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TMI Blog2022 (2) TMI 254X X X X Extracts X X X X X X X X Extracts X X X X ..... er dated 6 December 2018, the NCLT admitted an application, CP/708/(IB)/CB/2017 filed by the appellant, Consolidated Construction Consortium Limited, "Appellant"/"Operational Creditor", under Section 9 of the IBC for the initiation of the Corporate Insolvency Resolution Process, "CIRP" against the respondent, Hitro Energy Solutions Private Limited, "Respondent"/"Corporate Debtor". While admitting the application, the NCLT held that the respondent's Memorandum of Association, "MOA", without evidence to the contrary, proved that it took over a proprietary concern, Hitro Energy Solutions, "Proprietary Concern", and that the Proprietary Concern did owe the appellant an outstanding operational debt. Further, the NCLT declared a moratorium under Section 14 of the IBC and appointed an Interim Resolution Professional, "IRP". 3 In appeal, Company Appeal (AT) No 19 of 2019, the NCLAT set aside the NCLT's decision, dismissed the application of the appellant under Section 9 of the IBC and released the respondent from the ongoing CIRP. In support of its conclusions, it held: (i) the appellant was a 'purchaser', and thus did not come under the definition of 'operational creditor' under the IBC ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... uested them to make the payment. 9 In the interim, the respondent was incorporated on 28 January 2014, on the basis of an MOA dated 24 January 2014. Under the MOA, one of the four main objects of the respondent was to take over the Proprietary Concern. It reads as follows: "(A) THE MAIN OBJECTS OF THE COMPANY TO BE PURSUED BY COMPANY ON ITS INCORPORATION: [...] 4. To take over the existing Proprietorship firm Viz. M/S. Hitro Energy Solutions having its registered office at Chennai." 10 By its letter dated 23 July 2016, the appellant requested the Proprietary Concern to refund the amount of Rs. 50,00,000 since the contract had been terminated and the amount had been returned by the appellant to CMRL. It noted that once the amount was released by the Proprietary Concern, it would indemnify them against any future claim from CMRL. The letter reads as follows: "This is in reference to the purchase order Nos. KH000115, KH000116, KH000117, dated 24.06.2013 towards the supply of light fittings for our CMRL project. The advance amount of Rs. 50.00 Lakhs paid to you was directly released by our client, the CMRL at our request and the amount has already been debited to your account ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ietary Concern belongs to the appellant, and will not be claimed by them in the future. The minutes of the meeting state as follows: "The following points were discussed during the meeting * RSK explained the reasons and procedure for the direct payment from CMRL to vendors of CCCL. * RSK requested NSR to return the advance paid to Hitro Energy to Thom Light. * NSR refused the same since the payment had been received from CMRL through cheque and can be returned to CMRL only if CMRL claim the same. * RSK explained that, CCCL requested CMRL to release this advance to Hitro and the amount already been deducted in CCCL payables by CMRL, hence this amount belongs to CCCL and can be returned. * NSR refused the same and asked CCCL to get a letter from CMRL stating that, the advance paid to Hitro belongs to CCCL and CMRL does not claim the same in future from Hitro. * SR asked NSR, that CCCL can provide a Indemnity Bond to Hitro to return the Advance, and NSR refused and asked BG For the same amount to return the Advance, CCCL refused the same." 13 Thereafter, the appellant obtained a letter dated 27 December 2016 from CMRL where it noted that it had issued the cheque for Rs ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f it, the objection raised by the Counsel for the Corporate Debtor stands rejected. 12. It has been submitted by the Counsel for the Corporate Debtor that till date, the Proprietorship Firm is paying the income tax and also carrying on the business which is contrary to the Memorandum of Association of the Corporate Debtor viz., M/s. Hitro Energy Soluti9ns Private Limited. It seems that the Director of the Corporate Debtor viz., N. S. Rangachari may be making communications on behalf of Proprietorship Firm for the purpose of dubious transactions or Tax benefits but as per the Memorandum of Association, the same has been taken over by the Corporate Debtor of which there is no doubt at all. Thus, the Memorandum of Association being the constitutional document of the Corporate Debtor is an authentic documentary proof that the Proprietorship Firm has been taken over or converted into corporate entity. 