In the corporate realm, where several commercial laws are in operation, implementation of the same gets derailed, when the interpretation of that particular law (designed and promulgated to meet a particular purpose), is met with the anomalies prevalent in the sector at any given point in time.
This Article highlights and expounds one such anomaly which has been recently clarified by the Hon’ble Supreme Court in the matter of:
“Phoenix Arc Private Limited V. Spade Financial Services Limited. and Ors.”
The Insolvency and Bankruptcy code i.e., IBC, 2016 is a result of one of the most crucial structural reforms which was enacted to consolidate the existing framework by creating a single law for insolvency and bankruptcy. The prime objective of the legislation was to rescue the Financial Creditors in distress and to push forward the economy of the country by some way helping the Corporate Debtors as well in the larger scheme of things.
BACKDROP
The controversy came to the forefront when insolvency resolution process was initiated against AKME Projects Ltd (corporate debtor) and during the course of the proceedings an application under Section 60 (5)(c) IBC was filed by Phoenix Arc Pvt. Ltd. (Phoenix) where it was alleged that Spade Financial Services Pvt. Ltd. (Spade) and AAA Landmark Pvt. Ltd. (AAA) are related parties to the corporate debtor and it was pleaded that they should be excluded from the Committee of Creditors (CoC). Interestingly, Spade and AAA were not related parties when the corporate insolvency proceedings i.e CIRP commenced however they were so when the transaction in question took place, prior in time. Both spade and AAA had deeply rooted financial interests in the corporate debtor and the formal relationships at hand were severed before the onset of CIRP. In fact, in the appeal to SC, Phoenix challenged the finding by NCLAT where it was held that Spade and AAA were financial creditors to Corporate Debtor and it was pleaded that Spade and AAA could not be accorded the status of a creditor of the Corporate debtor, much less financial creditors.
THE STATUTE
As per section 21(1) of the IBC the insolvency resolution professional (IRP) is required to determine the financial standing of the corporate debtor, which in accordance with section 21(2) has to comprise of all the financial creditors i.e the person to whom financial debt is owed by the corporate debtor. However, to ensure a free and fair process such financial creditor does not have the right to participate in CoC if he is a related party of the corporate debtor.
ISSUE
The issue at hand was that whether the status of the related party will be determined “IN PRESENTI” i.e., at the time when the financial debt was incurred or whether it applies to all the financial creditors who at some point in time were a related party to the corporate debtor. In other words if financial creditors who were though not into any financial marriage with the Corporate Debtor at the time when CIRP was initiated but had a relationship at a prior period in time when debt was created, would be excluded from CoC by attracting the proviso to Section 21 (2) IBC or not?
RATIO
The Hon’ble Supreme Court found that AAA and Spade fell within the definition of related parties as per section 5(24) of IBC when the said debt was formed and affirmed the NCLAT order.
The apex court adopted the rule of purposive interpretation and held that the financial creditor who is not a related party at present will not be debarred from being a member of CoC however if the financial creditor ceases to become a related party only for fraudulent or ulterior motive of taking part in the COC to dilute the CIRP then he will be debarred from taking part in the same and the proviso to sec 21(2) will directly apply. Therefore, the intent behind the removal of the Related Party tag has to be clarified and examined. It was held by the court that the proviso is not related to the debt itself but to the relationship existing between the related party financial creditor and corporate debtor. Relevant extracts of the judgment are reproduced below:
“As such, the financial creditor who in preesenti 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”.
However, the proviso of Section 21 (2) shall not be attracted if a financial creditor is in presenti not a related party and it could not be debarred from being a member of CoC.
In the present case Supreme Court came to the conclusion after meticulously examining the close relationship which existed between the managerial personnel of the Corporate Debtor, Mr. Anil Nanda and the director of Spade and AAA, Mr. Arun Anand. The close nexus that both the person shared was also recorded and elaborated upon in the judgment, based on which the court reached to the conclusion that the order of NCLAT ousting Spade and AAA from participating in CIRP was correct.
AFTERMATH
Interpretation of laws and its right application in its true spirit is the bedrock of any judicial mechanism and a legal system. There is a need to check the crevices of its precedents in the light of the laws at hand and the facts of every case. Though prima facie this may seem as a miniscule idea, but it is the wisdom behind every legislation which is to be borne in mind while dispensing justice and executing orders, and if it is ignored then, the purpose behind existence of such a mechanism is itself thwarted. Hence, the Supreme Court rightly held that allowing the appeal by Spade and AAA would effectively mean to “allow the statutory provision to be defeated by a related party of a corporate debtor creating commercial contrivances which have the effect of denuding its status as a related party, by the time that the CIRP is initiated.”
The decision in the aforesaid matter will turn out to be a game changer to the extent that it clarified the right of participation of a related party in CIRP. The rationale behind passing the judgment was that if such related parties are allowed to participate in CIRP then it shall sabotage the purpose of having an independent CoC for the benefit of the corporate debtor and to ensure that the process is fair.