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Decisions of CoC constituted in violation of IBC cannot be validated on pretext of commercial wisdom

Decisions of CoC constituted in violation of IBC cannot be validated on pretext of commercial wisdom

The Hon’ble National Company Law Appellate Tribunal (NCLAT), New Delhi in the matter of Jayanta Banerjee v. Shashi Agarwal Liquidator of INCAB Industries Limited and Another, REED 2021 NCLAT Del 06509, held that all the statutory provisions for the conduct of Corporate Insolvency Resolution Process (CIRP) under the Insolvency and Bankruptcy Code, 2016 (IBC) are interlinked, which do not leave any scope for the Interim Resolution Professional (IRP)/ Resolution Professional (RP) to skip any of the provisions, and therefore when the constitution of the Committee of Creditors (CoC) itself is found to be tainted, then its decision cannot be validated on the pretext of exercise of commercial wisdom. This post discusses the background of the case in order to elucidate the contours of the dispute and analyzes the ruling pronounced by the NCLAT.


BACKGROUND

The Incab Industries Ltd. (Corporate Debtor) was admitted into the CIRP and Respondent No. 1 was appointed as IRP of the Corporate Debtor. Under the invitation of claims by the IRP, the Appellant and thousands of other employees who were employed with the Corporate Debtor submitted their claim, along with other Operational Creditors and Financial Creditors. Subsequently, after forming the CoC, the resolution was adopted on 5 December 2019, to liquidate the Corporate Debtor. The liquidation order came into the Appellant’s knowledge when the Application under Section 33 of the IBC was filed before National Company Law Tribunal, Kolkata Bench (NCLT). 


The Appellant intervened in the said matter and filed its opposition in the same. The Appellant also filed an Application under Section 60(5) of the IBC to remove the Respondent as the RP working connivance with the majority of the creditors of the Corporate Debtor. The CoC also consisted of Kamla Mills Pvt. Ltd. and Fasqua Investment Pvt. Ltd, both of which were managed and owned by one of the Directors of the Corporate Debtor, Mr. Ramesh Ghamandiram Gowani, who resigned from the management of the Corporate Debtor after the initiation of the CIRP. Both the applications filed by Appellant were rejected by NCLT and resultantly, the Appellant approached the NCLAT.


ANALYSIS

In order to facilitate analysis, this section has been divided into the following three parts: 


1. Whether Kamla Mills Pvt. Ltd. and Fasqua Investment Pvt. Ltd. who were made part of CoC are related parties in terms of proviso to section 21(2) of the IBC?


Section 5(24)(f) of the IBC defines ‘related party’ in relation to Corporate Debtor that includes anybody corporate whose board of directors, managing director or manager, in the ordinary course of business, acts on the advice, directions or instructions of a director, partner or manager of the Corporate Debtor. In the instant case, Mr. Ramesh Ghamanndiram Gowani had a substantial shareholding of 99.74% in Kamla Mills Pvt. Ltd. and was also Director and Shareholder of the Fasqua Investment Pvt. Ltd. It is also on record that Mr. Ramesh Ghamanndiram Gowani resigned from the Corporate Debtor’s Board with effect from 20 November 2019, i.e. much after initiation of the CIRP against the Corporate Debtor. 


The Hon’ble Supreme Court in the case of Phoenix ARC Private Limited v. Spade Financial Services Limited, REED 2021 SC 02501 has laid down the law that the term related party in the context of IBC is defined to ensure 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 Apex Court has further propounded that the 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. Hence, the NCLAT noted that Mr. Ramesh Ghamanndiram Gowani’s resignation from the Board of Directors of the Corporate Debtor after initiation of the CIRP will not circumvent the exclusion under the first proviso to section 21(2) of the IBC. 


Thus, NCLAT concluded that Kamla Mills Pvt. Ltd. and Fasqua Investment Pvt. Ltd. are the related party of the Corporate Debtor in terms of section 5(24)(f) and first proviso to section 21(2) of IBC. Consequently, they are not entitled to represent, participate and vote in the CoC of the Corporate Debtor.


2. Whether assignment of debt in violation of section 5 of the SARFAESI Act, 2002 and Factoring Regulation Act, 2011 is valid? 


On this issue, the NCLAT simply concluded that since the parties to the assignment deed were not made a party either before the NCLT or before NCLAT, the challenge to the assignment deed in question was not maintainable.


3. Whether IRP/RP can constitute CoC based on submission of claims only, without verifying and admitting or rejecting the claims? 


Based on the minutes of all the five CoC meetings in the instant case, the NCLAT noted that the CoC decided to liquidate the Corporate Debtor even without the valuation of the Corporate Debtor. Further, the IRP/RP formed the CoC even without admitting the claim, i.e. only based on claims submission. Moreover, considering the letters placed on record, it was evident that one of the Financial Creditors, namely Pegasus Assets Reconstruction Company, was regularly sending his objections to the RP about the determination of the voting percentage of the CoC members. However, despite reminders, RP, without even admitting/rejecting the claims of the Financial Creditors, had constituted the CoC and determined their voting percentage.


The NCLAT noted that all the statutory provisions for the conduct of CIRP are interlinked; it doesn’t leave any scope to the IRP/ RP to skip any of the provisions. For example, during CIRP, the IRP has to publish the notice in the newspaper for inviting claims. After receiving and collating the claims, he has to form the CoC. Based on the collation of the claims, IRP has to form the CoC from among the Financial Creditor. IRP has to assign the voting share to each creditor based on the Financial Debts owed to such creditor. Hence, without verification and admission of a claim, the IRP cannot assign the voting share to a creditor, and without that, there cannot be a meeting of the CoC.


In light of the foregoing, NCLAT held that the constitution of the CoC in the present case violated the proviso to Section 21(2) of the IBC read with Section 12(3) of CIRP Regulations. Therefore, the Constitution of the creditors’ committee was a nullity in the eye of law that vitiated the entire CIRP and the impugned order of liquidation passed by the NCLT was accordingly set aside. The NCLT was also directed to appoint another IRP/ RP in place of Respondent No.1.

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