Introduction

The intersection of insolvency law and criminal liability has emerged as one of the most debated areas in contemporary Indian jurisprudence. The Bombay High Court’s recent judgment delivered by Justice M.M. Nerlikar on October 1, 2025, at the Nagpur Bench has reinforced a critical legal position: directors and officers of a company cannot escape their Personal Criminal Liability of Directors Under Section 138 for offences under the Negotiable Instruments Act, 1881 (NI Act) merely because insolvency proceedings have been initiated against their company under the Insolvency and Bankruptcy Code, 2016 (IBC). This ruling addresses the growing concern among creditors about whether company directors could use insolvency proceedings as a shield against prosecution for cheque dishonour, thereby undermining commercial morality and the sanctity of negotiable instruments.

The case involved M/s. Anand Distilleries and its directors who sought discharge from a criminal complaint for cheque dishonour on the ground that insolvency proceedings were initiated against the company before the cheque bounced. The High Court’s decision clarifies that the timing of IBC proceedings—whether initiated before or after the cause of action under the Section 138 NI Act arises—is immaterial to the personal criminal liability of directors. This judgment reinforces the principle that while corporate entities may receive protection under insolvency moratorium, natural persons who were responsible for the affairs of the company when the offence was committed remain accountable under criminal law.

Understanding Section 138 of the Negotiable Instruments Act

The Negotiable Instruments Act, 1881, was enacted to provide a legal framework for the use of negotiable instruments like cheques, promissory notes, and bills of exchange in commercial transactions. Section 138 was introduced through an amendment in 1988 to address the growing problem of cheque dishonour, which was eroding trust in commercial dealings and hampering business transactions. The provision criminalizes the dishonour of cheques issued in discharge of legal liability or debt.

Section 138 states that where any cheque drawn by a person on an account maintained by him with a banker for payment of any amount of money to another person from out of that account for the discharge of any debt or other liability, is returned by the bank unpaid for reasons of insufficient funds or that it exceeds the arrangement made, and the payee or holder makes a demand for payment through notice within thirty days of receiving information from the bank, and the drawer fails to make payment within fifteen days of receipt of such notice, the drawer shall be deemed to have committed an offence. The punishment prescribed includes imprisonment for a term which may extend to two years, or with fine which may extend to twice the amount of the cheque, or with both.

The offence under Section 138 is complemented by Section 141 of the NI Act, which extends criminal liability to persons who were in charge of and responsible for the conduct of the business of the company at the time the offence was committed. This vicarious liability provision is central to how courts assess the personal criminal liability of directors under Section 138, ensuring that directors, managers, and other officers cannot hide behind the corporate veil when a company commits the offence of cheque dishonour. The provision creates a presumption of culpability against such persons unless they can prove that the offence was committed without their knowledge or that they exercised due diligence to prevent the commission of the offence.

The quasi-criminal nature of proceedings under Section 138 distinguishes them from purely civil recovery proceedings. While the primary objective is to facilitate debt recovery through the threat of criminal sanctions, the proceedings follow criminal procedure and result in criminal consequences including imprisonment. This dual character has been the subject of extensive judicial interpretation, particularly in understanding how such proceedings interact with other laws like the IBC.

The Insolvency and Bankruptcy Code and Moratorium Provisions

The Insolvency and Bankruptcy Code, 2016, was enacted as comprehensive legislation to consolidate and amend laws relating to reorganization and insolvency resolution of corporate persons, partnership firms, and individuals in a time-bound manner. The Code represents a paradigm shift from the debtor-in-possession model to a creditor-in-control regime, aimed at maximizing the value of assets and promoting entrepreneurship by balancing the interests of all stakeholders.

Section 14 of the IBC is a crucial provision that declares a moratorium upon admission of an insolvency application. The moratorium provision states that on the insolvency commencement date, the Adjudicating Authority shall by order declare that the moratorium shall have effect from the date of such order. During the moratorium period, several actions are prohibited including the institution of suits or continuation of pending suits or proceedings against the corporate debtor, execution of any judgment, decree or order against the corporate debtor, any action to foreclose, recover or enforce any security interest created by the corporate debtor, and the recovery of any property by an owner or lessor where such property is occupied by or in the possession of the corporate debtor.

The purpose of the moratorium is multifold. It provides breathing space to the corporate debtor to enable the resolution professional to assess the viability of the business, prepare an information memorandum, and invite resolution plans from prospective resolution applicants. It prevents a race among creditors to enforce their claims, which could lead to the dismemberment of the corporate debtor’s assets and destroy its value as a going concern. The moratorium creates a level playing field where all creditors’ claims are dealt with in a collective and orderly manner rather than through individual enforcement actions.

However, the scope and extent of the moratorium have been subjects of intense litigation and judicial interpretation. A critical question has been whether the moratorium extends to criminal proceedings, particularly those under Section 138 of the NI Act. This question becomes even more complex when examining whether the moratorium protects not just the corporate debtor but also its directors and officers who face personal liability under criminal law. The law has evolved through several landmark Supreme Court judgments that have attempted to delineate the boundaries of moratorium protection in the context of different types of proceedings.

Evolution of Judicial Interpretation: Supreme Court Precedents

The judicial understanding of the interplay between the IBC moratorium and Section 138 proceedings has evolved significantly through several landmark Supreme Court decisions. These judgments have progressively clarified the scope of moratorium protection and its applicability to different categories of defendants and different stages of proceedings.

In the landmark judgment of P. Mohanraj v. Shah Brothers Ispat Pvt. Ltd., decided on March 1, 2021, a three-judge bench of the Supreme Court examined whether proceedings under Section 138 of the NI Act against a corporate debtor would be covered by the moratorium under Section 14 of the IBC [1]. The Court held that when a moratorium order is passed under the IBC, parallel proceedings under Section 138 of the NI Act against the corporate debtor cannot be allowed to continue. The Court reasoned that proceedings under Section 138 and 141 of the NI Act are quasi-criminal in nature and would amount to a proceeding within the meaning of Section 14(1)(a) of the IBC. The judgment emphasized that the legislative intent behind the moratorium was to provide a peaceful period for the resolution professional to attempt to revive the corporate debtor as a going concern.

The Court in P. Mohanraj analyzed the nature of proceedings under Chapter XVII of the NI Act and concluded that despite having criminal elements, these proceedings are fundamentally about debt recovery. The judgment stated that the object of the IBC is to ensure revival and continuation of the corporate debtor by protecting the corporate debtor from its own management and from a corporate death by liquidation. The moratorium provision ensures that during the resolution process, the assets of the corporate debtor remain intact and are not depleted by individual enforcement actions. The Court explicitly held that continuing with Section 138 proceedings would defeat the very purpose of the moratorium as it would deplete the financial resources of the corporate debtor through fines and legal costs.

However, the P. Mohanraj judgment specifically dealt with proceedings against the corporate debtor itself, not its directors or officers. This distinction became crucial in subsequent litigation where directors sought to extend the benefit of moratorium to themselves. The Supreme Court addressed this issue in later judgments, particularly in the context of whether natural persons could claim immunity from Section 138 proceedings by virtue of their company being under insolvency resolution.

The Supreme Court further clarified the position regarding directors and officers in multiple subsequent decisions. In Sandeep Gupta v. Shri Ram Steel Traders decided by the Delhi High Court in 2023, the court held that Section 96 of the IBC concerning pre-packaged insolvency would not apply when a person is arrayed as an accused in a complaint under Section 138 in his capacity as a director of a company [2]. The judgment emphasized that the debt in question belonged to the company, not the director personally, but Section 141 of the NI Act fastens liability on every officer who was in management and control of the company’s affairs. This vicarious liability is personal to the director and cannot be extinguished by moratorium proceedings against the company.

The principle emerging from these cases is clear: while the corporate entity receives protection under the moratorium, natural persons who are liable under Section 141 of the NI Act remain exposed to criminal prosecution [3]. The moratorium cannot be used as a device to shield individual wrongdoers from facing consequences for offences committed while they were managing the company. This interpretation ensures that the protective mechanism of insolvency law does not become a refuge for those who have acted irresponsibly or fraudulently in their capacity as company directors or officers.

The Bombay High Court’s Decision: Case Analysis

The Bombay High Court judgment in the Ortho Relief Hospital and Research Centre case presents a critical clarification on the personal criminal liability of directors under Section 138 of the Negotiable Instruments Act, particularly in relation to insolvency proceedings. This detailed application of legal principles addresses a crucial question: can directors escape their personal criminal liability by invoking insolvency proceedings against their company?

The chronology of events in this case was particularly significant. In February 2018, Punjab National Bank initiated insolvency proceedings against M/s. Anand Distilleries under the IBC. The National Company Law Tribunal (NCLT) admitted the petition on February 14, 2018, which triggered the moratorium under Section 14 and led to the appointment of an Interim Resolution Professional. The petitioner hospital, being a creditor, lodged its claim with the resolution professional as required under the IBC process.

