This article is written by Harshita Naidu, pursuing a Certificate Course in Insolvency and Bankruptcy Code from LawSikho.com. Here she discusses “IBC Section 10 – A Peculiar and Distinctive Provision”.

Introduction

The provision is unique and dissimilar from other provisions of the Insolvency and Bankruptcy Code, 2016 as the Corporate Debtor is empowered to move an impugned petition against itself to initiate the Corporate Insolvency Resolution Process and declare itself as Insolvent.

Explanation

Section 10 of the Insolvency and Bankruptcy Code, 2016 (“Code”) grants a locus standi to the Corporate Applicant to initiate a Corporate Insolvency Resolution Process (“CIRP”) against itself. It is a benignant provision and is favorable not only to the creditors [either operational/financial creditors] but also to other concerned stakeholders of the Company. The National Company Law Tribunal pursuant to Section 60(5) of the Code has the jurisdiction to entertain and dispose of an application under Section 10 of the code.

Section 4 of the Code provides a locus standi to the Corporate Applicant to initiate a CIRP against itself. The cause of action arises when a Corporate Applicant defaults in repayment of the debt amounting to INR. 1, 00,000/- (Rupees One Lakh Only.) and above to either it’s Operational, Financial or other Creditors within the prescribed period. 

Interpretation of ‘Corporate Applicant

Section 5(5) of the Code defines Corporate Applicant as follows:

• A corporate debtor; or
• a member or partner of the corporate debtor who is authorized to make an application for the corporate insolvency resolution process under the constitutional document of the corporate debtor; or
• an individual who is in charge of managing the operations and resources of the corporate debtor; or
• a person who has the control and supervision over the financial affairs of the corporate debtor.

The aforesaid provision is comprehensive, as the meaning of the Corporate Applicant is not restricted to a Corporate Debtor and includes the Authorized Representatives appointed on behalf of the Board of the Debtor to make an application under the respective provider.

Therefore, it shall be assumed that the aforesaid is a clarificatory provision that is construed to give a wider meaning to the term- ‘Corporate Applicant.’

The rationale behind making an application under Section 10 of the Code

The policy of Law favors the Corporate Debtor if its business is severely affected due to bad market conditions and the non-availability of working capital funds. Business does not flourish always and may face financial crunch due to which the Corporate Debtor is unable to discharge its existing obligations. 

The onus lies on the Corporate Debtor to prove the fact that its business is affected in general and it has suffered huge losses in the previous Financial Years. If the same can be proved within the prescribed time frame, then the application shall be admitted by the Hon’ble Tribunal. 

Prerequisites for Initiation of Corporate Insolvency Resolution Process

The procedure for initiation of CIRP is delineated under Section 10 of the code wherein the Corporate Debtor is required to provide information under Form- 6 read with Rule 7 of the Insolvency and Bankruptcy [Application to Adjudicating Authority Rules],2016  (hereinafter referred to as AAA rules). 

It is incumbent on the Corporate Debtor to furnish all relevant and accurate information as asked under Form 6 with relevant information as directed under Section 10(3)of the Code which includes

• the information relating to its books of accounts and such other documents for such period as may be specified;
• the information relating to the resolution professional proposed to be appointed as an interim resolution professional; and
• the special resolution passed by shareholders of the corporate debtor or the resolution passed by at least three fourth of the total number of partners of the corporate debtor, as the case may be, approving the filing of the insolvency application.

Pursuant to Section 3(12) of the Code, the term “default”  means non-payment of debt when the whole or any part or installment of the amount of debt has become due and payable and is not paid by the debtor or the corporate debtor, as the case may be;

The Hon’ble National Company Law Appellate Tribunal observed in Unigreen Global Pvt. Ltd vs. Punjab National Bank1  that if there is a debt and a default has occurred and the Corporate Debtor is not ineligible under Section 11 of the Code, then Adjudicating Authority has no option but to admit the application unless incomplete in which Corporate Debtor is given time to rectify its defects.

As per Section 10(4), if the application is complete and fulfills all the criteria as mentioned above and is devoid of any technical error, it shall be admitted within fourteen days of filing the application by the Adjudicating Authority.