13. It has been submitted by the Counsel for the Corporate Debtor that in case the CMRL could have given a certificate that they would not claim Rs. 50 Lakhs from M/s Hitro Energy Solutions then, the amount could have been paid by the Corporate Debtor to the Operational Creditor, to wh ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... spondent changed its intention through a subsequent Board resolution. Further, the Proprietary Concern exists till date and is an entity separate from the respondent. Thus, the respondent cannot be made liable for its debt; PART D (ii) There is no privity of contract between the appellant and the respondent, since the appellant's contract was with the Proprietary Concern and the payment of the advance to the Proprietary Concern was made by CMRL; (iii) The appellant is not an operational creditor because: a. The appellant did not provide any goods or services to the respondent, but only availed of goods or services from the Proprietary Concern. Hence, the appellant will not be an operational creditor within the meaning of Section 5(20) of the IBC; and b. In any case, even if the debt exists, it is in the hands of CMRL, which has not legally transferred it to the appellant; (iv) The application is barred by limitation since it was filed on 1 November 2017, more than three years after the date of default, i.e., 7 November 2013; and (v) The appellant is seeking to misuse the present proceedings under the IBC for recovering its dues. 20 The rival submissions will now be co ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ce or copy of the invoice mentioned in sub-section (1) bring to the notice of the operational creditor- (a) existence of a dispute, if any, and record of the pendency of the suit or arbitration proceedings filed before the receipt of such notice or invoice in relation to such dispute; (b) the repayment of unpaid operational debt- (i) by sending an attested copy of the record of electronic transfer of the unpaid amount from the bank account of the corporate debtor; or (ii) by sending an attested copy of record that the operational creditor has encashed a cheque issued by the corporate debtor. Explanation.-For the purposes of this section, a "demand notice" means a notice served by an operational creditor to the corporate debtor demanding repayment of the operational debt in respect of which the default has occurred." In accordance with Section 8(1), an operational creditor can send a demand notice to the corporate debtor when a default occurs, and in the manner which may be prescribed. "Default" has been defined under Section 3(12) of the IBC, and it stood as follows at the relevant time: "(12) "default" means non-payment of debt when whole or any part or instalment of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... GOODS TO WHICH THE OPERATIONAL DEBT REFERS 5. RECORD OF DEFAULT WITH THE INFORMATION UTILITY (IF ANY) 6. PROVISION OF LAW, CONTRACT OR OTHER DOCUMENT UNDER WHICH DEBT HAS BECOME DUE 7. LIST OF DOCUMENTS ATTACHED TO THIS APPLICATION IN ORDER TO PROVE THE EXISTENCE OF OPERATIONAL DEBT AND THE AMOUNT IN DEFAULT " In contrast, Form 4 provides: "[Name of operational creditor], hereby provides notice for repayment of the unpaid amount of INR [insert amount] that is in default as reflected in the invoice attached to this notice." Hence, a demand notice for an operational debt by an operational creditor does not necessarily need to be accompanied by an invoice, but it may be sent where such debt arises under a "provision of law, contract or other document" and for which documents can be attached along with the demand notice. 25 The above conclusion is also supported by the Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations 2016, "CIRP Regulations 2016". In relation to claims by operational creditors, Regulation 7, as it stood at the relevant time, provided thus: "7. Claims by operational ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... effect that there is no notice given by the corporate debtor relating to a dispute of the unpaid operational debt; (c) a copy of the certificate from the financial institutions maintaining accounts of the operational creditor confirming that there is no payment of an unpaid operational debt by the corporate debtor; and (d) such other information as may be prescribed. (4) An operational creditor initiating a corporate insolvency resolution process under this section, may propose a resolution professional to act as an interim resolution professional. (5) The Adjudicating Authority shall, within fourteen days of the receipt of the application under sub-section (2), by an order- (i) admit the application and communicate such decision to the operational creditor and the corporate debtor if,- (a) the application made under sub-section (2) is complete; (b) there is no repayment of the unpaid operational debt; (c) the invoice or notice for payment to the corporate debtor has been delivered by the operational creditor; (d) no notice of dispute has been received by the operational creditor or there is no record of dispute in the information utility; and (e) there is no di ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... CATING