The insolvency code’s confusing clauses call for a review

KS Ravichandran | Updated on October 07, 2020

Under the Insolvency and Bankruptcy Code, 2016 (the Code), where there is a default on the part of corporate debtor in repaying a debt of ₹1 crore or above, state of insolvency of the corporate debtor is presumed and a creditor has the option to set in motion the Corporate Insolvency Resolution Process (CIRP) to bring about resolution of insolvency.

If no resolution happens, ipso facto, liquidation of the corporate debtor is ordered. In view of the systemic flaws and inefficiencies, during CIRP as well as during liquidation, the control over the management of the insolvent corporate debtor gets placed in the hands of a resolution professional and the Board of Directors remain suspended during those periods.

In V. Padmakumar v Stressed Assets Stabilisation Fund (SASF) & Anr. decided by the National Company Law Appellate Tribunal (NCLAT) on March 12, 2020, the account had become NPA in 2011 itself and a claim of ₹124 crore. Despite the fact that there was a decree passed by the DRT on August 17, 2018, the NCLAT, by a majority decision, had dismissed the application of the financial creditor. The contention that the audited financial statements of the corporate debtor discloses the liability and such disclosure operates as an acknowledgement of debt did not find favour with the NCLAT.

A majority of the bench of NCLAT ruled that if disclosures made in financial statements were to be treated as an acknowledgement of debt limitation would never stop its running. It is worth noting that other than the disclosures in the financial statements, no other document was produced to constitute acknowledgement of the debt within a period of three years before the date of the application under the Code. In a minority decision, a member had, however, expressed his dissent.

Previously, in Ishrat Ali v Cosmos Cooperative Bank Ltd and Others [Company Appeal (AT) (Ins) No.1121 of 2019 also, the NCLAT had formed a similar opinion while setting aside the order of NCLT commencing the CIRP. In that case too, the account of the corporate debtor had become NPA in 2014 itself and the Bank had also taken possession of the movable assets under Section 13(4) of the ‘SARFAESI Act, 2002’ as back as on 16 January 2017. Yet, the NCLAT ruled that for any action under the Code the limitation of time of three years prescribed Article 137 would apply and, hence, the action under the Code was time-barred.

In both above cases, NCLAT had relied on several decisions of the Supreme Court including Jignesh Shah and another vs. Union of India and another — (2019) 10 SCC 750 and BK Educational Services Private Limited vs. Parag Gupta and Associates — (2018) SCC Online SC 1921.

In fact, recently, in Babulal Vardharji Gurjar Vs. Veer Gurjar Aluminium Industries Pvt. Ltd. & Anr. (2020) SCC Online SC 647, the SC had held that the application made by the Respondent No. 2 under Section 7 of the Code in the month of March 2018, seeking initiation of CIRP in respect of the corporate debtor with the specific assertion of the date of default as July 8, 2011, is clearly barred by limitation for having been filed much later than the period of three years from the date of default as stated in the Application.

So, the question is whether disclosures in audited financial statements would constitute an acknowledgement of the debt, or not. Financial statements show the information derived from the books of accounts in accordance with Sections 128 and 129 of the Companies Act, 2013 and there should be some sanctity to audited financial statements which includes the directors’ report and auditors report.

Ironically, an audited balance sheet duly approved and authenticated in accordance with mandatory provisions of Section 134 of the Companies Act, together with the director’s responsibility statement will not serve as acknowledging debts owed by the company though if there had been a simple letter signed by an officer of the company would have been treated as a valid acknowledgement for the purpose of Section 18 of the Limitation Act. A conundrum of sorts, indeed. Practically speaking, if disclosures in financial statements are treated as acknowledgements of debts reviving the limitation, non-disclosures would result in contravention of the law and may lead to prosecution.

The stand taken by NCLAT in Padmakumar and Ishrat Ali’s cases appears to be requiring a review and moreover, even the stand taken by the SC in the cases above referred to appears to be contrary to the fundamental objectives of the Code. It appears to be inconsistent with the “debt and default” ingredients. The liability of the corporate debtor has not been obliterated from its books. The liability is real; the default is also real.

The writer is managing partner, KSR & Co Company Secretaries

Published on October 07, 2020

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