After the moratorium was declared, the directors of the company allegedly reassured the petitioner and asked them to present the cheque for encashment. When the cheque was presented on December 14, 2018, it was dishonoured with the remark of insufficient funds. Following the statutory procedure under the NI Act, the petitioner issued a legal notice on January 5, 2019, giving the drawer an opportunity to make payment within fifteen days. When no payment was received, the petitioner filed a criminal complaint under Section 138 of the NI Act.

The trial court, however, allowed an application filed by the directors on January 31, 2025, and discharged them from the criminal proceedings. The trial court’s reasoning was that since insolvency proceedings were initiated against the company before the cheque was dishonoured, the subsequent criminal complaint was barred by the moratorium provisions of the IBC. This interpretation suggested that the timing of the initiation of IBC proceedings was determinative of whether Section 138 proceedings could be maintained.

The petitioner challenged this discharge order before the Bombay High Court, represented by Advocate S.S. Dewani. The petitioner’s primary argument was that proceedings under the NI Act are penal in nature and fundamentally different from recovery proceedings under the IBC. It was contended that an approved resolution plan under the IBC pertains to the corporate debtor’s liabilities and does not absolve directors from their Personal Criminal Liability of Directors Under Section 138, which flows independently through Section 141 of the NI Act. The petitioner emphasized that directors, being natural persons, remain statutorily liable for prosecution regardless of any moratorium applicable to the corporate entity.

The respondent directors, represented by Advocate S.D. Khati, placed significant emphasis on the timeline of events. They argued that the IBC proceedings and moratorium were initiated on February 14, 2018, well before the cause of action for the Section 138 complaint arose through cheque dishonour on December 14, 2018. Their contention was that Section 14 of the IBC bars the institution of any legal proceedings against the corporate debtor after a moratorium is declared, and this bar should logically extend to directors who are prosecuted solely by virtue of their connection with the company. They sought to distinguish their case from situations where the cause of action arose before IBC proceedings, arguing that the temporal sequence was material to determining liability.

Justice M.M. Nerlikar framed the central legal question succinctly: whether prior initiation of proceedings under the IBC would frustrate the claim of the petitioner under Section 138 of the NI Act. After examining the Supreme Court precedents, the High Court concluded that the law on this issue is well-settled and the timing argument advanced by the respondents was legally untenable.

The High Court held that the moratorium under Section 14 of the IBC applies only to the corporate debtor, and natural persons mentioned in Section 141 continue to remain liable, reaffirming the personal criminal liability of directors under section 138 irrespective of insolvency proceedings. The judgment emphasized that proceedings under Section 138 are not recovery proceedings but are penal in nature, aimed at upholding the integrity of commercial transactions and maintaining faith in negotiable instruments. The personal penal liability of directors continues because such liability flows from their role in managing the company when the offence was committed, not merely from their association with the company.

The court explicitly rejected the timing argument, stating: “From the above discussion it is clear that it makes no difference whether the proceedings are initiated prior to initiation of IB Code proceeding or thereafter. The Supreme Court has in unequivocal terms held that natural persons cannot escape from their personal liability under Section 138 of the NI Act.” This categorical statement eliminates any ambiguity about whether the sequence of events affects the liability of directors under the NI Act.

The judgment further clarified that criminal proceedings do not fall under the category of proceedings that are to be kept in abeyance under Section 14 of the IBC when it comes to personal liability of directors and officers. The court held that the trial court had committed a gross error in allowing the discharge application and thereby discharging the accused directors. Consequently, the High Court allowed the writ petition, quashing and setting aside the trial court’s orders, and directed that the criminal complaint against the directors would proceed to trial. The court also rejected the respondents’ request to stay the judgment, indicating confidence in the correctness of its legal position.

Regulatory Framework Governing Directors’ Liability

The liability of company directors under Indian law is governed by a complex regulatory framework that spans multiple statutes including the Companies Act, 2013, the Negotiable Instruments Act, 1881, and the Insolvency and Bankruptcy Code, 2016. Understanding this framework is essential to appreciate how directors can be held personally liable for corporate defaults.

Section 141 of the Negotiable Instruments Act creates a specific statutory regime for holding company officials accountable for offences committed by the company. The provision states that if the person committing an offence under Section 138 is a company, every person who, at the time the offence was committed, was in charge of, and was responsible to the company for the conduct of the business of the company, as well as the company, shall be deemed to be guilty of the offence and shall be liable to be proceeded against and punished accordingly. This creates a presumption of culpability against directors and managing directors, subject to proving that the offence was committed without their knowledge or that they had exercised all due diligence to prevent the commission of the offence.

The Supreme Court has consistently held that to make a director liable under Section 141, it must be shown that he was in charge of and responsible for the conduct of the business of the company at the relevant time. Merely being a director is not sufficient unless the role is clearly established. However, once it is shown that a person was a director and was responsible for the affairs of the company, the burden shifts to that person to prove that they had no knowledge of the offence or had exercised due diligence.

When a director signs a cheque on behalf of the company, they are acting in their official capacity as a corporate agent. However, the personal criminal liability of directors under Section 138 that may arise from the cheque’s dishonour is distinctly personal and cannot be deflected onto the corporate entity. This is because the criminal liability relates directly to the individual director’s role in the decision-making process that led to the dishonour.

The IBC adds another layer to this framework. While Section 14 provides moratorium protection to the corporate debtor, Section 32A of the IBC specifically addresses criminal liability in approved resolution plans. This provision states that where the Adjudicating Authority has approved a resolution plan, no action shall be taken against the property of the corporate debtor in relation to an offence committed prior to the commencement of the corporate insolvency resolution process. However, this protection extends only to the corporate debtor and its properties, not to any person other than the corporate debtor who is involved in the commission of such an offence.

The distinction drawn by Section 32A is critical. It recognizes that while the corporate debtor should be allowed a fresh start under an approved resolution plan, individuals who committed offences while managing the company should not escape personal accountability. This ensures that insolvency resolution does not become a mechanism for personal immunity from criminal prosecution [5].

The interplay between these provisions creates a nuanced system where corporate rehabilitation is balanced against individual accountability. The corporate entity may be protected to enable its revival, but those who were responsible for decisions leading to criminal offences remain answerable under law. This prevents moral hazard where directors might engage in reckless or fraudulent conduct knowing that subsequent insolvency proceedings would shield them from consequences.

Distinction Between Corporate and Personal Liability

One of the fundamental principles established through judicial interpretation is the clear distinction between the corporate entity and the natural persons who manage it. This distinction is rooted in the basic principle of corporate law that a company is a separate legal entity distinct from its shareholders and directors. However, this separation does not mean that individuals can always escape liability for corporate wrongdoing.

When a cheque issued by a company is dishonoured, two parallel liabilities are created under the NI Act. First, the company as the drawer of the cheque is liable under Section 138. Second, by virtue of Section 141, directors and officers who were in charge of the company’s affairs at the relevant time also become personally liable. These are distinct liabilities even though they arise from the same wrongful act.

The moratorium under Section 14 of the IBC operates only on the corporate debtor. The term corporate debtor is specifically defined in Section 3(8) of the IBC to mean a corporate person who owes a debt to any person. This definition does not include natural persons who are directors or officers of the corporate debtor. Therefore, when a moratorium is declared, it freezes actions against the corporate debtor but does not automatically extend to individuals connected with that corporate debtor.

This distinction has important practical implications. When the NCLT admits an insolvency application and declares a moratorium, creditors cannot proceed with recovery actions against the company, attach its properties, or continue litigation against it for recovery of debts. However, these restrictions do not prevent creditors from proceeding against directors who are personally liable under statutory provisions like Section 141 of the NI Act [6].

The rationale for maintaining this distinction is grounded in both legal principle and policy considerations. From a legal standpoint, criminal liability is personal and cannot be diluted by corporate insolvency. The offence under Section 138 involves elements of mens rea and actus reus that are attributable to individuals who made decisions on behalf of the company. These individuals had the power to ensure that cheques issued by the company would be honored, and their failure to do so attracts personal criminal liability.

From a policy perspective, allowing directors to escape prosecution by hiding behind corporate insolvency would undermine the entire purpose of Section 138 of the NI Act. The provision was enacted to restore credibility to negotiable instruments and ensure that parties who issue cheques do so responsibly. If directors knew they could avoid prosecution through insolvency proceedings, it would incentivize irresponsible issuance of cheques and erode commercial morality.

The Supreme Court has emphasized that the IBC is designed to provide a fresh start to the corporate entity as a going concern, not to provide immunity to individuals who may have engaged in wrongful conduct. The resolution plan under the IBC addresses the debts and liabilities of the company, not the criminal liability of individuals. An approved resolution plan may release the company from its financial obligations, but it cannot extinguish the criminal prosecution of directors who were responsible for offences committed during their tenure.

