NCLT DECISION: Hytone Merchants v. Satabadi Investments Consultants

 

In “Hytone Merchants Pvt Ltd v. Satabadi Investments Consultants Pvt. Ltd.”[2], the National Company Law Tribunal (Hereinafter referred as “NCLT”) retained that the Adjudicating Authority (Hereinafter referred as “AA”) could indeed refuse to admit a somewhat complete application under section 7[3] of the Insolvency and Bankruptcy Code, 2016 (Hereinafter referred as “IBC”) once there are strong indications of embezzlement, connivance, or malicious intent under section 65 of the IBC. The NCLAT, notably, chose to disregard the petition on its own motion under section 65[4], implying that the corporate debtor never claimed the application had been fraudulent or motivated by animosity.

Key Words – NCLAT, Adjudicating Authority, Insolvency and Bankruptcy Code

1. Case Before the Adjucating Authority 

The Financial Creditor submitted an application with the AA[5] under section 7 of the IBC to reclaim a three-lakh unsecured debt. The Corporate Debtor ( Hereinafter referred as “CD”) claimed that its failure to repay the debt was due to a pandemic-induced downturn, and hence did not argue the establishment of a failure under section 7.

The application was deemed comprehensive in every way by the AA. At the proper moment, the default exceeded the threshold limit set forth in section 4[6] of the IBC (2019). Notwithstanding this, the AA retained that it was unattainable to presume that a company with a net worth of over Rs. 153 crores and a Corporate Guarantee of over Rs. 482 crores could not pay a minuscule amount of three lakhs by making reference to the CD’s master data and financial statement from the Ministry of Corporate Affairs. As a result, the application was denied by the AA. It’s worth noting that the AA didn’t provide the parties the opportunity to dispute the position prior to actually dismissing the petition.

2. Appeal in the NCLT

The Creditor challenged the order, claiming that AA was motivated by factors outside of the scope of section 7(5) of the IBC. The financial statements relied on by AA were for the financial year 2018-19, but the petition was made in the following cycle of 2019-20, it was stated. The CD’s financial situation deteriorated over the course of a year, resulting in default. CD was also accused of investing in firms that were now either in liquidation or going through to the Corporate Insolvency Resolution Process, resulting in the default of the disputed debt. Still, owing to the generally accepted accounting principles, the CD was obligated to exemplify the sums of money as receivable accounts, even though there continues to remain grim prospects of genuinely receiving the money.

The NCLAT rejected the arguments and upheld AA’s order under section 65 of the IBC. The NCLAT ruled that section 65 could not be interpreted solely in terms of imposing fines. The AA has the right to prevent the continuation of applications that are based on deception or malice. The tribunal considered “section 65 explicitly cites that any individual stimulates the insolvency resolution process or winding – up negotiations with the intention of deceiving or with malevolent purposes for any motive apart from resolution of Insolvency or liquidation, though as the case may, the Adjudicating Authority might indeed perpetrate a punitive measures”.

3.   Case Analysis

Review of the Section 7 Anvil:

Section 7(5)(a) states that an application must meet three conditions before being accepted, i.e.,  first, there must be a default; second, the application must be complete under Form I[7]; and third, there should be no awaiting judicial process to against Resolution Professional(“RP”) advocated to be chaired. In this situation, the AA was cautious about the first two prerequisites, although the RP’s appointment was not in question. “Innoventive Industries Ltd. v. ICICI Bank[8], the law on section 7(5) of the IBC was clearly spelt out in the authoritative decision. “As soon as the adjudicatory court is satisfied that an obligation has transpired, the application must also be admitted unless it is incomplete, in which case this might give notice to the applicant to redress the deficiency within 7 days of receipt of a notice from of the adjudicating authority,” according to the Apex court.

Furthermore, the NCLAT decided in “Shobhanath v. Prism Industries[9] that the AA is only needed to determine if there is a debt and a delinquency, and that it cannot examine any other unnecessary or superfluous factors. Thus, it may be confidently asserted that, even if the application satisfied the profile under section 7, the AA’s rejection of the application was driven by extraneous considerations beyond section 7, which is prohibited.

