NCLAT: Definition of financial debt under IBC does not use the expression that disbursement should be made to corporate debtor only

The National Company Law Appellate Tribunal (“NCLAT”), vide its order dated January 2, 2024, in the matter of Rajeev Kumar Jain v. Uno Minda Limited [2024 SCC OnLine NCLAT 28], has held that the definition of financial debt does not use the expression that disbursement should be made to the corporate debtor only. It further observed that the disbursement made on behalf, or at the instructions, of the corporate debtor will tantamount to disbursal made to the corporate debtor.

Facts

M/s. Unicast Autotech Private Limited (“Corporate Debtor”) was engaged in the business of manufacturing aluminium die casts and M/s. Uno Minda Limited (“Respondent”) was engaged in the business of supplying automotive solutions to original equipment manufacturers. Mr. Rajeev Kumar Jain (“Appellant”) was an ex-director and one of the shareholders of the Corporate Debtor.

The Corporate Debtor and its promoters including the Appellant approached the Respondent to discuss sale of 100% stake in the Corporate Debtor to the Respondent. The Appellant and other promoters of the Corporate Debtor agreed to transfer the Corporate Debtor along with its asset for INR 3 Crores against its outstanding dues through a Non-Binding Offer made by the Respondent (“NBO”).

In furtherance of the NBO, the Corporate Debtor and its promoters entered into a Business Support Agreement (“BSA”) with the Respondent. The BSA provided that the Respondent will acquire 100% shareholding of the Corporate Debtor and further agreed to supply raw material funding and critical capital working requirements and it was decided that all such money lent would be considered as unsecured debts given by the Respondent to the Corporate Debtor.

In May 2021, the Corporate Debtor approached the Respondent for further financial assistance. During discussions, the Respondent asked the promoters to pledge their entire shareholding in the Corporate Debtor and also furnish respective guarantees and accordingly the promoters along with its sister concern, M/s. Kiran Udyog Private Limited (collectively referred to as “Promoter Group”) pledged their shares, vide a Share Pledge Agreement dated May 12, 2021 (“SPA”), and issued the deed of guarantee.

The Respondent continued to provide support to the Corporate Debtor in acquiring goods required for its operations and between April, 2021 to May, 2021 certain payments were made by the Respondent amounting to INR 1.15 Crores. However, due to financial distress of the Corporate Debtor, the same could not be repaid to the Respondent.

Respondent issued a notice terminating the BSA and called upon the Promoter Group to repay INR 1.43 Crores as outstanding amount along with interest as per the BSA. The Appellant did not reply to the said notice. However, the Corporate Debtor repaid INR 24 Lakhs to the Respondent. The Respondent issued a legal notice for invoking guarantee furnished by the Promoter Group and calling them to pay outstanding dues and ultimately filed an application under Section 7 (Initiation of corporate insolvency resolution process by financial creditor) of the Insolvency and Bankruptcy Code, 2016 (“IBC”) which was admitted by the National Company Law Tribunal, New Delhi (“NCLT”), vide its order dated July 8, 2022 (“Impugned Order”).

Being aggrieved by the Impugned Order, the Appellant filed an appeal before the NCLAT.

Issue

Whether the debt given by the Respondent to the Corporate Debtor was a financial debt or an operational debt.

Arguments

Contentions of the Appellant:

The Appellant argued that the Impugned Order is illegal as there was no financial debt against the Corporate Debtor and the money owed to the Respondent could not have been treated as financial debt as no financial assistance has been provided by the Respondent and there was no time value of money involved.

The Appellant stated that the NCLT erred in concluding that the debt was a financial debt because it is secured by SPA and deed of guarantee, whereas the Corporate Debtor never agreed to repay the debt to the Respondent. The Appellant submitted that the understanding between the parties was that such unsecured debts would become payable only from the promoters.

