cause of action, as it would be unjust. The Report states, “all that has been said on the subject can be summarised by stating that the laws of limitation rest upon three main foundations – justice, convenience and the need to encourage diligence.” 

The very crux of having a limitation law in force is that a person cannot sleep over his rights[3] for an indefinite period and seek such remedy at a later stage. That being the tenet on which the law is based, there are several basic principles which the law states. These principles substantively affect the rights of parties. Recently, there has been a lot of commotion around the manner and the circumstances, in which the limitation law can be invoked in the context of the Insolvency and Bankruptcy Code, 2016 (‘Code’), though it is established now that the limitation law is applicable to the proceedings under the Code by virtue of section 238A.

In this article, we have made a humble attempt to analyse the various principles of the Limitation Act and its impact on the Code.

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INSOLVENCY OF FSPS AND THIRD PARTY RIGHTS UNDER SECURITISATION CONTRACTS

-Richa Saraf

(richa@vinodkothari.com)

 

The Insolvency and Bankruptcy Code, 2016 (“Code”) does not, in general, deal with insolvency of financial service providers (“FSPs”), as FSPs are seen to be systemic and complex structures with unique transactions in their kitty. However, the Dewan Housing Finance Corporation Limited (DHFL) collapse led to notification of the Insolvency and Bankruptcy (Insolvency and Liquidation Proceedings of Financial Service Providers and Application to Adjudicating Authority) Rules, 2019[1] (“Rules”) under Section 227 of the Code. The Rules applied the law to FSPs, with certain modifications[2]. The Rules, inter alia, with respect to third party assets, stipulates that the moratorium provisions will not apply to such assets or properties in custody or possession of the FSP, including any funds, securities and other assets required to be held in trust for the benefit of third parties. The Rules further state that the Administrator shall take control and custody of such third-party assets or receivables, but only for the limited purpose of dealing with them in the manner as may be notified by the Central Government.

Pending notification of clear rules with regard to third party assets with the FSPs, there were ambiguities, which demanded judicial intervention (see below). However, now, the Central Government has, vide notification dated 30.01.2020[3] (“Notification”), notified the manner in which third party assets in custody or possession of financial service providers (against whom insolvency proceedings have been initiated) has to be dealt with.

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Accumulated welfare benefits of employees and treatment under Resolution Plans

Megha Mittal

(resolution@vinodkothari.com)

The preamble of the Insolvency and Bankruptcy Code, 2016 (“Code”) enshrines the principle of balance of interests of all stakeholders. A major part of the stakeholders is represented by employees and workmen. Employees and workmen are one of the most significant pillars on which the economy runs, and hence, it becomes important to understand their footing under the Code and ensure that they have necessary safeguards from being put in a helpless position in a situation where the employer gets into insolvency.

It must be noted that section 5(20) read with section 5(21) includes claims in respect of employment under the ambit of “operational debt”, and as such empowers employees to initiate an application for insolvency against its employer, under section 9 of the Code, that is, as an operational creditor. Further, section 53 of the Code accords priority to the workmen dues at par with secured creditors, and next priority is given to employee dues. Hence, while on one hand their position as an applicant is secured, the position of its claims, especially terminal claims remains a rather unexplored sphere.

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Out-and-Out Ouster of Ineligible Persons- Liquidation Amendment Regulations, 2020 enact Discussion Paper proposals

-Megha Mittal

(resolution@vinodkothari.com

The Insolvency and Bankruptcy Board of India (“IBBI”/ “Board”) vide Notification No. IBBI/2019-20/GN/REG053, dated 06.01.2020, introduced the IBBI (Liquidation Process) (Amendment) Regulations, 2020 (“Amendment Regulations”) w.e.f. the same day.

In what seems to be an adaptation of the ideas proposed in the Discussion Paper dated 03.11.2019[1], the Amendment Regulations seem to have provided for  “out-and-out ouster” approach towards persons ineligible under section 29A of the Code, in liquidation processes too, thereby imbibing in the Liquidation Process Regulations, the orders of the Hon’ble National Company Law Appellate Tribunal (“NCLAT”) in Jindal Steel and Power Limited v. Arun Kumar Jagatramka & Gujarat NRE Coke Limited (Company Appeal (AT) No. 221 of 2018)[2] and State Bank of India v. Anuj Bajpai (Liquidator) (Company Appeal (AT) (Insolvency) No. 509 of 2019)[3]

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LIMITATION ON ROLE OF ADJUDICATING AUTHORITY

-Richa Saraf (resolution@vinodkothari.com)

