PHOENIX ARC PVT. LTD. VS. SPADE FINANCIAL SERVICES LTD. : CASE SUMMARY
The Supreme Court in Phoenix Arc Pvt Ltd Vs Spade Financial Services Ltd AIR 2021 SC 776 held that Financial Creditors, who are related party in praesenti, are barred from becoming member of CoC under first proviso of Section 21 (2) of IBC. Such Financial Creditors are also barred from becoming members of CoC, who have ceased to be related parties only to circumvent the exclusion under first proviso of Section 21 (2) of IBC.
FACTS OF THE CASE
CIRP was initiated against the Corporate Debtor on an application filed by Operational Creditor under Section 9 of the Insolvency and Bankruptcy Code, 2016. During CIRP, Spade Financial Services Ltd filed its claim. AAA also filed its claim. IRP rejected the claim of Spade on the ground that the claim does not fall under Financial Debt. IRP also rejected claim of Spade on the ground that it has been filed after expiry of the period for filing claim. Aggrieved by the same Spade as well as Phoenix approached NCLT which allowed their application and directed the Resolution Professional to admit them in category of Financial Creditors.
Yes Bank and Phoenix filed Application before NCLT for exclusion of Spade and AAA from CoC claiming that they are related parties. NCLT held that transactions of Spade and AAA with Corporate Debtor are collusive and they do not qualify to be considered as Financial Creditors. NCLAT also affirmed the findings of the NCLT.
FINDINGS OF THE SUPREME COURT
Spade had entered into MoU with the Corporate Debor dated 12th August, 2011 through which Spade provided the Corporate Debtor ICD worth a net amount of Rs. 66 Crore from 1st June 2009 till January 2013 which provided 24 % interest. Spade gave security of these ICD through 37 flats worth 39.825 Crores in their real estate project Akme Raaga and through 11 plots worth Rs. 3 Crore. Out of ICD provided to the Corporate Debtor by Spade Rs. 43.06 Crore worth was credited to the Account of Mr. Arun Anand.
AAA has entered into Development Agreements on 1st March, 2012 through which the Corporate Debtor sold 38.3% of its development rights in real estate project AKME RAAGA to AAA for a consideration of Rs. 32.80 Crore. AAA also entered in Agreement of Sale dated 25th October, 2021 which superseded Development Agreement through which AAA bought a saleable area of 313,928 square feet in AKME RAGA at a price of 43.06 Crore.
Mr Anil Nanda is major shareholder of JIPL which holds 80% of shares of Corporate Debtor. Arun Anand was also director of the Corporate Debtor upto 31st March, 2002. Mr. Arun Anand and his son Mr. Aditya Anand sold their shareholding in Corporate Debtor in 2004/2005. Mr Arun Anand was also brother-in-law of Sonal Anand who was director of the Corporate Debtor from November 2007 to 2013. Mr. Arun Anand has worked in different capacities for Anil Nanda for about 25 years.
The Supreme Court held that order dated 31st May, 2018 whereby the NCLT directed the RP to consider the claim of AAA and Spade as Financial Creditor will not act as Res Judicata as Phoenix and Yes Bank were not parties in that application.
Whether Spade and AAA are Financial Creditors ?
The Supreme Court analysed the nature of “financial debt” and observed that money advanced as debt should be in possession of the borrower. The borrower is obligated to return the money or its equivalent along with consideration for time value of money. A transaction which is sham or collusive would only create an illusion that money have been disbursed to the borrower but in fact parties have entered into transaction with ulterior motive.
The Supreme Court in respect of transaction with Spade noted that Rate of interest being charged on ICD was 12% while interest rate stipulated in MoU was 24%. MoU is unregistered and unstamped. No interest has been paid on the alleged loan. MoU does not stipulate period of repayment. Entirety of ICDs were not disbursed to Spade. No Board Resolution was passed by Spade approving the grant of ICDs and the charge created on the loan was not registered with the Registrar of Companies. MoU was nothing but an eyewash and collusive.
AAA and Corporate Debtor has entered into multiple agreements in respect of the same property without giving any explanation about or rationale regarding variation in consideration. These transactions were collusive with purpose of diverting the properties of the Corporate Debtor to AAA.
The Supreme Court concluded that since commercial arrangements between the Corporate Debtor and Spade and AAA were collusive, they would not constitute financial debt. As such Spade and AAA will not be Financial Creditors.
Whether Spade and AAA are related Parties ?
The Supreme Court noted that Section 5 (24) defines related parties. The definition of related party is very broad. The intention of the legislature is to capture all kind of interrelationship between the Financial Creditor and the Corporate Debtor.
Mr. Arun Anand was in control of Spade and AAA during relevant period. He held positions in Corporate Debtor or the Anil Nanda Group of companies, which included the Corporate Debtor. Mr. Anil Nanda and Mr. Sonal Anand also held positions in the Corporate Debtor and JIPL during this period. There were deep entanglement between entities of Mr. Arun Anand and Mr. Anil Nanda. Mr. Arun Anand did hold positions during this period which could have been used by him to guide the Corporate Debtor.
The Supreme Court concluded that Corporate Debtor, AAA and Spade were related parties.
Whether Spade and AAA can be excluded from CoC ?
Section 21 (1) requires the IRP to constitute CoC after collating claims. The CoC consists of Financial Creditors. Proviso to Section 21 (2) bars such Financial Creditor to become member of CoC which are the related party of Corporate Debtor. The controversy in this case was in respect of word “is” as Spade and AAA were no longer related parties.
The Supreme Court observed that objects and purposes of the Code are best served when CIRP is driven by external creditors so as to ensure that the CoC is not sabotaged by related parties of the Corporate Debtor.
Prima facie it would appear that use of simple present tense in the first proviso to Section 21 (2) indicates that the disqualification applies in praesenti. But the first proviso has be interpreted in light of context, object and purpose for which it was enacted. The purpose of excluding a related party is to obviate conflict of interest which are likely to arise in event related party is allowed to become member of CoC.
The Supreme Court held that only those financial creditors who are related parties in praesenti would be debarred from CoC. Those related parties are also barred from CoC, who cease to be related parties in order to circumvent the exclusion under the first proviso of Section 21 (2).
The Supreme Court held that Spade and AAA had been correctly excluded from CoC.
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Mukesh Kumar Suman is an advocate and legal author based at Delhi. He regularly appears before various Judicial Forums including NCLT, NCLAT, High Courts and the Supreme Court. He can be approached at mukesh_suman@outlook.com or +91 9717864570.