Impact on Commercial Transactions and Creditor Protection

The Bombay High Court’s judgment has significant implications for commercial transactions and creditor rights in India. By clarifying that directors remain personally liable for cheque dishonour regardless of insolvency proceedings against the company, the judgment strengthens the deterrent effect of Section 138 and enhances creditor protection.

In commercial practice, cheques serve as important instruments of credit and payment. Businesses routinely accept post-dated cheques as security for loans and advances, relying on the legal consequences of dishonour as a safeguard against default. If directors could escape liability by initiating insolvency proceedings against the company after issuing cheques, it would significantly undermine the utility of cheques as security instruments. Creditors would become reluctant to accept cheques, leading to increased transaction costs and reduced liquidity in commercial dealings.

The judgment ensures that creditors who have accepted cheques as security retain meaningful recourse against responsible individuals even when the corporate entity enters insolvency. This is particularly important for small and medium enterprises that often extend credit to larger companies based on the assurance provided by cheques signed by responsible directors. These creditors may not have the resources to conduct extensive due diligence or secure complex collateral arrangements, and they rely heavily on the deterrent effect of criminal prosecution under Section 138.

The decision also addresses a potential avenue for abuse where unscrupulous directors might deliberately trigger insolvency proceedings after issuing multiple cheques to different creditors, hoping to escape personal liability. By holding that the timing of IBC proceedings is irrelevant to directors’ liability under Section 138, the court eliminates this possibility and ensures that individuals cannot strategically use insolvency law to evade criminal consequences [7].

However, the judgment also maintains a balance by recognizing that not all directors are automatically liable. The requirement under Section 141 that the accused must have been in charge of and responsible for the conduct of business provides a safeguard against indiscriminate prosecution of all directors. Nominee directors, independent directors, or those who had no role in the financial decisions leading to the dishonour can potentially defend themselves by demonstrating their lack of involvement.

From the perspective of insolvency resolution, the judgment does not hinder the IBC process. The corporate debtor continues to receive moratorium protection, allowing the resolution professional to work on revival plans without interference from individual creditors. The continuation of criminal proceedings against directors operates on a parallel track and does not impede the collective resolution process. In fact, by maintaining pressure on directors who were responsible for the company’s financial mismanagement, it may incentivize better cooperation with the resolution process and more realistic resolution proposals.

Comparative Analysis with Personal Insolvency Provisions

An interesting dimension of the legal framework is the treatment of directors under personal insolvency provisions. Section 96 of the IBC deals with interim moratorium in personal insolvency cases. When an individual debtor files an application for initiating a resolution process, an interim moratorium period commences during which various actions against the debtor are prohibited.

Several directors who faced Section 138 prosecution have attempted to invoke Section 96 by filing personal insolvency applications, arguing that they should receive moratorium protection in their individual capacity. However, courts have consistently rejected this argument, holding that directors cannot escape their vicarious criminal liability under Section 141 of the NI Act by resorting to personal insolvency proceedings [8].

The Delhi High Court in Sandeep Gupta v. Shri Ram Steel Traders explicitly addressed this issue, holding that Section 96 of the IBC would not be applicable when a person is arrayed as an accused in a complaint under Section 138 in his capacity as a director of a company. The court reasoned that the debt for which the cheque was issued belonged to the company, not the director personally. The director’s liability under Section 141 is not because he owes the debt but because he was responsible for the company’s conduct when it committed the offence—an approach that reflects how courts have treated the personal criminal liability of directors under Section 138 as independent of any insolvency process.

This distinction is crucial. Personal insolvency provisions are designed to provide relief to individual debtors who are unable to pay their personal debts. They are not intended to shield individuals from criminal liability arising from their role in corporate management. If directors could use personal insolvency to avoid Section 138 prosecution, it would create an absurd situation where any person facing criminal prosecution could escape by declaring personal insolvency.

The courts have emphasized that criminal liability is not a debt that can be discharged through insolvency. The punishment under Section 138 includes both fine and imprisonment, and the imprisonment aspect cannot be addressed through any insolvency mechanism. Even if the fine component could theoretically be considered a debt, the criminal nature of the proceedings and the imprisonment sanction distinguish them from ordinary debt recovery.

Conclusion and Future Implications

The Bombay High Court’s judgment represents an important affirmation of established legal principles regarding the interplay between insolvency law and criminal liability under the Negotiable Instruments Act. By holding that directors cannot escape their personal liability for cheque dishonour by relying on insolvency proceedings against the company, the court has strengthened creditor protection and maintained the deterrent effect of Section 138.

The judgment resolves an important question about timing by clarifying that it is immaterial whether IBC proceedings were initiated before or after the cause of action under Section 138 arose. What matters is whether the accused was in charge of and responsible for the company’s affairs at the time the cheque was issued and dishonoured. This temporal neutrality prevents strategic manipulation of insolvency law to evade criminal liability.

Looking forward, this judgment is likely to significantly influence how directors approach their responsibilities in managing company finances. With the law now clarifying that Personal Criminal Liability of Directors Under Section 138 cannot be avoided through corporate insolvency proceedings, directors have a stronger incentive to maintain responsible financial stewardship and ensure stricter compliance in all cheque-related transactions.

For creditors, the judgment provides assurance that accepting cheques as security remains meaningful even in situations where the debtor company subsequently faces insolvency. This is particularly valuable for small creditors who may not have sophisticated security arrangements and rely primarily on the deterrent effect of criminal prosecution [9].

The decision also contributes to the evolving jurisprudence on the scope and limits of moratorium protection under the IBC. While the Code provides powerful tools for corporate rehabilitation, it does not create a zone of absolute immunity. The balance struck by courts between protecting viable businesses and ensuring individual accountability is essential for maintaining trust in both the insolvency system and the broader commercial ecosystem.

As insolvency law continues to develop in India, the principles established in this judgment will serve as important guideposts. They affirm that corporate rehabilitation and individual accountability are not mutually exclusive objectives but can coexist within a coherent legal framework. The judgment demonstrates judicial commitment to preventing the abuse of beneficial legislation while ensuring that legitimate creditor rights are protected.

References

[1] Supreme Court of India. (2021). P. Mohanraj & Ors. v. M/s. Shah Brothers Ispat Pvt. Ltd., (2021) 6 SCC 258. Available at: https://indiankanoon.org/doc/97452657/ 

[2] Delhi High Court. (2023). Sandeep Gupta v. Shri Ram Steel Traders & Anr., CRL.M.C. 381/2022. Available at: https://www.scconline.com/blog/post/2023/03/17/initiation-ibc-proceedings-does-not-absolve-company-director-signatories-of-criminal-liability-under-section-138-negotiable-instruments-act-supreme-court-legal-research-news-updates/ 

[3] LiveLaw. (2021). Moratorium Under Section 14 IBC Covers Section 138 NI Act Proceedings Against Corporate Debtor. Available at: https://www.livelaw.in/top-stories/moratorium-under-section-14-ibc-covers-section-138-ni-act-proceedings-against-corporate-debtor-supreme-court-170508 

[4] Bombay High Court. (2025). Ortho Relief Hospital and Research Centre v. M/s. Anand Distilleries & Ors., decided on October 1, 2025. Available at: https://lawtrend.in/prior-ibc-proceedings-do-not-bar-section-138-ni-act-action-against-company-directors-bombay-hc/ 

[5] Bar & Bench. (2021). Moratorium order under Section 14 IBC bars parallel proceedings against Corporate Debtor under Section 138 of NI Act. Available at: https://www.barandbench.com/news/litigation/moratorium-order-section-14-ibc-bars-parallel-proceedings-section-138-negotiable-instruments-act-supreme-court 

[6] SCC Online. (2023). Liability of the Erstwhile Directors: Section 138, Negotiable Instruments Act versus Insolvency and Bankruptcy Code, 2016. Available at: https://www.scconline.com/blog/post/2023/10/12/liability-of-the-erstwhile-directors-section-138-negotiable-instruments-act-versus-insolvency-and-bankruptcy-code-2016/ 

[7] LiveLaw. (2025). No S.138 NI Act Case Against Ex-Director Of Company When Cause Of Action Arose After IBC Moratorium Was Declared: Supreme Court. Available at: https://www.livelaw.in/supreme-court/no-s138-ni-act-case-against-ex-director-of-company-when-cause-of-action-arose-after-ibc-moratorium-was-declared-supreme-court-286691 

[8] LegitEye. (2023). Only corporate debtor is protected by moratorium while signatories/directors cannot escape from their penal liability u/s 138 of NI Act. Available at: https://legiteye.com/in-crlmc-3812022-punj-hc-only-corporate-debtor-is-protected-by-moratorium-while-signatoriesdirectors-cannot-escape-from-their-penal-liability-us-138-of-ni-act-by-filing-personal-insolvency-proceedings-delhi-hc-justice-jasmeet-singh-15-05-2023/ 

[9] iPleaders. (2021). The changing dynamics of section 14 of the IBC, 2016 vis-à-vis section 138 proceeding of NI Act,1881. Available at: https://blog.ipleaders.in/changing-dynamics-section-14-ibc-2016-vis-vis-section-138-proceeding-ni-act1881/ 

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Introduction

In a recent judgment, the NCLT Mumbai Bench has provided important clarifications regarding the applicability of the threshold limit for initiating corporate insolvency resolution processes under Section 9 of the Insolvency and Bankruptcy Code (IBC), 2016. The bench addressed the critical issue of whether the minimum default amount for triggering insolvency should be considered based on the date of the demand notice or the date of filing the application.

