Supreme Court: Ambit for adjudication of preferential transactions defined

The Supreme Court in its judgement dated February 26, 2020, in the case of Anuj Jain, Interim Resolution Professional for Jaypee Infratech Limited v. Axis Bank Limited, has clarified several issues including the scope and ambit for adjudication of preferential transactions, and the nature of financial debt particularly in relation to third-party mortgages amongst others.

Facts
This matter reached the Supreme Court by an appeal against an order dated August 01, 2018 passed by the National Company Law Appellate Tribunal regarding an application moved by the Interim Resolution Professional (“IRP”) of Jaypee Infratech Limited (“JIL”) seeking avoidance of certain transactions, whereby the corporate debtor (JIL) had mortgaged its properties as collateral securities for the loans and advances made by the lender banks and financial institutions to Jaiprakash Associates Limited (“JAL”), the holding company of JIL, as being preferential, undervalued and fraudulent, in terms of Sections 43, 45 and 66 of the Insolvency and Bankruptcy Code, 2016 (“IBC”). The contention of IRP, that the transactions in question were preferential, undervalued and fraudulent within the meaning of Sections 43, 45 and 66 of the IBC, were accepted in part by the NCLT, in its order dated May 16, 2018 and directions were issued for avoidance of at least six of such transactions. The transactions in question essentially create security for loans advanced to JAL from the assets (immovable property) belonging to JIL. The National Company Law Appellate Tribunal (“NCLAT”), however, took an entirely opposite view of the matter and upturned the order passed by NCLT.

Another issue was if the lenders of the JAL could be recognised as lenders of JIL for the purposes of the IBC on the strength of the mortgage created by JIL, as collateral security of the debt of its holding company, JAL. It is pertinent to note that the Committee of Creditors (“CoC”) was required by the Supreme Court to be reconstituted in view of the directions in Chitra Sharma v. Union of India (decided on November 06, 2019), and the subsequent amendments brought about in the IBC which allowed homebuyers to be part of the CoC of both JAL and JIL. This issue was raised by ICICI Bank Limited and Axis Bank Limited, which challenged the decision of the IRP of rejecting their claims to be recognized as financial creditors of JIL on account of the securities provided by JIL for the facilities granted by them to JAL.

Issues
Broadly, the following issues were discussed by the Supreme Court:
(i) Whether impugned transactions are preferential, falling within Section 43(2) of the IBC. In order to better understand the issue, it can be further categorised in the following manner:

• Extent of the look back period in terms of Section 43(4) of the IBC.
• Meaning and scope of ordinary course of business or financial affairs.
• Duties and responsibilities of resolution professional in CIRP as per Section 25 with respect to Section 43 of the IBC.

(ii) Whether lenders of JAL could be categorised as financial creditors of JIL.

Arguments
Issue (i):
Regarding the issue pertaining to the avoidance application, the counsel for the IRP argued that transactions have the effect of putting JAL, which is an equity shareholder and an operational creditor (for an amount of INR 261.77 crores) of JIL, in a beneficial position than it would have been in the event of distribution of assets under Section 53 (liquidation waterfall) of the IBC vis-à-vis other creditors; and that if the transactions are held to be valid, the liability of JAL towards its own creditors gets secured and becomes realisable from the value of the mortgaged properties whereby, JAL’s liabilities are reduced and JAL gets benefitted in exclusion of creditors of JIL.

It was further contended that the assets in question were released from the earlier mortgages and fresh mortgages were created during the look back period with increased/enhanced amount of facilities as provided under each individual transaction. The said so-called re-mortgage essentially amounts to a fresh mortgage within the relevant time of two years before the date of commencement of CIRP and was not done in the ordinary course of business of JIL and hence, is hit by Section 43 of the IBC.

It was further argued that Section 43 of the IBC ought to be read keeping in mind the intention of the legislature in introducing such provision, which had been to protect the creditors against siphoning away of corporate assets by the management of the company, who have special knowledge of the company’s financial troubles by virtue of its position, and that the true economic effect of the transaction must be put under the scanner.

Ordinary Course of Business:
Further, it was contended that mortgages could not have been made in the “ordinary course of business” of JIL, as it is difficult to fathom why a subsidiary would furnish security to its parent company in the ordinary course and, on the contrary, it is the parent company which at times furnishes security on behalf of its subsidiary since it derives economic value from the subsidiary. Since JIL was itself reeling under financial stress, why it would routinely undertake to secure the indebtedness of JAL by furnishing such high valued securities and that too when the amount of debt secured by way of mortgaging the assets of the corporate debtor increased from INR 3,000 crores to approximately INR 24,000 crores. Even though creation of third party security is a normal practice, the creation of every third party security cannot always deemed to have been done in the ordinary course of business; that such ‘ordinary course’ has to be determined under the circumstances when such transactions were entered into.

Relevant Period/ Lookback Period:
It was contended that the term ‘transaction’ under the IBC includes an agreement or arrangement in writing for the transfer of assets, or funds, goods or services from or to the corporate debtor. The use of the word ‘include’ would signify its natural import and is to be given a wide interpretation.