The NCLAT further held in this case that the use of the term “may” in section 7(5)(a) allows the AA to exercise considerable discretion before admitting or rejecting the application. As a result, NCLAT determined that AA’s decision to deny the application was correct. When compared to section 9(5)[10], which includes the word “must,” it is true to claim that the AA has been given some discretion under section 7, but this difference is not conclusive for such a conclusion.

Despite the fact that the NCLT’s decision in “India Bank v. Varun Resources Ltd[11] is not obligatory on the NCLAT, it could be used as a guide to recognize the applicability of discretion entrusted in AA under section 7. In this case, the NCLT concluded that the AA’s discretion should be used to admit rather than deny the application, especially when there is adequate documentary evidence of debt and default. On this basis, it is possible to conclude that the NCLAT erred in affirming the AA’s denial of the application notwithstanding the existence of ample documentary evidence establishing default.

When all of the requirements of section 7 are met and the CD nevertheless decides to settle the claim, discretion is granted. In such instances, the authority to reject the application can be utilized in order to create additional flexibility among parties, which is at the heart of effective bankruptcy legislation. Discretion can thus be taken where there are more substantial objectives of maintaining administrative costs without disturbing the existing business entity. In this case, however, the AA has failed to provide any such compelling cause to deny the application.

Misplaced Reliance on Section 65:

A cursory study of Section 65[12] reveals that there are two requirements to fall under the confines of the Section. Firstly, the application has indeed been filed whether illegitimately or even with malicious intent, and Secondly, this has been submitted for an intent apart from resolving insolvency or bankruptcy. Because the second portion, which deals with any other purpose, has been qualified by the phrase “fraud or evil intent,” both criteria should coexist. The learned NCLAT, on the other hand, appears to be driven solely by the second factor, with nothing in the ruling justifying the existence of the first. Without substantiating its decision on the existence of fraud or malicious intent, which is a sine-qua-non for section 65, the NCLAT decided that the application was filed for a reason other than insolvency.

Aside from that, section 7 processes are summary proceedings, which means the AA must decide the matter of default after a brief investigation and a quick conclusion[13]. Given this, the NCLAT held in “Monotrone Leasing v. PM Cold Storage”[14] that it is impossible to identify the applicant’s objective in such short processes unless it is demonstrated by documentary evidence. None of the parties in this case even mentioned fraud or ill intent, let alone the issue of laying documentary proof.

AA assumed collaboration (a type of fraud) between the Creditor and the CD in this case without letting any side to defend their position. The AA, however, did so in violation of section 424[15] of the Companies Act. In all of its proceedings, AA must follow the principles of Natural Justice, according to the Section. Referring this to section 65 of the IBC, the NCLAT concluded in “M/S Unigreen Global Private Limited v. Punjab National Bank[16]  that a prima facie statement must always be made before a penalty under section 65 may well be enforced. Following that, the AA is expected to provide the person with a reasonable opportunity to explain & refute their case. The AA in this case formed a prima facie opinion and gave it finality based on the CD’s net worth without enabling the parties to defend their arguments. The NCLAT must have remanded the case solely on this basis, as it jeopardized the parties’ ability to submit their case.

In the lack of any documented proof or averment, it’s difficult to see how the NCLAT came to the conclusion that the Creditor’s application contained fraud or mala fide intent. Furthermore, if there are any doubts about the existence of fraud or malice, the applicability of section 65 becomes problematic.

4.  Conclusion

The court’s decision expands the scope of AA further than the confines of section 7. It has the potential to become a wild horse in the long run, with the AA rejecting applications despite real default. It is not a rule of thumb that a corporation with a solid net worth may create sufficient cash flows to pay its commitments, as it has been persuasively stated and confirmed by the Bankruptcy Law Reforms Committee (BLRC) report. According to the BLRC research, bankruptcy is frequently caused by financial failure (a mismatch among payment and receivables) or company failure (insufficient revenue to meet financial obligations), or both. However, in this case, the NCLAT assumed, based on net value and corporate assurances, that both defects must coexist to cause insolvency, which is incorrect. 

