When it works, the IBC is supposed to pick up wrecked, defaulting companies, and, fuelled by money infused by new owners, propel them back into flight. The problem is that this transformation is not possible without a collective, almost consensus-based process that involves taking the blessing of multitudes of creditors, other stakeholders, and ultimately, courts. The complex, labyrinthine transactions that have to be unpicked, and the conflicting claims that have to be decided, lend themselves easily to costly litigation. What is more, the parties involved, mainly companies, have access to the best advisors, and Company Tribunals are understaffed, overburdened and just do not have sufficient time. Given these inherent problems, the Code is unworkable unless courts take a practical, outcome-based approach.
For a taste of the high stakes jostling for position that the corporate insolvency resolution process (CIRP) involves, and how hard it is for courts, one need look no further than the facts of the recent Supreme Court case of Phoenix Arc v. Spade Financial.
On 18 April 2018, a company called AKME Projects, part of the Anil Nanda Group, was declared insolvent, and its resolution process was ordered to commence. Creditors were invited to file their claims. Two of the claimants were a company called Spade, owned by Mr. Arun Anand and his family, and its subsidiary, another company called AAA. Other creditors objected to Spade and AAA getting the coveted tag of financial creditors (which brings with it the right to be paid before other creditors, together with membership of the Committee of Creditors, that controls the destiny of the corporate debtor during the CIRP). It was also alleged that these companies were related parties of the corporate debtor and were therefore ineligible, as per Section 21 of the IBC, to be members of the Committee of Creditors.
Financial creditors
The first issue to be determined was whether Spade and AAA were financial creditors. Spade made its claim on the basis of a Memorandum of Understanding by which it gave a deposit of Rs. 26.55 crores at an interest rate of 24% to the corporate debtor and other companies “on behalf” of the corporate debtor, which was, rather curiously, repayable in terms of the mutual agreement of parties. Although the contract expressly provided for interest to be paid at 24%, Spade stated that in actuality an interest of only 12% was charged, and its claim was on that basis. The agreement provided for a security for 37 flats and 11 plots, but the charge was not registered. There was no Board resolution authorising the deposit. It later transpired that even the interest rate of 12% was not paid to Spade. Looking at these facts, the Supreme Court concluded that the Memorandum of Understanding was “an eyewash”, a sham, and no consideration for the time value of money (a prerequisite for a financial debt) could be stated to be present. Spade’s claim was rejected.
As for AAA, it had entered into a Development Agreement with the corporate debtor for a sale consideration of Rs. 32.8 crores to purchase 38.3% development rights in a project. This was on 1 March 2012. However, the parties ran into legal issues in subdividing the development licence granted to the corporate debtor. To circumvent this problem, a few months later, on 25 October 2012, the Development Agreement was terminated and in its place were executed an Agreement to Sell, and a “side letter” (never a good document to produce in court when seeking to avoid being accused of executing a fraudulent transaction). The two new documents were contradictory. The Agreement to Sell was for purchase of flats. The sale consideration was Rs. 86.01 crores, of which AAA paid Rs. 43.06 crores as an advance payment. However, the side letter noted that the area bought by AAA was 38.3% of the project “AKME Raaga” and AAA would accordingly provide for various costs pertaining to its development. In other words, this was a development agreement by a different name. Inevitably, AAA’s claim, which hinged on the Agreement to Sell (and therefore the money paid under it) being held to be part of a genuine transaction to purchase flats, was rejected.
Related parties
Since neither Spade nor AAA were financial creditors, they were not eligible to be members of the Committee of Creditors of the corporate debtor. The statute that barred financial creditors who are related parties from participating in deliberations of the Committee of Creditors was completely irrelevant in their case. Therefore, the Supreme Court did not have to decide whether they were related parties. Nevertheless, the Court went into this question and decided it.
Even aside from the unfortunate fact that ‘Anand’ and ‘Nanda’ are anagrams of each other, this much was clear: there were numerous connections between the two and their companies, including the corporate debtor. To cite a few – Anand held the position of consultant to the corporate debtor, later became group CEO to the Anil Nanda Group of Companies, and was a director of a wholly owned subsidiary of the corporate debtor which also held shares in Spade. Another fact that tilted the scales against Spade and AAA was that the ongoing litigation between Spade and the corporate debtor started only after the IBC came into force, making it vulnerable to the charge of being created for optics. Despite all this, the problem that worried the Supreme Court in this case was that none of the connections between Spade, AAA and the corporate debtor existed any longer, and the disqualification in Section 21 clearly applies only to a creditor who “is” a related party, i.e. in the present tense.
The Court eventually decided that Spade and AAA had shrugged off the burden of being related parties by resorting to “commercial contrivances” with the intention of entering the CoC, and if the section was “purposively” interpreted, then the disqualification applied to them.
In short, it was not about to let the puny word “is” get in its way when it seemed clear to it that it was being taken for a ride. What is notable in all this is the fact that the Court did not knowfor sure about the commercial contrivances, since there was no trial, and IBC proceedings are summary in nature. It just smelled a rat. By holding as it did, the top Court essentially encouraged Tribunals to value practicality over certainty – cut through the complexities of designedly opaque corporate transactions with the razor of common sense, it seemed to say. Fair enough.
