The Supreme Court (“SC”) by its judgement dated August 28, 2020 (“Judgment”) in the case of M/S Radha Exports (India) Private Limited v. K.P. Jayaram & Another [Civil Appeal No. 7474 of 2019] held that a personal loan to a promoter or director of a company cannot trigger the Corporate Insolvency Resolution Process (“CIRP”).

Facts

M/s Radha Exports (India) Private Limited (“Appellant Company”) filed an appeal under Section 62 of the Insolvency and Bankruptcy Code, 2016 (“IBC”), against an order of the National Company Law Appellate Tribunal (“NCLAT”). The brief background of the case is that, the National Company Law Tribunal (“NCLT”) had passed an order dated December 19, 2018 rejecting the application filed by Mr. K.P. Jayaram (“Respondent No. 1”) and Mrs. Shoba Jayaram (“Respondent No. 2”), (collectively “the Respondents”) under Section 7 of the IBC, inter alia, on the grounds that they were not financial creditors of the Appellant Company, and in any case the alleged claim of the Respondents was barred by limitation. Being aggrieved by the order of the NCLT, the Respondents preferred an appeal at the NCLAT. The NCLAT by a judgment and order dated September 02, 2019 allowed the appeal against the order passed by NCLT. Thereafter, being aggrieved by the order passed by the NCLAT, the Appellant Company filed this appeal at the Hon’ble Supreme Court.

The Appellant Company contended that the Respondents were closely acquainted with one Mr. M. Krishnan, and Mrs. Radha Gouri, who were the promoters of the Appellant Company. The Respondents had advanced an aggregated loan of INR 2.20 crores (unsecured and free of interest), to M/S Radha Exports, a proprietorship concern of Mrs. Radha Gouri, during the period between 2002 and 2004. Thereafter, the Appellant Company was incorporated under the Companies Act, 1956 on or about July 19, 2004, to take over the business of the proprietorship concern, M/s Radha Exports, along with its assets and liabilities. The Appellant Company stated that as on July 19, 2004, the proprietorship concern, M/s Radha Exports, had a loan liability of INR 1,11,85,350/-, which was taken over by the Appellant Company.

The Respondents requested the Appellant Company to convert a sum of INR 90,00,000/- from out of the said outstanding loan, as share application money for issuance of shares in the Appellant Company, in the name of the Respondent No. 2, and the same was confirmed by the Respondents, by their letter dated January 11, 2011, addressed to the Deputy Commissioner of Income Tax, Company Circle V(3), Chennai. Accordingly, a sum of INR 90,00,000/- was adjusted by the Appellant Company, as share application money, for issuance of shares of the Appellant Company in the name of the Respondent No. 2. Subsequently, the loan was repaid in full by the year 2006.

In October 2007, the Respondent No. 2 resigned from the Board of the Appellant Company. At the time of resignation, the Respondent No .2 requested the Appellant Company to treat the share application money of INR 90,00,000/- as share application money of Mr. M Krishnan and to issue shares of the value of INR 90,00,000/- in the name of Mr. M. Krishnan. The amount of share application money of INR 90,00,000/- transferred to Mr. M. Krishnan, was to be treated as a personal loan from the Respondent No. 2 to the said Mr. M. Krishnan.

