Between the Lines | NCLAT: The occurrence of a default, and not the inability to pay debt is relevant for admitting or rejecting an application for initiation of CIRP under the IBC

The National Company Law Appellate Tribunal (“NCLAT”) in the case of Monotrone Leasing Private Limited v. PM Cold Storage Private Limited (decided on July 6, 2020) has held that the inability to pay-off debts and committing default are different aspects which are required to be adjudged on equally different parameters, and that ascertaining commission of default is important when assessing applications to initiate Corporate Insolvency Resolution Process (“CIRP”) rather than the ability to pay.

Facts and Arguments
Monotrone Leasing Private Limited (“Appellant”) filed an application under Section 7 of the Insolvency and Bankruptcy Code, 2016 (“IBC”) against the PM Cold Storage Private Limited (“Respondent”) for initiation of CIRP on the ground that the Respondent committed default in repaying a financial debt of INR 27,19,110.

The Appellant contends that it had lent a sum of INR 25 lacs to the Respondent for 90 days, on which interest was to be charged at the rate of 15% per annum. The Respondent acknowledged receipt of the same by a letter dated June 14, 2017 which further stated the terms of the transaction. The Respondent issued a post-dated cheque on September 12, 2017 for a sum of INR 25 lacs drawn on State Bank of India in favor of the Appellant. But, even after September 12, 2017 the loan transaction between the parties was extended for a further period of one year. Subsequently, the Respondent handed over a post-dated cheque of INR 25 lacs dated October 09, 2018, which was dishonored.

A notice under Section 138 of the Negotiable Instruments Act, 1881 was served upon Respondent on November 01, 2018. The Respondent contended that no debt is due and payable to the Appellant, as the amount borrowed from it had been “squared off” due to a large number of transactions between the parties after which a civil suit was initiated for the recovery of the alleged amount. Subsequently, the Appellant filed for an application to initiate CIRP under Section 7 of the IBC before the National Company Law Tribunal, Kolkata (“NCLT”).

The NCLT rejected the application on the ground that the NCLT cannot act as a recovery tribunal, especially as the Appellant could not produce the required documents to show that it received any application from the Respondent for the loan. The Appellant did not produce the record of default from the information utility which is required under Section 7(3)(a) of the IBC.

The NCLT further noted that the competent civil court having jurisdiction found that there exists a prima facie case in favor of the Respondent and has issued interim prohibitory order against the Appellant restricting the Appellant from recovering the amount claimed herein. It further noted that the Respondent has filed a financial statement showing a balance of more than INR 25 lacs which shows that it is a solvent company. This was subsequently appealed by the Appellant before the NCLAT.

Issue
Whether the application under Section 7 of the IBC is maintainable.

Observations of the NCLAT

An adverse inference was drawn against the Appellant on account of non-submission of documents required for obtaining a loan from an NBFC. However, it was also observed that the NCLT is expected to admit or reject an application for initiation of CIRP solely on the basis of parameters laid down under Sections 7,9 or 10 of the IBC. It was held that the NCLT failed to appreciate that the issuance of cheque also gives an unconditional admission on behalf of the Respondent towards the debt of the Appellant. Thus, the adverse inference drawn by the NCLT for not submitting any explanation regarding the earlier cheque dated September 12, 2017 was held to be without
any basis.

It was observed that the Supreme Court of India had, in the case of Innoventive Industries Limited v. ICICI Bank [(2018) 1 SCC 407], laid down the guiding principles to admit or reject an application filed under Section 7 of the IBC. The Supreme Court of India had held that, to admit an application, the NCLT is to be satisfied that a default has occurred and that the corporate debtor is entitled to point out that a default has not occurred in the sense that the “debt”, which may also include a disputed claim, is not due. A debt may not be due if it is not payable in law or in fact. The moment the NCLT is satisfied that a default has occurred, the Application must be admitted unless it is incomplete.

The application filed by the Appellant under Section 7 of the IBC, read with Rule 4 of the Insolvency and Bankruptcy (Application to Adjudicating Authority) Rules, 2016, was held to be complete. In the circumstances, it is clear that the observation of the NCLT is sans any evidence.

One of the grounds of rejection taken by the NCLT is that the Respondent is a solvent company as the financial statement of the Respondent in the financial year ending March 2017 depicts revenue from operation in the Respondent’s account as INR 34,13,351 and a balance of more than INR 25 lacs. The NCLAT emphasized that a presumption cannot be drawn merely on the basis that a company, being solvent, cannot commit any default. As observed in financial and economic parlance, the inability to pay-off debts and committing default are two different aspects which are required to be adjudged on equally different parameters. Inability/ability to pay debt has no relevance for admitting or rejecting an application for initiation of CIRP under the IBC.