The respondents, particularly the lenders of JAL stated that the transactions in question are not preferential and do not fall under Section 43 of the IBC and submitted that they, being bankers and financial institutions, are regularly engaged in the business of extending loans and other facilities which form the backbone of economic growth, since Section 43(3)(a) carves out exception for the transactions made in the ordinary course of business. It was stated that taking of such securities, including third party security, is one of the normal and ordinary features of their business and dealings, particularly that of corporate money lending. They stated that if at all such third party securities are avoided on the allegation of being preferential, it is likely to have a devastating effect on the entire economy because the bankers and financial institutions would then be left high and dry and for future dealings, they shall have no alternative but to restrict their activities only to the direct party securities which would, in turn, result in retardation and regression.

A creditor of JAL, Axis Bank, further contended that the land parcels were mortgaged on February 24, 2015, which is beyond even the two years formulation, the relevant time being from August 10, 2015 to August 09, 2017 as the lookback period for related party transactions is two years. The subsequent re-execution of the mortgage deeds on September 15, 2015 and then again on December 29, 2016 cannot be considered a substantive event since the nature and identity of the security remained the same and no fresh encumbrances were created and the same was done merely to reflect the increase in the facilities and members of the consortium.

Standard Chartered Bank, another creditor of JAL, argued in furtherance of the arguments earlier advanced regarding the fact that the transactions were made in the ordinary course of business by pointing out that in the annual reports of JIL the mortgaged properties were disclosed as ‘inventories’ for the corporate debtor being a real estate company; and hence, dealing with the ‘inventories’/‘stock-in-trade’ is in the ordinary course of business. It was also argued that for the purpose of Section 43 of the IBC, the relationship between the respondent-lenders and JIL ought to be looked into rather than assuming JAL to be the primary transferee.

JAL, while pointing out previous transactions such as cash infusions, bank guarantees and pledges of shares by JAL on behalf of JIL demonstrated that transactions between the two entities were in their ordinary course of business and further argued that the mortgage of land in favour of the lenders of JAL was authorised in the manner provided in Section 186 of the Companies Act, 2013.

Issue (ii):
The central question was if the lenders of JAL could be recognised as financial creditors of JIL for the purposes of the IBC. It was pointed out that in the present case, the corporate debtor has created a mortgage of its property in favour of third party without any consideration for time value of money, therefore, the basic ingredient of ‘financial debt’ was not made, since the lenders of JAL having not disbursed any debt against the consideration for the time value of money to JIL, thus, there is no money owed by JIL to the lenders. It was also argued that holding security interest would not automatically make an entity a financial creditor, and that ‘mortgage’ was not covered under the definition of financial debt under the IBC.

The lenders of JAL argued that the nature and character of a ‘mortgage’ is such that it secures a debt; and in the present case, the mortgage in question, as made by JIL, had been to secure the debt obligations of its holding company, JAL. The learned counsel has also referred to an order in the case of SREI Infrastructure Finance Limited v. Sterling International Enterprises Limited, (decided on March 13, 2019), wherein it is held that a third party mortgagor, who mortgages the property to secure the financial obligation of another party, stands in the position of a guarantor; and the mortgagee is a financial creditor of the third party mortgagor. It was further argued that as per the mortgage deeds/loan documents entered into between the parties, JIL had unequivocally promised to pay to the debts/liabilities owed by JAL in accordance with the terms and conditions of the secured financing documents executed.

Observations of the Supreme Court
The Supreme Court first analysed the historical background, objects, scheme and structure of the relevant parts of the IBC, after which it proceeded to address the issues framed by it.

Issue (i):
It was observed that there has been no creditor-debtor relationship between the lender banks and JIL, but that will not be decisive of the question of the ultimate beneficiary of these transactions. The mortgage deeds in question, entered by JIL to secure the debts of JAL, amount to creation of security interest to the benefit of JAL. It was also held that the transactions put JAL in such capacity that it is a related party to JIL and is a creditor as also surety of JIL. In other words, JIL owed antecedent financial debts as also operational debts and other liabilities towards JAL therefore, the requirement of Section 43(2)(a) was met. Further, it was observed that JAL, as an operational creditor would not be given priority in repayment as per the liquidation waterfall provided for in Section 53 of the IBC. Therefore, it was observed that the requirement under Section 43(2)(b) was met. Thus, it was concluded that JIL has given a preference in the manner laid down in Section 43(2) of the IBC.

With regard to the lookback period, it was held that the argument of the respondents that the impugned transactions were not of creation of any new encumbrance by JIL and in fact, most of the properties in question had already been under mortgage with the respective lenders much before the lookback period commenced and that the re-mortgages could not be counted as separate ‘transactions’, cannot be accepted. It was held that so-called remortgage, on all its legal effects and connotations, could only be regarded as a fresh mortgage.

