Supreme Court confirms, sale certificates from confirmed auction sales do not require mandatory registration

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Barsha Dikshit and Neha Malu | resolution@vinodkothari.com

In the context of an auction sale conducted during liquidation or by a secured creditor, the sale certificate serves as a critical document, evidencing the transfer of title to the purchaser upon confirmation of the sale. Its legal nature and the procedural requirements such as registration and the payment of stamp duty have often been a subject of scrutiny and debate. 

The Hon’ble Supreme Court in the matter of State of Punjab & Anr. v Ferrous Alloy Forgings P. Ltd. & Ors. reaffirmed the principle that a sale certificate issued by the authorised officer is not compulsorily registrable under section 17(1) of the Registration Act, 1908. The Court further clarified that compliance with Section 89(4) of the Registration Act, which provides for forwarding of a copy of the sale certificate by the authorised officer to the registering authority, is sufficient to satisfy the statutory requirements. However, in instances where the purchaser voluntarily presents the original sale certificate for registration or uses the same for some other purpose, the document is liable to attract stamp duty as prescribed under the Indian Stamp Act, 1899, or the relevant state enactments governing stamp duty. 

This article examines the legal framework governing sale certificates in auction sales, analyzing the procedural and practical nuances associated with their registration and the evolving interpretations rendered by courts in the context of SARFAESI Act and Insolvency and Bankruptcy Code, 2016. 

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Navigating the Complexity of ‘Contingent Claims’ in IBC: a call for clarity

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– Barsha Dikshit & Archana Kejriwal (resolution@vinodkothari.com)

The Insolvency and Bankruptcy Code, 2016 (‘Code’) provides a unified and collective resolution mechanism aimed at resolving the claims of multiple creditors against a corporate debtor. In this process, creditors who may have varying claims based on the nature of their financial or operational relationship with the debtor, submit their claims, which are collated either by the resolution professional (in the case of a resolution process) or the liquidator (in the event of liquidation) and ultimately these claims are satisfied from the recoveries made through either an approved resolution plan or by way of realization during the liquidation process in terms of section 53 of the Code.

At the core of this framework lies a critical question- What constitutes a legitimate “claim” as per the Code, and how does one qualify as a “creditor” eligible for repayment? 

While claims that are clearly defined or crystallized are relatively easy to account for, the matter becomes complex when dealing with contingent or unascertainable claims. Although there have been judicial interpretations addressing this concern, the law is still evolving and lacks clarity on certain aspects. 

In this write up, the author seeks to analyze the validity of ‘contingent claims’ under the Code in light of the recent judgement passed by Hon’ble NCLAT in the matter of SBS Holdings v Mohan Lal Jain, whereby NCLAT had held that claims arising from an arbitral award issued after the liquidation commencement date, even if the liquidator has participated in the arbitration process, cannot be entertained during the liquidation process of the corporate debtor.

Validity of contingent claims under the Code

A contingent claim, by its nature, is dependent upon the occurrence or non-occurrence of an uncertain future event. Such claims, although not crystallized at the time of insolvency initiation may have significant implications for creditors and the corporate debtor. While the term ‘contingent claim’ is not explicitly defined in the Code, Section 3(6) of the Code defines a “claim” as:

“(a) a right to payment, whether or not such right is reduced to judgment, fixed, disputed, undisputed, legal, equitable, secured, or unsecured.

(b) right to remedy for breach of contract under any law for the time being in force, if such breach gives rise to a right to payment, whether or not such right is reduced to judgment, fixed, matured, unmatured, disputed, undisputed, secured or unsecured;”

While the definition does not explicitly distinguish between crystallized claims and contingent claims. However, the inclusive nature of the definition has led to the interpretation that contingent claims fall within the ambit of ‘claims’ that can be admitted during the CIRP or liquidation process, as the case may be. 