Thereafter, by a legal notice dated November 19, 2012, the Respondents called upon the Appellant Company to repay to the Respondents a sum of INR 1,49,60,000/- alleged to be the outstanding debt of the Appellant Company, repayable to the Respondents as on July 19, 2004. By a letter dated December 05, 2012, the Appellant Company refuted the claim of the Respondents, whereupon the Respondents filed a petition in the High Court of Madras under Sections 433 (e) & (f) and 434 of the Companies Act 1956, for winding up of the Appellant Company. The said petition was transferred to the Chennai Bench of NCLT for adjudication. Thereafter, by an order dated August 04, 2017, the NCLT dismissed the said winding up petition, on the ground that the Respondents had failed to comply with the provisions of Section 7(3)(b) of the IBC. However, the order allowed the Respondents the liberty to withdraw the petition. Meanwhile the Respondents withdrew the said petition and consequently, on December 07, 2017, issued a fresh “demand notice” to the Appellant Company which was refuted by a letter dated December 14, 2017 by the Appellant Company, inter alia, claiming that all amounts due and payable by the Appellant Company or its predecessor-in-interest to the Respondents, had duly been paid within 2007 and 2008. The Respondents, thereafter, filed a petition under Section 9 of the IBC, as an operational creditor of the Appellant Company. However, the Respondents withdrew this case and filed a fresh petition under Section 7 of the IBC claiming principal amount of INR 2.10 Crores along with interest at the rate of 24% per annum from 2007, amounting to INR 4,41,60,000/-

Issues

Maintainability of the CIRP under Section 7 of the IBC initiated against the Appellant Company.

Observations of the Supreme Court

The SC observed that the NCLAT was not inclined to accept the submission of the Appellant Company, that the entire amount had been paid, for two purported reasons. The first reason was that the Correlation Statement showed payments of certain amounts amounting to INR 53,05,000/- in favour of Customs, Chennai and payments amounting to INR 1,75,000/- in favour of one Mr. Kulasekaran. The Respondents, as financial creditors, had disputed that these payments were towards the dues of the financial creditors. The second reason was that, if the total amount had been paid, there was no reason for the Appellant Company to take the plea that the amount was not payable, the same being barred by limitation.

In response to the second reasoning, the SC observed that it is well settled in law that alternative defences are permissible to contest a claim. It was thus open to the Appellant Company, to refute the claim of the Respondents by taking the plea of limitation and also to contend that no amount was in fact due and payable by the Appellant Company to the Respondents. The Court relied on Innoventive Industries Limited v. ICICI Bank and Another [(2018) 1 SCC 407] and B.K. Educational Services Private Limited v. Parag Gupta and Associates [(2019) 11 SCC 633] to hold that even otherwise, it was for the applicant invoking CIRP, to prima facie show the existence in his favour, of a legally recoverable debt, and once a debt, or even part thereof, becomes due and payable, the limitation period for resolution process begins. In other words, the Respondents had to show that the debt is not barred by limitation, which they failed to do.

The SC went on to observe that basis the letter signed by the Respondents, the Respondent No. 2 resigned from the Board of the Appellant Company and at that time the Respondent No. 2 requested the Appellant Company to treat the share application money of INR 90,00,000/- as share application money of Mr. M. Krishnan and to issue shares for aforesaid value to Mr. M. Krishnan. The amount was to be treated as a personal loan from the Respondent No. 2 to Mr. M. Krishnan, in essence, a personal loan to a promoter or a director of a company. Hence the same cannot trigger the CIRP under the IBC.

The SC importantly also observed the limited scope of proceedings/disputes that the NCLT may entertain to resolve under Section 7 of the IBC. The SC stated that the disputes as to whether the signatures of the Respondents are forged or whether records have been fabricated, can be adjudicated upon evidence including forensic evidence in a regular suit.

The SC further observed that the payment received for shares, duly issued to a third party at the request of the payee, as evident from official records, cannot be a debt, not to speak of financial debt.

Decision of the Supreme Court
In view of the above, SC held that personal loan to a promoter or a director of a company cannot trigger CIRP under the IBC.

Vaish Associates Advocates View

This judgement of the SC will herald a much-needed clarity on the nature of transactions within a company that can be included as “debt” under IBC. It has been made clear by the SC that the payment received for shares, duly issued to a third party at the request of the payee cannot be a debt at all under the IBC.

Thus, this judgement clears the air on complex transactions between promoters and directors in their individual capacity, absolving the company from any liability that can be construed as debt under IBC. This judgement therefore prevents the misuse of the IBC, for purposes of initiating CIRP for the recovery of money.

For more information please write to Mr. Bomi Daruwala at [email protected]

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