Background of the Case

The case involved Ralco Extrusion Private Limited, an operational creditor, who filed an application against Centech Engineers Private Limited, the corporate debtor, claiming a default in payment and seeking to initiate insolvency proceedings. The operational creditor argued that the default amount and the issuance of a demand notice under Section 8 of the IBC met the criteria for initiating proceedings.

Legal Analysis

Determining the Relevant Date for Threshold Limit Under IBC Application

The NCLT Mumbai Bench, comprising Hon’ble Shri K. R. Saji Kumar (Judicial Member) and Shri Sanjiv Dutt (Technical Member), emphasized that for determining the applicability of the threshold limit under Section 9 of the IBC, the relevant date is the date of filing the insolvency application, not the date of issuing the demand notice.

Important Paragraph from the Judgment:

“What is relevant for determining the minimum threshold is not the date of giving notice under Section 8 but the date when the application is filed.”

Application of Threshold Limit Under IBC Post Amendment

The bench referred to the amendment to the IBC effective from March 24, 2020, which raised the minimum default amount from Rs. 1 lakh to Rs. 1 crore. It was highlighted that any application filed after this date must reflect a default of at least Rs. 1 crore to be considered for admission under Section 9.

Key Excerpt from the Judgment:

“It is now settled that the threshold limit of Rs.1 crore will be applicable for applications filed under Sections 7, 9, and 10 on or after 24.03.2020, even if the debt in default is on a date earlier than 24.03.2020.”

Implications of the Judgment

This ruling has significant implications for operational creditors and corporate debtors. It clarifies that operational creditors need to ensure that the default amount meets the current threshold at the time of filing the application, regardless of when the debt became due or when the demand notice was issued.

Key Considerations for Operational Creditors

– Operational creditors must assess the default amount against the threshold effective on the application filing date.

– The issuance of a demand notice prior to the amendment does not grandfather older threshold limits for applications filed post-amendment.

Conclusion: Implications of the Judgment on Threshold Limit Under IBC Application

The NCLT Mumbai Bench’s decision brings clarity to the application of threshold limits under the IBC for initiating insolvency proceedings. This ensures that creditors are aware of the requirements and that insolvency processes are initiated only when substantial default amounts are involved, aligning with the legislative intent to prevent misuse of the insolvency framework.

This judgment serves as a guiding principle for similar cases, reinforcing the importance of adhering to statutory thresholds and procedural correctness in insolvency proceedings.

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Introduction

In recent years, the landscape of insolvency and bankruptcy resolution in India has undergone significant transformations, spurred by the enactment of the Insolvency and Bankruptcy Code (IBC). Among the various mechanisms introduced to bolster the efficacy and efficiency of insolvency proceedings, the Pre-Packaged Insolvency Resolution Process (PPIRP) stands out as a promising avenue for expeditious resolution, particularly tailored to address the unique challenges faced by Micro, Small, and Medium Enterprises (MSMEs) amidst the backdrop of the COVID-19 pandemic.

Introduction to Pre-Packaged Insolvency Resolution Process (PPIRP):

The Pre-Packaged Insolvency Resolution Process (PPIRP) represents a proactive approach towards insolvency resolution, premised on the notion of pre-negotiated resolution plans between financially distressed companies and their creditors. Instituted as a distinct chapter within the IBC framework, PPIRP delineates a structured mechanism for the submission, endorsement, and implementation of pre-packaged plans, thereby expediting the resolution process while safeguarding the interests of all stakeholders involved.

Understanding the Legal Framework of Pre-Packaged Insolvency Resolution Process:

A comprehensive understanding of the legal framework governing PPIRP is imperative to discern its operational dynamics and procedural intricacies. Sections 54A to 54M of the IBC, introduced through a series of amendments, serve as the bedrock of PPIRP implementation. These sections outline eligibility criteria, procedural requirements, and regulatory mechanisms governing the initiation, approval, and execution of pre-packaged resolution plans. Key provisions include provisions for base resolution plan formulation (Section 54B), insolvency professional appointment (Section 54C), and plan implementation (Section 54G), among others.

Differentiating PPIRP from Conventional Insolvency Resolution Mechanisms:

Contrasting PPIRP with traditional Corporate Insolvency Resolution Process (CIRP) elucidates fundamental disparities in objectives, procedures, timelines, and stakeholder roles. While CIRP prioritizes asset maximization and broader insolvency resolution, PPIRP underscores the significance of pre-negotiated plans in expediting restructuring efforts and mitigating financial distress. By streamlining administrative processes and fostering creditor collaboration, PPIRP offers a viable alternative to conventional insolvency resolution mechanisms, particularly for MSMEs grappling with the adverse effects of the pandemic-induced economic downturn.

Analyzing the Benefits of Pre-Packaged Insolvency Resolution Process:

The benefits accrued from adopting PPIRP as a preferred mechanism for insolvency resolution are manifold. From time and cost efficiency to enhanced creditor participation and asset preservation, PPIRP offers a myriad of advantages that resonate with the evolving needs of today’s dynamic business landscape. By facilitating swift resolution, minimizing asset erosion, and fostering stakeholder engagement, PPIRP emerges as a potent tool for revitalizing financially distressed entities and steering them towards sustainable recovery.

Exploring Landmark Cases and their Implications:

Examining landmark cases wherein PPIRP has been successfully deployed provides valuable insights into its efficacy and applicability in real-world scenarios. By analyzing notable cases such as the resolution of Ruchi Soya Industries Limited’s insolvency, stakeholders can glean valuable lessons regarding the practical implementation and impact of PPIRP on corporate restructuring efforts. Moreover, such case studies serve as catalysts for informed decision-making and policy formulation aimed at optimizing the PPIRP framework for future endeavors.

Proposing Suggestions for Enhancing PPIRP Efficacy:

In light of the evolving landscape of insolvency resolution, it is imperative to proactively identify areas for improvement and refinement within the PPIRP framework. Suggestions ranging from educational initiatives aimed at MSMEs to reevaluation of connected person prohibitions underscore the importance of adaptive policymaking and stakeholder engagement in fostering a conducive environment for PPIRP adoption and implementation. By soliciting feedback, fostering collaboration, and embracing a culture of continuous improvement, policymakers can ensure that PPIRP remains a robust and responsive mechanism for addressing the evolving needs of the business ecosystem.

Conclusion:

The Pre-Packaged Insolvency Resolution Process (PPIRP) represents a paradigm shift in the realm of insolvency resolution, offering a potent blend of expediency, efficacy, and stakeholder engagement. By harnessing the power of pre-negotiated resolution plans, PPIRP holds the potential to usher in a new era of insolvency resolution characterized by swift turnaround times, minimized asset erosion, and enhanced stakeholder participation. However, realizing this potential necessitates concerted efforts towards education, advocacy, and procedural refinement aimed at optimizing the PPIRP framework for diverse business scenarios. Through collaborative engagement and adaptive policymaking, stakeholders can unlock the full potential of PPIRP as a transformative mechanism for revitalizing financially distressed entities and fostering sustainable economic recovery.

Expanding upon the nuanced intricacies and multifaceted implications of PPIRP within the broader landscape of insolvency resolution, this discourse aims to provide a comprehensive analysis of its potential, challenges, and opportunities for future growth and refinement. By delving deeper into the operational dynamics and regulatory framework governing PPIRP, stakeholders can gain a holistic understanding of its role in reshaping the contours of insolvency resolution in India’s dynamic business environment.

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Introduction

In a landmark judgment delivered on 02.04.2024, the NCLAT provided crucial insights into the interpretation of financial debt under the Insolvency and Bankruptcy Code (IBC), 2016, particularly emphasizing the broad spectrum covered by the concept of the time value of money. This judgment, *Arunkumar Jayantilal Muchhala Vs. Awaita Properties Pvt. Ltd. and Anr.*, marks a pivotal step in understanding the nuances of financial transactions within the insolvency framework.