With regard to whether the transactions were made in the ordinary course of business affairs, it was observed that Section 43(a)(3) of the IBC calls for purposive interpretation so as to ensure that the provision operates in sync with the intention of legislature and achieves the avowed objectives therefore, the word ‘or’ should be read as ‘and’, thus, the provision should read as; ‘transfer made in the ordinary course of the business or financial affairs of the corporate debtor and the transferee’.

It was observed that an activity could be regarded as ‘business’ if there is a course of dealings, which are either actually continued or contemplated to be continued with a profit motive. Therefore, even if transferees submit that such transfers had been in the ordinary course of their business, the question would still remain if the transfers were made in the ordinary course of business or financial affairs of JIL so as to fall within the exception provided in the IBC.

The decision of the High Court of Australia in the case of Downs Distributing Company Pty Limited v. Associated Blue Star Stores Pty Limited (in liq.) ((1948) 76 CLR 463) was referred to, where it was held that ordinary course of business would mean: “that the transaction must fall into place as part of the undistinguished common flow of business done, that it should form part of the ordinary course of business as carried on, calling for no remark and arising out of no special or particular situation.”

The Supreme Court therefore, held that even if the transactions in question were entered in the ordinary course of business of bankers and financial institutions like the present respondents but on the given set of facts, there is not an iota of doubt that the impugned transactions do not fall within the ordinary course of business of JIL, which had been promoter as a special purpose vehicle floated by JAL for the purpose of construction and operation of Yamuna Expressway and for development of the parcels of land along with the expressway for residential, commercial and other uses. Therefore, the Supreme Court concluded that providing mortgages to secure the loans of JAL, at the cost of its own financial health could not be construed to be in the ‘ordinary course of business of JIL.

It was further held that since the lenders, as a part of their due diligence are required to study the viability of the enterprise that it is lending to in order to ensure, inter alia, that the security against such loan/advance/facility is genuine and adequate and that the lenders should have assessed if the security provided to them was prudent and viable. It was also observed that since several of the lenders of JIL were also lenders of JAL, they could not plead ignorance about the financial position of either party and should have been aware of the risk involved.

After holding that the transactions were hit by Section 43 of the IBC, the Supreme Court further went on to express how it expected resolution professionals to apply the provisions.

Issue (ii):
Firstly, the determination of Issue (i) was reiterated, and it was held that the security interests created by JIL over the properties in question stand discharged in whole. However, the Supreme Court saw it fit to answer the question raised on basis of the law in order to create a lasting precedent. It was observed that the IBC confers upon financial creditors with a pivotal role in the corporate insolvency resolution process due to the fact that financial creditors are, from the very beginning, involved in assessing the viability of the corporate debtor who can, and indeed, engage in restructuring of the loan as well as reorganisation of the corporate debtor’s business when there is financial stress.

The Supreme Court further went on to hold that there was not an iota of doubt that for a debt to become ‘financial debt’ for the purpose of Part II of the IBC, the basic element is that it ought to be a disbursal against the consideration for time value of money and that for a person to be designated as a financial creditor of a corporate debtor, it has to be shown that the corporate debtor owes a financial debt to such person. Understood this way, it becomes clear that a third party to whom the corporate debtor does not owe a financial debt cannot become its financial creditor for the purpose of Part II of the IBC.

It was further observed that the position and role of a person having only security interest over the assets of the corporate debtor could easily be contrasted with the role of a financial creditor because the former shall have only the interest of realising the value of its security (there being no other stakes involved and least any stake in the corporate debtor’s growth or equitable liquidation) while the latter, apart from looking at safeguards of its own interests, would also simultaneously be interested in rejuvenation, revival and growth of the corporate debtor. Thus understood, it is clear that if the former, that is, a person having only security interest over the assets of the corporate debtor is also included as a financial creditor and thereby allowed to have its say in the processes contemplated by Part II of the IBC, the growth and revival of the corporate debtor may be the casualty.

Therefore, it was held that if a corporate debtor has given its property in mortgage to secure the debts of a third party, it may lead to a mortgage debt and, therefore, it may fall within the definition of ‘debt’ under Section 3(10) of the IBC. However, it would remain a debt alone and cannot partake the character of a ‘financial debt’ within the meaning of Section 5(8) of the IBC. Thus, it was concluded that the lenders of JAL, on the strength of the mortgages in question, may fall in the category of secured creditors, but such mortgages being neither towards any loan, facility or advance to the corporate debtor nor towards protecting any facility or security of the corporate debtor, it cannot be said that the corporate debtor owes them any ‘financial debt’ within the meaning of Section 5(8) of the IBC; and hence, such lenders of JAL do not fall in the category of the ‘financial creditors’ of JIL.

Decision of the Supreme Court
The Supreme Court held that the transactions were hit by Section 43 (preferential transactions and relevant time) of the IBC, and the NCLT had correctly passed directions as per Section 44 (orders in case of preferential transactions) of the IBC.