ON THE DEFAULT, IF ANY (ATTACH A COPY OF THE ORDER) 4. RECORD OF DEFAULT WITH THE INFORMATION UTILITY, IF ANY (ATTACH A COPY OF SUCH RECORD) 5. DETAILS OF SUCCESSION CERTIFICATE, OR PROBATE OF A WILL, OR LETTER OF ADMINISTRATION, OR COURT DECREE (AS MAY BE APPLICABLE), UNDER THE INDIAN SUCCESSION ACT, 1925 (10 OF 1925) (ATTACH A COPY) 6. PROVISION OF LAW, CONTRACT OR OTHER DOCUMENT UNDER WHICH DEBT HAS BECOME DUE 7. A STATEMENT OF BANK ACCOUNT WHERE DEPOSITS ARE MADE OR CREDITS RECEIVED NORMALLY BY THE OPERATIONAL CREDITOR IN RESPECT OF THE DEBT OF THE CORPORATE DEBTOR (ATTACH A COPY) 8. LIST OF DOCUMENTS ATTACHED TO THIS APPLICATION IN ORDER TO PROVE THE EXISTENCE OF OPERATIONAL DEBT AND THE AMOUNT IN DEFAULT " D.2 Legislative History 28 Unlike other foreign jurisdictions, which usually differentiate between secured and unsecured creditors only, the IBC is unique because it provides for two different classes of creditors: operational creditors and financial creditors. To understand the position of the former within the framework of the IBC, it is important to understand the distinction between these two classes. 29 The primary source is Volume I of the Report ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... supplied)
30 It is thus clear that operational creditors are those whose debt arises from operational transactions, i.e., transactions which are undertaken in relation to the operation of an enterprise. As the examples in the BLRC Report suggest, these generally include transactions involving goods or services which are considered necessary for the operational functioning of an entity.
31 The Joint Parliamentary Committee Report on the IBC differentiates between financial and operational creditors in the following terms, Pg 14, available at X X X X Extracts X X X X X X X X Extracts X X X X ..... a term loan or for working capital that enables the corporate debtor to either set up and/or operate its business. On the other hand, contracts with operational creditors are relatable to supply of goods and services in the operation of business. Financial contracts generally involve large sums of money. By way of contrast, operational contracts have dues whose quantum is generally less. In the running of a business, operational creditors can be many as opposed to financial creditors, who lend finance for the set-up or working of business. Also, financial creditors have specified repayment schedules, and defaults entitle financial creditors to recall a loan in totality. Contracts with operational creditors do not have any such stipulations. Also, the forum in which dispute resolution takes place is completely different. Contracts with operational creditors can and do have arbitration clauses where dispute resolution is done privately. Operational debts also tend to be recurring in nature and the possibility of genuine disputes in case of operational debts is much higher when compared to financial debts. A simple example will suffice. Goods that are supplied may be substandard. Ser ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... and operational creditors, the Court noted that: first, generally operational creditors are suppliers of goods and services whereas the home buyer advances money to the developer, so that the debtor is the supplier (of the flat); second, an operational creditor has no interest in or stake in the corporate debtor, unlike a home buyer who is vitally concerned with the real estate project; and third, in an operational debt, there is no consideration for the time value of money since the consideration of the debt is the goods or services that are either sold or availed of from the operational creditor whereas in real estate projects, money is raised from the allottee, being raised against consideration for the time value of money. The Court held: "42. It is impossible to say that classifying real estate developers is not founded upon an intelligible differentia which distinguishes them from other operational creditors, nor is it possible to say that such classification is palpably arbitrary having no rational relation to the objects of the Code. It was vehemently argued by the learned counsel on behalf of the petitioners that if at all real estate developers were to be brought within ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... es such payments in instalments which are co-terminus with phases of completion of the real estate project does not any the less make such payments as payments involving "exchange" i.e. advances paid only in order to obtain a flat/apartment. What is predominant, insofar as the real estate developer is concerned, is the fact that such instalment payments are used as a means of finance qua the real estate project. One other vital difference with operational debts is the fact that the documentary evidence for amounts being due and payable by the real estate developer is there in the form of the information provided by the real estate developer