The decision would cause instability and ambiguity in present bankruptcy law, which is unwelcome and goes against the ideals for which the code was created. Assume the case is taken to the appeals court. In such situation, it is predicted that the Hon’ble Supreme Court will overturn this order based on its past rulings, preventing the AA from exercising unrestricted discretion when allowing an insolvency application, in line with the IBC’s goal of minimal judicial intervention. 


[1] BBA.LLB, 4th Year, Bharati Vidyapeth New Law College, Pune

[2] Company Appeal (AT) (Insolvency) No. 258 of 2021

[3] The Insolvency and Bankruptcy Code 2016, Part II: Insolvency Resolution & Liquidation for Corporate Persons, Chapter II: Corporate Insolvency Resolution Process, Section 7: Initiation of Corporate Insolvency Resolution process by financial creditors,<https://ibclaw.in/section-7-initiation-of-corporate-insolvency-resolution-process-by-financial-creditor-chapter-ii-corporate-insolvency-resolution-processcirp-part-ii-insolvency-resolution-and-liquidation-for-corpor/>, August 13, 2021  

[4] The Insolvency and Bankruptcy Code 2016, Part II: Insolvency Resolution & Liquidation for Corporate Persons, Chapter VI: Adjudicating Authority for Corporate Persons, Section 65: Fraudulent or malicious initiation of proceedings, < https://ibclaw.in/section-65-fraudulent-or-malicious-intiation-of-proceedings/ >, August 13, 2021

[5] Hytone Merchants Private Limited [CIN: U51109WB1994PTC063994] V Satabdi Investments Consultants Private Limited [CIN: U74120WB2008PTC124106], Date of hearing: 04.01.2021, Order pronounced on: 02.02.2021, <https://nclt.gov.in/sites/default/files/January2021/Interim-orderpdf/CP%20IB%202192%20KB%202019.pdf> August 13, 2021 

[6] The Insolvency and Bankruptcy Code, 2016, Part II: Insolvency Resolution and Liquidation for Corporate Persons, Chapter I: Preliminary, Section 4: Application of this part, < https://ibclaw.in/section-4-application-of-this-part-ii-insolvency-resolution-and-liquidation-for-corporate-persons-chapter-i-preliminary-definitions/ >, August 13, 2021

[7] Form 1, Sub-Rule (1) of  Rule 4, Application by Financial Creditors to Initiate Corporate Insolvency Resolution Process under Chapter II of Part III under Chapter IV of Part II of the Code, Under 7 of the Insolvency and Bankruptcy Code, 2016 read with Rule 4 of the Insolvency and Bankruptcy (Application to Adjudicating Authority) Rule, 2016

[8] Civil Appeal No. 8337-8338 of 2017

[9] Company Appeal (AT) (Insolvency) No. 557 of 2018, (Arising out of Order dated 5th July, 2018 passed by the Adjudicatin Authority (National Company Law Tribunal), Allahabad Bench in C.P. No. 168/ALD/2017)

[10] The Insolvency and Bankruptcy Code, 2016, Part-II Insolvency Resolution and Liquidation for Corporate Persons, Chapter-II Corporate Insolvency Resolution Process, Section 9: Application for initiation of corporate insolvency resolution process by operational creditor.

[11] Company Petition No. 247/I & BP/NCLT/MAH/2017

[12] Supra 4

[13] Gulabchand Gamnaji v. Moti Chatraji, ILR (1901) 25 Bom 523, 11-09-1900

[14] Company Appeal (AT) (Insolvency) No. 99 of 2020,[Arising out of Impugned Order dated 11th December 2019 passed by the Adjudicating Authority/National Company Law Tribunal, Kolkata Bench, Kolkata in Company Petition (IB) No. 142(KB)/2019]

[15] http://ebook.mca.gov.in/Actpagedisplay.aspx?PAGENAME=17867, August 13, 2021

[16] Company Appeal (AT) (Insolvency) No. 81 of 2017, [arising out of Order dated 8th May, 2017 by NCLT, Principal Bench, New Delhi in C.P. No. (IB)-39(PB)/2017]

By Avnip Sharma

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