Background of the Case

The case revolved around a dispute regarding the initiation of the insolvency resolution process against the corporate debtor, highlighting the intricate nature of financial debts and the encompassing scope of the time value of money.

The Core Issue: Exploring Time Value of Money

At the heart of the dispute was whether various forms of benefits or value accruing to the creditor, other than regular interest, can be considered under the ambit of the time value of money, thus constituting a financial debt.

Key Provisions and Legal Interpretations

The Concept of Financial Debt under IBC

The IBC defines financial debt as a debt along with interest, if any, which is disbursed against the consideration for the time value of money.

NCLAT’s Interpretation on Time Value of Money

The tribunal elaborated that the time value of money is not confined to regular or timely returns received for the duration for which the amount is disbursed but also encompasses any other form of benefit or value accruing to the creditor as a return for providing money for a long duration.

“The concept of time value of money has nowhere been defined in the IBC. Time value of money is not only a regular or timely return received for the duration for which the amount is disbursed as an amount in addition to the principal, but also covers any other form of benefit or value accruing to the creditor as a return for providing money for a long duration.”

The Decision to Admit the Section 7 Application

The tribunal underscored that once the Adjudicating Authority is subjectively satisfied that there is a debt and a default has been committed by the Corporate Debtor, and the Section 7 application is complete in all respects, it must admit the application.

Implications of the Judgment

For Financial Creditors

This judgment broadens the scope of what can be considered as financial debt, allowing creditors to include various forms of economic benefits received over the duration of the loan as part of their claims.

For Resolution Professionals

Resolution professionals must now take a holistic view of the benefits accruing to creditors, beyond traditional interest payments, when evaluating claims and formulating resolution plans.

Impact on Insolvency Proceedings

This judgment sets a precedent for future insolvency cases, ensuring that the definition of financial debt encompasses a wider range of economic advantages, thereby protecting the rights of creditors.

Conclusion: A Milestone in Insolvency Law with Emphasis on Time Value of Money

The *Arunkumar Jayantilal Muchhala Vs. Awaita Properties Pvt. Ltd. and Anr.* judgment by the NCLAT serves as a significant milestone in the evolution of insolvency law in India. By clarifying the scope of financial debt to include various forms of the time value of money, the tribunal has enhanced the framework for assessing and processing insolvency resolutions, ensuring a fair and equitable consideration of creditors’ claims.

This judgment not only aids in the precise identification and evaluation of financial debts but also fortifies the principles of justice and equity at the heart of the IBC, promoting a more inclusive and comprehensive approach to insolvency resolution in India.

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Introduction

The NCLT Ahmedabad Bench’s judgment in *Mr. Shalabh Kumar Daga RP of Silver Proteins Pvt. Ltd. Vs. Mr. Himanshu J Domadia and Ors.* dated 11 March 2024, illuminates the critical aspects of handling avoidance Transactions under IBC. By delving into Sections 43, 45, and 49 of the IBC alongside Regulation 35A of the CIRP Regulations 2016, this judgment underscores the necessity for a resolution professional (RP) or liquidator to diligently identify and address transactions that potentially harm the creditor’s collective interests.

The Core of the Judgment

Examination of Avoidance Transactions under IBC

The application brought forth by the liquidator aimed to scrutinize certain transactions by Silver Proteins Pvt. Ltd. for being potentially preferential, undervalued, or fraudulent under Sections 43, 45, and 49 of the IBC.

“It is only resolved in the meeting of SCC that the application is to be filed. Nowhere the applicant has mentioned that he has formed an opinion whether the corporate debtor has been subjected to transaction covered under Section 43, 45, and 49 of the IBC that too before 115th day from the commencement of CIRP.”

Regulation 35A of the IBBI (Insolvency Resolution Process for Corporate Persons) Regulations 2016

Regulation 35A typically mandates the resolution professional (RP) to form an opinion on the occurrence of certain transactions that might be detrimental to the interests of the creditors. This includes identifying preferential transactions, undervalued transactions, extortionate credit transactions, and fraudulent transactions, as per the relevant sections of the Insolvency and Bankruptcy Code (IBC), 2016. The regulation aims to ensure that the RP scrutinizes the financial activities of the corporate debtor to protect the assets for the benefit of all stakeholders.

Given this context, the regulation emphasizes the necessity for the RP to actively investigate the affairs of the debtor to ascertain if any transactions occurred that could potentially harm the creditors or give undue benefit to certain parties. This duty underscores the role of the RP not just as an administrator of the insolvency process but also as a guardian of the creditors’ rights, tasked with ensuring the equitable treatment of all parties involved.

The Mandate of Regulation 35A

The judgment reiterates the imperative laid out in Regulation 35A of the IBBI (Insolvency Resolution Process for Corporate Persons) Regulations 2016, emphasizing the resolution professional’s responsibility to form an opinion on avoidance transactions.

“(1) On or before the seventy-fifth day of the insolvency commencement date, the resolution professional shall form an opinion whether the corporate debtor has been subjected to transaction covered under sections 43, 45, 50, or 66…”

Implications and Analysis

The Necessity for Due Diligence

The judgment underscores the RP’s or liquidator’s crucial role in conducting due diligence to form an opinion on whether the corporate debtor engaged in transactions that could adversely affect the creditors. This proactive assessment is vital for preserving the debtor’s estate’s integrity and ensuring equitable distribution among creditors.

The Importance of Forming an Opinion

A striking aspect of this judgment is the emphasis on the necessity for the RP or liquidator to explicitly form and document their opinion on the nature of transactions as preferential, undervalued, or fraudulent. This step is fundamental before proceeding with applications to challenge such transactions.

Challenges in Establishing Avoidance Transactions under IBC

The judgment also sheds light on the complexities involved in proving the existence of avoidance transactions. The burden of proof rests on the applicant to not only identify such transactions but also establish the intention behind them and their impact on the corporate debtor’s estate.

Insolvency Resolution Strengthened: Focus on Avoidance Transactions

The *Mr. Shalabh Kumar Daga RP of Silver Proteins Pvt. Ltd. Vs. Mr. Himanshu J Domadia and Ors.* judgment serves as a pivotal reference point for resolution professionals and liquidators navigating the intricate landscape of avoidance transactions within the IBC framework. It reinforces the procedural rigor mandated by Regulation 35A of the CIRP Regulations 2016, ensuring that the examination of preferential, undervalued, and fraudulent transactions is conducted with due diligence and factual substantiation.

This judgment not only aims to protect the creditors’ collective interests but also fortifies the principles of fairness and transparency in the insolvency resolution process. By elucidating the procedural and evidentiary standards required to address avoidance transactions, the NCLT Ahmedabad Bench contributes to the evolving jurisprudence under the IBC, fostering a more robust and accountable insolvency resolution mechanism in India.

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In a landmark decision, the Supreme Court of India, in the case of *M/s Orator Marketing Pvt. Ltd. vs. M/s Samtex Desinz Pvt. Ltd.*, delves into the intricacies of financial debt under the Insolvency and Bankruptcy Code, 2016 (IBC). This judgment, rendered by a bench comprising Justice Indira Banerjee and Justice V. Ramasubramanian, addresses the nuanced question of whether an interest-free term loan, extended to meet the working capital requirements of a corporate entity, qualifies as a financial debt under the IBC.

The Genesis of the Dispute

The appeal was against the National Company Law Appellate Tribunal (NCLAT), New Delhi’s dismissal of Orator Marketing Pvt. Ltd.’s plea. The crux of the matter revolved around the rejection of a petition filed under Section 7 of the IBC by the National Company Law Tribunal (NCLT), New Delhi, predicated on the understanding that an interest-free loan does not constitute a financial debt as it ostensibly lacks the consideration for the time value of money.

“The short question involved in this Appeal is whether a person who gives a term loan to a Corporate Person free of interest on account of its working capital requirements is not a Financial Creditor and therefore incompetent to initiate the Corporate Resolution Process under Section 7 of the IBC.”

The Legal Conundrum

At the heart of the dispute was the interpretation of the term “financial debt” under Section 5(8) of the IBC and whether an interest-free loan disbursed for working capital requirements could be construed under this ambit. The original lender, M/s Sameer Sales Private Limited, had advanced a term loan of Rs.1.60 crores to the corporate debtor, which was subsequently assigned to Orator Marketing Pvt. Ltd.

“According to the Appellant the loan was due to be repaid by the Corporate Debtor in full within 01.02.2020. The Appellant claims that the Corporate Debtor made some payments but Rs.1.56 crores still remain outstanding.”

Financial Debt Under IBC: Judicial Reasoning and Analysis

The Supreme Court meticulously analyzed the provisions of the IBC, particularly the definitions of “debt,” “claim,” “default,” “financial creditor,” and “financial debt.” The bench underscored the expansive nature of these definitions, noting the absence of an express exclusion of interest-free loans from the ambit of “financial debt.”

