Related Party Can't Be Allowed Backdoor Entry Into CoC On Account Of Its Operational Debt: NCLT Kolkata

The NCLT, Kolkata bench of Justice Ashok Kumar Bhardwaj has held that once a Financial Creditor had been classified as a “related party”, it could not be allowed to gain entry into Committee of Creditors (CoC) on account of its Operational Debt as it would amount to defeating the legislative intent of keeping related parties out and running of CoC by external creditors. Reliance was placed upon the judgment of the Supreme Court in Phoenix Arc Private Limited vs. Spade Financial Services Private Limited & Ors. to hold that the exclusion referred to in first proviso to Section 21(2) of Insolvency and Bankruptcy Code, 2016 (IBC) lays emphasis on the relationship existing between the parties and not the debt itself. Brief Facts: M/s Energy Properties Private Limited (Corporate Debtor) is the owner of a plot of land in Howrah, West Bengal. M/s Avani Towers Private Limited (Financial Creditor/Developer) signed a Development Agreement dated 16.06.2008. According to the terms of the agreement, the Developer was required to deposit Rs.12 crores as security. The security deposit included a further amount of up to Rs. 3 crores subject to an interest rate of 18% per year compounded quarterly. The Financial Creditor did not do any development work on the relevant premises. Parties engaged in a dispute as a result of non-performance of development work. The Financial Creditor filed a petition under section 7 of IBC qua the debt of Rs. 10.91 crores, which consisted of the security deposit of Rs. 3.50 crores. On 20.03.2024, NCLT admitted the petition. The Applicant stated that Avani Towers is a related party of the Corporate Debtor under Section 5(24) of the IBC. The Applicant contended that the classification of claim of Avani Towers as operational debt was erroneous and dehors the provisions of IBC. Avani Towers had a 40% shareholding in the Corporate Debtor. Therefore, it was disqualified from being a member of the CoC. The RP treated the sum of Rs. 12 crores as operational debt only to avoid the trappings of Section 21 of IBC and to constitute the CoC with Avani Towers having an overwhelming majority in it. Mr. Chintan Jhunjhunwala, suspended Director of Corporate Debtor preferred an application questioning the classification of Avani Towers as operational creditor of the Corporate Debtor. In an order dated 27.09.2024 it was held that a creditor who already stands classified as a 'related party Financial Creditor' under Section 5(24) of the Code cannot represent the CoC in any manner and that the first proviso of Section 21(2) shall squarely apply to an Operational Creditor. The Members of the Bench had a difference of opinion on the issue of inclusion of Avani Towers in the CoC of the Corporate Debtor. Therefore, in terms of Section 419(5) of the Companies Act, 2013, a reference of the following issue was made for the opinion of the NCLT. Issue: Whether a financial creditor who has been categorized as a related party under Section 5(24) of the Code can be included in the CoC in terms of Regulation 16 of the IBBI (Insolvency Resolution Process for Corporate Persons), 2016 on account of its operational debt. Submissions: Mr. Joy Saha, Senior Counsel appearing for the Applicant contended that the advance of Rs. 3.5 crores with 18% interest falls within the ambit of financial debt under Section 5(8) of the IBC. He referred to Carestream Health India Pvt. Ltd. v. Seaview Mercantile LLP in Company Appeal (AT) (Insolvency) No. 579 of 2023, where it was held that “the scope of "operational debt" under the IBC does not encompass situations like security deposits unrelated to any immediate service rendered”. He referred to the judgment of Supreme Court in Phoenix Arc Private Limited vs. Spade Financial Services Limited & Ors. to buttress that the exclusion referred to in first proviso to Section 21(2) of IBC, 2016 is related not to debts but relationship existing between the parties. Mr. Jishnu Saha, Senior Counsel for Respondent No. 2, submitted that when the RP had decided to include Respondent No. 2 in CoC as operational creditor, the CoC rightly decided to not include Respondent No. 2 in CoC being a Financial Creditor. He referred to the judgment rendered by the Supreme Court in Phoenix ARC Private Limited v. Spade Financial Services Limited & Ors. and espoused that the meaning of the first proviso to Section 21(2) of IBC is to exclude the related party of the Corporate Debtor from CoC to obviate conflict of interest in the event that the party is allowed to become part of CoC. Observations: The Tribunal noted that in the minutes of the first meeting of the CoC of the Corporate Debtor, it had been categorically noted that Avani Towers Pvt. Ltd. i.e. the sole financial creditor of the Corporate Debtor was a related party of the Corporate Debtor. The Tribunal observed that Section 5(24)(j) of the Code indicates that ...

Related Party Can't Be Allowed Backdoor Entry Into CoC On Account Of Its Operational Debt: NCLT Kolkata

Tazeen Ahmed

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