The Appellant argued that except the BSA, the Respondent was also in charge of the Corporate Debtor, both in respect to company affairs and financial affairs and the Respondent cannot assume the character of a financial creditor.

Contentions of the Respondent:

The Respondent argued that the default was committed in making repayment to the Respondent and referred to several clauses of the BSA and SPA in support of its arguments that there was clear financial debt and not operational debt. The Respondent argued that the debt and the liability of the borrowers was an admitted position between the parties and once default takes place, it is the right of the financial creditors to approach NCLT. The Respondent contended that BSA was entered into by both the Corporate Debtor and its promoters and only the Corporate Debtor had been repaying the amount so far to the Respondent.

The Respondent highlighted that the BSA stated that both the Corporate Debtor as well as its promoters were to make the payments and also defined the joint and several liability on both the Corporate Debtor as well as its promoters.

Respondent denied that it was looking after the management of the Corporate Debtor and submitted that clause 3.2 of BSA was incorporated only to protect the financial interest of the Respondent, which provided that any withdrawal and borrowing of money or operation of the bank account of the Corporate Debtor was required to be approved by two persons, one from the Corporate Debtor and one from the Respondent.

Observations of the NCLAT

The NCLAT observed that financial debt means debt along with interest, if any. This means that interest is not sine qua non, therefore, interest may or may not be payable by the Corporate Debtor and it is the understanding between the parties which is significant and relevant to ascertain the existence of time value of money which can be in several forms, other than pure payment of interest.

The NCLAT observed that the definition of financial debt under Section 5(8) (Definition of ‘financial debt’) of IBC does not use the expression that disbursal should be made to a corporate debtor only. Hence, it can be implied that any disbursal made on behalf of the Corporate Debtor or at the instructions of the Corporate Debtor may also tantamount to disbursal made to the Corporate Debtor. The NCLAT also observed that the Corporate Debtor was the beneficiary of such disbursal made by the Respondent.

The NCLAT observed that the BSA, SPA and deed of guarantees were made jointly by the Corporate Debtor, its promoters and the Respondent. The Corporate Debtor procured raw material from vendors for which payments were made by the Respondent, at the instructions of the Corporate Debtor and therefore it assumes the character of financial debt. The NCLAT also observed that the Respondent was only supplying funds for working capital needs of the Corporate Debtor which is nothing but financial debt. The NCLAT observed that any financial assistance towards working capital cannot be treated as operational debt and has to be taken only as financial debt.

Decision of the NCLAT

In view of the above, the NCLAT held that there was a financial debt and default which was rightly appreciated by NCLT in the Impugned Order and accordingly the appeal was dismissed by NCLAT.

VA View:

The NCLAT has rightly observed that while ‘financial debt’ under IBC means a debt along with interest, if any, however the element of interest is not absolutely necessary and it is the understanding between the parties which is significant and relevant to ascertain the existence of time value of money which can be in several forms, other than pure payment of interest.

Further, NCLAT has correctly noted that the definition of financial debt under IBC does not use the expression that disbursement shall only be made to a corporate debtor. Therefore, NCLAT was correct in arriving at the conclusion that disbursement made on behalf, or at the instructions, of a corporate debtor will tantamount to disbursement made to a corporate debtor. Since the corporate debtor is the beneficiary in these scenarios, the disbursed amount shall assume the character of financial debt.

For any query, please write to Mr. Bomi Daruwala at [email protected]

Delhi High Court: Directors of a company cannot be made a party to an arbitration proceeding which has been initiated against the company by the virtue of the ‘group of companies doctrine’

The Delhi High Court, vide its judgement dated January 24, 2024, in the matter of Vingro Developers Private Limited v. Nitya Shree Developers Private Limited and Others [ARB.P. 667/2023], has held that directors of a company cannot be made a party to an arbitration proceeding which has been initiated against the company by the virtue of the ‘group of companies doctrine.’