Status of ‘Contingent claim’ during CIRP

In CIRP, Regulation 13 of the Insolvency and Bankruptcy Board of India (IBBI) (Insolvency Resolution Process for Corporate Persons) Regulations, 2016 (hereinafter, ‘CIRP Regulations’), provides that the Resolution Professional (RP) shall verify every claim submitted under the CIRP and may either admit or reject such claims based on the available evidence and records, and Regulation 14 acknowledges the possibility of contingent claims by allowing the RP to “estimate” claims that are not fully crystallized. This estimation is critical as it permits contingent claims to be included within the broader claim pool, ensuring that such claims are not ignored merely because they have not yet matured.

Status of ‘Contingent claim’ during Liquidation

In case of liquidation, Section 38 of the Code read with Regulation 16 of the Insolvency and Bankruptcy Board of India (Liquidation Process) Regulations, 2016 (hereinafter, ‘Liquidation Regulations’) provides for submission of claims by creditors in the liquidation process. Further, Reg. 25 of the Liquidation Regulations empowers the liquidator to “make an estimate of the value of the claim” when a claim cannot be ascertained precisely, thereby allowing the liquidator to admit contingent claims in estimated value for distribution purpose. 

Thus, CIRP Regulations and Liquidation Regulations both recognize the existence of contingent claims, thereby imposing a duty on the IRP/RP or the Liquidator, as the case may be, to exercise due diligence and make reasonable estimates regarding such claims, admitting them accordingly. Notwithstanding the common duty to estimate and admit contingent claims, the roles, responsibilities, and rights of the RP and the Liquidator are distinct and operate within the separate frameworks of the CIRP and liquidation proceedings, respectively.

Judicial precedents relating to treatment of ‘contingent claims’ under the Code

The judicial precedents relating to ‘contingent claims’ under the Code emphasize an inclusive approach to recognise claims that could become liabilities in the future. While recognizing contingent claims, courts have upheld the need for fair and equitable treatment, balancing creditor interests with the efficiency of the insolvency process. Moreover, some of the judgments have underscored the importance of valuation methods that reflect the realistic likelihood of contingent events, ensuring that contingent claims do not unduly burden the resolution process or impair creditor interests. The treatment of contingent claims, while still evolving, is guided by the principles of fairness.

For instance, in the matter of Essar Steels Limited, Committee of Creditors v. Satish Kumar Gupta & Ors (2020), Hon’ble Supreme Court has held that the resolution professional can admit a contingent claim at the notional value of INR1 if there are pending disputes regarding the claims in question.

In the matter of Innoventive Industries Ltd. v. ICICI Bank and Anr. (2018), the Hon’ble Supreme Court has emphasized the inclusive definition of “claim” under the Code. The Court held that the term “claim” includes a right to payment, even if it is disputed i.e. whether or not such right is reduced to judgment, fixed, disputed, undisputed, legal, equitable, secured, or unsecured. This broad definition extends to contingent claims, allowing them to be admitted in insolvency proceedings, provided they can be substantiated as potential liabilities.

In Phoenix ARC Private Limited v Spade Financial Services Limited & Ors.(2021), Hon’ble SC has addressed the treatment of certain financial claims that had characteristics similar to contingent claims. The Court held that contingent claims, when verified and valued, must be recognized appropriately in the resolution process. However, their priority in distribution must align with established principles of fairness, prioritizing claims based on certainty and enforceability over those based on speculative or highly conditional events.

Thus it is clear that the existence of ‘contingent claim’ as on the CIRP commencement/ liquidation commencement cannot be denied. Infact, it is the IRP/RP or the Liquidator who are entrusted with the duty to make best estimates for such claims.

[May also read Global scenario on treatment of ‘Contingent claim’ in our related article here].