Vaish Associates Advocates View
This landmark judgement of the Supreme Court cleared the air on many issues. Firstly, it was elucidated by the Supreme Court as to what actually was a preferential transaction and further, it laid down the steps that should be taken by a resolution professional in order to determine the same. It clarified the law with regard to the operation of the look back period under the IBC.

However, the status of third party mortgagees has not been clarified except for stating that they will not be reckoned as ‘financial creditors’ which means they would not be a part of the committee of creditors and would not be able to vote on issues. This has essentially created a new class of creditors, namely creditors to other entities such as sister concerns/ subsidiaries/ holding companies.

It was also observed that such lenders should be conducting thorough due diligence and analysis with regard to the entity which is actually providing the security and to determine if the security so provided is prudent and viable. Further, by an extension of the reasoning provided herein, other securities provided on behalf of third parties, which is a common occurrence in India, would not constitute ‘financial debt’ in relation to a corporate debtor.

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

NCLT: Automatic waiver of legal proceedings is not permitted in a resolution plan

The National Company Law Tribunal, Ahmedabad Bench (“NCLT”) in the case of Bhavi Shreyansh Shah, Resolution Professional for VS Texmills Private Limited v. Canara Bank and Others (decided on January 01, 2020) held that as per the provisions of the Insolvency and Bankruptcy Code, 2016 (“IBC”) automatic waiver of legal proceedings by/ against a corporate debtor is not allowed in a resolution plan.

Facts
An application was filed by Reliance Commercial Finance Limited, which was a financial creditor of V S Texmills Private Limited (“Corporate Debtor”) under Section 7 of the IBC seeking initiation of the Corporate Insolvency Resolution Process (“CIRP”) against the Corporate Debtor. The application was admitted on January 09, 2019, and Bhavi Shreyansh Shah was appointed as an interim resolution professional, who subsequently became the Resolution Professional (“RP”) in the first meeting of the Committee of Creditors (“CoC”) on February 06, 2019. In the third meeting of the CoC, which was convened on March 14, 2019, it was agreed to invite Expressions of Interest (“EoI”) from potential resolution applicants.

Pursuant to the invitation for EoIs, the RP received two EoIs, one from Chamaria Fashions Private Limited (“Chamaria”) and the other from Vikash Enterprises. Thereafter, Vikash Enterprises withdrew from the process, leaving Chamaria as the only interested potential resolution applicant. Revised resolution plan dated June 20, 2019 was discussed by the CoC in its fifth meeting where they sought improvement of the plan and accordingly, Chamaria was given a chance to rectify the resolution plan. It was also resolved by the CoC to extend the CIRP period and accordingly, an interlocutory application was preferred by the RP, pursuant to which the adjudicating authority by its order dated July 12, 2019 extended the CIRP for another 90 days beyond the initial 180 days. The CoC approved the Resolution Plan dated June 20, 2019 which was modified by addendums, the last being an addendum dated September 11, 2019 with majority voting share of 92.44% of the CoC in favour of the same.

Issue
The core issue identified while approval of the NCLT of the resolution plan submitted was sought by the RP was whether automatic waiver of legal proceedings against/ by a corporate debtor can be permitted in a resolution plan.

Observations of the NCLT
The NCLT held that to decide the issue it will be pertinent to notice the very object of the IBC, which is resolution. It held that on glancing at the preamble of the IBC it can be ascertained that the IBC aims to promote resolution over liquidation. The purpose of resolution is for maximization of value of assets of the corporate debtor and thereby all creditors. As per the provisions of the IBC, the first objective is resolution. The second objective is maximization of the value of assets of the corporate debtor. The third objective is promoting entrepreneurship, availability of credit and balancing interests. Therefore, these objectives of the IBC are sacrosanct. It was observed that the IBC only allows for liquidation on the failure of the corporate insolvency resolution process and facilitates and encourages resolution. As held by the Supreme Court of India in the case of Arcelor Mittal India Private Limited v. Satish Kumar Gupta and Others (decided on October 04, 2018) if there is a resolution applicant who can continue to run the corporate debtoras a going concern, every effort must be made to ensure that this is made possible.

Subsequently, the NCLT analysed its own powers and functions with regards to a resolution plan and cited the decision of the Supreme Court of India in K. Sashidhar v. Indian Overseas Bank and Others (decided on February 05, 2019), where it was held that the NCLT has no authority to analyse and evaluate the commercial decision of the CoC to enquire into justness of the rejection of the resolution plan by dissenting financial creditors.

