Shobhnath & Ors vs Prism Industrial Complex Ltd

(Arising out of Order dated 5th July, 2018 passed by the Adjudicating Authority (National Company Law Tribunal), Allahabad Bench in C.P. No. 168/ALD/2017)

IN THE MATTER OF:

Shobhnath & Ors. ...Appellants

Vs.

Prism Industrial Complex Ltd. ...Respondent

Present: For Appellant: - Mr. Ashok Kriplani with Mr. Hitesh, Advocates.

For Respondent: - None.

J U D G M E N T

SUDHANSU JYOTI MUKHOPADHAYA, J.

The Appellant- Mr. Shobhnath filed an application under Section 7

of the Insolvency and Bankruptcy Code, 2016 ("I&B Code", for short)

against 'Prism Industrial Complex Limited'- ('Corporate Debtor'). The

Adjudicating Authority (National Company Law Tribunal), by detailed

judgment dated 5th July, 2018 rejected the application under Section 7

with following reasons:

"Whether insolvency application can be

entertained in a case where financial fraud exists? 2

Admittedly the corporate debtor company had

raised deposits from retail investors, by instruments

purporting to be debentures. The debentures were issued

to more than 3000 investors.

In accordance with the provisions of sec. 67 of the

Companies Act, 1956, these debentures were deemed to

have been issued to public. - - - -

The debentures were issued in breach of the public

issue norms, and therefore, the debentures must be

redeemed immediately.

Additionally, some of the debentures were

regarded to be "deposits", being unsecured

debentures, and orders have been passed by the

NCLT for immediate repayment of the said

debentures.

Even while the said orders of NCLT are pending for

execution, and have not been acted upon application

has been made by some of the financial creditors for

insolvency of the Corporate Debtor under sec. 7 of the IBC.

There are two essential reasons why such

an application for declaration of insolvency and

moratorium under sec. 7 cannot be granted.

Company Appeal (AT) (Insolvency) No. 557 of 2018 3

First reason is purely a question of bonafide

reasons for making the application, and the implications

of the insolvency declaration and ensuing moratorium.

There is no doubt that the enactment of the

insolvency resolution process under the IBC is a step

towards resolution or rectification of an insolvency. There

is a company which had run into financial problems; the

creditors are proposing to collectively bail the company

out. These provisions are intended for repairing a broken

house that still can be repaired, and can avoid demolition.

The intent of Insolvency resolution process cannot be to

interfere in cases where there are financial irregularities,

illegalities or indications of a financial fraud.

The present case is one where interests of a large

number of retail investors, from whom money has been

raised in the guise of debentures or deposits, is involved.

None of these retail investors, who have been deprived of

their life's savings, could be intending to be benevolent to

think of resolution or revival of such a company. It is also

evident that having raised money from numerous

investors, the promoters/directors have siphoned the

funds out into various affiliated companies. This is evident

from a study of the balance sheet of the company.

Company Appeal (AT) (Insolvency) No. 557 of 2018 4

Where the situation is reflective of a financial

fraud, and orders of NCLT for immediate repayment of

the debentures/deposits have remained unexecuted,

what the ends of justice require is effective

implementation of orders already issued, and sternest

prosecution of an offender responsible for

financial fraud. The benevolent scheme of IBC for a

resolution of a company under distress is not meant for a

case of a financial fraud or irregularity, where the

directors/promoters have deliberately engaged in a

scheme having striking similarity with the Infamous "chit

funds" or Ponzi schemes. The promoters/directors face

serious criminal implication for breach of the orders of SEBI

as well noncompliance of provisions of sec. 73/74 of the

Companies Act 1956. It is also notable that section 75 of

the Companies Act provides that raising of deposits, or

non-payment thereof, amounts to a serious corporate

fraud, punishable under sec. 447 of the Companies Act.

It can be no one's case that in such a murky

scenario of corporate fraud, section 7, which is

intended for a holistic collective healing process,

could be rightly deployed.

Company Appeal (AT) (Insolvency) No. 557 of 2018 5

The second reason why CIRP process cannot

be initiated in a case such as the one in hand, is a

combined reading of sec. 3(17) and sec. 3 (16) (a) of the

Code. As per sec. 3(16) (a), the business of accepting

deposits is included in the definition of "financial services".

A financial services provider, as per sec. (17) is one who is

engaged in the business of providing financial services, in

accordance with authorization or registration granted

under the law. Where an authorization or registration is

required by statute, not obtaining the same cannot grant

the entity the right to get out of the provisions which are

intended to apply to an entity engaged in similar services.