It was stated that the judgement of the Supreme Court of India in Swiss Ribbons Private Limited v. Union of India [(2019) 4 SCC 17] clarifies that rather than the “inability to pay debts”, it is the “determination of default” that is relevant for allowing or disallowing an application filed under Sections 7,9 or 10 of IBC. The said shift enables an applicant to prove by documentary evidence that there was an obligation to pay the debt and that the debtor has failed to fulfill its repayment obligations. Therefore, to allow the application under Section 7, it is not relevant to see the inability of the corporate debtor (in this case, Respondent) to pay the debt.

It was observed by the NCLT that the civil court has issued an interim prohibitory order against the Appellant and others stating that they cannot recover the amount claimed. The Respondent has failed to file any such order of the civil court prohibiting realization of the said amount. However, it is to be clarified thatby the non-obstante clause in Section 238 of the IBC, the IBC has an overriding effect over any other law that is inconsistent with it. Therefore, the civil court was not competent to issue an injunction order for a case pending under the IBC. It was observed that the NCLT has erred in rejecting the application based on the pendency of civil suit between the parties.

Decision of the NCLAT
The application under Section 7 of the IBC was admitted and the CIRP was initiated for the Respondent, as the NCLAT was satisfied that a default had taken place.

Vaish Associates Advocates View
This judgement clarifies an important position of law, and holds that the financial ability of an entity is not relevant when ascertaining if CIRP should be initiated. The only aspect that the NCLT has to determine while admitting a company into CIRP is whether a default in repayment has occurred.

Therefore, with regards to financial credit, borrowers must strive to repay their loans as and when they are due, and cannot take shelter in the fact that they are solvent and have the financial resources to repay the amount due to protect themselves from CIRP.

With regard to the adverse inferences drawn by the NCLT on the Appellant on account of non-submission of documents required to avail of a loan from an NBFC and for not providing explanation regarding earlier cheque dated September 12, 2017, the NCLAT has clearly defined the parameters on which an application to initiate the CIRP is to be judged.

Further, the ruling of the NCLAT with regard to the interim prohibitory order issued by the civil court is to be appreciated, as such orders can frustrate and hinder the CIRP process and that the IBC, being a complete code by itself and pursuant to non-obstante provision contained in Section 238 of the IBC, should prevail.

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

Supreme Court: The appellant’s plea on limitation was illusory; the date of execution of sale deed was deliberately excluded to overcome limitation and mislead the court

The Supreme Court of India (“SC”) by its judgement in Dahiben v. Arvindbhai Kalyanji Bhanusali through Legal Representative and Others [Civil appeal no. 9519 of 2019] (decided on July 9, 2020) upheld the order of the Gujarat High Court (“GHC”) affirming the decision of the trial court which had allowed the application of respondent nos. 2 and 3 under Order VII Rule 11 (a) and (d) of the Civil Procedure Code, 1908 (“CPC”). The said application had been filed by the said respondents for rejecting the plaint presented by the appellant towards cancellation of a sale deed.

Facts
Cancellation of a sale deed had been sought in respect of certain premises located in Village Mota, Surat (“Suit Property”), which was under restrictive tenure and hence covered under Section 73AA (restriction on transfer of occupancies of tribals to tribals or non-tribals) of the Land Revenue Code (“Land Revenue Code”). The appellant, being the owner of the Suit Property, filed an application before the Collector of Surat to obtain permission to sell the Suit Property to respondent no. 1 and recorded their NOC for the same. The Collector permitted the sale and after carrying out title verification and other procedures stipulated under the Land Revenue Code, fixed the sale price to be INR 1,74,02,000 (Indian Rupees One Crore Seventy-Four Lakhs Two Thousand only). It was decided that the purchaser, that is, respondent no. 1, would make payment by cheque and reference to the same would be made in the sale deed.