Decision of the NCLT
The NCLT held that on perusal of the resolution plan, it was found that the resolution plan met the requirements of Section 31 (approval of resolution plan) read with Section 30(2) (examination of resolution plan by resolution professional) of the IBC. The application was allowed however, the NCLT held that Clause e of Chapter IV of the resolution plan would not be allowed since it relates to the subject matter of the various competent authorities, each having their own jurisdiction. The clause is reproduced below:
“All business permits required by the Corporate Debtor to conduct its business and which have not been granted, cancelled, terminated, revoked, suspended or not renewed; having been granted or reinstated, as the case may be, at no additional costs to the resolution applicant or Corporate Debtor… ”

It was further held that the approval of the resolution plan does not mean automatic waiver or abatement of legal proceedings, if any, which are pending by or against the corporate debtor as those are the subject matter of the concerned competent authorities having their own jurisdiction to pass any appropriate order as the case may be. The resolution applicant, on approval of the plan may approach those competent authorities for appropriate reliefs sought for in Clause e of Chapter IV of the resolution plan. It was further held that the matters referred to in Clause e of Chapter IV of the resolution plan are the subject matter of the concerned appropriate competent authorities, and that the resolution applicants have the liberty to approach them for any concession, relief or dispensation as the case may be.

Vaish Associates Advocates View:

The NCLT, in declining to allow automatic waiver of legal proceedings to be a part of the resolution plan has decided on what was a grey area of the law, specifically on the powers of a resolution plan to decide on points such as business permits or licenses that have been previously cancelled, terminated, revoked or suspended for any
reason.

Business permits are a very wide-ranging topic, and for certain permits/ licenses, the company in question may have to demonstrate that they can meet certain benchmarks in order to achieve the same. Therefore, the NCLT has rightly held that such licenses should not be granted as a matter of right just by inclusion into the resolution plan, and that each company should apply for the same independently.

It also held that with respect to waiver of legal proceedings, all pending matters cannot be terminated at the stroke of a pen, and that each competent authority would have the power to pass judgements as it deems fit.

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

Supreme Court: Provident Fund benefits payable to contractual employees from date of filing writ petition and not retrospectively

The Supreme Court of India (“SC”) has, in the case of Pawan Hans Limited and Others v. Aviation Karmachari Sanghatana and Others (decided on January 17, 2020), held that the contractual employees in an establishment (not hired through a contractor) are also entitled to provident fund (“PF”) benefits.

Facts
Pawan Hans Limited (“Appellant”) is a company where Government of India holds 51% stake and the balance 49% is with Oil and Natural Gas Company Limited. The Appellant notified ‘Pawan Hans Employees Provident Fund Trust Regulations’ (“Regulations”) in 1986 and constituted ‘Pawan Hans Employees Provident Fund Trust’ (“Trust”) in 1987 for giving PF benefits to the employees.

Relevant clauses in Regulations are reproduced hereunder:

“1.3 – These Regulations shall apply to all the employees of the Corporation.
…
2.5. –“Employee” means any person who is employed for wages/salary in any kind of work, monthly or otherwise, in or in connection with the work of the Corporation and who gets his wages/salary directly or indirectly from the Corporation, and excludes any person employed by or through a contractor or in connection with the work of the Corporation but does not include any person employed as an apprentice or trainee. ”

Although the Regulations defined the term ‘employee’ to include any person employed directly or indirectly, the Appellant provided PF benefits only to its regular employees. Consequently, Aviation Karmachari Sanghatana (“Respondent”) made representations to the Appellant to extend the benefit under Regulations even to contractual employees.

However, the Appellant did not give response to the representations. Accordingly, the Respondent approached Honourable Bombay High Court (“BHC”) by filing a writ petition. By its order dated September 12, 2018, BHC concluded that the contractual employees are entitled to benefits under Employees’ Provident Funds and Miscellaneous Provisions Act, 1952 (“Act”) and Employees’ Provident Funds Scheme, 1952 (“Scheme”). Hence BHC directed the Appellant to enrol contractual employees under the Scheme. Further, it directed the Appellant to deposit PF contribution for the period commencing from the date when such employees became eligible under Scheme till the time they worked for the Appellant. Being aggrieved by the said order, the Appellant preferred an appeal before the SC.

Issues
(i) Whether the Appellant is under a statutory obligation to provide the PF benefit.
(ii) If contractual employees are entitled to PF benefit, whether such benefit is payable under the Regulations or the Act?
(iii) If contractual employees are entitled to PF benefit, from what date the aforesaid benefit be extended to them?

Arguments
The Appellant, inter alia, argued that: neither the Act nor notification dated March 22, 2001 (the said notification made provisions of the Act applicable to certain specified establishments including the airlines industry, other than airlines owned or controlled by the Central or State Government) thereunder is applicable to it. As under Section 1(b) of the Act, an establishment belonging to or under the control of the Centre and whose employees are entitled to the benefit of contributory PF in accordance with any scheme or rules framed by the Central or State Government in respect of such benefits, is exempted under the Act. The SC in Regional Provident Fund Commissioner v. Sanatan Dharam Girls Secondary School [(2007) 1 SCC 268] laid down a twin-test for an establishment seeking exemption from the Act, namely, (I) the establishment must be either “belonging to” or “under the control of” the Central or State Government and (ii) employees of such an establishment should be entitled to the benefit of contributory provident fund or old age pension in accordance with any scheme or rule framed by the Central Government or State Government governing such benefits. As far as the question of scheme was concerned, the Company already had its own Regulations in force.