“The NCLT and NCLAT have overlooked the words “if any” which could not have been intended to be otiose. ‘Financial debt’ means outstanding principal due in respect of a loan and would also include interest thereon if any interest were payable thereon.”

The critical observation by the Supreme Court, pointing out the oversight of the words “if any” by the NCLT and NCLAT, is in reference to the definition of “financial debt” under Section 5(8) of the Insolvency and Bankruptcy Code, 2016 (IBC). This section is pivotal in determining what constitutes a financial debt, thereby identifying the entities eligible to initiate the Corporate Insolvency Resolution Process.

Section 5(8) of the IBC: A Closer Look

Section 5(8) of the Insolvency and Bankruptcy Code, 2016, defines “financial debt” as follows:

“(8) ‘financial debt’ means a debt along with interest, if any, which is disbursed against the consideration for the time value of money and includes—

(a) money borrowed against the payment of interest;

(b) any amount raised by acceptance under any acceptance credit facility or its de-materialised equivalent;

(c) any amount raised pursuant to any note purchase facility or the issue of bonds, notes, debentures, loan stock or any similar instrument;

(d) the amount of any liability in respect of any lease or hire purchase contract which is deemed as a finance or capital lease under the Indian Accounting Standards or such other accounting standards as may be prescribed;

…

(f) any amount raised under any other transaction, including any forward sale or purchase agreement, having the commercial effect of a borrowing…”

This definition explicitly acknowledges that a “financial debt” may include interest but crucially adds the qualifier “if any” to indicate that the presence of interest is not a mandatory criterion for a debt to qualify as a financial debt. The inclusion of “if any” suggests that the legislation intentionally accommodates interest-free loans within the ambit of financial debts, provided they meet the core requirement: the disbursement of debt against the consideration for the time value of money.

Understanding “if any” in the Context of Financial Debt

The phrase “if any” plays a significant role in the interpretation of “financial debt.” It signifies that while interest is a common feature of financial debts, its absence does not preclude a debt from being recognized as a financial debt under the IBC. This interpretation is vital for comprehending the breadth of financial debts and ensuring that the provisions of the IBC are inclusively applied to encompass a range of financial arrangements, including interest-free loans. 

By highlighting the overlooked “if any” phrasing, the Supreme Court clarifies that the IBC’s framework is designed to be comprehensive, capturing various forms of credit arrangements that extend beyond traditional interest-bearing loans. This understanding is critical for stakeholders in insolvency proceedings, ensuring that the legislative intent of the IBC—to streamline and encompass a broad spectrum of financial relationships within its purview—is faithfully executed.

This nuanced interpretation underlines the IBC’s goal of addressing corporate insolvency in a manner that is both pragmatic and inclusive, acknowledging the diversity of financial instruments and arrangements in the contemporary financial landscape. The Supreme Court’s clarification ensures that the scope of “financial debt” is adequately broad to include interest-free loans, thereby affirming the rights of creditors holding such instruments to participate in the insolvency resolution process.

The Verdict: Clarifying Financial Debt Under IBC

In setting aside the judgments of both the NCLAT and NCLT, the Supreme Court unequivocally held that interest-free loans advanced to finance the business operations of a corporate body do indeed qualify as “financial debt” under the IBC. The apex court emphasized the need for a broad interpretation of the term “financial debt” to encompass interest-free loans, thereby aligning with the overarching objectives of the IBC.

“‘Financial Debt’ would have to be construed to include interest-free loans advanced to finance the business operations of a corporate body. The appeal is therefore allowed… The petition under Section 7 stands revived and may be decided afresh in accordance with law and in the light of the findings above.”

Expanding the Definition of Time Value of Money

The concept of the “time value of money” under the IBC has been a subject of extensive judicial scrutiny. In the landmark decision of Pioneer Urban, the Supreme Court elucidated that TVM extends beyond mere interest on loans to include the intrinsic benefits derived from financial transactions, such as advance payments for property construction. This broader interpretation signifies a shift towards recognizing the multifaceted nature of financial contributions and their impact on corporate financing.

“The Supreme Court in Pioneer Urban recognized that the time value of money includes the benefits accrued from advance payments, challenging the conventional notion that financial debt is synonymous with interest-bearing loans.”

The Orator Marketing Decision: A Critical Shift

The Orator Marketing case further delved into the ambit of financial debt, particularly focusing on whether interest-free loans qualify as financial debt under the IBC. The Supreme Court’s affirmative stance in this case underscores the principle that the essence of a financial debt lies in the consideration for the time value of money, irrespective of the accrual of interest. This decision opens up new avenues for creditors to assert their rights under the IBC, emphasizing the commercial effect of borrowing as a key determinant.

“In Orator Marketing, the Supreme Court posited that interest-free loans, by their commercial effect, fall within the scope of financial debt, broadening the category of financial creditors eligible to initiate insolvency proceedings.”

Implications of Financial Debt Under IBC for Creditors and the Insolvency Resolution Process

The expansive interpretation of financial debt, particularly regarding the time value of money, has profound implications for the insolvency resolution process. By including a wider array of financial transactions as financial debt, the IBC allows for a more inclusive creditor participation in the Committee of Creditors (CoC). This inclusivity, while enhancing the democratic nature of the insolvency process, also necessitates a careful balance to ensure that the CoC’s decision-making remains effective and aligned with the objective of maximizing the debtor company’s value.

“The inclusion of creditors with interest-free loans within the CoC underscores the need for a nuanced understanding of financial debt, ensuring that the resolution process remains both inclusive and focused on the optimal recovery for all stakeholders.”

Towards a Refined Jurisprudence on Financial Debt under IBC

The evolving jurisprudence on financial debt, marked by significant rulings like Pioneer Urban and Orator Marketing, calls for a refined understanding of the IBC’s provisions. It highlights the necessity for legislative clarity and judicial consistency in interpreting the time value of money and its implications for defining financial debt. As the IBC continues to mature, the legal community and stakeholders alike must navigate these complexities to foster a robust insolvency resolution framework.

“The journey towards a comprehensive jurisprudence on financial debt under the IBC underscores the dynamic nature of insolvency law and the critical role of the judiciary in shaping its contours for the benefit of the Indian economy.”

These sections can seamlessly integrate into the “Navigating the Financial Debt Terrain” article, offering a detailed exploration of the time value of money and its significance in the context of financial debt under the IBC.

Conclusion

This landmark decision by the Supreme Court significantly broadens the scope of what constitutes a financial debt under the IBC, thus impacting the rights and remedies available to creditors of corporate debtors. It affirms the principle that the essence of a financial debt lies not in the accrual of interest but in the disbursement of a loan against the consideration for the time value of money, whether or not interest is chargeable. This judgment not only clarifies the legal position concerning interest-free loans but also underscores the IBC’s goal of facilitating the resolution of corporate insolvency in a creditor-friendly manner, ensuring that the mechanism for the resolution of financial distress is both inclusive and effective.

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The National Company Law Appellate Tribunal (NCLAT), New Delhi, recently delivered a significant judgment in the case involving Mr. Girish Nalavade against Bhrugesh Amin and Ors., which serves as a pivotal examination of the principles governing the commercial wisdom of the Committee of Creditors (CoC) within the framework of the Insolvency and Bankruptcy Code, 2016 (IBC). This ruling, while affirming the sanctity of the CoC’s decision-making process, provides a detailed exploration of the scope for judicial intervention in the Corporate Insolvency Resolution Process (CIRP) and addresses the constraints faced by dissatisfied stakeholders, specifically homebuyers, in influencing the outcome of insolvency proceedings.

Contextualizing the Dispute

The core of the dispute revolved around the dissatisfaction of a class of 77 homebuyers with the CoC-approved resolution plan for Modella Textile Industries Ltd., which was undergoing CIRP. The appellants sought to overturn the CoC’s decision, advocating for either a rejection of the approved plan or a call for fresh bidding to accommodate the specific demands of the homebuyers.

Legal Framework Under Scrutiny

At the heart of the tribunal’s examination were the principles laid out in Section 61 of the IBC, which pertains to appeals against the orders of the Adjudicating Authority (the National Company Law Tribunal, or NCLT). This section forms the basis for understanding the appellate mechanism within the IBC’s architecture, offering a window into the judicial review of CIRP decisions.

Understanding the Commercial Wisdom of Committee of Creditors in Legal Scrutiny

The NCLAT meticulously navigated the arguments presented, emphasizing that:

“Once the CoC has approved the resolution plan by requisite majority and the same is in consonance with applicable provisions of law and nothing has come to light to show that the Resolution Professional had committed any material irregularities in the conduct of the CIRP proceedings, the same cannot be a subject matter of judicial review and modification.”

This assertion underscores the tribunal’s deference to the collective commercial judgment of the CoC and delineates the boundaries of judicial intervention in CIRP matters.