compulsorily under RERA. This information, like the information from information utilities under the Code, makes it easy for homebuyers/allottees to approach NCLT under Section 7 of the Code to trigger the Code on the real estate developer's own information given on its webpage as to delay in construction, etc. It is these fundamental differences between the real estate developer and the supplier of goods and services that the legislature has focused upon and included real estate developers as financial debtors. This being the case, it is cl ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e. it must exist before the receipt of the demand notice or invoice, as the case may be. In case the unpaid operational debt has been repaid, the corporate debtor shall within a period of the self-same 10 days send an attested copy of the record of the electronic transfer of the unpaid amount from the bank account of the corporate debtor or send an attested copy of the record that the operational creditor has encashed a cheque or otherwise received payment from the corporate debtor [Section 8(2)(b)]. It is only if, after the expiry of the period of the said 10 days, the operational creditor does not either receive payment from the corporate debtor or notice of dispute, that the operational creditor may trigger the insolvency process by filing an application before the adjudicating authority under Sections 9(1) and 9(2). This application is to be filed under Rule 6 of the Insolvency and Bankruptcy (Application to Adjudicating Authority) Rules, 2016 in Form 5, accompanied with documents and records that are required under the said form. Under Rule 6(2), the applicant is to dispatch by registered post or speed post, a copy of the application to the registered office of the corporate d ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n utility [Section 9(5)(ii)(d)]. Section 9(5)(ii)(d) refers to the notice of an existing dispute that has so been received, as it must be read with Section 8(2)(a). Also, if any disciplinary proceeding is pending against any proposed resolution professional, the application may be rejected [Section 9(5)(ii)(e)]." It further noted that when a notice is received by a corporate debtor under Section 8(2), it is enough that a dispute is pending and it is not necessary that a suit/arbitration also be pending: "38. It is, thus, clear that so far as an operational creditor is concerned, a demand notice of an unpaid operational debt or copy of an invoice demanding payment of the amount involved must be delivered in the prescribed form. The corporate debtor is then given a period of 10 days from the receipt of the demand notice or copy of the invoice to bring to the notice of the operational creditor the existence of a dispute, if any. We have also seen the notes on clauses annexed to the Insolvency and Bankruptcy Bill of 2015, in which "the existence of a dispute" alone is mentioned. Even otherwise, the word "and" occurring in Section 8(2)(a) must be read as "or" keeping in mind the legi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... could jeopardize the financial health of the corporate debtor. Indeed, in Swiss Ribbons (supra), this Court observed that the IBC was not akin to a recovery legislation for creditors, but is a legislation beneficial for the corporate debtor: "28. It can thus be seen that the primary focus of the legislation is to ensure revival and continuation of the corporate debtor by protecting the corporate debtor from its own management and from a corporate death by liquidation. The Code is thus a beneficial legislation which puts the corporate debtor back on its feet, not being a mere recovery legislation for creditors. The interests of the corporate debtor have, therefore, been bifurcated and separated from that of its promoters/those who are in management. Thus, the resolution process is not adversarial to the corporate debtor but, in fact, protective of its interests. The moratorium imposed by Section 14 is in the interest of the corporate debtor itself, thereby preserving the assets of the corporate debtor during the resolution process. The timelines within which the resolution process is to take place again protects the corporate debtor's assets from further dilution, and also pro ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... m that. 42 It is then that we come to the core of the dispute - while the appellant has argued that the debt is in the nature of an operational debt which makes them an operational creditor, the respondent has opposed this submission. The respondent's submission, which was accepted by the NCLAT, seeks to narrowly define operational debt and operational creditors under the IBC to only include those who supply goods or services to a corporate debtor and exclude those who receive goods or services from the corporate debtor. For reasons which shall follow, we reject this argument. 