It was also contended that since several contractual employees had superannuated, passed away, resigned or ceased to be in the employment of the Appellant, the BHC had committed an error by applying provisions of the Act retrospectively from the date the contractual employees joined the Appellant. Finally, it was contended that the BHC order had doubled the Appellant’s liability as the contractual employees had already been paid their full monthly financial benefits/emoluments.

Respondent No. 3, that is, Regional Provident Fund Commissioner (“RPFC”) submitted that Appellant was not covered under the Act and thus BHC’s direction to deposit contribution from the date of eligibility of the contractual employees till the date of remittance was not workable and could not be sustained.

The Respondents, inter alia, argued that: (i) Regulations defined the term ‘employee’ to include all employees, including employees engaged on contractual basis, who are in the direct or indirect employment of the Appellant; (ii) the contractual employees were employed directly by the Appellant and not through any contractor; (iii) the Appellant directly remunerated the contractual employees; and (iv) the Appellant is not a government owned/ controlled company since its affairs were managed and controlled by a board of directors.

Observations of the Supreme Court
In order to be exempted from the Act, the Appellant had to meet the ‘twin test’ to seek exemption under the Act as laid down in Regional Provident Fund Commissioner v. Sanatan Dharam Girls Secondary School [(2007) 1 SCC 268]– (i) being a government company; and (ii) providing PF benefits to all employees. While the Appellant did in fact have its own scheme in force, it restricted the applicability of such scheme only to the ‘regular employees.’ Moreover, the Appellant’s scheme was not framed by the Central or State government, nor applicable to all of its employees. Therefore, the SC observed that the Appellant did not fulfil the second test and, held that the Appellant was liable to provide PF benefits to contractual employees.

The SC observed that the contractual employees would be entitled to PF benefits either under the Act or Regulations as: (i) they were not engaged through any contractor; (ii) they received wages/salary directly without involvement of any contractor since the date of their engagement; (iii) they have been in continuous employment of the Appellant for long periods of time; and (iv) their work was of perennial and continuous nature owing to which they cannot be termed ‘contractual’ in nature. However, SC preferred to cover the contractual employees under the Regulations over the Act so as to ensure uniformity in the service conditions of all the employees of the Appellant.

The SC elaborated on the predicament faced by the Appellant in complying with BHC’s order by holding that the BHC order would create imbalance if it were to be applied retrospectively. The SC observed as under:

“Provident Fund is normally managed on actuarial basis; the contributions received from employer and the employee are invested and the income by way of interest forms the substantial fund through which any pay-out is made. For all these years the Fund in question was subsisting on contributions made by the other employees and, if at this stage, the benefit in terms of the judgment of the High Court is extended with retrospective effect, it may create imbalance. Those who had never contributed at any stage would now be members of the fund. The fund never had any advantage of their contributions and yet the fund would be required to bear the burden in case any pay-out is to be made. Even if concerned employees are directed to make good contributions with respect to previous years with equivalent matching contribution from the employer, the fund would still be deprived of the interest income for past several years in respect of such contributions.” (emphasis supplied).

Decision of the Supreme Court

1. The Appellant to provide PF benefit to the contractual employees from January 2017 when writ petition was filed before the BHC. However, PF benefit would not be extended to contractual employees who have superannuated, expired, resigned or ceased to be in employment of the Appellant on the date of SC judgement;

2. RPFC to compute the PF amount for the period of January 2017 to December 2019 (“Contribution Period”) to be deposited in to the Trust by Appellant and the contractual employees;

3. The Appellant was directed to pay simple interest at the rate of 12% per annum for the Contribution Period under Section 7Q (interest payable by the employer) of the Act on the amount so computed by RPFC;

4. Contractual employees to deposit matching PF contribution for the Contribution Period along with interest at the rate of 6% per annum; and

5. From January 2020 onwards, the Appellant and the contractual employees to make their respective contributions as per the Regulations.

Vaish Associates Advocates View:

The SC has established a progressive stance by bringing ‘contractual employees’ on the same footing as that of the regular employees in terms of PF contribution. Further, SC’s direction to the employer as well the contractual employees to pay PF contribution from the date of writ petition (January 2017), instead of a retrospective date (from the date when the contractual employee became eligible) is carefully thought out. SC has also undertaken a positive approach by directing employees to make the same PF contribution as the employer. As such, the Act or the Scheme nowhere provides that the employee needs to make PF contribution for the past period or that the employee needs to pay interest on such contribution in respect of the said period.

Further, in light of the peculiarity of the facts and circumstances of this case, the SC exercised pragmatism in holding that contractual employees who have superannuated, expired, resigned or ceased to be in employment of the Appellant are ineligible to receive PF benefit.

