Final Year Business Law student at
NMIMS Kirit P. Mehta School of Law, Mumbai
Payment received for shares, duly issued to a third party at the request of the payee, cannot be a debt, not to speak of financial debt; A Personal Loan to a Promoter or a Director of a Company cannot Trigger CIRP- the Supreme Court
Case- M/S Radha Exports (India) Private Limited vs K.P Jayaram & Anr., 2020- SC
FACTS OF THE CASE
In the present case, the appellant company M/S Radha Exports (India) Pvt. Ltd. (hereinafter referred to as “the Corporate Debtor”) filed an appeal under Section 62 of I&B Code against an order passed by NCLAT In favour of the respondents Mr. M Krishnan (hereinafter referred to as “Respondent No. 1”) and Mrs. Radha Gauri (hereinafter referred to as “Respondent No. 2”) before Adjudicating Authority based on following grounds.
The Appellant Company (Corporate Debtor) was incorporated as a private company in the name of M/S Radha Exports (India) Pvt. Ltd. to take over business of Proprietorship Concern (M/S Radha Exports) which had taken loans from the Respondents.
The Respondents were the promoters of the Appellant Company. The Respondent No.2 Mrs. Radha Gauri, owned a proprietorship concern M/s Radha Exports which had taken loans from the Respondents. The Appellant Company, on incorporation took over M/s Radha Exports with all assets and liabilities.
On the incorporation of the Appellant Company, the Respondent No. 2, Mrs. Radha Gauri became a board member of the appellant company and requested the company to convert a substantial amount of outstanding loan as share application money for issuance of shares in the company. This is confirmed by the Respondents in the Income Tax proceedings.
The Appellant Company, on request of the Respondent, adjusted the said loan amount to issue shares in the name of the Respondent Mrs. Radha Gauri.
Later the Respondent, Mrs. Radha Gauri resigned from the board of the Appellant Company and requested the company to treat her share application money as the share application money of Respondent No.2, Mr. M Krishnan and to issue shares in his name. The transferred amount was treated as personal loan from Radha Gauri to M. Krishnan in this case.
However, much later, the Respondents called upon the Appellant Company by sending a legal notice to repay the alleged outstanding loans to the Respondents.
The Appellant Company denied the said claims by the Respondents. Therefore, the Respondents filed a petition under Section 9 of IBC to initiate the Corporate Insolvency Resolution Process in the NCLT claiming to be an operational creditor of the Appellant Company and re-filed later under Section 7 of IBC as a financial creditor of the Appellant Company.
In winding up application filed by the Respondents, the NCLT refused to admit the application under Section 7 on the grounds that the Respondents failed to provide proofs of any debt due from the Appellant Company and the claims were barred by limitation under Article 136 of the Limitation Act. Whereas, the Appellant Company had presented written letters by the Respondent admitting the payment to the Income Tax Authorities.
“The NCLT held that the Respondents had failed to prove that there was any debt due from the Appellant Company, to the Respondents, observing that the Appellant Company had produced proof of payments.”
A Company Appeal was filed by the Respondents in NCLAT, which in turn, set aside the order of NCLT and allowed the appeal of the Respondents.
Therefore, the aggrieved Appellant Company filed an appeal under Section 62 of the Insolvency and Bankruptcy Code, 2016 to the Supreme Court against the order of NCLAT.
ISSUES BEFORE THE SUPREME COURT
Issues before the Supreme Court are –
I. Whether the winding up application filed the Respondents based on disputed debt barred by the Limitation Act?
II. Can personal loan to Promoter or a Director of a company trigger the Corporate Resolution Process under the IBC?
III. Can payment received for shares, duly issued be a debt under IBC?
DISCUSSION AND FINDINGS
ON ISSUE 1
With regards to the first Issue, the Applicant, should place any material disclosing how the debt is still alive after lapse of three years from the date of disbursement. Whenever any claim is made, when it is beyond three years period as envisaged under Article 136 of the Limitation Act, the person making claim is bound to disclose and explain as to how the debt claim is not barred by limitation. No such effort has been made by these Applicants i.e. the respondents to prove that this is within limitation.
The two case laws were relied upon by the parties:
Innoventive Industries Ltd. v. ICICI Bank and Anr. The Supreme Court observed and held- “The judgment is however, not an authority for the proposition that a petition under Section 7 of the IBC has to be admitted, even if the claim is ex facie barred by limitation.”
B.K. Educational Services Pvt. Ltd. v. Parag Gupta and Associates. The Court held “The right to sue”, therefore, accrues when a default occurs. If the default has occurred over three years prior to the date of filing of the application, the application would be barred under Article 137 of the Limitation Act, save and except in those cases where, in the facts of the case, Section 5 of the Limitation Act may be applied to condone the delay in filing such application.”
The applicant invoking the Corporate Insolvency Resolution Process has to prima facie show the existence of a legally recoverable debt in his favour. In other words, the respondent had to show that the debt is not barred by limitation, which they failed to do.
The Supreme Court held-
“The NCLT rightly refused to admit the application under Section 7 of the IBC, holding the same to be barred by limitation. The Appellate Tribunal has erred in law in reversing the judgment and order of the earlier Adjudicating Authority.”
ON ISSUE 2
With regards to the second Issue, the Hon’ble Supreme Court observed that when the Respondent resigned from the Board of the Appellant Company, she had requested the Appellant Company to treat the share application money as share application money to another person and to issue shares for aforesaid value to him. The amount was to be treated as a personal loan from the Respondent to the said person. The Court held that a personal loan to a Promoter or a Director of a company cannot trigger the Corporate Resolution Process under the IBC.
“A personal Loan to a Promoter or a Director of a company cannot trigger the Corporate Resolution Process under the IBC. Disputes as to whether the signatures of the Respondents are forged or whether records have been fabricated can be adjudicated upon evidence including forensic evidence in a regular suit and not in proceedings under Section 7 of the IBC.”
“The application under Section 7 of the IBC was not maintainable. As rightly held by the NCLT there was no financial debt in existence.”
The Apex Court further referred to the definitions mentioned In Section 2 of IBC- (8) Corporate Debtor, (10) Creditor, and (12) Default.
ON ISSUE 3
With regards to the third issue, the Hon’ble Supreme Court further agreed with NCLT in that even otherwise, the application under Section 7 of the Insolvency and Bankruptcy Code was not maintainable as there was no financial debt in existence.
The Hon’ble Supreme Court observed that as per the definition of ‘financial debt’ in Section 5(8) makes it clear that ‘financial debt’ means a debt along with interest, if any, disbursed against the consideration for time value of money and would include money raised or borrowed against the payment of interest
“The payment received for shares, duly issued to a third party at the request of the payee as evident from official records, cannot be a debt, not to speak of financial debt. Shares of a company are transferable subject to restrictions, if any, in its Articles of Association and attract dividend when the company makes profits.”
The Court clearly stated that the shares Issued by a company in favour for a person cannot be treated as debt since it provides a sense of ownership in the company to the person. Therefore, such a person cannot be treated as a “financial creditor” and such a payment towards issued shares cannot be treated as a “financial debt”. Without “financial debt”, an application to initiate CIRP under Section 7 cannot be maintained.
Therefore, the Hon’ble Apex Court on 28th August 2020 allowed the appeal and set aside the order of NCLAT.