It is a well settled principle that a writ petition may be entertained by the High Courts only in absence of any efficacious alternate remedy. However, one of the exceptions to the said rule is where there is lack of jurisdiction on the part of the statutory/ quasi- judicial authority, against whose order a judicial review is sought. In the recent case of Embassy Property Developments Pvt. Ltd. vs. State of Karnataka & Ors.[1], the primary issue for consideration before the Hon’ble Supreme Court was with regard to the jurisdiction of High Court to grant relief against the order of NCLT, disrupting the hierarchy laid down by the Code. For the said purpose, the Apex Court examined the limitations on the power exercisable by the Adjudicating Authority, and held that in case any party is aggrieved by the decision of NCLT, the Code provides for filing of an appeal before NCLAT, however, considering the exercise of excess jurisdiction by the NCLT, the High Court may entertain a petition under Article 226/ 227 of the Constitution.

The article analyses the impact of the ruling on the jurisdiction of NCLT to deal with various matters related to the corporate debtor under insolvency or liquidation.

FACTS OF THE CASE

The National Company Law Tribunal, Chennai Bench vide order dated 12.03.2018 ordered for initiation of corporate insolvency resolution process of Tiffins Barytes Asbestos & Paints Ltd. (“Corporate Debtor”).

The Corporate Debtor held a mining lease granted by the Government of Karnataka, which was to expire on 25.05.2018. A notice for pre- termination of the lease was issued by the Government of Karnataka before CIRP commencement, on ground of violation of various statutory rules, and terms and conditions of the lease agreement, however, the order of termination was passed by the Government of Karnataka after the commencement of CIRP.

The RP filed an application before NCLT, Chennai, praying for setting aside of the order of Government of Karnataka, and seeking a declaration that the lease should be deemed to be valid until 31.03.2020 in terms of Section 8A(6) of the Mines & Minerals (Development and Regulation) Act, 1957 (“Mines Act”), and also, a consequential direction on the Government of Karnataka to enter into a supplemental lease deed. The Adjudicating Authority allowed the RP’s application, setting aside the order of Government of Karnataka on the ground that the same is in violation to the moratorium under Section 14 of the Insolvency and Bankruptcy Code. Challenging the order of NCLT, Government of Karnataka moved a writ petition before High Court of Karnataka, wherein the Hon’ble High Court granted a stay of operation of the NCLT directions. The RP, the Resolution Applicant and the Committee of Creditors (“Appellants”) then filed an appeal before the Supreme Court against the interim order passed by the High Court.

CONTENTIONS W.R.T. JURISDICTION OF NCLT AND THE OBSERVATIONS OF THE SUPREME COURT:

1. IBC is a complete code in itself and has an overriding effect over other laws: The Code covers the entire gamut of law relating to insolvency resolution of corporate persons and others in a time bound manner, therefore, one of the contentions raised in the matter was that there exists no room to challenge the orders of NCLT, otherwise than in the manner provided in the Code.  In this regard, it was contended that Section 60(5) provides an exclusive jurisdiction to NCTL to deal with all the matters relating to the corporate debtor. The relevant extract is reproduced below for reference:

“Notwithstanding anything to the contrary contained in any other law for the time being in force, NCLT shall have jurisdiction to entertain or dispose of –

(a) any application or proceeding by or against the corporate debtor or corporate person;

(b) any claim made by or against the corporate debtor or corporate person, including claims by or against any of its subsidiaries situated in India; and

(c) any question of priorities or any question of law or facts, arising out of or in relation to the insolvency resolution or liquidation proceedings of the corporate debtor or corporate person under this Code.”

 Further, since Section 238 stipulates that the provisions of this Code shall have effect, notwithstanding anything inconsistent therewith contained in any other law for the time being in force or any instrument having effect by virtue of any such law, the only option available with the RP is to move an application before NCLT under the provisions of the Code.

The Apex Court discussed the limitation on the jurisdiction of NCLT to exercise its power under Section 60(5). It held that NCLT is a creature of a special statute to discharge certain specific functions, and it cannot be elevated to the status of a superior court having the power of judicial review over administrative action. Observing that NCLT is not even a civil court, which has been granted the jurisdiction, by virtue of Section 9 of the Code of Civil procedure, to try suits of civil nature, and therefore, NCLT can only exercise only such powers which are within the contours of jurisdiction prescribed by the statute, which it is required to administer.

Citing an instance where a corporate debtor may have suffered an order at the hands of the Income Tax Appellate Tribunal, at the time of initiation of CIRP, the Apex Court observed that if Section 60(5)(c) of the Code is interpreted to include all questions of law or facts under the sky, an RP will then claim a right to challenge the order of the Income Tax Appellate Tribunal before the NCLT, instead of moving a statutory appeal under Section 260A of the Income Tax Act, 1961, and the jurisdiction of NCLT laid down in Section 60(5) cannot be stretched so far as to bring such absurd results.

