‘Related Parties’ under IBC cannot participate in CIRP process and be part of Committee of Creditors.

Listen to this article




Civil Appeal No. 2842 of 2020 decided on February 3rd , 2021.



The present appeal was filed before the Supreme Court by the petitioner challenging the  order of National Company Law Appellate Tribunal (hereinafter referred as “NCLAT”) which dismissed the appeal under Section 61 of the Insolvency and Bankruptcy Code, 2016(hereinafter referred as “IBC”) preferred by AAA Landmark Private Limited and Spade Financial Services Private Limited(hereinafter referred as “the Company”) challenging an order of the National Company Law Tribunal (hereinafter referred as “NCLT”). The NCLT had held that the Company have to be excluded from the Committee of Creditors(hereinafter referred as “CoC”) formed in relation to the Corporate Insolvency Resolution Process initiated against AKME Projects Limited (hereinafter referred as “Corporate Debtor”) because they were related parties.

Claim of Spade:

During the CIRP process, claims were invited by the Interim Resolution Professional (IRP) and Spade filed its claim as Financial Creditor. The basis for claim filed by Spade was an alleged MOU executed with the Corporate Debtor which stated an amount of Inter Corporate Deposits (ICDs) granted to the Corporate Debtor by Spade bearing interest of 24% repayable in terms of mutual agreement between the parties.

Spade submitted before the Court that it has granted ICDs of Rs. 66,00,00,000 (approx.) to the Corporate Debtor between June 2009 and January 2013. Out of this amount, Spade claimed a principal amount of Rs. 23,00,00,000. The balance amount of Rs. 43,06,00,000 was credited in the account of AAA, which is a wholly owned subsidiary of Spade. The total claim of Spade increased to Rs. 109,11,00,000 in 7 years on account of interest at the rate of 24%.

Claim of AAA:

AAA filed its claim before the IRP as a creditor for its sum. Thereafter, it filed a revised claim as a financial creditor for a revised amount on 23.05.2018. AAA said that it had entered into a Development Agreement with the Corporate Debtor on 01.03.2012 for a sale consideration to purchase development rights in a project. On 25.10.2012, that Development Agreement was terminated and an Agreement to Sell along with a Side Letter was executed between AAA and the Corporate Debtor for purchase of flats. The sale consideration amount was further enhanced in the Development Agreement. AAA further paid a certain sum as advance payment under the Agreement to Sell, which was adjusted out of the ICDs payable to Spade as noted above. The claim of AAA is with respect to the principal amount of Rs. 43,06,00,000, which along with interest at the rate of 18% increased to Rs. 109,72,00,000 in 5 years.

Constitution of COC:

The CoC was constituted on 22.05.2018. The IRP rejected the claim of Spade on the ground that the claim was not in the nature of a financial debt in terms of section 5(8) of IBC as there was an absence of consideration for the value of money, i.e., there was  no stipulated time period for repayment of the claimed ICDs.

Further, the claim of AAA was also rejected on the ground that its revised claim as a financial creditor was filed after the expiry of the period for filing such a claim.

Proceedings before NCLT:

Aggrieved by the rejection, AAA and Spade filed an application to be included in CoC and the same was allowed by the NCLT. The other financial creditors- Phoenix and YES Bank were not made party to this proceeding.

Accordingly, NCLT allowed Spade and AAA to submit their claims as financial creditors and directed the IRP to consider their claims.

Later, after a CoC meeting that was also attended by newly approved financial creditors AAA and Spade; Phoenix and YES Bank filed applications for exclusion from the CoC before the NCLT on the grounds that they are related parties.

Accordingly, NCLT held that Spade and AAA do not qualify as financial creditors. It took note of first proviso of Section 21(2) of the IBC which states that 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.

Proceedings before NCLAT:

In an appeal before the NCLAT, it observed that ‘admittedly’ Spade and AAA ‘are financial creditors of the corporate debtor’. Further, it was held that both the entities were related parties within section 5(24) of IBC on the grounds that after cancellation of Development agreement, AAA and Corporate Debtor entered into an Agreement to Sale and Side Letter which was merely a camouflage under which they were partners in developing a residential project to be sold to a third party.

