By Pooja Punjabi Oberai | Pramod S. Prabhudesai
Chartered Accountants
11. Dr. Venkadasamy Venkataramanujan vs. Securities and Exchange Board of India, Mumbai [2021] 123 taxmann.com 126 (SAT-Mum.) Date of order: 7th February, 2020
Independent Director – Where appellant was inducted as an Independent Director of company and there was no finding that act of company in collection of funds under collective investment scheme without obtaining certificate of registration occurred with appellant’s knowledge or consent, order of SEBI prohibiting appellant from accessing securities market for four years could not be sustained and same was to be quashed
FACTS
The present appeal has been filed against the order of the whole-time member (‘WTM’) of the Securities and Exchange Board of India (‘SEBI’) who held that the scheme floated by the company was nothing but a collective investment scheme (‘CIS’) in terms of section 11AA of the SEBI Act, 1992 and that this was done without obtaining a certificate of registration as required u/s 12(1B) of the SEBI Act and Regulation 3 of the SEBI (Collective Investment Schemes) Regulations, 1999. The WTM had directed the company and its directors, including the appellant, to abstain from collecting any money from investors or to carry out any CIS, including the present scheme, and further to return the money so collected. The WTM further restrained the appellant and others from accessing the securities market and prohibited them from buying, selling or otherwise dealing in the securities market for a period of four years.
The appellant ‘V’, being one of the directors and being aggrieved by the order, has filed the present appeal.
‘V’ was appointed as an Independent Director on 26th February, 2015 and resigned on 21st July, 2015. His resignation was accepted by the company on 31st August, 2015 and intimated to the Registrar of Companies on 5th October, 2015.
‘V’ contended before the WTM and SAT that he was appointed in view of the requirement under the CIS Regulations for appointment of a professional as an Independent Director. ‘V’ was not a shareholder in the company, he was not directly associated with the persons who were running it, nor was he involved in its day-to-day running. He also urged that in view of section 149(12) of the Companies Act, 2013 an Independent Director cannot be held liable for such misfeasance which occurred without his knowledge.
It was also noted from the WTM order that ‘V’ has been held responsible only on the ground that part of the mobilisation of the fund was done during the period when he was appointed as a director.
HELD
The Tribunal came to the conclusion that the order insofar as it relates to ‘V’ cannot be sustained. There is no dispute about the fact that he was appointed as an Independent Director by the company in order to comply with the eligibility criteria for CIS application under the relevant Regulations. The Tribunal further noted that a specific assertion was made that ‘V’ did not attend any Board meeting which fact has not been disputed by the respondent. It also noted that ‘V’ was not directly associated with the persons having control over the affairs of the company, nor was he involved in the running of the company and this fact has been stated by the company itself. It was also emphasised that ‘V’ was not holding any shares in the company.
The mere fact that the company had mobilised certain funds under the CIS during the short period when ‘V’ was an Independent Director would not by itself make him liable for the misfeasance committed by the company unless it is shown that he was also involved in the decision-making process or in the collection of the funds. Neither of the two elements was present in the instant case.
The Tribunal further noted the provisions of section 149(12) of the Companies Act, 2013 and observed that a perusal of the same makes it clear that an Independent Director shall be held liable only in respect of such acts of omission or commission by a company which had occurred with his knowledge, attributable through a Board process, and with his consent or connivance, or where he had not acted diligently.
In the instant case, there is no finding by the WTM that the acts of the company in the collection of the funds had occurred with the knowledge of ‘V’ or that he was part of the decision-making processes through Board’s resolution, or that the activities of the company were being done with his consent or connivance.
The Tribunal observed that there is no finding that ‘V’ had not acted diligently. In fact, the record indicates that he was only appointed for a period of five months and had not attended any meeting of the Board.
Hence, the Tribunal held that the order insofar as ‘V’ is concerned cannot be sustained and quashed the order passed by the WTM.
12. Union of India, Ministry of Corporate Affairs vs. Mukesh Maneklal Choksi [2019] 101 taxmann.com 98 (NCLT-Mum.) Date of order: 3rd January, 2019
Where family members of statutory auditor were shareholders of the company and statutory auditor had issued audit report without examining books of accounts of company, provisions of section 143(3)(d) of the Companies Act, 2013 had been violated and statutory auditor would cease to function as statutory auditor of the company
FACTS
A complaint was filed alleging that shares of the respondent company were not listed on the Pune Stock Exchange. There was siphoning of investors’ money and the company had not issued financial statements after 1995.