2. Measure to protect the asset of the Corporate Debtor: Section 25(1) of the Code stipulates that it shall be the duty of the resolution professional to preserve and protect the assets of the corporate debtor, and therefore, the IRP moved the NCLT for appropriate reliefs, for the purpose of preservation of properties of the Corporate Debtor.

It was further contended by the counsel of the IRP that Section 14 of the IBC granted a deemed extension of lease, and therefore, the application before NCLT was only for declaration of that the lease is valid. In this regard, reliance was placed on Section 14(1)(d) which prohibits, during the period of moratorium, the recovery of any property by an owner or lessor where such property is occupied by or in the possession of the corporate debtor.

The Supreme Court observed that the moratorium provided for in Section 14 cannot have any impact on the right of the Government to refuse extension of lease. The Apex Court discussed the purpose and scope of moratorium and held that moratorium is only to preserve the “status quo and not to create a new right. Analysing the provision contained in Section 14(1)(d), it was held that the said section will not go to the rescue of the Corporate Debtor since what is provided therein is only the right not to be dispossessed but does not by itself provides the right which the Corporate Debtor does not otherwise have (in the instant case, the right to have the renewal of lease). Further, considering that there existed disputes arising under the Mines Act, and those revolving around decisions of statutory or quasi-judicial authorities, the Supreme Court deliberated on the provisions contained in Section 18(f)(vi) of the Code-

The IRP shall take control and custody of any asset over which the corporate debtor has ownership rights as recorded in the balance sheet of the corporate debtor, or with information utility or the depository of securities or any other registry that records the ownership of assets, including assets subject to the determination of ownership by a court or authority.”

If the intent of the Code was to confer with NCLT the jurisdiction to decide all types of claims relating to the asset of the corporate debtor, Section 18(f)(vi) would not have provided for determination of ownership by a court or other authority, and therefore, the Apex Court held that wherever the corporate debtor has to exercise rights in judicial, quasi- judicial proceedings, the RP cannot short- circuit the same and bring a claim before NCLT taking advantage of Section 60(5).

3. Jurisdiction based on consensus between parties: One of the contentions raised in the appeal was that since the State of Karnataka recognised the jurisdiction of NCLT for raising all its contentions, it was not open to the Government to later question the jurisdiction of the NCLT in next round of litigation. The Apex Court held that the fact that the Government of Karnataka conceded to the jurisdiction of the NCLT does not ipso facto provide NCLT with the jurisdiction to entertain any application. NCLT is a creature of statue, any jurisdiction to the NCLT has also been granted by the statute, and the mere agreement between parties to approach a particular court or tribunal does not automatically provide jurisdiction to a court.

CONCLUSION

From the above discussion, it is clear that the jurisdiction of Adjudicating Authority is confined only to contractual matters between parties, and an order passed by a statutory/ quasi- judicial authority under certain special laws, or which falls in the realm of public law, cannot be determined by NCLT. A decision taken by the government or a statutory authority cannot, by any stretch of imagination, be brought within the fold of “arising out of or in relation to insolvency resolution” as appearing in Section 60 of the Code. The correctness of the said decision can be called into question only in a superior court vested with the power of judicial review over administrative action.

 

[1] https://main.sci.gov.in/supremecourt/2019/33953/33953_2019_4_1501_18757_Judgement_03-Dec-2019.pdf

Insolvency and Bankruptcy Code (Second Amendment) Bill, 2019 Quick review of Proposed Amendments

Megha Mittal

(resolution@vinodkothari.com)

Amidst the lingering need to fill in certain critical gaps to ensure streamlining of corporate insolvency resolution process (“CIRP”), the Cabinet on 10.12.2019 approved the Insolvency and Bankruptcy (Second Amendment) Bill, 2019 (“Amendment Bill”)[1] further to amend the Insolvency and Bankruptcy Code, 2016 (“Code”), which is now pending approval by the Houses.

The objective of the amendment being to remove difficulties, while it is expected that the amendments will have a retrospective impact to the extent possible, the Amendment Bill hints that the different provisions of the Amendment Bill shall be effective from different dates; and where the effect is retrospective in nature, it shall be deemed to be effective from the date the particular section originally came into force.

