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IBC Prevails: Violation of S. 295 of Companies Act, 1956 No Bar to Section 7 Application

[NCLAT New Delhi] Violation of S. 295 of the Companies Act, 1956, in itself, is not sufficient ground to reject an S. 7 IBC application when the debt and default are proved.


Introduction:

In the matter of Kalpesh Ramniklal Shah v. Mundara Estate Developers Ltd and Anr.[i], the National Company Law Appellate Tribunal at New Delhi (‘NCLAT’) observed that allegations of violating s. 295 of the Companies Act, 1956, do not prevent the filing of an application under s. 7 of the Insolvency and Bankruptcy Code, 2016 (‘IBC’) as the IBC serves a distinct purpose and objective.


Brief Facts:

  • The Financial Creditor (‘FC’) had filed a s. 7 IBC application against the Corporate Debtor (‘CD’) for default of Rs. 89,76,41,443/-. Since the Adjudicating Authority had admitted the said application, the CD has filed the present appeal before NCLAT.

  • The CD had entered into two agreements dated 27.01.2011 and 28.12.2012 with the FC. The agreement dated 27.01.2011 was entered between the CD and one Metroglobal Ltd. involving a principal amount of Rs. 24 crores, wherein shares of the CD and another were pledged as security to the FC. This agreement further included provisions of Post-Dated Cheques (‘PDCs’) and a charge of penal interest in case of failure to repay the said principal amount.

  • Further, the agreement dated 28.12.2012 was executed between the CD and the FC for a payment of Rs. 46 crores which involved the assignment of two properties i.e., one in Vadodara and the other in Gujarat.

  • It was submitted by the CD that the Key Managerial Personnel (‘KMP’) of the FC held a majority shareholding in the CD and that it is a ‘related party’ and hence the alleged loan transaction was in contravention of s. 295 of the Companies Act, 1956. On the other hand, the FC claimed that no transaction occurred between the CD and the related party.

  • The CD had further admitted its debt liability towards the FC in the balance sheets signed by the CD from Financial Year (‘F.Y.’)2010-2011 to F.Y. 2019-2020. These balance sheets further demonstrated that the CD was not a going concern and was only incurring liabilities.

Held:

  • The NCLAT observed that, according to the balance sheets on record, the CD had not generated any revenues from operations or sales and had acknowledged the recorded debt towards the FC. Hence, the NCLAT held that the Adjudicating Authority had not erred in admitting the application under s. 7 of the IBC.

  • The Tribunal further observed that even if the settlement agreement dated 28.12.2012 was accepted for the sake of argument, still the CD never paid or cleared the dues outstanding towards the FC, which in turn proved the existence of a debt and the default.

  • The NCLAT firmly rejected the CD’s submission that a KMP was a related party exercising control over the CD and held that even if there is an allegation of violation of s. 295 of the Companies Act, 1956, it does not interfere with the filing of the s. 7 application and to proceed under the IBC. It further observed that the purpose of IBC is different and that the violation of s. 295 of the Companies Act, 1956 has different consequences.

Analysis:

  • S. 295 of the Companies Act, 1956 (corresponding to s. 185 of the Companies Act, 2013) prohibits a company from giving loans to its directors or their relatives but it cannot be ground in itself to reject a s. 7 IBC application, where the existence of debt and default are proved.

  • Violation of s. 295 of the Companies Act, 1956, can be addressed independently under the Companies Act, 1956; and did not help the CD in this case to deny the loan transaction and the disbursement of the amount to the FC.

  • The Supreme Court judgment in Innoventive Industries Ltd. v. ICICI Bank[ii] was cited in this case by NCLAT to emphasize that when a CD commits a default on a financial debt, the role of the Adjudicating Authority is to satisfy itself that a default has occurred, regardless of whether the debt is disputed.

  • The judgement explains the importance of IBC and further states that the non-payment of disputed debt would also be a default so long as it is “due.” The reason to bring insolvency law under a single umbrella complements the object of speeding up the insolvency process. The timelines and the procedures must be properly adhered to so that the actual outcome of IBC is achieved.

  • The IBC is a creditor-friendly law, and its purpose is to revive financially distressed companies and to protect the interest of all stakeholders including the creditors.


End Notes:


[i] 2023 SCC OnLine NCLAT 398

[ii] (2018) 1 SCC 407


Authored by Aishwarya Pawar, Advocate at Metalegal Advocates. The views expressed are personal and do not constitute legal opinion.

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