The dichotomy of Section 10 with Section 65 and 66 of the Code and the notion of Financial Fraud

Although Section 10 is an independent provision that is favorable to all concerned stakeholders, it is always read in light with Section 65 [Fraudulent or malicious initiation of proceeding] and Section 66[fraudulent trading or wrongful trading] of the respective Code.

NCLT has time and again reaffirmed the purpose of the code and has made clear that the spirit of Law is to provide resolution to distressed Companies. However, the provisions are misused by the petitioners with the intention to defraud the stakeholders.

The intention of the corporate debtor shall not be incredulous and deceitful.  Section 65 and Section 66 protects the interest of the Stakeholders and stipulates punishment for Financial Irregularities and Fraud. Section 10 read with Section 65 and 66 is co-related with the Vulnerable Transactions i.e. Section 43 to 51 of the Code.

Section 10 and its interplay with Section 65 – There are various instances where Corporate Applicants make an application with fraudulent or malicious intent and frustrate the proceedings of the court.  Section 65 states that if CIRP or liquidation proceedings are initiated by any person with fraudulent or malicious intent for any purpose other than the purpose for resolution of insolvency or liquidation then heavy penalties shall be imposed by the Adjudicating Authority.  

The same shall be elucidated by way of a few illustrations:

• For instance, JKL Ltd. is a related party of Mr. B who works in the capacity of a Director for a Company named EFG Ltd. Mr. B is also a Director in JKL Ltd and holds along with his wife more than 2 per cent of paid-up share capital.  JKL Ltd. executed a Loan agreement with EGF Ltd. in September 2018 which states that EFG Ltd. is in distress and the main object of the agreement was to provide loan amounting to INR 5, 00,000/- (Rupees Five Lakhs Only.)so that EFG Ltd. is able to repay the outstanding dues to its secured Financial Creditors – named ‘XYZ’. Suppose, after repaying the outstanding debts to ‘XYZ’, JKL Ltd. seeks repayment within the prescribed period and EFG Ltd. does not return the requisite amount to JKL Ltd. and initiates a CIRP against itself under Section 10 in November 2019 with a malicious intent stating that Company is undergoing severe losses. It may happen that the initiation of CIRP is done with an ulterior motive and EFG Ltd. is not undergoing any financial distress and the intention is only to rehabilitate itself and to frustrate the proceedings of the Court. As JKL ltd. is a Related Party under Section 5(24) (e) of the Code, the initiation of CIRP by EFG Ltd. is malafide in nature. 

NOTE: In the same case, if JKL Ltd. is not a related party of EFG Ltd. and suppose if Mr. B has friendly relations with JKL Ltd. for the past 20 years and EFG Ltd. clears all dues of ‘XYZ’  but has not repaid the outstanding debts taken from JKL Ltd and initiates CIRP u/s 10 of the Code. In both situations, it can be assumed safely that the application is not made in good faith and falls under the purview of Section 65 of the Code. 

• Consider another situation; EFG Ltd. has another class of creditors which includes its Operational Creditors and unsecured Financial Creditors. EFG Ltd. pays the outstanding debt to ‘XYZ’ creditors who are its secured Financial Creditors and does not pay any amount to the other class of creditors.  Suppose, ‘XYZ’ participates in the policymaking process of EFG Ltd. and hence can be termed as Related party as per section 5(24)(m) of the Code. As EFG Ltd. is unable to pay the outstanding amount to its operational and unsecured Financial Creditors, it voluntarily initiates CIRP against itself under section 10 within a year’s time.  It can be inferred from this illustration that, ‘XYZ’ is given preferential treatment under Section 43 of the Code as Mr. B has some direct or indirect connection with creditors ‘XYZ’;

It can be inferred from the above situations that, Section 65 of the Code comes into the picture in both the cases, as the Corporate Debtor has a fraudulent and malicious intent.