Views of NCLAT in the matter of SBS Holdings v. Mohanlal  Jain

In the instant case, an appeal was submitted before Hon’ble NCLAT , wherein the appellant contested the decision of the Liquidator. The appellant argued that a claim arising from an arbitration award, issued after the liquidation commencement date in ongoing arbitration proceedings in which the Liquidator participated on behalf of the CD), had not been considered by the Liquidator. The Liquidator had declined to admit the claim on the grounds that it was submitted after the deadline for claim submission as stipulated under Regulation 16 of the Liquidation Regulations.

Upon review, the Hon’ble NCLAT upheld the decisions of both the Liquidator and the National Company Law Tribunal (NCLT), dismissing the appeal. The Hon’ble NCLAT held that claims based on an arbitration award issued after the liquidation commencement date are inadmissible, even where the Liquidator has participated in the arbitration proceedings during the liquidation process. The Hon’ble NCLAT stated- “When a statute provides for liquidation commencement date as a date up to which claims can be filed and proved, no claim thereafter can be entertained by the Liquidator.”

Conclusion

The treatment of contingent claims under the Code remains an evolving and intricate area of law. It is important to understand that contingent claims are not ‘unknown’, but rather ‘uncertain’ at the time of the insolvency proceedings, While the Code includes contingent claims within its broad definition of “claim,” their admission and valuation during the CIRP and liquidation processes necessitate careful assessment and estimation by IRP/RP/Liquidator, as the case may be. While there may be instances of delayed filing by claimants, such procedural delays are typically technical in nature, and the Code  also permits the late submission of claims under certain circumstances.

There are many judicial precedents that have supported the inclusion of contingent claims in insolvency proceedings. However, the recent ruling by NCLAT in SBS Holdings v. Mohanlal Jain, in the humble view of the author, tends to have added complexity by presenting divergent views. 

In the humble view of the author, the Code’s principal objective is to enable the swift revival of distressed companies and ensure equitable repayment to creditors. The exclusion of valid contingent claims would undermine this goal, potentially leaving creditors without recourse. As such, it is imperative that the legal framework surrounding contingent claims be clarified and refined to provide fair treatment to creditors with contingent liabilities, thus strengthening the overall integrity of the insolvency process.

Supreme Court clarifies the boundaries of “Inherent Powers” of NCLAT

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CIRP Withdrawal in GLAS Trust Company LLC v BYJU Raveendran & Ors

– Barsha Dikshit, Partner | resolution@vinodkothari.com

It is a well-established principle that the exercise of inherent powers is permissible only in the absence of an express provision within the statutory framework. Also, that the Insolvency and Bankruptcy Code, 2016 (IBC) is not to be used as a mechanism for mere debt recovery.

In a recent ruling in GLAS Trust Company LLC vs. BYJU Raveendran & Ors[1]., the Hon’ble Supreme Court set aside the order of the National Company Law Appellate Tribunal (NCLAT) [2]that permitted withdrawal of CIRP post admission by NCLT, by exercising inherent powers under Rule 11 of the NCLAT Rules, 2016, despite existing statutory procedures for CIRP withdrawal. The matter arose from a dispute concerning the validity of a settlement, wherein a financial creditor objected to the source of settlement funds, asserting that it constituted preferential payment or amounted to round-tripping, thereby warranting judicial scrutiny under the insolvency framework.

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

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Importance of Filing Timely Claims in IBC: A Guide for Government Departments

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– Neha Malu, Deputy Associate | resolution@vinodkothari.com 

Introduction

In the landscape of corporate insolvency, the timely submission of claims by creditors is of paramount importance. The Insolvency and Bankruptcy Code, 2016 (“IBC”) provides a structured process for dealing with corporate debtors in distress. This article highlights the necessity of adhering to prescribed timelines for claim submission and underscores the repercussions of delays, drawing on pertinent judicial rulings. Additionally, it offers a comprehensive overview for government departments on the process of filing claims under the IBC.