Hereinafter, the sale was carried out by a registered deed of sale dated July 2, 2009 (“Sale Deed”). Respondent No. 1 had issued 36 (thirty six) cheques pursuant to the same, the details of which were also recorded in the Sale Deed. Subsequently, respondent no. 1 sold the Suit Property to respondent nos. 2 and 3 for an amount of INR 2,01,00,000 (Indian Rupees Two Crores One Lakh only) by a registered deed of sale dated April 1, 2013. On December 05, 2014, the appellant filed a civil suit before the Principal Civil Judge, Surat wherein she impleaded both the original (respondent no. 1) and subsequent purchasers (respondent nos. 2 and 3), and prayed that the Sale Deed dated July 2, 2009 be set aside, on account of non-payment of the entire sale consideration by respondent no. 1.

Issues

The trial court had identified the following issues:
(i)  Whether there was a cause of action in the plaint.
(ii)  Whether the suit was barred by limitation.

Arguments

Contentions of the appellant:

The appellant had stated in the plaint that the Sale Deed should be cancelled on the grounds that it was illegal, void and not binding as the entire consideration amount had not been paid by respondent no. 1. The appellant alleged that respondent no. 1 had paid only INR 40,000 (Indian Rupees Forty Thousand only) through 6 (six) cheques and the remaining 30 (thirty) cheques issued for INR 1,73,62,000 (Indian Rupees One Crore Seventy Three Lakhs Sixty Two Thousand only) were bogus and further, prayed for the restoration of the Suit Property.

As a corollary, the appellant also prayed for cancellation of the subsequent sale deed dated April 1, 2013 entered into by respondent no. 1 with respondent nos. 2 and 3 for the Suit Property.

Contentions of respondent nos. 2 and 3:

Respondent nos. 2 and 3 thereafter, applied for rejection of the appellant’s plaint under Order VII Rule 11 (a) and
(d) (rejection of plaint) of the CPC stating that the appellant’s plea was barred by limitation and that no cause of action was disclosed by the appellant as such. They made further submissions as follows:

• The appellant had already admitted the execution of the Sale Deed before the Sub-Registrar, Surat.
• The cause of the appellant was barred by limitation as it should have been filed within 3 (three) years of the date of Sale Deed, that is, on or before July 1, 2012.
• The appellant had participated in the proceedings before the Revenue Officer for transfer of the Suit Property in the revenue records in favor of the respondent no. 1. Further, before confirming the entry into the record of rights (or ‘Hakk Patrak’) for transfer of the Suit Property in favor of respondent no. 1, a notice under Section 135D (register of mutations and register of disputed cases) of the Land Revenue Code had been served on the appellant and ever since then respondent no. 1 has been paying the land revenue for the same.
• Respondent nos. 2 and 3 had purchased the Suit Property from respondent no. 1 after conducting due verification of title reports and inspection of revenue records. They had purchased the Suit Property by paying consideration for the amount of INR 2,01,00,000 (Indian Rupees Two Crores and One Lakh only) by the sale deed dated April 1, 2013. Pursuant to this, the names of respondent nos. 2 and 3 were entered into in the revenue records.
• In order to mislead the court, the appellant had produced a 7/12 extract dated July 20, 2009 (which was prior to the mutation in favor of respondent no. 1).

Observations

Observations of the trial court:

On perusal of the Sale Deed, it was noted that the appellant had in fact accepted and acknowledged the payment of the full sale consideration from respondent no.1, through cheques which were issued prior to the execution of the Sale Deed, during the period between July 07, 2008 and July 2, 2009. The court held that had the appellant not been able to encash 30 (thirty) cheques, a complaint ought to have been filed, or proceedings should have been initiated for recovery of the unpaid sale consideration. There was however, nothing on record to show that the appellant had made any complaint in this regard for a period of over 5 (five) years.

The appellant had also failed to produce the returned cheques, passbooks, bank statements, or any other document to support averments made in the plaint. The court observed that the lack of action on part of the appellant for over 5 (five) years after execution of Sale Deed meant that the averment in the plaint could not be considered. The cause of action had arisen when respondent no.1, had issued bogus cheques in 2009. Herein, as per the provisions of the Limitation Act, 1963 (“Limitation Act”) the suit should have been filed by 2012.

The trial court, on the basis of the settled position in law, held that the suit of the appellant was barred by limitation, and allowed the application of respondent nos. 2 and 3 under Order VII Rule 11(d) CPC, hence rejecting the plaint.

Observations of the Gujarat High Court:

Aggrieved by the findings of the trial court, the appellant approached the GHC. The division bench of the GHC found that there was no dispute regarding the execution of the Sale Seed and its subsequent conveyance. In the said Sale Deed, it was admitted and acknowledged by the appellant that full sale consideration had been received. In fact, the Sale Deed had complete particulars with respect to payment of sale consideration by way of 36 (thirty six) cheques. The Suit Property was successfully transferred to respondent no. 1 and hence the said Sale Deed could not be held bad in law. The court also concurred with the view of the trial court that suit was barred by limitation. Further, the court stated that since the appellant had made no averments against the respondent nos. 2 and 3, there was no privity of contract between them.