The Inspecting Officer u/s 207(3) of the Companies Act, 2013 issued summons to all the directors of the respondent company in addition to R1, who were the Statutory Auditors of the respondent company for the financial years 2014-15 and 2015-16.
The Statutory Auditor in his statements stated that he had not audited the books of accounts of the company. However, he had signed the Audit Report of the company for the relevant period.
The petitioner Ministry of Corporate Affairs (MCA) filed a petition u/s 140(5) of the Companies Act, 2013 for direction that R1 should immediately cease to function as Statutory Auditor of the respondent company. It was also prayed that MCA be permitted to appoint an independent auditor to replace R1 in terms of the first proviso to section 140(5) of the Companies Act, 2013 read with Explanation 1 thereto.
HELD
The Tribunal on perusal of the application noted that the respondent company is not listed on any stock exchange despite the assurances given in the prospectus dated 10th October, 1996 and its present directors are apparently dummy / shadow directors of the company. The Chairman had dodged his responsibilities to assist in the inspection and it was further noted that all the commonly-known attributes of a shell company were in existence in the case of the company under inspection.
Relying on the statement on the oath of R1, it was clear that R1, i.e., the statutory auditor, has failed to exercise his duty and has further stated that he has issued the Audit Report even without examining any of the records / books of accounts of the company.
It is recorded that family members of R1 are shareholders of the respondent company, whereas section 141(3)(d) of the Companies Act, 2013 specifically prohibits a statutory auditor being appointed as such if his relative or partner is holding any security or interest in the company.
The Tribunal further noted that issuing the audit report of the company even without examining any books of accounts is a clear-cut violation of the statutory provision of section 141(3)(d) of the Companies Act, 2013.
Under the circumstances, the Tribunal ordered that R1 shall immediately cease to function as statutory auditor of the company. The MCA is permitted to appoint an independent auditor for the respondent company to replace R1 in terms of the first proviso to section 140(5) of the Companies Act, 2013 read with Explanation 1 thereto.
13. Phoenix Arc Pvt. Ltd. vs. Spade Financial Services Ltd. Civil Appeal No. 2842 of 2020 (SC) Date of order: 1st February, 2021
Sections 5(7), 5(8) and first proviso to section 21(2) of Insolvency and Bankruptcy Code, 2016 – Parties would not be regarded as Financial Creditors if they entered into collusive or sham transaction with Corporate Debtor – The transaction could not be regarded as financial debt – Parties would qualify as related party and excluded from COC if they were related at the time of creation of debt but ceased to be related parties when CIRP was initiated for the purpose of gaining a backdoor entry to the COC
FACTS
Corporate Insolvency Resolution Process (‘CIRP’) was initiated against P Co (‘Corporate Debtor’) on 18th April, 2018 by an operational creditor, Mr. H. During the process of CIRP, the Resolution Professional (‘RP’) invited claims. S Co filed its claim as a financial creditor in Form C for a sum of Rs. 52.96 crores on 10th May, 2018. S Co later revised its form to submit a claim of Rs. 109.11 crores. The basis for filing these claims was an MOU dated 12th August, 2011 which stated that inter-corporate deposits (‘ICDs’) of Rs. 26.55 crores were granted to the Corporate Debtor by S Co bearing an interest rate of 24%. Subsequently, it was submitted that ICDs worth Rs. 66 crores were granted to the Corporate Debtor between June, 2009 and January, 2013.
AAA filed its claim before the IRP in form F as a creditor other than financial or operational creditor for a sum of Rs. 109.72 crores on 23rd May, 2018. It had entered into a Development Agreement dated 1st March, 2012 with the Corporate Debtor to purchase development rights in a project. On 25th October, 2012 the Development Agreement was terminated and an agreement to sell, along with a side letter, was executed between AAA and the Corporate Debtor for purchase of flats. The sale consideration for the agreement to sell was enhanced to Rs. 86,01,00,000 from Rs. 32,80,00,000 under the Development Agreement. AAA paid a sum of Rs. 43.06 crores which along with interest at the rate of 18% increased to Rs. 109.72 crores.