Now, in case of IBC, there are two stages- 

  1. Corporate insolvency resolution process (CIRP) stage, and
  2. Liquidation stage. 

Upon initiation of CIRP, an interim resolution professional is appointed who makes a public announcement in Form A within 3 days of his appointment. The respective creditors of the concerned corporate debtor are required to file their claims within the timeline specified herein below. However, it is to be noted that if the CIRP of the concerned corporate debtor fails, the creditors are also required to submit their claims once again in the liquidation process. 

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Interest Imbalance: Will the disproportionate interest Split in Loan Transfers be liable to withholding tax?

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ITAT Ruling Clarifies Taxation on Disproportionate Interest share in Loan Transfers

– Dayita Kanodia | Finserv@vinodkothari.com

Direct Assignment of a loan or transfer of loan exposures refers to the process where financial institutions, such as banks, purchase a pool of loans or assets from other entities, typically NBFCs, without the involvement of a third-party intermediary. In this arrangement, the buying institution directly acquires the ownership of the loans or assets and the associated rights, including the right to receive future payments from the borrowers. This method allows the selling NBFC to offload its loans, thereby freeing up capital, while the purchasing institution gains the opportunity to enhance its loan portfolio and earn interest income from the acquired loans. This Direct Assignment is essentially what is popularly known as the transfer of loan exposure.

The RBI issued the transfer of loan exposures directions in 2021 regulating all transactions among regulated entities involving transfer of loan exposures.

Interest sharing and servicing after the transfer

Pursuant to a transfer of loan, it is not necessary that the future interest income arising from the loans would be shared in the same proportion as that of the transfer. For instance, if an NBFC assigns 90% of the loan portfolio to a bank, there is no mandate that all interest income received in the future would be shared in the same proportion of 90:10. Generally, the borrower is not made aware of the transfer and therefore it is important that the NBFC continues to service the loan. In such cases it is only fair that the NBFC gets a higher proportion of interest. Accordingly, it is quite common in direct assignment transactions to have a disproportionate interest share. 

The question which now arises is whether this excess interest income retained by the NBFC would be taxable under the provisions of the income tax act. 

ITAT Ruling and taxation on disproportionate interest share in loan transfers

A recent ITAT ruling of May 7, 2024 clarifies the taxation treatment for disproportionate interest share in case of loan transfers. In this case, NBFC assigned 90% of the loan portfolio to a bank via the direct assignment route. However, the bank was not receiving the entire interest on the 90% loan assigned but was only entitled to a fixed percentage of share while the NBFC retained the excess interest. Accordingly, the revenue department was of the view that the assessee was responsible to deduct TDS on the excess interest allowed to be retained by the NBFC under section 194A of the Income Tax Act. 

The revenue department further raised the question on deduction of TDS under SEction 194J and 194H of the Income Tax Act. 

Interest Retained not a result of money borrowed or debt incurred by the transferee

For the deciding the fate of the NBFC under section 194A of the Income Tax Act, the following was observed by the ITAT:

  1. For TDS to be deducted under section 194A of the Income Tax Act, the crucial aspect to be satisfied was whether the part interest allowed to be retained by the originating NBFC by the bank is payment in the nature of interest to the NBFC for any money borrowed or debt incurred by the bank.
  1. It was acknowledged that the 90% of the loan portfolio was assigned to the bank and consequently any default among the assigned loans would result in loss to the bank. 
  1. Any amount collected from the borrowers was initially getting deposited in an escrow account and was subsequently distributed between the NBFC and the bank in accordance with the agreement entered into by the entities. 
  1. It could not be shown that the interest allowed to be retained with the NBFC was a result of any money borrowed or debt incurred by the bank from the NBFC. 
  2. Accordingly, the assessee was under no obligation to deduct TDS on the excess interest retained by the NBFC under section 194A. 

Interest retained not in the nature of fees for any professional / technical services rendered by the transferor

The next issue which was adjudicated in the case was whether the interest allowed to be retained with the NBFC was a consideration for rendering professional / technical services by the transferor NBFC to the transferee bank. 