Observations of the Supreme Court:

Aggrieved by the decision of the GHC, the appellant was constrained to appear before the SC. The SC examined the scope of Order VII Rule 11 of the CPC which dealt with rejection of a plaint. It was noted that the power to terminate a civil suit was a drastic one and hence the procedure laid down in Order VII Rule 11 must be followed strictly.

The SC had laid down a test for the application of Order 7 Rule 11 of the CPC. The plaint which is presented to the court has to be read in its entirety along with the documents that are relied upon, basis which it is to be determined if a decree can be passed. If on a meaningful reading of the plaint, it was found that the suit was manifestly vexatious and without any merit, and did not disclose a right to sue, the court would be justified in exercising the power under Order VII Rule 11 of the CPC.

The case as per the plaint was that even though the Sale Deed was executed for a consideration of INR 1,74,02,000 (Indian Rupees One crore Seventy Four Lakhs and Two Thousand only), only INR 40,000 (Indian Rupees Forty Thousand only) was paid to the appellant at the time. Whereas the averments in the plaint are completely contrary to the recitals in the plaint which record that the entire sale consideration was “paid” by respondent no. 1 during the period between July 7, 2008 and July 7, 2009. Even if the case of the appellant was to be believed, it was inconceivable that the payments had remained unpaid and the appellant would have been completely silent for a period of over 5 (five) years without even issuing a legal notice/ instituting recovery proceedings for the unpaid sale consideration.

Further, reliance was placed upon Vidyadhar v. Manikrao and Another [(1999) 3 SCC 573)] wherein it was held that the words “price paid or promised or part paid and part promised” indicated that actual payment of the whole of the price at the time of the execution of the Sale Deed was not a sine qua non for completion of the sale. Even if the whole of the price had not been paid, but the document had been executed, and thereafter registered, the sale would be complete, and the title would pass on to the transferee under the transaction. The non-payment of a part of the sale price would not affect the validity of the sale. Once the title in the property has already passed, even if the balance sale consideration is not paid, the sale could not be invalidated on this ground.

Decision of the Supreme Court

The SC held that even if the averments of the appellant were true and the entire sale consideration had not been paid it would not be a ground for cancellation of the Sale Deed. The plea that the fraud was learnt in 2014 on receipt of the index of the Sale Deed was misconceived and would not be a cause of action. The plea was illusory, and was only intended to overcome the period of limitation.

The appellant deliberately did not mention the date of the registered Sale Deed dated July 2, 2009 since it would be evident that the suit was barred by limitation. The prayer however mentioned the date of the subsequent sale deed dated April 1, 2013 when the suit property was later sold to respondent nos. 2 and 3. The omission of execution of the Sale Deed dated July 2, 2009 in the prayer clause, was done deliberately and knowingly, so as to mislead the court on the issue of limitation.

Further, the suit filed by the appellant was held to be vexatious, meritless and not disclosing a right to sue. Thus, the SC upheld the decision of the GHC and trial court in rejecting the plaint of the appellant in accordance with Order VII Rule 11 (a) and (d) of the CPC.

Vaish Associates Advocates View
The instant case is an example of misrepresentation by the plaintiffs who hid crucial information and tried to mislead the Court, creating an illusion of the existence of cause of action, despite it being barred by the statute of limitation.

It is pertinent to note that even though the limitation in this case was 3 (three) years, the appellant had filed their suit after a period of 5 (five) years from the execution of the Sale Deed, stating non-payment of consideration. As far as rejection of a plaint is concerned which is the essence of this judgement, Order VII, Rule 11 of the CPC deals with various circumstances in respect of such rejection. The aforestated provision is pivotal in the sense that it saves the time of the Court from frivolous and vexatious litigation. Further, these provisions are mandatory in nature, and make use of the words, “The plaint shall be rejected in the following cases…”

Upholding the application of respondent nos. 2 and 3 under the aforesaid provisions of CPC, the SC rejected the plaint as: (a) no cause of action could be made out and (b) suit was barred by limitation. The SC had acted upon the settled principle of law to hold that there is no merit to the argument of the appellant and the plaint could not be entertained as it fell under Order VII Rule 11 of the CPC.

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