The Committee of creditors (‘COC’) was established on 22nd May, 2018. On 25th May, 2018 the IRP rejected the claim of Spade inter alia on the ground that the claim was not in the nature of a financial debt in terms of section 5(8) of IBC since there was an absence of consideration for the time value of money, i.e., the period of repayment of the claimed ICDs was not stipulated. The IRP also rejected the claim of AAA on the ground that its claim as a financial creditor in Form C was filed after the expiry of the period for filing such a claim.
Phoenix was a part of the COC on the basis of its claim arising from a registered Deed of Assignment in its favour dated 28th December, 2015 pursuant to which Karnataka Bank Limited had assigned the non-performing assets relating to the credit facilities granted to the Corporate Debtor.
AAA and Spade filed an application before the National Company Law Tribunal (‘NCLT’) to be included in the COC. The NCLT on 30th May, 2018 allowed these applications where none of the other creditors such as Yes Bank or Phoenix were present. As a result of the inclusion of AAA and Spade, the voting share of Phoenix in the COC was reduced to 4.28%.
Yes Bank and Phoenix filed an application before the NCLT to exclude AAA and Spade from the COC on the ground that they were related parties. Upon hearing the submissions, NCLT held that the transactions between the Corporate Debtor and both SPADE and AAA were collusive in nature. Accordingly, they did not qualify to be considered as financial creditors. NCLT took note of the first proviso to section 21(2) of the IBC, which stated that a financial creditor who is a related party of the Corporate Debtor shall not have the right of representation, participation or voting in the COC. Therefore, the application of Yes Bank and Phoenix for exclusion of Spade and AAA was upheld by the Court.
NCLAT upheld the view taken by the NCLT to exclude Spade and AAA from the COC. However, there was an inadvertent observation that ‘admittedly’ Spade and AAA were financial creditors of the Corporate Debtor. Mr. Anil Nanda, in concert with Mr. Arun Anand and his family, had created a web of companies which were related parties to the Corporate Debtor and was now trying to gain a backdoor entry into the COC through them. Phoenix and Yes Bank thus filed an appeal before the Supreme Court challenging the observation of NCLAT that Spade and AAA were financial creditors to the Corporate Debtor.
HELD
The Supreme Court examined in detail the transactions between the Corporate Debtor, Spade and AAA which gave rise to their claims as Financial Creditors.
In the case of Spade, it was observed that the MOU dated 12th August, 2011 which provided ICDs to the Corporate Debtor charged interest at the rate of 24%. However, Spade has stated that actually only 12% interest was charged and hence its claim is on that basis. The Corporate Debtor through this MOU provided security for the ICDs through 37 flats worth Rs. 39.825 crores in their real estate project, AKME RAAGA. Further, additional security was provided through 11 plots worth Rs. 3 crores in another project. The charge was not registered. Out of the ICDs provided to the Corporate Debtor by Spade, Rs. 43.06 crores’ worth were credited to the account of Mr. Arun Anand by consent. However, this has been disputed by Spade.
As for AAA, the Supreme Court noted that the Development Agreement dated 1st March, 2012 was superseded by an agreement to sell dated 25th October, 2012 through which AAA bought a saleable area of 313,928 sq. ft. in AKME RAAGA at a price of Rs. 43.06 crores. A side letter executed on the same day noted that the area bought by AAA was 38.3% of AKME RAAGA and AAA would provide for the cost of its development accordingly.
The Supreme Court also observed that there was a close relationship between the key managerial personnel of the Corporate Debtor, Mr. Anil Nanda, and the director of Spade and AAA, Mr. Arun Anand.
The Court heard the parties at length and also their submissions on the issues.
The submission of the Corporate Debtor that the order of the NCLT dated 31st May, 2018 where it admitted AAA and Spade as financial creditors operated as res judicata was rejected by the Supreme Court on the grounds that other creditors were not heard. The order was passed without giving them an opportunity of being heard.
The next submission of the Corporate Debtor that the issue of the eligibility of Spade and AAA as financial creditors was never raised before the NCLT was found to be contrary to the material produced on record.
The next issue raised by the Corporate Debtor was that NCLAT acted beyond jurisdiction in the appeal filed by AAA and Spade in inquiring into whether they are related parties. This submission was also not accepted by the Supreme Court.