It is notable that sec.3 (7) excludes a financial

services provider from the ambit of the Code The intent of

the exclusion is simple if an entity is engaged in financial

services business, it has a systemic significance. It

involves money belonging to public. If such a company is

put into a situation of moratorium, and the payments

made by such entity are halted, the financial system

could get into a tail spin. Such a serious implication to the

fact, keeping such entities outside a benevolent, remedial

law such as IBC, is all the more important for such a truant

Company Appeal (AT) (Insolvency) No. 557 of 2018 6

entity, which is sitting with public money, and that too,

without any authorization.

The consequential impact of the commencement of

CIRP will be moratorium. This will actually mean the

orders made by SEBI or NCLT for immediate refund of the

money, raised from retail investors will not be

implemented during the moratorium period. Also, the

constitution of the Committee of Creditors and the system

of voting there at, goes on the basis of majority by value. It

is quite possible that the corporate person may have

created creditors with high value, who may care feast for

the interests of retail investors, from whom money has

been. Hence, the so-called resolution plan may harm the

interests of such investors.

Considering the Intent of the CIRP provisions,

public interest involved and the ends of justice, we are of

the view that in the present case, the application for CIRP

deserves to be rejected.

The learned counsel for the financial creditor has

emphasised on admitting the petition, for initiation of CIRP.

Corporate debtor itself has filed its no objections in the

form of affidavit, claiming that CIRP process will be in the

interest of the debenture holders/ depositors and the

Company Appeal (AT) (Insolvency) No. 557 of 2018 7

corporate debtor. The petition filed in the insolvency and

bankruptcy code cannot be admitted only on the ground

that corporate debtor has not opposed the petition Section

65 of The Insolvency and Bankruptcy Code 2O16

provides that

"if any person initiates the insolvency

resolution process or liquidation proceedings

fraudulently with malicious intent for any

purpose other than for resolution of insolvency,

or liquidation, as the case may be, the

adjudicating authority may impose upon such

person a penalty which shall not be less than

Rs. 1 lakh, but we may extend to one crore

rupees."

Thus it is clear that while a petition is filed under

Insolvency and Bankruptcy Code 2016, fraudulently

with malicious intention for initiation of CIRP, then in

that case the petition cannot be admitted not be

admitted and actions should be initiated under section

65 of the Code. This is a fit case where we find that this

petition has been filed fraudulently for initiation of

corporate, insolvency process, therefore petition

deserves to be dismissed.

Company Appeal (AT) (Insolvency) No. 557 of 2018 8

Order

The petition filed by the financial creditor under

section 7 of the Insolvency and Bankruptcy code is

dismissed for the reasons assigned in the body of the

judgment. We further order that show cause notices under

section 65 of The Insolvency and Bankruptcy Code

against the petitioner/ financial creditors be issued. Reply

against the notices may be filed within three weeks from

today.

A copy of this order be communicated to the SEBI

and to the Central Government through RD(NR).

List on dated 7th August, 2018 of further

proceeding."

2. The Adjudicating Authority by impugned Judgment also directed

for issuance of show-cause notice under Section 65 of the 'I&B Code'

against the Appellants/ 'Financial Creditors' for further decision.

3. Learned counsel appearing on behalf of the Appellants submitted

that the Adjudicating Authority is required to take into consideration the

relevant facts as recorded in Form-1 to find out whether debt is payable

Company Appeal (AT) (Insolvency) No. 557 of 2018 9

and the application is complete or not. If the debt is payable and default

is of more than Rs.1 lakh and record is complete, the Adjudicating

Authority is bound to admit the application.

4. In spite of service of notice and publication of advertisement in two

Newspapers one in English- 'Times of India, Allahabad Edition' and

another is Hindi- 'Hindustan, Allahabad Edition', the 'Corporate Debtor'

has not appeared.

5. From the impugned order, we find that the Adjudicating Authority

has allowed intervention applications filed by different creditors, which is

not the requirement of the 'I&B Code'/ law.

6. In "Innoventive Industries Ltd. v. ICICI Bank & Anr.─ Company

Appeal (AT) (Insolvency) Nos. 1 & 2 of 2017", this Appellate Tribunal

held that before admitting an application under Sections 7 or 9, a limited

notice is required to be given to the 'Corporate Debtor' by the Adjudicating

Authority.