Facts

Nitya Shree Developers Private Limited (“Respondent”) and Vingro Developers Private Limited (“Petitioner”) executed 12 Builder Buyer Agreements (“Agreements”) with respect to 12 plots of land in the project for the construction of a residential township project namely “RLF City”. The Agreements were signed by the director of the Respondent. The Respondent failed to deliver the possession of the plots to the Petitioner on the due date as per the Agreements, despite many reassurances from the Respondent. Accordingly, the Petitioner sent a legal notice, dated October 12, 2022, to the Respondent asking for a refund of the amount paid by the Petitioners along with the interest. However, the Petitioner was not satisfied by the reply of the Respondent and thereafter sent another notice dated December 10, 2022 but the said notice was not acknowledged by the Respondent.

Resultantly, arbitration was invoked by the Petitioner, vide a notice dated January 16, 2023, under Section 21 (Commencement of arbitral proceedings) of the Arbitration and Conciliation Act, 1996 (“Arbitration Act”) and as stipulated in the arbitration clause of the Agreements. Since no response from the Respondent was received by the Petitioner to the notice, a petition under Section 11 (Appointment of arbitrator) of Arbitration Act was filed by the Petitioner for seeking appointment of an arbitrator. The Petitioner added the directors of the Respondent as parties to the arbitration proceeding along with the Respondent. The directors of the Respondent were not signatories to the agreements.

Issue

Whether the non-signatories to an arbitration agreement, that is, the directors of a company are bound by the arbitration agreement by the virtue of the ‘group of companies doctrine’.

Arguments

Contentions of the Petitioner:

It was submitted by the Petitioner that the Petitioner agreed to buy a total of 12 plots of land from the Respondent in the project of the Respondent and in furtherance of the said purchase, the Petitioner made the advance payments before the execution of the Agreements as per the demand of the Respondent and the Petitioner also produced bank statements reflecting the records of payments made to the Respondent.

Further, it was submitted by the Petitioner that a total payment of INR 1,39,05,000 has been made by the Petitioner to the Respondent and the Petitioner has completely fulfilled its contractual duty and on the other hand, the Respondent has failed to do so. The Petitioner submitted that there were several attempts made by the Petitioner to contact the Respondent and there were many false reassurances by the Respondent for the timely delivery of the plots of land and initiation of full refund after failing to deliver the possession of the plots in due time.

It was also contended by the Petitioner that the directors of the Respondent are significant parties to the petition and to substantiate its claims, the Petitioner cited the decision of the Supreme Court in the case of Cox and Kings Limited v. SAP India Private Limited [Arbitration Petition (Civil) No. 38 of 2020] (“Cox and Kings Case”), wherein the Supreme Court upheld the ‘group of companies doctrine’ and its application to bind non-signatories to an arbitration agreement and the Supreme Court also observed that under Section 2(1) (Definition) read with Section 7 (Arbitration agreement) of the Arbitration Act, ‘parties’ include both signatories as well as non-signatories. Additionally, it was held that there exists a difference between non-signatories and third-parties, as non-signatories are those who express consent through means other than signatures.

The Petitioners further submitted that the director of Respondent is a signatory on the Agreements executed between the parties and the statement of account of the Petitioner which is maintained with the Respondent also bears the signatures of the said director. Further, since a combined response has been filed by the Respondent and its directors, therefore the directors cannot be separated from the Respondent.

Contentions of the Respondent:

It was contended by the Respondent that the directors of the Respondent are not parties to the Agreements and therefore, the present petition is liable to be dismissed. In order to substantiate its contentions, the Respondent relied upon the judgement of Sundaram Finance Limited v. T. Thankam, [(2015) 14 SCC 444], wherein it was held that in the case of more than one party to a petition, if there are those not covered under the arbitration agreement or those not party to the arbitration agreement, then such matter cannot be referred to arbitration against such parties.

