The Supreme Court held that the Collusive or sham transactions with a corporate debtor will not amount to ‘financial debt’ under the Insolvency and Bankruptcy Code 2016.
The appellant, Phoenix Arc Private Limited raised two sets of appeal wherein it challenged the order of the National Company Law Appellate Tribunal (NCLAT).
The NCLAT dismissed the appeal under Section 61 of the Insolvency and Bankruptcy Code, 2016 preferred by AAA Landmark Private Limited and Spade Financial Services Private Limited to assail the order NCLT.
The NCLT had held that AAA and Spade have to be excluded from the Committee of Creditors (CoC) formed in relation to the Corporate Insolvency Resolution Process (CIRP) initiated against AKME Projects Limited, who is a Corporate Debtor. NCLT passed its order on an application filed by Phoenix Arc Private Limited and YES Bank under Section 60(5)(c) of the IBC.
The other issue raised was whether AAA and Spade are financial creditors, NCLT in its July 2019 order had noted that AAA and the Corporate Debtor had entered into multiple agreements regarding the same property without giving any explanation or rationale regarding variation in the consideration.
The appellant submitted that though the NCLAT correctly dismissed the appeal filed by Spade and AAA, holding that they are related parties of the Corporate Debtor and are hence to be excluded from the CoC, there is an erroneous finding that they are financial creditors.
The appeal by Phoenix challenged the NCLAT order on the grounds that it was contrary to the record; and both AAA and Spade are not even creditors of the corporate debtor, much less financial creditors.
The three judge bench of Justices Dr Dhananjaya Y Chandrachud, Indu Malhotra and Indira Banerjee held that the exclusion under the first proviso to Section 21(2) is related not to the debt itself but to the relationship existing between a related party financial creditor and the corporate debtor.
The court said that as such, the financial creditor, who in praesenti is not a related party, would not be debarred from being a member of the CoC.
The Court further held that in case where the related party financial creditor divests itself of its shareholding or ceases to become a related party in a business capacity with the sole intention of participating the CoC and sabotage the CIRP, by diluting the vote share of other creditors or otherwise, it would be in keeping with the object and purpose of the first proviso to Section 21(2), to consider the former related party creditor, as one debarred under the first proviso.
The Supreme Court noted that the transactions were collusive in nature entered with the purpose of diverting properties of the Corporate Debtor to AAA.
“Since the commercial arrangements between Spade and AAA, and the Corporate Debtor were collusive in nature, they would not constitute a ‘financial debt’. Hence, Spade and AAA are not financial creditors of the Corporate Debtor,” it added.
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