Section 10 and its Interplay with Section 66 of the Code

As per section 66(1), if during the CIRP or liquidation process, it is found that any business of the corporate debtor was carried out with the intention of defrauding creditors or for any fraudulent purpose then, the resolution professional shall make an application to the adjudicating authority informing the fraudulent transaction. Adjudicating authority upon receiving such an application may pass an order that any person who was knowingly parties to the carrying on of the business in such manner shall be liable to make such contributions to the assets of the corporate debtors as it may deem fit. Section 66(1) extends liability on “any person” who was knowingly a party to such transaction. It can be assumed safely that Company and its directors are under its ambit.

However, as per Section 66(2), liability is extended specifically to the director or partner of the corporate debtor in case of fraudulent or wrongful trading. As per the directions of NCLT, director or partner is liable to make contributions to the assets of the Corporate Debtor  if before the insolvency commencement date, such director or partner knew or ought to have known that there was no reasonable prospect of avoiding the commencement of a corporate insolvency resolution process in respect of such corporate debtor; and such director or partner did not exercise due diligence in minimizing the potential loss to the creditors of the corporate debtor.

Twilight period is the time when the director knew or ought to have known that there was no reasonable possibility of avoiding the commencement of resolution of the company, till the time the company actually enters into resolution. It is the responsibility of a Director/ Partner to exercise due diligence during the twilight period.   

For the purposes of this section a director or partner of the corporate debtor, as the case may be, shall be deemed to have exercised due diligence if such diligence was reasonably expected of a person carrying out the same functions as are carried out by such director or partner, as the case may be, in relation to the corporate debtor.

If any illegitimate and felonious transaction is executed with an intention to defraud the creditors, then the persons involved in such transaction shall be held liable and shall contribute to the assets of the Corporate Debtor.

The same shall be elucidated by way of few illustrations:

• For instance, In January 2019, ABC Ltd. [the Corporate Debtor], entered into a gift deed with DEF Ltd. and transferred property worth INR 30,00,000/-(Rupees Thirty Lakhs Only). In October 2019, ABC Ltd. declared itself as insolvent as it was unable to repay the outstanding amount of INR 20,00,000/-(Rupees Twenty Lakhs Only)  to its creditors and initiated CIRP against itself under section 10 and later the Resolution Professional realized that DEF Ltd. holds twenty per cent voting rights in ABC Ltd. The transaction is an undervalued transaction as per Section 45 and also attracts Section 66(1) of the Code.
• Consider another situation; Mr. D [Director of ABC Ltd.] in his sole discretion sold assets of ABC Ltd. worth INR 10 Lakhs for INR 2 Lakhs. The property was sold to Mr. F who is the brother of Mr. D in January 2019. If in October 2019, CIRP u/s 10 is initiated and the Resolution Professional becomes aware of the fact that Mr. D is a related party then it falls under the purview of the undervalued transaction and in addition to this Mr. D will be personally liable under Section 66(2) of the Code.

The above situations also attract Section 49, as the corporate debtor/ Director of the Corporate Debtor as the case may be has entered into an undervalued transaction with the intention to keep away the assets beyond the reach of the persons entitled to claim, which will adversely affect the interest in relation to such claim.

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NOTE: In all the aforementioned circumstances, the transactions fell within the lookback period of two years [ one year – if the transaction is executed with a non-related party] prior to the commencement of insolvency proceedings, as prescribed for preferential or undervalued transactions between related parties under the Code.

Case Law Analysis

Section 10 and its misuse are explicated with the help of a Landmark judgment delivered by the Hon’ble Tribunal, in the matter of Munisuvatra Agri International Ltd filed under Section 10 of the Code.

Facts in Issue:

• Whether the application is filed u/s 10 of the code to defraud its creditors?
• Whether change in name and address of the Corporate Debtor is done with malicious intent?
• Is shareholder’s approval a prerequisite before initiation of CIRP?

