IBC: The Balance Sheet-Acknowledgment Saga Settles, But There is Something More Concerning
[Kumari is a student at National Law University, Delhi.]
On 15 April 2021, a 3-judge bench of the Supreme Court (SC) in ARCIL v Bishal Jaiswal (Bishal-II) has finally held that balance-sheet entries are not barred from being treated as acknowledgment of liability under Section 18 of the Limitation Act 1963 (Limitation Act) and whether a particular entry therein amounts to acknowledgment or not would be a fact-specific inquiry. It thus overruled Bishal Jaiswal v ARCIL (Bishal) (NCLAT 5-member bench). It also overruled the majority’s decision in V. Padmakumar v SASF (Padmakumar) (NCLAT 5-member bench) and upheld the minority decision of Justice AIS Cheema therein.
While this article celebrates the SC’s final decision on the specific issue of balance-sheet-acknowledgment, it argues that the SC failed to test this issue on the substantive principle of Section 18 (acknowledgment). This failure is critical because even though that principle was laid down long ago, later decisions have not maintained a normative clarity in that regard. Thus, while settling the issue of balance-sheet as an acknowledgement of debt, the SC lost the opportunity to reinforce a principle which is essential for Section 18 jurisprudence.
Principles underlying Section 18, Limitation Act
As per Section 18, if a debtor, in writing, acknowledges his liability regarding his debt at any time during the prescribed limitation period qua that debt, the limitation period gets renewed from the date the acknowledgment was signed. The law does not prescribe any specific document that should contain the acknowledgment. So, there is no question of prima facie rejecting balance-sheets as acknowledgment. What is essential for testing a document on Section 18 is that (a) it fulfils the Section 18 requirements and (b) the statement was made with an intention to admit the jural relationship of debtor-creditor (SF Mazada v Durga Prosad Chamaria (Mazada), LC Mills v Aluminum Corporation). This article does not focus on the former, which is a technical requirement. Rather, it deals with the latter, substantive principle.
The balance-sheet story so far: pre-IBC
Balance-sheet, by mentioning a company’s liabilities, categorically admits the jural relationship of debtor-creditor. Nevertheless, the argument against it is that since balance-sheet is legally mandated to be filed every year, any admission made therein is not made with an intention to admit, hence, would not amount to acknowledgment (B. Rukmananand v Official Liquidator). However, this argument has been consistently rejected, most authoritatively by the Calcutta HC in Bengal Silk v Ismail Golam (Bengal Silk). Bengal Silk held that despite balance-sheets being legally mandated, there is no legal compulsion regarding any particular admission therein and the admissions are nevertheless conscious and voluntary admissions.
However, it stopped there and did not explain the procedure to determine whether a particular admission is voluntary or not since a company is required to truly report all of its existing liabilities in balance-sheets. Given that, the author believes that later cases should have engaged more on this procedural aspect to completely settle this issue which they did not do. Nevertheless, Bengal Silk’s ratio has consistently been applied by later cases in accepting balance-sheet entries as acknowledgment. It was only in 2020 when certain NCLAT decisions deviated from this settled position in context of the Insolvency and Bankruptcy Code 2016 (IBC).
The settled story unsettles: post-IBC
Balance-sheet acknowledgment outside IBC continued to follow Bengal Silk. However, in IBC context, in February 2020, a two-judge NCLAT bench in G Eswara Rao v SASF, without even engaging with Bengal Silk, held that balance-sheet entries would not amount to acknowledgment due to the attached legal compulsion. Further, it held that accepting such entries as acknowledgment would render law of limitation irrelevant as with every year’s balance-sheet, limitation would keep on shifting indefinitely. In March 2020, the majority in Padmakumar just reiterated these reasonings without any engagement. Padmakumar was not appealed against, but in September 2020, a 3-member bench referred the majority’s decision in Padmakumar for reconsideration by a larger bench. In December 2020, the reference got rejected and Padmakumar got affirmed by a 5-member NCLAT bench in Bishal. Bishal then got appealed before the SC and hence came Bishal-II.