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Ablution by Resolution

The Insolvency and Bankruptcy Code (Second Amendment) Bill, 2019 seeks to wash out liability of corporate debtors resolved under IBC

-Sikha Bansal (resolution@vinodkothari.com)

 

Resolution under the Insolvency and Bankruptcy Code, 2016 (‘Code’) is a harbinger of fresh start of the corporate debtor, which passes into the control of a new management by the very application of section 29A. The fresh start would have no meaning if the corporate debtor or the new management thereof have to bear the brunt of offences which the corporate debtor or its officers committed prior to ablution under the Code – that is, one cannot be made to reap what they did not sow. As such, it was important to provide immunity to the corporate debtor and its assets, the successful resolution applicant and the new management personnel.

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WHETHER LANDLORD IS AN OPERATIONAL CREDITOR UNDER IBC?

Richa Saraf

(resolution@vinodkothari.com)

For an amount to be classified as an operational debt, a sort of filtration process is provided under the Insolvency and Bankruptcy Code. Firstly, the amount should fall under the ambit of “claim” as defined under Section 3(6) of the Code. Secondly, such a claim should fall within the confines of the definition of “debt” under Section 3(11) of the Code, meaning it should be by way of a liability or obligation due from any person. Thirdly, such a “debt” should strictly fall within the scope of “operational debt” as provided in Section 5(21) of the Code, i.e. the claim should arise in respect of:

  • provision of goods or services including employment; or
  • a debt in respect of the repayment of dues arising under any law for the time being in force and payable to the Central Government, any State Government or any local authority.

If the claim by way of debt does not fall under any of the three categories as mentioned above, the claim cannot be categorised as an operational debt, even though there may be a liability or obligation due from the corporate debtor to the creditor, and hence, such a creditor disentitled from maintaining an application for initiation of corporate insolvency resolution process of the corporate debtor.

There seems to be some rationale in restricting only to operational creditors for initiation of CIRP, other than financial creditors. Default committed to operational creditors in relation to payment of their debt definitely connotes that the corporate debtor is not even in a position to service the regular payments and operational expenses, as required in the day-to-day functioning of the corporate debtor, which provides a clear indication to its insolvency, warranting the resolution process being put in place.

If the corporate debtor is carrying on its operations on a rented premises, the rental dues also cannot escape the ambit of operational debt under the Code. Below we discuss whether a landlord with unpaid rent is a supplier of services, and hence, an operational creditor.

Relevant Provisions:

Section 5(20) of the Insolvency and Bankruptcy Code defines an “operational creditor” to mean a person to whom an operational debt is owed and includes any person to whom such debt has been legally assigned or transferred.

To determine whether a landlord will be regarded as an operational creditor under the ambit of Section 5(20) of the Code, it is also relevant to understand the intention of the law makers. The Bankruptcy Law Reforms Committee, in its report dated November, 2015[1], states that “Operational creditors are those whose liability from the entity comes from a transaction on operations”. While discussing the different types of creditors, the Committee points out that “enterprises have financial creditors by way of loan and debt contracts as well as operational creditors such as employees, rental obligations, utilities payments and trade credit.” Further, while differentiating between a financial creditor and an operational creditor, the Committee indicates “the lessor that the entity rents out space from is an operational creditor to whom the entity owes monthly rent on a three-year lease.

Lessor or landlord to be regarded as operational creditor:

The Apex Court in Mobilox Innovations Pvt. Ltd. v. Kirusa Software Pvt. Ltd.[2], laying down as to who can trigger the insolvency resolution process, relied upon the report of Bankruptcy Law Reform Committee, which considers a lessor as an operational creditor.

NCLT, Kolkata Bench, in the case of Sarla Tantia vs. Nadia Health Care Ltd.[3], relied on the order of the Apex Court in Mobilox Innovations (supra), and held as follows:

“Letting out premises on rent is nothing but providing the services… Hence, receiving any consideration by way of rent, lease from time to time or license fee for letting out the premises falls under the purview of providing services and the consideration that is receivable becomes ‘Operational Debt’. ‘Arrears of rent’ are in the nature of ‘operational debt’ within the meaning of definition of operational debt defined under Section 5(21) of the I&B Code.”

 The Tribunal also placed reliance on the provisions of the Central Goods and Services Tax Act, 2017. Schedule- II of the Act list down the activities that are to be treated as supply of goods or services, and paragraph 2 of the schedule stipulates as follows:

“(a) any lease, tenancy, easement, licence to occupy land is a supply of services;

(b) any lease or letting out of the building including a commercial, industrial or residential complex for business or commerce, either wholly or partly, is a supply of services.”