As per section 194J of the Act, any person, not being an individual or HUF, who is responsible for paying to a resident any sum, inter alia, by way of fees for professional services or fees for technical services shall at the time of credit of such sum to the account of payee deduct tax at source.

For this purpose the ITAT observed the following:

  1. The NBFC and the Bank entered into a tripartite service agreement pursuant to which the originating NBFC was appointed as servicer for the loans. The NBFC was therefore responsible for managing, collecting and receiving payment of the receivable and depositing the same in the ‘Collection and Payout Account’ to enable the distribution of the payout therefrom and providing certain other services.
  1. As per the service agreement, a one time service fee of Rs.1 Lakh was agreed to be payable by the bank to the NBFC as consideration for the services rendered.
  1. The ITAT brushed aside the contention of the revenue department that service fee of Rs 1L was inadequate and the excess interest allowed to be retained by the NBFC should in fact be considered as fee for rendering the services by the transferor NBFC. 
  1. There was a separate tripartite Deed of Assignment of receivables entered into by the parties according to which the bank paid the entire principal amount equivalent to 90% of the entire pool to the NBFC upfront. However, it was observed that the transfer being an independent commercial transaction cannot be on a cost to cost basis without there being any markup.
  1. Accordingly, the bank opted to pay the consideration for the loans assigned partially by way of an upfront payment equivalent to the principal amount of the loan assigned to it and partly by agreeing to earn a lower rate of interest on its portion of assigned loans and allowing the NBFC to retain the part interest received from the borrower.
  1. Therefore the liability under section 194J of the Income Tax Act was only for the service fee of Rs.1 L and cannot be extended to the excess interest share retained by the NBFC.
  1. Accordingly, the assessee was under no obligation to deduct TDS on the excess interest share retained by the NBFC under section 194J of the Income Tax Act. 

Interest retained not in the nature of commission / brokerage

The last issue in this case to be decided before the ITAT was whether the retained interest would fall in the category of commission or brokerage and was liable to TDS under section 194H of the Income Tax Act. 

As per section 194H of the Act, any person, not being an individual or HUF, who is responsible for paying to a resident, any income by way of commission or brokerage, shall at the time of credit of such income to the account of the payee deduct tax.

For determining the tax treatment under this section, the ITAT observed the following:

  1. It could not be said that the loans originated by the NBFC were on behalf of the bank.
  1. For the services rendered by the NBFC, it was observed that the same was pursuant to a separate service agreement which provides for payment of separate service fees in lieu of such services.
  1. Accordingly, it cannot be contended that the transferor NBFC was acting as an agent of the transferee bank.
  1. Accordingly, the liability to deduct TDS on the excess interest retained by the NBFC under section 194H of the Income Tax Act does not arise. 

Concluding Remarks 

In conclusion, the recent ITAT ruling has provided significant clarity on the taxation treatment of disproportionate interest shares in loan transfers, particularly in the context of Direct Assignment transactions. 

In this case, the ITAT emphasized that the interest retained by the NBFC was not a result of any money borrowed or debt incurred by the bank. Additionally, it was clarified that the interest retained did not constitute fees for professional or technical services rendered by the transferor NBFC, nor did it fall within the ambit of commission or brokerage.

As the financial landscape continues to evolve, such judicial pronouncements play a crucial role in fostering transparency, compliance, and fairness in taxation.

Relinquishment of source of profit in favour of an RP: also an RPT

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Mahak Agarwal | corplaw@vinodkothari.com

The broad spectrum of the definition of Related Party Transactions (RPTs) under the Listing Regulation, continues to be an error prone area in terms of compliance. A recent SEBI ruling has further strengthens this aspect where the phrase ‘transfer of resources, services or obligations’ has been explained in an extremely new dimension with a commendable insight from the authorities which again shows that the regulators can no more be restricted by the imaginary boundaries placed by the corporates when it comes tightening the loose ends of corporate governance.