A recent development
In August 2020, in Babulal V. Gurjar v Veer Gurjar, the SC made various observations on the application of the Limitation Act to proceedings under the IBC in light of the latter’s objectives. It further held that Section 18 benefit would not accrue to the facts of that case. However, it did not make any general observation on Section 18. But later NCLAT/NCLT judgments like Bishal and some others had misinterpreted the fact-specific holding of Babulal to observe that Section 18 does not apply to IBC proceedings at all, hence no question of applying Section 18 to balance-sheets arises. So, as the law post-Bishal stood, Section 18 was made inapplicable to IBC cases without any rationale. However, soon the SC in Sesh Nath Singh v Baidyabati and Laxmi Pat v Union Of India clarified that Section 18 indeed applies to IBC proceedings. However, the balance-sheet issue was not yet settled. Against this background came the much-needed pronouncement by the SC in Bishal-II.
Bishal-II – things said, unsaid
Bishal-II observed that a balance-sheet, forming part of the annual financial statement (Sections 129-34, Companies Act 2013 (Companies Act)) is accompanied by some notes and the auditor’s report (Section 134(7)). Either of the two may contain certain caveats/information regarding any particular liability in the balance-sheet. Such caveat/information, when read together with the balance-sheet may negate the acknowledgment of that liability in certain cases. It would thus be a fact-specific inquiry to decide whether a particular balance-sheet entry is unequivocal or is qualified.
In other words, the option with the companies to qualify a particular liability with some caveats in the notes negates the argument that balance-sheet entries are legally compelled entries. So, for example, if a company owes a debt whose limitation would expire in some time from the date of signing of the balance-sheet, legally it cannot conceal this liability in the balance-sheet (for balance-sheet has to contain a true and fair view of the company’s assets/liabilities – Section 129, Companies Act), but if it mentions the liability, it will become an acknowledgment. However, applying Bishal-II, the notes or auditor’s report may mention a statement like, ‘the debt would become time-barred soon and the company does not intend to acknowledge that liability’. Thus, reading the balance-sheet together with this statement would negate the acknowledgment.
This way, Bishal-II rightly held that a company may negate an acknowledgment qua a particular balance-sheet entry if there is such mention in the notes/auditor’s report. However, it failed to hold whether such negation means the negation of an intention to admit the debtor-creditor relationship or not. The next section highlights this point further.
The substantive angle of ‘intention to admit the jural relationship’
As discussed earlier, the intention to admit the jural relationship is key to Section 18 as seminally pronounced by the SC in Mazada, LC Mills and other prominent cases. However, regarding balance-sheets, this element has been conveniently ignored over time, and Bishal-II has been no better.
The law established by Mazada is that for a statement to be considered as acknowledgment, it should not only establish the existence of a jural relationship (debtor-creditor), but more importantly, it should also contain an intention to admit such jural relationship. However, this intention does not have to be for the specific purpose of extending the limitation. But Bishal-II held in paragraph 12 that per Mazada, all that is important is whether the acknowledgment establishes the existence of a jural relationship or not. It did not talk about the element of intention, hence sidetracked itself from the substantive principle of Section 18.
A substantive analysis would suggest that a balance-sheet entry if qualified by some notes that shows an intention-not-to-admit-the-jural relationship, it would deny acknowledgment. But if an entry is not so qualified, an intention-to-admit would be presumed because the directors had an option that they did not exercise. This way, if a passing reference is made in the notes regarding a particular liability but that is not of a nature that negates the intention-to-admit-the-jural-relationship, it would not amount to negation, and acknowledgment would be presumed. In other words, if a clear intention is required for acknowledgment, a clear intention has to be there for negation of acknowledgment. Bishal-II did not undertake this analysis.
Bishal-II held that the caveats in the notes would be read together with the balance sheet to see if the admission is unequivocal or qualified. So, this way, it suggested the correct procedure to determine if there is acknowledgment or not. However, it should have gone a step ahead to hold that the notes should contain an intended denial of jural relationship; it could not do so because it had already recused itself from the substantive element of intention.
Conclusion and future implications
With Bishal-II, the SC may have rightly settled the balance-sheet-acknowledgment issue for good, but its reasoning in arriving at its decision lacks a discussion on the substantive element of Section 18, i.e., intention to admit the jural relationship. While this omission may/may not impact the balance-sheet issue, its larger implication would arise when (emphasis intended) a future discussion on section 18 regarding some other document arises – where the courts may be expected to test it on the substantive element and Bishal-II would be a problematic precedent. Further, on a much broader level, it is a worrying trend being set by the SC where, in engaging with the specific facts of the cases, the court has been losing sight of the core principles of the laws to be applied to those facts. This should be concerning for it may jeopardize the process of a nuanced evolution of the laws with the Tata-Mistry and Bishal-II cases being prominent examples of this trend.