Investor Or Creditor? – The SEBI V. IBC Battle

Saurabh Mishra And Charu Sharma

23 Feb 2022 8:23 AM GMT

  • Investor Or Creditor? – The SEBI V. IBC Battle

    The Insolvency and Bankruptcy Code ("IBC") was introduced in India in order to consolidate laws relating to reorganisation and insolvency resolution. However, the revolutionary legislation has been at odds with some of the pre-existing or contemporary financial legislations such as the Prevention of Money Laundering Act, 2002 ("PMLA"), the Maharashtra Relief Undertakings (Special Provisions Act), 1958 the Real Estate (Regulation and Development) Act, 2016 and most recently the novice law is at loggerheads with the Securities Exchange Board of India ("SEBI") due to overlapping definitions.

    BACKGROUND – CONFLICT BETWEEN SEBI AND NCLT'S ORDERS

    The conflict is best reflected in the recent case of HBN Dairies. HBN Dairies floated a Collective Investment Scheme ("CIS") without obtaining registration from SEBI. When it came to SEBI's notice, the SEBI passed an order to attach the properties of HBN Dairies to pay off the investors. An appeal was filed before the Securities Appellate Tribunal ("SAT"), which directed SEBI to resolve the plight of the investors expeditiously and preferably within six months. When the same was not complied with, investors filed an application under Section 7 of the IBC for initiating Corporate Insolvency Resolution Process against HBN Dairies.

    On acceptance of the application, the National Company Law Tribunal ("NCLT") ordered SEBI to de-attach the properties that were attached earlier.
    [1] The NCLT placed reliance on the non-obstante clause of Section 238 of the IBC and held that the moratorium provision under Section 14 of the IBC would override Section 28A of the SEBI Act, which empowers the recovery process by selling the property belonging to the corporate entity. Aggrieved by the order of the NCLT, a Special Leave Petition has been filed by SEBI before the Supreme Court in the case of
    SEBI v. Rohit Sehgal
    [2], which is pending as on date.

    WHO IS A CREDITOR?

    Section 3(10) of the IBC, 2016 states:

    "Creditor means any person to whom a debt is owed and includes a financial creditor, an operational creditor, a secured creditor, an unsecured creditor and a decree-holder;"

    Courts have been liberal in their interpretation of the term creditor to make recovery of dues easier and more accessible to a wider ambit of distressed people. For instance, in
    Ghanashyam Mishra v. Edelweiss Asset Reconstruction Co. Ltd
    .,
    [3] the Supreme Court went on to interpret Section 3(10) harmoniously with Sections 5(20) and 5(21) and held that the Central and State governments can be creditors under the IBC. Further, in Pioneer Urban Land Infrastructure v. Union of India,[4] the Supreme Court put homebuyers in the category of creditors and enabled them to be a part of the Committee of Creditors in a resolution plan intended to secure monies from the corporate debtor or real estate agent. The Court then went on to explain the meaning of debt under the Code:
    "A debt is a liability or obligation in respect of a right to payment, even if it arises out of breach of contract, which is due from any person, notwithstanding that there is no adjudication of the said breach, followed by a judgment or decree or order."

    Section 5(8) of the IBC states that a financial debt must be disbursed against the consideration for time value of money. Therefore, any person who gives money to a debtor in hopes of getting an assured return later would be a creditor. Even if the claim arises out of a breach of contract, it will be considered a financial debt.

    WHO IS AN INVESTOR?

    In 2018, a Committee was appointed by SEBI under the chairmanship of Justice (Retd.) Anil R. Dave on the Measures for Strengthening the Enforcement Mechanism of the Board and Incidental Issues ("Dave Committee"). When the idea of a collective investment scheme was floated, the three important identifying characteristics suggested by the Dave Committee were pooling of investments; management by a separate entity; and absence of day-to-day control of the customers/investors.

    Section 11AA of the SEBI Act defines a Collective Investment Scheme a pool of funds constituting of payments made by the investors, wherein such funds are utilized for the purposes of the scheme or arrangement and the contributions or payments are made with a view to receive profits, income, produce or property. Further, the investors do not have day-to-day control over the funds. SEBI requires such schemes to be registered under the CIS regulations. However, even if such schemes are unregistered, SEBI still has the right to regulate them under the proviso to Section 11AA.

    Conclusively, an investor under the CIS would be someone who would contribute to a pool of funds not controlled by himself with the objective of getting promised returns.