This article delves into the basis which the Regulators considered for concluding a mutual understanding and agreement between related parties to be an RPT notwithstanding the  contention of the company. The essential question of law involved in this case was whether the allocation of certain products and geographic areas between RPs constitutes an RPT. The article contains our analysis of SEBI’s order in the matter affirming the said stand.

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Summary of Important Supreme Court Judgements on IBC

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Team Resolution | resolution@vinodkothari.com

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Group Insolvency: Relevance of Substantive Consolidation in Indian Context

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– Vinod Kothari and Sikha Bansal[1] | resolution@vinodkothari.com

Introduction

Insolvency law has always to be aligned to economic realities; when it comes to solving the problem of corporate insolvencies, an economy cannot disregard the prevalent corporate structures. The design which corporates adopt to conduct business must, in fact, be one of the most critical factors while designing the insolvency laws.  Thus, if group assets, contracts, technological assets, investments or intellectual or other business rights remain scattered across a complicated group of intertwined entities, an insolvency law framework that remains constrained by the bounds of “legal entity” is unlikely to achieve the objective of ensuring preservation and, in case of liquidation, equitable distribution of corporate value for the benefit of stakeholders.

Propagation of group structures in India

Therefore, the key question to start is: do Indian businesses have complex group structures, involving layers of entities, whether legally structured as subsidiaries or not? An OECD report, prepared  with significant inputs from SEBI[2], citing data collected from 4100 listed companies as of December 2020, says that there are on an average 50 subsidiaries for listed companies forming part of NIFTY-50, a number which has tripled over the last 15 years. It goes further to say that there are 15 listed companies which have more than 100 subsidiaries, whereas there are some which have over 200. Further, out of the 100 largest listed companies by market capitalization, approximately 40 India listed companies had three or more layers of subsidiaries/step-down subsidiaries, surpassed only by Singapore and Malaysia among OECD countries.

If the numbers stated in the above survey are surprising, it must be submitted that these numbers do not incorporate (a) number of layers on the top of the listed entity, that is, the chain of holding companies or companies; (b) associates, as quite often, the shareholding may be split across several group entities with none of them having sufficient holding to be termed as holding company; (c) the chain of companies above or below a listed company where the chain is snapped by use of a chain-breaker, that is, an entity which itself is not a subsidiary of the listed entity, but owns or is owned by a vertical chain of entities. The plausible economic reasons for existence of group structures are: efficiencies in operations, reduced dependence on external finances, and economies of scale. And as such, one would often see overlaps in asset use (e.g. asset of one entity being shared across group entities, or used as security against borrowings of entities), liabilities (group entities being joint obligors, third party security providers), common stakeholders (shareholders, directors, lenders, etc.) across group entities. However, such complex group structures have the potential to house complex web of transactions, thereby increasing the opacity of such structures and chances of wrongdoings, misconduct and lawlessness. Holding entities are most commonly employed to raise finance for group holdings, using pledge of operating companies’ shares, and use such borrowings to finance the operating companies. It is also commonplace practice to have a group’s brand or intellectual property owned by a promoter group entity. As there were many cases where group transactions were involved and/or put to question by the courts during insolvency proceedings[3].

The complete article has been published in the “Annual Publication 2023: IBC – Evolution, Learnings and Innovation” and can be accessed on the link here, from Page 281 onwards.

[1] With research support and assistance, gratefully acknowledged, by Neha Malu

[2] https://www.oecd.org/corporate/ca/Company-Groups-in-India-2022.pdf

[3] Yadubir Singh Sajwan & Ors. Vs. M/s. Som Resorts Private Limited [Company Petition No. (IB)-67(ND)/2022], ArcelorMittal India Pvt. Ltd. v. Satish Kumar Gupta [Civil Appeal nos.9402-9405 OF 2018] etc.