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

NCLAT: No default by real estate developer if possession delayed due to reasons beyond control

An application had been filed by home buyers, Shilpa Jain and Akash Jain (collectively, “Respondents”) under Section 7 of the Insolvency and Bankruptcy Code, 2016, to initiate Corporate Insolvency Resolution Process (“CIRP”) against Raheja Developers (“Corporate Debtor”). The National Company Law Tribunal, Special Bench at New Delhi (“NCLT”) by order dated August 20, 2020 (“Impugned Order”), initiated CIRP against the Corporate Debtor. The promoter/shareholder Navin Raheja (“Appellant”) thereafter filed an appeal before the National Company Law Appellate Tribunal (“NCLAT”) in order to challenge the Impugned Order on two primary grounds: (i) that there was fraudulent and malicious initiation of the CIRP; and (ii) that the application filed by the Respondents was barred by limitation and not maintainable on several other grounds. The NCLAT by its judgement dated January 22, 2020 held that if the delay was not due to the Corporate Debtor, it could not be alleged that the Corporate Debtor had defaulted.

FACTS
The Respondents had booked an apartment in the residential project of the Corporate Debtor, in respect of which the Corporate Debtor had: (i) issued a joint allotment letter dated August 3, 2012; and (ii) executed a Flat Buyer’s Agreement dated August 3, 2012 (“Buyer’s Agreement”). In pursuance of the same, the Corporate Debtor received a total amount of INR 86,62,691 from the Respondents. As per Clause 4.2 of the Buyer’s Agreement, possession of the apartment was to be provided within thirty-six months, that is, by August 3, 2015. As per the said clause, in the event the construction could not be completed by the Corporate Debtor within the allotted time frame, the Corporate Debtor was under an obligation to pay the Respondents compensation at the rate of INR 7 per square feet of the super area per month for the entire period of the delay commencing from the time the apartment was to be conveyed. Thereafter, the Respondents filed an application under Section 7 of the IBC (initiation of corporate insolvency resolution process by financial creditor) before the NCLT. They were seeking a refund of the entire principal amount of INR 86,62,691 along with interest at the rate of 18% per annum.

ISSUES
(i) Whether the Corporate Debtor had committed a default if the offer of possession had been delayed due to reasons beyond the control of the Corporate Debtor.

(ii) Whether the Respondents had filed the application before the NCLT with a fraudulent and malicious intent for reasons other than for resolution of insolvency or liquidation.

ARGUMENTS
Contentions raised by the Appellant:

(I) The Corporate Debtor had taken the plea before the NCLT that it had issued a notice of possession for the apartment on November 15, 2016, and even after repeated requests, the Respondents had refused to take possession of the apartment.

The Corporate Debtor had also informed the NCLT that it had already filed a writ petition before the Supreme Court (“SC”) against the application filed by the Respondents. Under the said writ petition, the Corporate Debtor had challenged the constitutional validity of explanation to Sections 5(8)(f), 7, 21(6A)(b) and 25A of the IBC which respectively deal with any amount raised from an allottee under a real estate project shall be deemed to be an amount having the commercial effect of a borrowing, initiation of corporate insolvency resolution process by financial creditor, application for appointment of insolvency professional other than interim resolution professional for certain class of creditors and rights and duties of authorized representative of financial creditors. Herein, the SC had also issued a notice staying all proceedings before the NCLT. Despite the same, and not considering the decision of the SC in Pioneer Urban Land and Infrastructure Limited and Another v. Union of India and Others [2019 SCC Online SC 1005], the Impugned Order was passed.

(ii) The Corporate Debtor had also informed the NCLT that as per the Buyer’s Agreement, the possession of the apartment was to be handed over to the allottees subject to certain force majeure conditions. In this instance, any delay could be attributed to these force majeure conditions and not to the Corporate Debtor.

The Corporate Debtor had completed the construction in advance and further, an occupation certificate was also applied for by the Corporate Debtor in the year 2013. As such, the Corporate Debtor had complied with all obligations under the Buyer’s Agreement. It was also contended that any delay in processing of the application for the occupation certificate could be attributed to the delay of the relevant authority. Therefore, such delay was clearly beyond the control of the Corporate Debtor or the promoter. Despite such delays, the Corporate Debtor had managed to secure the occupation certificate in 2016. In pursuance of the receipt of the said certificate, the possession of the apartment was offered to the Respondents by way of the notice of possession on November 15, 2016. However, the Respondents conveniently chose to file a petition under Section 7 of the IBC after the expiry of a period of two years from the notice of possession. The Respondents had also failed to comply with the various formalities provided for by the Corporate Debtor in the notice of possession. Such conduct of the Respondents only reflects their mala fide intention.

(iii) In addition, the Corporate Debtor had also annexed a demand letter seeking payment of an outstanding amount of INR 86,62,851. The Respondents had also defaulted to make the aforesaid payment and had deliberately suppressed such fact. The Respondents were now seeking a refund of the entire amount along with interest, totaling to INR 87,32,108, which was higher than the principal amount paid by the Respondents. It was notable that the Respondents were also given the discretion to accept the money deposited by them if they did not intend to accept possession.

Observations of the NCLAT

As per Clause 4.4 of the Buyer’s Agreement, the construction was subject to force majeure conditions which, inter alia, included the condition for delay in grant of completion/ occupation certificate by the Government and/ or any other authority or if non-delivery of possession is beyond the control of the company. In such a case, the Corporate Debtor was entitled to a reasonable extension of time for delivery of the possession depending on the prevailing circumstances.