    JURISPRUDENTIAL ANALYSIS

    An Assured Returns Scheme ("ARS") is characteristically similar to a Collective Investment Scheme, the only difference being the control of property. In an ARS, the developer assures a certain rate of monthly return for every unit of property in the project in consideration for the purchaser paying up 90-100% of the unit value at the development phase of the project. Under the ARS, the developer also promises to complete the project within a specific date and hand over the possession of the property to the purchaser.

    This arrangement is favourable to the developer as he is able to raise funds at a lower cost and with no collateral. On the other hand, the scheme appears to be lucrative to the purchaser as he is promised an assured rate of return and will also be in possession of the property on the agreed date of completion.

    Conclusively, in an ARS, the investor has control over property while in a CIS, there is no such control but an ARS has the key three ingredients of a CIS, as suggested by the Dave Committee: pooling of investments; management by a separate entity; and absence of day-to-day control of the customers/investors. In the event that such property is not demarcated specifically, an ARS would come in the category of a CIS, as held by a Whole Time Member, SEBI.
    [6]

    When confusion befell over the ARS being under RERA jurisdiction or IBC jurisdiction, the National Company Law Appellate Tribunal held that amounts raised by developers under assured return schemes had the "commercial effect of a borrowing", which became clear from the developer's annual returns in which the amount raised was shown as "commitment charges" under the head "financial costs".

    [7]
    In addition, the inflows and outflows were distanced by time and there was a compensation for time value of money. As a result, such allottees were held to be "financial creditors" within the meaning of Section 5(7) of the Code.[8] This decision was further upheld by the Supreme Court in the Pioneer judgement.

    While this article does not pertain to the specifics of the HBN case, it would be interesting to look at one of the major reasons put forward by SEBI to favour its position. It stated that the objective of the IBC is to save the business and primacy is not given to the interests of the creditor/investor. The NCLT bench at Mumbai dealt with a similar factual matrix involving attachment of properties of a company which had floated a CIS without registration. When the Tribunal was adjudicating about the existence of a financial debt it held that:

    "There is no jural relationship in between this Petitioner and the Corporate Debtor because the contract purported to have been entered between this Petitioner and the Corporate Debtor is not recognised by any law, indeed there is a prohibition under SEBI Act to collect funds as mentioned under Section 11AA of the SEBI Act unless and until license for CIS has been granted by the SEBI."
    [9]

    In Appeal from the NCLT, Mumbai' bench's order, the NCLAT further reconciled the SEBI Act and the IBC and held as follows:

    "Having heard learned counsel for the appellant, while we agree that initiation of 'Corporate Insolvency Resolution Process' under 'I&B Company Appeal (AT) (Insolvency) No. 162 of 2017 Code' cannot be nullified by any order passed by SEBI nor can be a ground to reject an application under Section 9 of the 'I&B Code' but as there is an 'existence of dispute' with regard to the invoices raised by the Appellant-'Operational Creditor', we hold that the application under Section 9 of the 'I&B Code' was not maintainable."
    [10]

    While the NCLT Mumbai's approach might be a possible solution for the current case, there is no denying that if the CIS were legally registered under the SEBI Act and its regulations, there is no striking difference between a creditor under IBC and an investor in a CIS. Further, if one tries to form a logical sequence, if an ARS is essentially a CIS, and an ARS comes under IBC domain, would CIS not come under IBC domain too? This is an intersection in law that deserves to be interpreted by the Supreme Court soon.

    Authors: Saurabh Mishra is an Advocate on Record of Supreme Court of India. Charu Sharma is a third year student of National Law University, Jodhpur. Views are personal.


    [1] Order dated 30.4.2019 in C.A. No. 359(PB)/2019, National Company Law Tribunal, New Delhi, Principal Bench

    [2] Special Leave Petition (Civil) No.13678 of 2019

    [3] (2021) 9 SCC 657

    [4] (2019) 8 SCC 416

    [5] Ibid

    [6] In the matter of MVL Limited, 2014 SCC OnLine SEBI 73

    [7] Nikhil Mehta and Sons (HUF) v. AMR Infrastructure Ltd., 2017 SCC OnLine NCLAT 859

    [8] Ibid

    [9] Shobha Limited v. Pancard Clubs Ltd., 2017 SCC OnLine NCLT 7486

    [10] Sobha Limited v. Pancard Clubs Ltd., 2017 SCC OnLine NCLAT 606


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