Factual Matrix

• Corporate Applicant initiated Insolvency proceedings itself as it was unable to repay the outstanding amount to its Operational and Financial Creditors and filed an application under Section 10 of the Code.
• The Operational creditors, Financial creditors, Shareholders, and Independent directors challenged the maintainability of the application stating that the application is made with a malicious intent to defraud its creditors.
• Creditors alleged that the name of the Corporate Debtor is changed from LMJ International Pvt. Ltd to Sri Munisuvrata Agri International Ltd. and registered office address is also changed surreptitiously without informing the Creditors within a week before making an application under Section 10 of the Code. 
• It was also alleged that to avoid the outstanding liabilities, Corporate Debtor changed the name of the Company and registered an address with an ulterior motive to defraud the creditors so that the creditors do not come to know that section 10 application is filed and seek shelter under moratorium under Section 14 of the Code;
• It was also submitted by the creditors that shareholder’s approval was not taken before initiating CIRP;
• One of the Independent Directors stated that due to family disputes between the directors of the Company, no Board meetings were held in the Company and he was not informed of the change in the name of the Company and registered office.
• Creditors also submitted that there was no default at the time of making application under section 10 and the credit facility availed by the Corporate Debtor has not fallen due and no demand notice has been issued for the failure of repayment. 
• It was also contended by one of the Operational creditors that according to the previous years’ balance sheets, Company was profit-making, however, the provisional balance sheet showed that Company is incurring losses.

Arguments on behalf of Corporate Applicant

• The company was incorporated in the year 1992 under the name LMJ International Limited and the nature of the business was related to import and export of food products. In the course of business and due to change in the policy of RBI by discounting Letter of Understanding and Letter of Comforts for trade credit, the export, and import business suffered loss and the Corporate Applicant was unable to ensure payment for exports shipment and honor letter of credit. So this case was instituted not because of inability to pay the debt but because of impossibility to continue its business due to certain circulars issued by RBI.
• The overall control and management of the Company were vested with the Managing Director, Mr. Suresh Kumar Jain who was the elder brother of the then present directors and held a 51 per cent stake in the Company. As huge losses were incurred in the business during his tenure, Corporate Debtor made an application under section 10 of the Code as it was unable to repay the outstanding debts to the creditors.

Judgement

“Corporate Applicant has filed the Section 10 application with a malafide intention and an ulterior motive and for a purpose other than for resolution so as to frustrate the recovery proceedings pending before courts upon declaring a moratorium”. 

Analysis

• Application dismissed pursuant to Section 65 of the Code as the Corporate Applicant had a malicious intent other than for resolution of insolvency or liquidation as the case may be. 
• Concealment of facts regarding the change in name and registered office address is done with an intention to defraud its creditors.
• Corporate Applicant was not in a position to produce any documentary evidence before the Tribunal which could prove the existence of default. Merely stating that a specific amount is due does not mean that default is committed. If the occurrence of default is not established by supporting evidence, then Section 10 application shall not be admitted.  
• Special Resolution is a prerequisite for filing a Section 10 application. The non-production of the same leads to non-compliance.

Final Thoughts

• Transparency is the hallmark in today’s corporate world.  
• Sections 43 to Section 51 are known as the ‘vulnerable transactions’. They differ from Section 66 in the sense that the general remedy in case of any vulnerable transaction will be a reversal of impact of any successful transaction whereas Section 66 states that if any person initiates any fraudulent or wrongful trading, that person shall be held liable to make a contribution to the assets of the Corporate Debtor.  
• It shall be assumed from the aforementioned that the spirit of Section 10 is potentially misused if provisions relating Section 65 or 66 or vulnerable transactions relating to Section 43 to 51 are attracted.
• Pursuant to Section 66[1], liability is extended on people who were knowingly parties to such transactions and covers directors and partners within its ambit. It is triggered to invoke Group Liability. The outsiders of the Company can also be held liable which may include creditors of the Company.
• Whereas, Section 66[2], specifically creates an additional obligation on the directors or partners. Directors or Partners shall not misuse their powers and must not misappropriate the assets of the Company. 
• Exercising due diligence is one of the key functions that a director needs to perform.

References

• The Insolvency and Bankruptcy Code, 2016, Section 65 and 66.
• The Insolvency and Bankruptcy Code, 2016, Section 43 – 51.
• C.A.(IB) Nos. 635, 652, 722 & 778/KB/2018 And Inv. A. (IB) No. 800/KB/2018 In C.P(IB) No. 615/KB/2018

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