Analysis of the Appellants’ Contentions

The appellants raised multiple grounds for contesting the CoC’s decision, including alleged procedural irregularities and the demand for alterations to the resolution plan to better serve the interests of the homebuyers. In response, the tribunal noted:

“It has also not been controverted by the Appellant that all the 77 Homebuyers, including the Appellant, have accepted the offer of 100% of their principal amount from the SRA.”

This observation highlights the consensus reached among the stakeholders and affirms the procedural integrity of the resolution plan’s approval.

Concluding Reflections on Committee of Creditors’ Commercial Wisdom

The judgment solidifies the principle that the commercial wisdom of the CoC is paramount and that individual dissatisfaction cannot override the collective decision-making process, particularly when no material irregularities are apparent. This stance not only reinforces the intent of the IBC to ensure a timely and efficient resolution of insolvency cases but also clarifies the limits of judicial review in matters where the commercial decisions of the CoC are contested.

In essence, the NCLAT’s ruling in the case of Mr. Girish Nalavade Vs. Bhrugesh Amin and Ors. elucidates the careful balance the IBC seeks to maintain between legal oversight and the autonomy of the CoC’s commercial judgment. It serves as a guiding precedent for future insolvency proceedings, emphasizing the need for a principled and structured approach in addressing the challenges and disputes that arise within the ambit of the IBC.

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Introduction

The Insolvency and Bankruptcy Code (IBC) has been a subject of intense legal scrutiny and interpretation in recent years. One of the most contentious issues pertains to the entitlement of dissenting financial creditors under the IBC.

The Contention: Security Interest of Financial Creditors

A frequently vexed question arises as to the claim of a secured financial creditor either on the basis of the security interest it holds or otherwise. Such creditors, along with workmen, are first in the order of priority under Section 53(1) of the Code. However, what the other creditors would receive also depends upon how the secured creditors are settled.

Divergent Rulings: The Need for Clarification

In Essar Steel (India) Ltd. v. Satish Kumar Gupta, the Supreme Court observed that a secured creditor would be entitled to the value of its security. On the other hand, in India Resurgence ARC (P) Ltd. v. Amit Metaliks Ltd., the Court held that the secured creditor would not be entitled to the value of its security but would receive in proportion to what the others in the same class receive. These rulings seem to contradict one another but according to some legal experts, it is not so.

The CoC’s Role: Exercising Commercial Wisdom

In both cases, the Court proceeded on the premise that in the insolvency regime, the Committee of Creditors (CoC) is entitled to exercise commercial wisdom in dealing with the revival of the ailing corporate debtor and determine what amounts were to be paid to each class of creditors.

Dissenting Financial Creditors : A Position of Compromise?

The Supreme Court in Essar Steel (India) Ltd. v. Satish Kumar Gupta has held that in a corporate insolvency resolution process, as per Section 30(2)(b), a dissenting financial creditor would be entitled to at least what it would receive under Section 53(1) in case of liquidation (i.e., minimum liquidation value). However, the position in corporate insolvency resolution process (CIRP) is much different than that in an insolvency process.

In insolvency process, there is a moratorium in place where there is a freeze on the assets of the corporate debtor and all the financial creditors come together to form the CoC. Approval to a resolution plan by the requisite majority is binding on all the stakeholders including dissenting financial creditors. It is thus, possible that under the approved resolution plan a dissenting financial creditor may not receive the value of the security held by it.

Dissenting Financial Creditors : Court’s Clarification for Larger Bench

The Court also rejected the argument of the respondent that Section 30(2)(b)(ii) is unworkable because it involves deeming fiction relating to liquidation, which is inapplicable during the CIRP period. It noted that the dissenting financial creditor has to statutorily forgo and relinquish his security interest on the resolution plan being accepted, and his position is same and no different from that of a secured creditor who has voluntarily relinquished security and is to be paid under Section 53(1)(b)(ii) of the Code.

“We wish to clarify that Section 53(1) is referred to in Section 30(2)(b)(ii) with the purpose and objective that the dissenting financial creditor is not denied the amount which is payable to it being equal to the amount of value of the security interest. The entire Section 53 is not made applicable,” the judgment authored by Justice Sanjiv Khanna stated.

Since it was taking a contrary view from a coordinate bench’s judgment, the bench said that it is proper and appropriate that the issue is referred to a larger bench. The matter be, accordingly placed before the Hon’ble the Chief Justice for appropriate orders, the judgment stated.

Conclusion: Dissenting Financial creditors under IBC

The entitlement of dissenting financial creditors under the IBC is a complex issue that requires careful consideration. The Supreme Court’s rulings provide some guidance, but the final decision often rests with the CoC. As the law continues to evolve, it will be interesting to see how these issues are resolved in the future.

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The Insolvency and Bankruptcy Code, 2016 has fundamentally transformed the corporate insolvency landscape in India by establishing a time-bound framework for resolution and liquidation of financially distressed companies. Within this framework, the role of the Committee of Creditors in liquidation under IBC is crucial, as it decides the course of action for corporate debtors. Recent judgments by the National Company Law Appellate Tribunal have provided clarity on key issues, including whether a Committee of Creditors can be constituted with a single operational creditor and the requirement that liquidation decisions be supported by reasoned justifications. These rulings have significant implications for creditors, corporate debtors, and resolution professionals navigating the insolvency process.

The Legislative Framework Governing Liquidation

The Insolvency and Bankruptcy Code establishes a structured mechanism for initiating liquidation proceedings when resolution efforts fail or prove impossible. Section 33 of the Code delineates the circumstances under which liquidation may be commenced. The provision grants the Adjudicating Authority the power to order liquidation in specific situations: when no resolution plan is received before the expiry of the insolvency resolution process period, when a submitted resolution plan fails to meet statutory requirements and is consequently rejected, or when the Committee of Creditors decides to liquidate the corporate debtor during the resolution process itself [1].

The statutory scheme empowers the Committee of Creditors with significant authority. Under Section 33(2) of the Code, where the resolution professional intimates the Adjudicating Authority of the Committee’s decision to liquidate at any time during the corporate insolvency resolution process but before confirmation of a resolution plan, approved by not less than sixty-six percent of the voting share, the Adjudicating Authority must pass a liquidation order. This provision reflects the legislature’s intent to vest primary decision-making authority in the hands of creditors who have financial stakes in the corporate debtor’s assets [2].

The composition and functioning of the Committee of Creditors is governed by Sections 21 and 24 of the IBC. The Committee typically consists of all financial creditors of the corporate debtor, excluding related parties. Financial creditors are entitled to voting rights proportionate to their claims. Operational creditors, conversely, occupy a different position within the statutory framework. They may attend meetings of the Committee if their aggregate dues constitute at least ten percent of the total debt, but they possess no voting rights regardless of the magnitude of their claims [3].

This distinction between financial and operational creditors finds its roots in the recommendations of the Bankruptcy Law Reforms Committee. The Committee observed that operational creditors typically lack the capacity to assess the commercial viability of a corporate debtor and are generally unwilling to accept the risks associated with postponing payments in exchange for potentially better future prospects. Financial creditors, being institutions that have extended credit with consideration for the time value of money, are better positioned to make informed decisions about resolution versus liquidation.

The Jaipur Trade Expocentre Judgment and Reasoned Decision-Making

The NCLAT’s judgment in Jaipur Trade Expocentre Private Limited v. Metro Jet Airways Training Private Limited and Others represents a watershed moment in understanding the obligations of the Committee of Creditors when deciding to liquidate a corporate debtor. The tribunal unequivocally held that decisions of the Committee to liquidate must be accompanied by reasons and cannot be made arbitrarily [4].

In this particular matter, the Committee of Creditors had passed a resolution to liquidate the corporate debtor. The resolution recorded specific reasons supporting the liquidation decision: the company had no employees, no active business operations, no registered office, had failed to file annual accounts with the Ministry of Corporate Affairs since March 31, 2011, had not filed any returns, and had conducted no transactions since 2017. The tribunal examined these recorded reasons and found them sufficient to justify the liquidation decision.

The tribunal emphasized that while the statutory scheme under Section 33(2) empowers the Committee of Creditors to decide on liquidation after its constitution, this power cannot be exercised capriciously. The requirement of providing reasons serves multiple purposes within the insolvency framework. First, it ensures transparency in the decision-making process, allowing stakeholders to understand the basis for liquidation. Second, it facilitates meaningful judicial review by enabling the Adjudicating Authority and appellate tribunals to assess whether the Committee’s decision is grounded in legitimate commercial considerations. Third, it protects against arbitrary exercises of power that might prejudice the interests of other stakeholders.

This principle aligns with the broader jurisprudence established by the Supreme Court in landmark cases interpreting the Code. The apex court has consistently held that while the commercial wisdom of the Committee of Creditors is supreme and deserves judicial deference, it must operate within the boundaries of the statutory framework. The requirement of reasoned decision-making represents one such boundary that safeguards the integrity of the insolvency process.