A holding company of the Corporate Debtor, Joint Investment Private Limited (“JIPL”) holds shareholding in Spade.

Hence, NCLAT came to the conclusion that the Adjudicating Authority had rightly excluded both Spade and AAA from participation in the CoC.

JIPL appealed to the Supreme Court against the said order of NCLAT challenging the limited aspect which are:

  1. Whether Spade and AAA are financial creditors of the Corporate Debtor;
  2. Whether Spade and AAA are related parties of the Corporate Debtor;
  3. Whether Spade and AAA have to be excluded from the CoC.


Whether Spade and AAA are financial creditors of the Corporate Debtor?


The Supreme Court held that in view of the collusive nature of the transactions which the Company alleged as financial debt under section 5(8) IBC, Spade and AAA cannot be labelled as Financial Creditors under section 5(7) IBC.

The Supreme Court said that the money advanced as debt should be in the receipt of the borrower. The borrower is obligated to return the money or its equivalent along with the consideration for a time value of money, which is the compensation or price payable for the period of time for which the money is lent. A transaction which is sham or collusive would only create an illusion that money has been disbursed to a borrower with the object of receiving consideration in the form of time value of money, when in fact the parties have entered into the transaction with a different or an ulterior motive. In other words, the real agreement between the parties is something other than advancing a financial debt.

The Code has made provisions for identifying, annulling or disregarding “avoidable transactions” which distressed companies may have undertaken to hamper recovery of creditors in the event of the initiation of CIRP. It recognises that for the success of an insolvency regime, the real nature of the transactions has to be unearthed in order to prevent any person from taking undue benefit of its provisions to the detriment of the rights of legitimate creditors.

Since the commercial arrangements between Spade and AAA, and the corporate debtor were collusive in nature, they would not constitute a ‘financial debt’. Hence, the Supreme Court held that Spade and AAA are not financial creditors of the Corporate Debt.


Whether Spade and AAA are related parties of the Corporate Debtor?


The Supreme Court affirmed the decision of NCLAT that the Spade and AAA are related parties of the Corporate Debtor. The Court held that the definition describes ‘related parties’ as a commutative relationship and is significantly broad. The intention of the legislature in adopting such a broad definition was to capture all kinds of interrelationships between the financial creditor and the corporate debtor. The definition under the IBC is exhaustive.

The definition ensures that those entities which are related to the corporate debtor can be identified clearly, since their presence can often negatively affect the insolvency process. The purpose of excluding a related party of a corporate debtor from the CoC is to obviate conflicts of interest which are likely to arise in the event that a related party is allowed to become a part of the CoC.

The exclusion under the first proviso to section 21(2) is related not to the debt itself but to the relationship existing between a related party Financial Creditor and the corporate debtor. As such, the Financial Creditor who in praesenti 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, 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.

While the default rule under the first proviso to section 21(2) is that only those Financial Creditor that are related parties in praesenti would be debarred from the CoC, those related party Financial Creditor that cease to be related parties in order to circumvent the exclusion under the first proviso to section 21(2), should also be considered as being covered by the exclusion thereunder. Otherwise, a related party Financial Creditor can devise a mechanism to remove its label of a ‘related party’ before the corporate debtor undergoes CIRP, so as to be able to enter the CoC and influence its decision making at the cost of other Financial Creditor.


Whether Spade and AAA have to be excluded from the CoC?


The Supreme Court affirmed the decision of NCLAT excluding the inclusion of Spade and AAA from the CoC in accordance with the first proviso of Section 21(2). The Court held that the aim of the CoC is to enable coordination between various creditors so as to ensure that the interests of all stakeholders are balanced, and the value of the assets of the entity in financial distress is maximised. The Court further said that the objects and purposes of the Code are best served when the CIRP is driven by external creditors, so as ensure that the CoC is not sabotaged by related parties of the corporate debtor. This is the intent behind the first proviso to section 21(2).


Leave a Reply