Allahabad Bank v. Poonam Resorts: NCLAT’s Primer on Section 7
[Soham is an Associate at Vashi and Vashi Advocates and Solicitors, Mumbai.]
There is no gainsaying in the fact that whilst an insolvency application filed by an operational creditor can be denied admission on the grounds of a ‘pre-existing dispute’, the Insolvency and Bankruptcy Code 2016 (IBC) does not envisage entertaining similar objections in relation to an application filed with respect to financial debt, especially at the stage of admission. In cases of applications filed under Section 7 of the IBC (Section 7 Application), the National Company Law Tribunal (NCLT) merely has to ascertain the following:
whether there exists a default;
whether the application is complete in all respects; and
whether there are any pending disciplinary proceedings against the proposed resolution professional.
Accordingly, the objections that a financial creditor (FC) can statutorily take to oppose admission of a Section 7 Application include disputing the existence of the default itself. The NCLT, in a Section 7 Application, merely has to establish the existence of a default and is statutorily barred from going into disputed questions of fact, including but not limited to ascertaining the default amount. It is under such circumstances that the National Company Law Appellate Tribunal (NCLAT) recently had an opportunity to interpret and reaffirm the extremely limited scope of a Section 7 Application in the case of Allahabad Bank v. Poonam Resorts.
The FC in this case (i.e., Allahabad Bank) filed two applications under Section 7 of the IBC against Poonam Resorts and Link House Industries (Corporate Debtors) on the ground that the Corporate Debtors had committed default in respect of the financial debt which was due and payable, both in law and in fact, to the FC. The Corporate Debtors, in turn, raised objections under Section 75 of the IBC for furnishing of fraudulent information in the Section 7 Application against a commercially solvent company with the sole intent of prematurely triggering the corporate insolvency resolution process (CIRP) despite the Corporate Debtors being willing and capable to repay the due and outstanding amounts. Further, the Corporate Debtors also alleged that the FC had furnished false information in the records of the information utility and accordingly claimed that due diligence was not carried out during the sanctioning of the loans which had been disbursed to them.
NCLT Order: Extending the Shelf Life of Section 7 Application?
The NCLT observed that the Corporate Debtors had raised a preliminary issue on the physical disbursement of the loan amount into its account for the period between 5 April 2011 to 13 August 2018 and more particularly from 31 March 2012. Noting that there was a physical disbursement of INR 25 crores as of date, the NCLT opined that there were internal transfer entries made in certain bank accounts of the FC, including but not limited to escrow accounts, which the FC was unable to satisfactorily explain.
By taking cognizance of the impugned statement of accounts of the FC and more particularly, the application under Section 75 of the IBC moved by the Corporate Debtors against the FC, the NCLT held that the balance of convenience was tilted in favour of the Corporate Debtors and there existed a prima facie case for conducting proper diligence of the loan accounts sanctioned in favour of the Corporate Debtors. Accordingly, the NCLT proceeded to appoint an independent auditor firm to verify the legitimacy of the loan accounts.
NCLAT Reversing NCLT’s Folly?
Aggrieved by the NCLT order, the FC appealed to the NCLAT contending that the NCLT had erroneously ordered a forensic audit of the loan facilities, even though the Section 7 Application was complete in all respects. The FC also claimed that the instant applications were awaiting adjudication since September, 2019.
Relying upon the Supreme Court’s judgment in Innoventive Industries v. ICICI Bank, the NCLAT set aside the NCLT order and reiterated that the scope of the NCLT in a Section 7 Application is to merely ascertain the existence of a default. The NCLAT further went on to hold that Section 7(4) of the IBC statutorily recognizes the 14 day time limit within which the NCLT is required to ascertain default from the date of receipt of a Section 7 Application and observed that the very essence of the CIRP is resolution of stressed assets in a time bound manner. Allowing an audit of the loan facilities extended by the FC, in the NCLAT’s opinion, would do violence to the summary nature of Section 7 proceedings.
Assuming without admitting that the FC in any given case has failed to furnish adequate evidence, the NCLAT opined that in such circumstances, the NCLT is at liberty to pass appropriate orders as deemed necessary or in the event that the application is incomplete, return such application to the FC for rectifying the defect within 7 days of receipt of such notice by the NCLT. However, permitting a pre-admission inquiry cannot, under any circumstance, be allowed under the IBC.
In conclusion, the NCLAT sounded a word of caution and observed that since Section 75 of the IBC is a penal provision which requires a merit based inquiry and fact finding in respect of the commission of an offence by the FC, the Corporate Debtors cannot seek shelter under Section 75 to frustrate the provisions of the IBC under Section 7 at the stage of admission, unless a case of forgery and/or falsification of documents is prima facie and/or patently established. Noting that the common written submissions tendered before the NCLT by the parties records the liability of the Corporate Debtors in respect of the loan facilities availed by them, the NCLAT held that it would be apposite under law to prolong the admission process by way of a drawn out forensic audit and stated that the admission of a Section 7 Application cannot statutorily be predicated on the adjudication of a Section 75 application.
The Way Forward: Lessons for the Future
At the outset, it is crucial to understand that the NCLAT’s decision was rendered in the specific facts and circumstances of the instant case and by no means propounds a blanket provision of law. The NCLAT, whilst holding that allowing a pre-admission inquiry would be contrary to the provisions of the IBC, has also qualified the circumstances under which such an enquiry would be maintainable, i.e. when the tests of forgery and/or falsification of documents are patently and/or prima facie satisfied.
It is pertinent to note that the legislative wisdom behind the introduction of Section 75 in the IBC was to prevent corporate debtors from being dragged into insolvency even when they have the capacity to make payments of their dues. Since insolvency effectively acts as a commercial death warrant for the debtor company, the decision rendered by the NCLAT in the instant case, in no manner whatsoever, dilutes the safeguards provided to corporate debtors under the IBC. The IBC was enacted for resolution of stressed assets in a time bound manner – if creditors begin to weaponize the provisions of the IBC as a coercive recovery mechanism against unsuspecting debtors, the safeguard provided under Section 75 of the IBC can be optimized to prevent forceful and mala fide initiation of the CIRP.
Notably, the IBC does not permit corporate debtors to file an application under Section 75 of the IBC. Since Section 75 falls under Chapter VII of Part II of the IBC (which provides for Offences and Penalties), all offences under the IBC have to be tried by the Special Court set up under the Companies Act 2013. However, in an effort to provide corporate debtors with a remedy to redress false applications being filed under Section 7 to prematurely push a company into insolvency, the IBC allows corporate debtors to file applications under Section 65 which empowers the NCLT to impose civil sanctions by way of fines for mala fide initiation of the CIRP.
However, as outlined in the instant case, if the provisions of the IBC for safeguarding corporate debtors are used to solely prolong the admission of Section 7 Applications and as a recourse to stall imminent CIRPs, the protection offered by the provision shall cease to exist. It is crucial for the debtor company to satisfy to the NCLT, prima facie, that the initiation of the CIRP was mala fide and dishonest and is supported by misstatements and falsified documents.
With fresh proceedings under Sections 7, 9 and 10 of the IBC suspended by way of the IBC (Amendment) Ordinance 2020, pending Section 7 Applications in the emergent circumstances will potentially be taken up by NCLTs on a priority basis. Therefore, dilatory tactics to delay and/or stall admission of Section 7 Applications will not be looked upon favourably by the NCLTs, unless it is ex facie evident that the CIRP is sought to be initiated to prematurely coerce the corporate debtor into insolvency based on falsified documents and material misstatements.