7. The matter subsequently fell for consideration before the Hon'ble

Supreme Court in "Innoventive Industries Ltd. v. ICICI Bank and

Anr.─ (2018) 1 SCC 407" wherein dealing with the provisions of Sections

7 or 9, the Hon'ble Apex Court observed and held as follows:

"27. The scheme of the Code is to ensure that

when a default takes place, in the sense that a

Company Appeal (AT) (Insolvency) No. 557 of 2018 10

debt becomes due and is not paid, the insolvency

resolution process begins. Default is defined in

Section 3(12) in very wide terms as meaning non-

payment of a debt once it becomes due and

payable, which includes non-payment of even

part thereof or an instalment amount. For the

meaning of "debt", we have to go to Section 3(11),

which in turn tells us that a debt means a liability

of obligation in respect of a "claim" and for the

meaning of "claim", we have to go back to Section

3(6) which defines "claim" to mean a right to

payment even if it is disputed. The Code gets

triggered the moment default is of rupees one lakh

or more (Section 4). The corporate insolvency

resolution process may be triggered by the

corporate debtor itself or a financial creditor or

operational creditor. A distinction is made by the

Code between debts owed to financial creditors

and operational creditors. A financial creditor has

been defined under Section 5(7) as a person to

whom a financial debt is owed and a financial

debt is defined in Section 5(8) to mean a debt

which is disbursed against consideration for the

time value of money. As opposed to this, an

Company Appeal (AT) (Insolvency) No. 557 of 2018 11

operational creditor means a person to whom an

operational debt is owed and an operational debt

under Section 5(21) means a claim in respect of

provision of goods or services.

28. When it comes to a financial creditor

triggering the process, Section 7 becomes

relevant. Under the explanation to Section 7(1), a

default is in respect of a financial debt owed to

any financial creditor of the corporate debtor- it

need not be a debt owed to the applicant financial

creditor. Under Section 7(2), an application is to be

made under sub-section (1) in such form and

manner as is prescribed, which takes us to the

Insolvency and Bankruptcy (Application to

Adjudicating Authority) Rules, 2016. Under Rule

4, the application is made by a financial creditor

in Form 1 accompanied by documents and

records required therein. Form 1 is a detailed form

in 5 parts, which requires particulars of the

applicant in Part I, particulars of the corporate

debtor in Part II, particulars of the proposed

interim resolution professional in part III,

particulars of the financial debt in part IV and

Company Appeal (AT) (Insolvency) No. 557 of 2018 12

documents, records and evidence of default in

part V. Under Rule 4(3), the applicant is to

dispatch a copy of the application filed with the

adjudicating authority by registered post or speed

post to the registered office of the corporate

debtor. The speed, within which the adjudicating

authority is to ascertain the existence of a default

from the records of the information utility or on the

basis of evidence furnished by the financial

creditor, is important. This it must do within 14

days of the receipt of the application. It is at the

stage of Section 7(5), where the adjudicating

authority is to be satisfied that a default has

occurred, 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 adjudicating authority is satisfied that a

default has occurred, the application must be

admitted unless it is incomplete, in which case it

may give notice to the applicant to rectify the

defect within 7 days of receipt of a notice from the

adjudicating authority. Under sub-section (7), the

Company Appeal (AT) (Insolvency) No. 557 of 2018 13

adjudicating authority shall then communicate

the order passed to the financial creditor and

corporate debtor within 7 days of admission or

rejection of such application, as the case may be.

29. The scheme of Section 7 stands in contrast

with the scheme under Section 8 where an

operational creditor is, on the occurrence of a

default, to first deliver a demand notice of the

unpaid debt to the operational debtor in the

manner provided in Section 8(1) of the Code.

Under Section 8(2), the corporate debtor can,

within a period of 10 days of receipt of the

demand notice or copy of the invoice mentioned of

a dispute or the record of the pendency of a suit

or arbitration proceedings, which is pre-existing-

i.e. before such notice or invoice was received by

the corporate debtor. The moment there is

existence of such a dispute, the operational

creditor gets out of the clutches of the Code.

30. On the other hand, as we have seen, in the

case of a corporate debtor who commits a default

of a financial debt, the adjudicating authority has

merely to see the records of the information utility

Company Appeal (AT) (Insolvency) No. 557 of 2018 14

or other evidence produced by the financial

creditor to satisfy itself that a default has

occurred. It is of no matter that the debt is

disputed so long as the debt is "due" i.e. payable

unless interdicted by some law or has not yet

become due in the sense that it is payable at some

future date. It is only when this is proved to the

satisfaction of the adjudicating authority that the

adjudicating authority may reject an application

and not otherwise."

8. In "Innoventive Industries Ltd. v. ICICI Bank and Anr." (Supra),

it is made clear that the 'debt' means a liability of obligation in respect of

a 'claim' and a 'claim' means a right to payment even if it is disputed.

The Code gets triggered the moment default is of rupees one lakh or more.

9. The Hon'ble Supreme Court specifically held that when it comes to

a 'Financial Creditor' triggering the process, Section 7 becomes relevant.

