Listen to this articlePHOENIX ARC PRIVATE LIMITED
Versus
SPADE FINANCIAL SERVICES LIMITED
Civil Appeal No. 2842 of 2020 decided on February
3rd , 2021.
JUDGES: INDIRA BANERJEE, D.Y. CHANDRACHUD & INDU MALHOTRA JJ.
FACTS:
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:
- Whether
Spade and AAA are financial creditors of the Corporate Debtor;
- Whether
Spade and AAA are related parties of the Corporate Debtor;
- Whether
Spade and AAA have to be excluded from the CoC.
ISSUE
Whether Spade and AAA are financial creditors of the Corporate
Debtor?
HELD
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.
ISSUE
Whether
Spade and AAA are related parties of the Corporate Debtor?
HELD
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.
ISSUE
Whether Spade and AAA have to be excluded from the CoC?
HELD
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).