43 First, Section 5(21) defines 'operational debt' as a "claim in respect of the provision of goods or services". The operative requirement is that the claim must bear some nexus with a provision of goods or services, without specifying who is to be the supplier or receiver. Such an interpretation is also supported by the observations in the BLRC Report, which specifies that operational debt is in relation to operational requirements of an entity. Second, Section 8(1) of the IBC read with Rule 5(1) and Form 3 of the 2016 Application Rules makes it abundantly clear that an operational creditor can issue a no ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... The true test for determining whether the exclusion in the first proviso to Section 21(2) applies must be formulated in a manner which would advance the object and purpose of the statute and not lead to its provisions being defeated by disingenuous strategies. [...] 104. Hence, while the default rule under the first proviso to Section 21(2) is that only those financial creditors that are related parties in praesenti would be debarred from the CoC, those related party financial creditors 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. Mr Kaul has argued, correctly in our opinion, that if this interpretation is not given to the first proviso of Section 21(2), then 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 creditors." Thus, the Court struck a balance between the text of the statute and the purpose which it sought to achieve by excluding those related ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ction 4(1) provides the relevant information that an MOA shall provide, which includes, in sub-Clause (c), that it should provide "the objects for which the company is proposed to be incorporated and any matter considered necessary in furtherance thereof". 50 Section 10(1) of CA 2013 elucidates the legal effect of an MOA in the following terms: "10. Effect of memorandum and articles.-(1) Subject to the provisions of this Act, the memorandum and articles shall, when registered, bind the company and the members thereof to the same extent as if they respectively had been signed by the company and by each member, and contained covenants on its and his part to observe all the provisions of the memorandum and of the articles." 51 Further, Section 13 provides the requirements for the alteration of an MOA. The relevant parts of Section 13 are as follows: "13. Alteration of memorandum.-(1) Save as provided in Section 61, a company may, by a special resolution and after complying with the procedure specified in this section, alter the provisions of its memorandum. [...] (6) Save as provided in Section 64, a company shall, in relation to any alteration of its memorandum, file with t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... purpose of a company and it is expected that the company will fulfill/attempt to fulfill the objects it has laid out in its MOA. 53 In the present case, the MOA of the respondent unequivocally states that one of its main objects is to take over the Proprietary Concern. However, the respondent has produced a resolution dated 1 September 2014 passed by its Board of Directors, purportedly resolving to not take over the Proprietary Concern. The resolution states: "CERTIFIED TRUE COPY OF THE RESOLUTION PASSED AT THE MEETING OF BOARD OF DIRECTORS HELD AT 10.00 AM ON 1st SEPTEMBER 2014 AT THE REGISTERED OFFICE OF THE COMPANY AT CHENNAI. "RESOLVED THAT the company do hereby decided not to take over the Proprietorship concern M/S.HITRO ENERGY SOLUTIONS as envisaged in clause 4 of main objects of the Memorandum of Associations of the Company."" In support of the resolution, the respondent has also produced a certification from the banker of the Proprietary Concern, Indian Bank, Mylapore Branch, on 10 April 2018 and from the Chartered Accountants of the Proprietary Concern, K R Sarangapani and Co, on 27 April 2018. 54 Admittedly, there was no reference to the resolution in the counter ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... appellant is 7 November 2013, when the cheque was issued by CMRL to the Proprietary Concern. As such, the submission is that the limitation of three years under Article 137 of the Limitation Act 1963, "Limitation Act" would expire on 7 November 2016, while the application under Section 9 was only filed on 1 November 2017. 58 In B.K. Educational Services (P) Ltd. v. Parag Gupta & Associates, (2019) 11 SCC 633 ("B.K. Educational Services"), a two-judge Bench of this Court held that the Limitation Act would apply to applications filed under Sections 7 and 9 of the IBC. The Court held: "42. It is thus clear that since the Limitation Act is applicable to applications filed under Sections 7 and 9 of the Code from the inception of the Code, Article 137 of the Limitation Act gets attracted. "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." 59 The respo ..... X X X X Extracts X X X X X X X X Extracts X X X X
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