The Corporate Debtor also reserved the right to alter the terms and conditions of allotment or even suspend the scheme in case the circumstances warrant the same. As per Clause 5.1 of the Buyer’s Agreement, the Appellant had a right to cancel the allotment upon refunding payment along with interest at the rate of 5% per annum. In essence, it could not be stated that the Respondents were remedy less. The NCLAT observed that in the case of Pioneer, the SC had held that the Real Estate (Regulation and Development) Act, 2016 (“RERA”) was in addition to and not in derogation of the provisions of any other law for the time being in force. Therefore, the remedies under RERA were additional and not exclusive to the remedies under IBC. Thus, the provisions of IBC would also apply in addition to RERA.

The SC had also noted in the aforesaid judgement that under Section 19 (rights and duties of allottees) of RERA, an allottee was entitled to claim possession of the apartment, plot or building, as the case may be, or refund of amount paid along with interest in accordance with the terms of the agreement for sale. In addition, all allottees were responsible for making necessary payments in instalments within the time specified in the agreement for sale and were also liable to pay interest at such rate as may be prescribed for any delay in such payment. Further, an allottee was duty bound to take physical possession of the apartment, plot or building, as the case maybe, within a period of two months of issuance of the occupancy certificate.

The SC had also taken note of the Andaman and Nicobar Islands Real Estate (Regulation and Development) (General) Rules, 2016, that made provisions for ‘interest payable by promoter and allottee’ and the ‘timelines for refund’, wherein it had observed that once a default relating to amounts due and payable to the allottee was made out in an application under Section 7 of the IBC, the burden shifted on the promoter/ real estate developer to point out that allottee himself was a defaulter. Further, it was also important for the promoter/real estate developer to point out under Section 65 of the IBC that CIRP has been invoked fraudulently. This could be done by showing that: (i) the allottee was only a speculative investor and not genuinely interested in purchasing the apartment; and (ii) the allottee did not want to fulfil his obligation to take possession of the apartment under RERA in light of a failing real estate market. The NCLAT noted that as per the judgement of the SC in Pioneer, the Corporate Debtor could now refer to Section 65 of the IBC to show that the proceedings had been invoked fraudulently or maliciously.

The NCLAT observed that in a large number of cases, the allottees happened to be speculative investors. They simply wanted to forsake possession and seek monies already paid. The NCLAT noted that the NCLT had refused to accept the notice of possession, wherein a further period of four months and a further period of three months were sought for handing over possession and registration, respectively.

As such, the NCLAT also noted that the Appellant had taken a stand before the NCLT in respect of non-availability of necessary infrastructure facilities by the government for carrying out developmental activities.

Further, the Appellant had also agreed to pay the amount with interest but the Respondents wanted a higher percentage of money at the rate of 18% per annum.

While the Respondents haven’t denied that they were offered possession, the fact remains that after two years, they did not seek possession and only wanted their money back. As per Clause 4.4 of the Buyer’s Agreement, the Corporate Debtor could not be made responsible if there was a delay on account of non-availability of necessary infrastructure facilities being provided by the government for carrying out developmental activities. The delay in providing the occupation certificate therefore, fell squarely within the said clause.

Decision of the NCLAT

The NCLAT held that the Respondents had filed the application under Section 7 of the IBC fraudulently with malicious intent, and only wanted to jump ship and retrieve the amount paid by employing coercive measures. Delay in grant of approval by the relevant competent authority could not be taken into consideration in holding that the Corporate Debtor had delayed in delivering possession. Further, the NCLT had also ignored the decision of the SC, which though delivered prior to the admission of the application was binding on all courts.

The NCLAT held that the case fell within the ambit of Section 65 of the IBC. It also imposed penalty on the Respondents in addition to setting aside the Impugned Order and dismissing the application under Section 7 of the IBC. The NCLAT also observed that before admitting any case, it would be desirable for the NCLT to enquire if the intention of the allottees was to seek refund and not the possession of the apartment.

Moreover, if the delay was attributable to force majeure and not to the fault of the Corporate Debtor, it could not be alleged that the Corporate Debtor had defaulted in delivering the possession.

Vaish Associates Advocates View:

This is a welcome move by the NCLAT in reaffirming the judgement of the SC in Pioneer and acknowledging that allottees cannot simply jump ship by attuning their decision to seek possession of the apartment/ refund of amounts paid as per the prevailing real estate market.

The decision imposes a duty upon the NCLT to place an application filed by the allottee under strict scrutiny to determine the true intent of the allottee. As such, once a prima facie case is made out by the applicant, the real estate developer is given an opportunity to prove that the allottee was himself a defaulter and point out, as under Section 65 of the IBC, that the allottee had in fact filed an application only with a fraudulent intent.

Further, the decision also reinforces a protection to the real estate developer if the possession was delayed due to reasons beyond control.

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