SC uses ‘smoke-test’
Classifies persons as ‘related parties’ on the basis of ‘intermingled transactions’
-Sikha Bansal & Megha Mittal
While in general, in order to classify a transaction as a related party transaction, one needs to first determine whether the parties involved are ‘related parties’; however, in a recent case Phoenix Arc Private Limited v. Spade Financial Services Limited & Ors.[1] (‘Ruling’), the Hon’ble Supreme Court (‘SC’) has deduced ‘relationship’ between the parties on the basis of the underlying transactions.
The SC has read the definitions of ‘financial creditor’ and ‘related party’ (in relation to the corporate debtor) under sections 5(7) and section 5(24), respectively, of Insolvency and Bankruptcy Code, 2016 (‘Code’), in light of the ‘collusive arrangements’, ‘and ‘extensive history demonstrating interrelationship’ among the parties. Broadly put, it was held that the board/directors of these companies were ‘acting’ under the pervasive influence of common set of individuals, having ‘deeply entangled’ interrelationships. Besides, the SC refused to entertain the entities as financial creditors, as the debt was merely an eye-wash, arising out of sham and collusive transactions.
Therefore, the Ruling, in a way, uses ‘smoke’ to trace if there is a ‘fire’. The presence of collusion, entangled interrelationships, etc. have been seen as indicators suggesting that the parties were in fact ‘related’ and are thus ineligible to occupy seats in the committee of creditors.
This article touches upon the significant aspects of the Ruling, including how this ‘smoke-test’ used by the SC can act as a precedent in interpreting the provisions of the Code, specifically those relating to related parties.