The application is made by a 'Financial Creditor' in Form 1 accompanied

by documents and records required therein. Form 1 is a detailed form in

5 parts, which requires particulars of the applicant in Part I, particulars

of the 'Corporate Debtor' in Part II, particulars of the proposed 'Interim

Resolution Professional' in Part III, particulars of the 'Financial Debt' in

Part IV and documents, records and evidence of default in Part V.

Company Appeal (AT) (Insolvency) No. 557 of 2018 15

10. Thus, it is clear that once the record is complete, Code is to be

triggered if there is a default of more than Rs. 1 lakh. The 'Corporate

Debtor' can only point out that the debt may not be due in a sense it is

not payable in law or in fact.

11. This Appellate Tribunal in numerous cases has stated that notice

is to be given only to the 'Corporate Debtor' in an application under

Sections 7 or 9 of the 'I&B Code'. The question of intervention by a third

party before the admission of the application under Sections 7 or 9 does

not arise.

12. It is a settled law that the Adjudicating Authority is only required

to ensure whether there is a debt and default on the basis of record (Form

1). It cannot take into consideration any other facts which are irrelevant.

The 'Corporate Insolvency Resolution Process' not being a litigation much

less adversarial litigation or a recovery proceeding or a money suit, has

been held by this Appellate Tribunal in "Binani Industries Limited vs.

Bank of Baroda & Anr.─ Company Appeal (AT) (Insolvency) No. 82 of

2018 etc.". For the said reason, we hold that the Adjudicating Authority

cannot notice to hold that owing to the financial fraud the amount was

not paid by the 'Corporate Debtor'.

13. Section 65 of the 'I&B Code' provides "Fraudulent or malicious

initiation of proceedings" which reads as follows:

Company Appeal (AT) (Insolvency) No. 557 of 2018 16

"65. Fraudulent or malicious initiation of

proceedings.─(1) If, any person initiates the

insolvency resolution process or liquidation

proceedings fraudulently or with malicious intent for

any purpose other than for the resolution of insolvency,

or liquidation, as the case may be, the Adjudicating

Authority may impose upon a such person a penalty

which shall not be less than one lakh rupees, but may

extend to one crore rupees.

(2) If, any person initiates voluntary liquidation

proceedings with the intent to defraud any person, the

Adjudicating Authority may impose upon such person

a penalty which shall not be less than one lakh rupees

but may extend to one crore rupees."

14. From the aforesaid provision, it is clear that if, any person initiates

the Insolvency Resolution Process or Liquidation Proceedings

fraudulently or with malicious intent for any purpose other than for the

resolution of insolvency, or liquidation, the Adjudicating Authority has

power to impose upon such person penalty which shall not be less than

one lakh rupees, and may extend to one crore rupees.

15. In the present case, the Adjudicating Authority has failed to show

that the present proceeding under Section 7 was filed by the Appellant

fraudulently or with malicious intention for initiation of the 'Corporate

Company Appeal (AT) (Insolvency) No. 557 of 2018 17

Insolvency Resolution Process' against the 'Corporate Debtor'. Whatever

the grounds shown for not entertaining the application are not related

and beyond Form 1 and were not to be pleaded. In fact, nothing on the

record to suggest that the Appellant filed application fraudulently with

malicious intention for initiation of the 'Corporate Insolvency Resolution

Process' against the 'Corporate Debtor'.

16. Prima facie no case was made out before the Adjudicating Authority

for passing any observation under Section 65 of the 'I&B Code' merely on

the ground that the Directors and Promoters have engaged in Scheme

having striking similarity with the infamous chit funds or Ponzi Schemes.

The Promoters/ Directors may face serious criminal implication for

breach of the orders of SEBI, but that cannot be ground to reject the

application under Section 7 against the 'Corporate Debtor', or to initiate

any proceeding under Section 65 against the Appellants, who have no

connection with the Directors or Promoters of the 'Corporate Debtor'.

17. For the reasons aforesaid, we set aside the impugned judgment

dated 5th July, 2018 and remit the case to the Adjudicating Authority to

admit the application after notice to the 'Corporate Debtor' so as to enable

the 'Corporate Debtor' to settle the claim. No intervention application can

be entertained by the Adjudicating Authority before admission of the

application.

Company Appeal (AT) (Insolvency) No. 557 of 2018 18

The appeal is allowed with aforesaid observations and direction. No

costs.

(Justice S.J. Mukhopadhaya) Chairperson

(Justice A.I.S. Cheema) Member(Judicial)

(Kanthi Narahari) Member(Technical) NEW DELHI 6th August, 2019

AR

Company Appeal (AT) (Insolvency) No. 557 of 2018