SUPREME COURT HOLDS COLLUSIVE AND SHAM TRANSACTIONS WITH CORPORATE DEBTOR NOT CONSIDERED AS FINANCIAL DEBT

The Three Judge Bench of the #SupremeCourt has in a recent case of Phoenix Arc Private Limited vs Spade Financial Services Limited & Ors. passed a Judgment dated 01-02-2021 and held that firstly, as the Respondents are not #financialcreditors and secondly, as the Respondents are related parties of the #CorporateDebtor, they must be excluded from the #CommitteeofCreditors.

In this case, one of the Respondents, Spade Financial Services Limited, filed its Claim in the capacity of financial creditor before the Interim Resolution Professional (IRP) with respect to the Corporate Insolvency Resolution Process (CIRP) initiated against the Corporate Debtor, AKME Projects Limited (Corporate Debtor). Whereas, the other Respondent, AAA Landmark Private Limited filed its Claim as a creditor, other than a financial creditor or operational creditor before the IRP with respect to the CIRP initiated against the Corporate Debtor. But when the IRP rejected both the claims, the Respondents approached the National Company Law Tribunal (NCLT), New Delhi Bench. The NCLT allowed both the Respondents to submit their claims as financial creditors with a direction to the IRP to consider their claims.

Meanwhile, a Committee of Creditors (CoC) was constituted on 22-05-2018. The Appellant, Phoenix Arc Private Limited, being a Financial Creditor and a member of the CoC, filed an Application in the NCLT seeking exclusion of the Respondents from the CoC on the ground that they are related parties of the Corporate Debtor. The NCLT passed an Order dated 19-07-2019, whereby, it was held that the Respondents are not financial creditors. Further, the Respondents are held to be related parties of the Corporate Debtor, as the Respondents were involved in making financial arrangements and debt settlements for the Corporate Debtor. Also, the Corporate Debtor used to act in accordance with the instructions and directions of Mr. Arun Anand, the Director of the Respondents-Companies. Hence, the Respondents should be excluded from the CoC.

Aggrieved by the NCLT Order dated 19-07-2019, the Respondents herein filed an Appeal before the National Company Law Appellate Tribunal (NCLAT). The NCLAT passed a Judgment dated 27-01-2020 and held that although the Respondents are financial creditors of the Corporate Debtor, but as they are the related parties of the Corporate Debtor, they should be excluded from the CoC.

Thereafter, the Appellant filed an Appeal before the Supreme Court and challenged the NCLAT Judgment dated 27-01-2020 to the extent that it says that the Respondents are the financial creditors of the Corporate Debtor.

The Apex Court made the following observations in this case:

1) That as per Section 5 (7) of the Insolvency and Bankruptcy Code 2016 (the Code) “financial creditor” means any person to whom a financial debt is owed and includes a person to whom such debt has been legally assigned or transferred to. Further, Section 5 (8) of the Code stipulates that the essential ingredient of a “financial debt” is disbursal against consideration for the time value of money.

2) That in genuine cases, money advanced as a debt should be in receipt of the borrower. The borrower has the obligation to return the money or its equivalent for a time value of money. However, in case of a transaction which is sham or collusive, the parties would have entered into the transaction with a different or an ulterior motive. At times, companies enter into such transactions to defraud genuine creditors.

3) The Code provides that such avoidable transactions should be identified, and unearthed in order to prevent any person from taking undue benefit of its provisions to the detriment of the rights of legitimate creditors.

4) In this case, the Supreme Court held that the Respondents had not charged any interest towards the alleged debt advanced to the Corporate Debtor. Further, there is no mention about period of repayment of debt in any document, hence, there is absence of consideration for time value of money, which is the essential ingredient of a financial debt.

5) That as the said transaction is an eye-wash and collusive, therefore, the commercial arrangement between the Respondents and the Corporate Debtor would not constitute a financial debt. Hence, they cannot be deemed to be financial creditors of the Corporate Debtor.

6) That further, in this case, Mr Arun Anand, the Director of the Respondents-Companies has also held multiple positions in the Corporate Debtor. The Board of Directors of the Corporate Debtor are accustomed to acting upon the instructions of Mr. Arun Anand. Further, the Respondents-Companies and the Corporate Debtor have been involved in various commercial arrangements with each other and the families of the owners of the said Companies have also been constantly associated with each other. Hence, the Respondents are held to be related parties of the Corporate Debtor.

7) That as per the first Proviso to Section 21 (2) of the Code, a financial creditor who is a related party of the corporate debtor shall not have the right of representation, participation or voting in the CoC. The said provision is reproduced below:

21. Committee of creditors

(2) The committee of creditors shall comprise all financial creditors of the corporate debtor:

Provided that a financial creditor or the authorised representative of the financial creditor referred to in sub-section (6) or sub-section (6A) or sub-section (5) of section 24, if it is a related party of the corporate debtor, shall not have any right of representation, participation or voting in a meeting of the committee of creditors

8) Hence, the Respondents, being related parties of the Corporate Debtor, have to be excluded from the CoC, as otherwise, if the Respondents are allowed to be a part of the CoC, they would be influenced by the Board of the Corporate Debtor, which would ultimately affect the other independent financial creditors.

Thus, the Apex Court held that due to the collusive nature of the transactions, the Respondents cannot be held as financial creditors and further, as the Respondents are related parties of the Corporate Debtor, they must be excluded from CoC. Thus, the Supreme Court upheld the NCLAT Judgment to the extent that it excluded the Respondents from the CoC, in accordance with first Proviso to Section 21 (2) of the Code.

Harini Daliparthy
Senior Legal Associate
The Indian Lawyer

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