The primary contention of Phoenix and Yes Bank before the Supreme Court was to challenge the observation of the NCLAT that it was an admitted position that AAA and Spade are financial creditors. The Supreme Court examined the provisions of sections 5(7) and 5(8) of the Code which define the terms financial creditor and financial debt, respectively.
The Supreme Court observed that money advanced as debt should be in the receipt of the borrower. The borrower is obligated to return the money or its equivalent along with the consideration for a time value of money, which is the compensation or price payable for the period of time for which the money is lent. A transaction which is sham or collusive would only create an illusion that money has been disbursed to a borrower with the object of receiving consideration in the form of time value of money, when in fact the parties have entered into the transaction with a different or an ulterior motive.
Further, the Court observed that for the success of an insolvency regime the real nature of the transactions has to be unearthed in order to prevent any person from taking undue benefit of its provisions to the detriment of the rights of legitimate creditors.
Relying on the observations of the NCLT and the submissions made by Yes Bank, Phoenix and the Corporate Debtor, the Court held that the MOU entered between Spade and the Corporate Debtor was an eye-wash and collusive in nature. Similarly, the Corporate Debtor and AAA converted the Development Agreement into an agreement to sell executed along with a side letter to circumvent the legal prohibition on splitting a development license in two parts. The transaction between AAA and the Corporate Debtor was also held to be collusive in nature.
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.
The Supreme Court took note of section 5(24) of the Code which defines the term ‘related party’ along with the detailed submissions of the parties on the relationship of key managerial personnel. It was observed that the definition of ‘related party’ under the Code was significantly broad. The intention of the Legislature in adopting such a broad definition was to capture all kinds of inter-relationships between the financial creditor and the Corporate Debtor.
It was observed that Mr. Arun Anand has held multiple positions in companies which form part of the Anil Nanda Group of Companies. Further, Mr. Anil Nanda has himself invested in companies owned by Mr. Arun Anand and had commercial transactions with them. Through Spade and AAA’s own admission, Mr. Arun Anand was appointed as the Group CEO of the Anil Nanda Group of Companies (for however short a period) on circular approval by Mr. Anil Nanda himself. Finally, Mr. Arun Anand’s brother in-law, Mr. Sonal Anand, has also been consistently associated with companies in the Anil Nanda Group of Companies, including the Corporate Debtor.
It was observed that there was a deep entanglement between the entities of Mr. Arun Anand and Mr. Anil Nanda, and Mr. Arun Anand did hold positions during this period which could have been used by him to guide the affairs of the Corporate Debtor. Based on this, the Supreme Court upheld the conclusion of the NCLAT that Mr. Arun Anand would be a related party of the Corporate Debtor in accordance with section 5(24)(h) and section 5(24)(m)(i). Mr. Arun Anand, Spade and AAA were related parties of the Corporate Debtor during the relevant period when the transactions on the basis of which Spade and AAA claimed their status as financial creditors took place.
The Supreme Court further noted that the COC is comprised of financial creditors, under loan and debt contracts, who have the right to vote on decisions, and operational creditors such as employees, rental obligations, utilities payments and trade credit, who can participate in the COC but do not have the right to vote. The aim of the COC is to enable coordination between various creditors so as to ensure that the interests of all stakeholders are balanced and the value of the assets of the entity in financial distress is maximised.
In the context of the first proviso to section 21(2), the issue before the Supreme Court was whether the disqualification under the proviso would attach to a financial creditor only in praesenti, or whether the disqualification also extends to those financial creditors who were related to the corporate debtor at the time of acquiring the debt.
The Court held that where a financial creditor seeks a position on the COC on the basis of a debt which was created when it was a related party of the corporate debtor, the exclusion which is created by the first proviso to section 21(2) must apply. If the definition of the expression ‘related party’ u/s 5(24) applies at the time when the debt was created, the exclusion in the first proviso to section 21(2) would stand attracted.
The Supreme Court further clarified 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.
Thus, the default rule under the first proviso to section 21(2) is that only those financial creditors that are related parties in praesenti would be debarred from the COC, those 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.
The Supreme Court concluded that Spade and AAA were not financial creditors of the Corporate Debtor and accordingly the NCLAT observation to that extent was set aside. The exclusion of Spade and AAA from the COC was upheld for the reasons stated above.