A similar observation was given by the Hon’ble NCLT, Mumbai Bench in the case of Indiabulls Real Estate Company Private Limited vs. Crest Steel & Power Private Limited[4]. In the said case, the petitioner had given its premises on lease under an agreement, and since there was arrears of rent, the petition under Section 9 of the Code was filed. The NCLT held that not an iota of doubt can be raised whether the present proceedings are maintainable u/s 9 of the Code or not. Such claim is very much within the definition of “operational debt”, and thus, come in the purview of Sec. 9 of the Code.

Contrary rulings:

National Company Law Appellate Tribunal, in the case of Jindal Steel & Power Ltd. vs. DCM International Ltd. [5], held as follows:

“Admittedly, the Appellant is a tenant of Respondent- ‘Corporate Debtor’. Even if it is accepted that a Memorandum of Understanding has been entered between the parties in regard to the premises in question, the Appellant being a tenant, having not made any claim in respect of the provisions of the goods or services and the debt in respect of the repayment of dues does not arise under any law for the time being in force payable to the Central Government or State Government, we hold that the Appellant tenant do not come within the meaning of ‘Operational Creditor’ as defined under sub-section (20) read with sub-Section (21) of Section 5 of the Insolvency and Bankruptcy Code, 2016 (hereinafter referred to ‘I&B Code’) for triggering Insolvency and Bankruptcy Process under Section 9 of the ‘I&B Code’”

Relying on the aforementioned judgment of NCLAT, NCLT, Mumbai Bench, in Citicare Super Speciality Hospital vs. Vighnaharta Health Visionaries Pvt. Ltd.[6], dismissed the petition which was in relation to arrears of license fee.

NCLT, New Delhi, in Parmod Yadav & Anr vs. Divine Infracon (P) Ltd.[7], noted that the word “operational” or for that matter “operation” has not been defined anywhere in the Code. In fact the General Clauses Act, 1897 also do not define the term, hence, the term has to be given a meaning as ordinarily understood. Merriam Wester defines the term “operational” as “of or relating to operation or to an operation”[8]. Further, from the usage of the term “goods or services” in relation to Section 14(2) of the Code, and what constitute or do not constitute or in other words qualify to be considered as “essential goods or services”, determined that the term “goods or services” used in the definition of operational debt must directly relate to direct input to the output produced or supplied by the corporate debtor. Thus, any debt arising without nexus to the direct input to the output produced or supplied by the corporate debtor, cannot, in the context of Code, be considered as an operational debt, even though it is a claim amounting to debt. However, without going into the aspect whether an immovable property in itself constitutes stock- in- trade of the corporate debtor and has a direct nexus to its input- output, being an integral part of its operations, the Bench held that lease of immovable property cannot be considered as a supply of goods or rendering of services, and thus, cannot fall within the definition of operational debt. In this regard, reliance was also placed on Col. Vinod Awasthy vs. AMR Infrastructure Ltd.[9]

Further, relying on Jindal Steel (supra) and Citicare (supra), NCLT Hyderabad also, in the case of Manjeera Retail Holdings Pvt. Ltd. vs. Blue Tree Hospitality Pvt. Ltd.[10], held that the petitioner claiming default in payment of rent of the premises leased out cannot be treated as an operational creditor, and the amount involved cannot be treated as an operational debt.

Conclusion:

The view taken in various cases that transactions relating to immovable properties do not have a direct nexus with the input- output of the corporate debtor, and thus, do not qualify to be operational debt, seems to be restrictive. More so, when the intention of the law makers is evidently clear from perusal of the BLRC report, which specifically includes rental obligations as operational debt.


[1] http://ibbi.gov.in/BLRCReportVol1_04112015.pdf

[2] https://indiankanoon.org/doc/166780307/

[3] https://nclt.gov.in/sites/default/files/Interim-order-pdf/CP%28IB%29%20No-108-KB-2018.pdf

[4]https://nclt.gov.in/sites/default/files/Interim-order-pdf/Indiabulls%20Real%20Estate%20Company%20Private%20Limited%20CP%201664-2017%20NCLT%20ON%2011.03.2019%20FINAL-IBC.pdf

[5] http://ibbi.gov.in/BLRCReportVol1_04112015.pdf

[6]https://nclt.gov.in/sites/default/files/final-orders-pdf/Citicare%20Super%20Speciality%20Hospital%20CP%20567%20of%202018%20NCLT%20on%2011.3.2019%20Final.pdf

[7] http://164.100.158.181/Publication/New_Delhi_Bench_III/2017/Others/174.pdf

[8] https://www.merriam-webster.com/dictionary/operational

[9] http://164.100.158.181/Publication/Principal_Bench/2017/Others/Col.%20Vinod%20Awasthy%20(Final).pdf

[10] https://nclt.gov.in/sites/default/files/Interim-order-pdf/1_347_0.pdf