The Respondent while relying upon clause 19 of the Agreements submitted that the Petitioner only paid an amount of INR 1,39,05,000 out of a total of INR 1,54,50,000 due for the 12 plots and therefore, the Petitioner cannot expect to be given possession for the same without full payment. It was submitted by the Respondent that the Respondent has completed the project and handed over the possession to many other bona-fide purchasers who paid up the complete cost of the plots. Additionally, the Petitioner was offered the possession of the 12 plots in 2017 within the promised time period and the Respondent requested for a full payment for the said plots. However, the Petitioner failed to pay the balance sum of INR 15,45,000 which was due for payment on December 30, 2016. Further, merely a notice was received by the Respondent on October 12, 2022, to which it duly replied.

The Respondent contended that its directors have merely acted in their capacity as directors and therefore they cannot be held personally liable. The Respondent also contended that since the Agreements were only executed between the Petitioner and Respondent, there exists no arbitration agreement wherein the directors of the Respondent are parties, therefore, the name of the directors may be deleted from the array of parties before referring the matter for arbitration.

Observations of the Delhi High Court

The Delhi High Court observed that the jurisdiction of the Delhi High Court in the present case is only limited to the examination of the existence of a prima facie arbitration agreement and not to analyse the other issues in the present case. Accordingly, it was noted by the Delhi High Court that it was evident that the current dispute could be referred to arbitration as there was an arbitrable dispute between the parties arising out of the Agreements which contained an arbitration clause.

It was observed by the Delhi High Court that the Respondent was the principal and the directors of the Respondent were merely agents of the Respondent. The Delhi High Court also took into consideration the findings of the Supreme Court in the Cox and Kings Case, wherein the Apex Court emphasised on the application of the ‘group of companies doctrine’ and held that in order to bind a non-signatory to an arbitration agreement, there must exist a common intention between the parties to do so. In the present case, in light of the principles of the Section 182 (“Agent” and “principal” defined) and Section 230 (Agent cannot personally enforce, nor be bound by, contracts on behalf of principal. Presumption of contract to contrary) of the Indian Contract Act, 1872 (“Contract Act”), the Delhi High Court observed that the relationship between Respondent and its directors is that of principal and agent. In light of the above, the Delhi High Court distinguished the Cox and Kings Case from the present case, as an intention to bind a non-signatory to the agreement between the parties cannot be discerned in the present case. The Delhi Court placed reliance on the case of Vivek Automobiles Limited v. Indian Incorporated [(2009) 17 SCC 657], wherein it was held that the agent could not be sued when the principal had been disclosed.

Thus, it was observed by the Delhi High Court that it becomes clear that subject to a contract to the contrary, the agent cannot be held liable for or be bound by contracts entered into or on behalf of the principal.

Decision of the Delhi High Court

The Delhi High Court held that the directors of the Respondent are not the parties to the arbitration agreement and they are only agents by virtue of being the directors of the Respondent. Therefore in the absence of a contract to the contrary, the directors cannot be held liable for the acts done by the principal, that is, the Respondent.

VA View:

The Delhi High Court analysed the current case against the backdrop of the Cox and Kings Case where the Apex Court has examined the applicability of ‘group of companies doctrine’. The Delhi High Court has also emphasised on the ‘separate legal entity’ concept which separates the members of a company from the company. In the present case, the Court examined the applicability of ‘group of companies doctrine’ in the context of Indian arbitration jurisprudence and the instances where a non-signatory can be made a party to an arbitration agreement involving multiple parties.

This case has emphasised the scope, extent, and limitation on the obligations of a director of a company by virtue of his position as a ‘director’. As per the Delhi High Court, there exists a relationship of principal-agent between a company and its directors, as envisaged in the Contract Act. Therefore, it was rightly held that under the ‘group of companies doctrine’ the directors of a company cannot be made a party to an arbitration agreement since the directors of a company are merely agents to the principal, that is, the company.

For any query, please write to Mr. Bomi Daruwala at [email protected]