Single Operational Creditor and Committee Constitution

A particularly contentious issue that has emerged in insolvency jurisprudence concerns whether a Committee of Creditors can be constituted with a single operational creditor. The NCLAT addressed this question with clarity in its analysis of V. Duraisamy v. Jeyapriya Fruits and Vegetables Commission Agent and Others. The tribunal held that the Insolvency and Bankruptcy Code contains no provision enabling the constitution of a Committee of Creditors with a single operational creditor when no claims have been received from financial creditors [5].

In the Duraisamy case, the corporate debtor had been struck off by the Registrar of Companies for failing to file financial statements. An operational creditor subsequently filed a petition under Section 9 of the Code seeking initiation of corporate insolvency resolution process. Following admission of the petition, the Interim Resolution Professional issued a public announcement inviting claims from creditors. However, not a single claim was received from any financial creditor. The only claim before the resolution professional came from the operational creditor who had initiated the proceedings.

The Adjudicating Authority directed the Interim Resolution Professional to constitute a Committee of Creditors with the sole operational creditor as its member. On appeal, the NCLAT reversed this direction and held that the corporate insolvency resolution process should be closed with respect to the corporate debtor. The tribunal reasoned that the statutory scheme contemplates the Committee of Creditors as a body of financial creditors possessing the commercial acumen and risk appetite necessary to make informed decisions about resolution. Operational creditors, while entitled to attend meetings when their dues exceed the statutory threshold, are deliberately excluded from voting precisely because they lack the characteristics that justify membership in the decision-making body.

This interpretation finds support in the fundamental architecture of the Code. Section 21 defines the Committee of Creditors as comprising all financial creditors of the corporate debtor. Section 24 permits operational creditors to participate in meetings without voting rights under specified conditions. The statutory language and structure leave no room for constituting a Committee consisting exclusively of operational creditors in the ordinary course.

Importantly, the Jaipur Trade Expocentre judgment clarified that the Duraisamy decision does not establish any ratio preventing the constitution of a Committee of Creditors where a single operational creditor is involved alongside financial creditors. The tribunal distinguished between two scenarios: one where no claims are filed and no Committee is constituted at all (as in Duraisamy), and another where a Committee is duly constituted but happens to include a single operational creditor along with financial creditors. The latter scenario does not violate any provision of the Code.

Judicial Review of Liquidation Decisions

The extent of judicial review over decisions regarding liquidation by the Committee of Creditors under the IBC represents a critical aspect of insolvency jurisprudence. In Committee of Creditors of Essar Steel India Limited v. Satish Kumar Gupta, the Supreme Court established foundational principles that define the scope of judicial intervention, balancing respect for the Committee’s commercial wisdom with the need to ensure compliance with statutory requirements. [6].

The apex court held that the Adjudicating Authority’s jurisdiction is circumscribed by Section 30(2) of the Code when reviewing resolution plans. The authority cannot interfere with the commercial wisdom of the Committee of Creditors. However, it retains limited jurisdiction to ensure that the Committee has taken into account certain fundamental considerations: that the corporate debtor needs to continue as a going concern during the insolvency resolution process, that the value of the corporate debtor’s assets should be maximized, and that the interests of all stakeholders including operational creditors have been adequately addressed.

This principle extends to decisions regarding liquidation. While the Committee of Creditors possesses authority to decide whether to pursue resolution or liquidation under IBC, the decision must reflect consideration of the statutory objectives. The Adjudicating Authority cannot substitute its own business judgment for that of the Committee, but it can examine whether the decision is supported by reasons and whether it contravenes any provision of law.

The NCLAT has repeatedly affirmed that the decision of the Committee of Creditors regarding liquidation, when properly made with reasons and in accordance with statutory requirements, is entitled to significant deference. Courts will not interfere merely because an alternative course of action might have been preferable. The standard of review focuses on procedural propriety and statutory compliance rather than the substantive merits of the business decision.

Treatment of Operational Creditors in Insolvency

The position of operational creditors within the insolvency framework warrants careful examination. While these creditors lack voting rights in the Committee of Creditors, the Code incorporates several protections to safeguard their interests. Section 30(2)(b) of the Code, as amended in 2019, mandates that operational creditors must receive at least the higher of two amounts in any resolution plan: the liquidation value of their claims under Section 53, or the amount they would receive if the resolution plan amount were distributed according to the priority order specified in Section 53 [7].

This statutory mandate emerged following the Supreme Court’s intervention in the Essar Steel litigation. The original NCLAT judgment in that matter had directed equal distribution among all creditors, disregarding the distinction between secured and unsecured creditors and between financial and operational creditors. The Supreme Court reversed this approach and upheld the Committee’s authority to determine distribution among different classes of creditors, subject to the minimum payment requirements.

The apex court clarified that equitable treatment does not mean equal treatment. Creditors in different classes are entitled to differential treatment based on the nature of their claims and security interests. However, the Court emphasized that while the Committee has discretion in determining what to pay and how much to pay to each class of creditors, the decision must demonstrate that the Committee has balanced the interests of all stakeholders and that it has not completely excluded operational creditors from any meaningful recovery.

In practical terms, operational creditors face significant challenges in insolvency proceedings. Their exclusion from voting rights means they cannot directly influence critical decisions such as approval of resolution plans or decisions to liquidate. Their only recourse lies in approaching the Adjudicating Authority or appellate tribunals if they believe their statutory rights have been violated. The limited judicial review available focuses on ensuring minimum statutory protections rather than maximizing recovery for operational creditors.

The Supreme Court in Swiss Ribbons Private Limited v. Union of India examined constitutional challenges to the differential treatment of financial and operational creditors. The Court upheld the classification as based on intelligible differentia serving the legitimate objectives of the Code. The Court noted that financial creditors typically have longer-term relationships with corporate debtors and are better equipped to evaluate prospects for revival. Operational creditors, being primarily concerned with recovery of dues for goods supplied or services rendered, lack the same incentive to take risks associated with corporate revival [8].

Commercial Wisdom and Stakeholder Interests

The doctrine of commercial wisdom represents a cornerstone principle in insolvency jurisprudence. The Supreme Court has repeatedly emphasized that the Committee of Creditors, being composed of sophisticated financial institutions with economic stakes in the outcome, is best positioned to make decisions about the fate of corporate debtors. Courts should not second-guess these decisions unless they contravene statutory provisions or reflect procedural irregularities.

However, commercial wisdom is not absolute and must operate within the framework established by the Code. When the Committee of Creditors decides on liquidation under IBC, it must ensure that its decisions reflect the core objectives of the insolvency regime: time-bound resolution, maximization of asset value, and protection of stakeholder interests. In making such decisions, the Committee should carefully weigh whether liquidation would produce better outcomes than continued resolution efforts, whether the corporate debtor’s assets are deteriorating, whether operational viability can be restored, and the potential impact on stakeholders, including employees and operational creditors.

The requirement of providing reasons for liquidation decisions serves as a check on the exercise of commercial wisdom. Without this requirement, the Committee could make decisions based on considerations that might not align with statutory objectives or stakeholder interests. The recording of reasons creates a paper trail that enables meaningful review and ensures accountability.

Procedural Requirements for Liquidation

When a Committee of Creditors decides to proceed with liquidation under IBC, a clear procedural framework ensures transparency and protects stakeholders. The resolution professional must inform the Adjudicating Authority, providing supporting documentation such as minutes of the Committee meeting, the reasons for the liquidation decision, and proof that the required sixty-six percent voting threshold was met.

Upon receiving intimation of the Committee’s decision, the Adjudicating Authority examines whether procedural requirements have been satisfied. This includes verifying that proper notice was given to all Committee members, that the voting was conducted in accordance with the Code and applicable regulations, and that the decision was supported by adequate reasons. If satisfied, the authority passes a liquidation order directing that the corporate debtor be liquidated in the manner prescribed by the Code, issuing a public announcement of liquidation, and requiring the order to be sent to the authority with which the corporate debtor is registered.

The liquidation order triggers several consequences. Under Section 33(5), no suit or other legal proceeding can be instituted by or against the corporate debtor once liquidation commences, subject to specified exceptions. Section 33(7) deems the liquidation order as notice of discharge to officers, employees, and workmen of the corporate debtor, unless the liquidator continues business operations during liquidation. These provisions create a moratorium that protects the corporate debtor’s assets and facilitates orderly liquidation proceedings [9].

Conclusion

The NCLAT’s jurisprudence on liquidation decisions under the Insolvency and Bankruptcy Code reflects a careful balance between empowering creditors with decision-making authority and ensuring that such authority is exercised responsibly with adequate safeguards. The requirement that liquidation decisions under IBC, be supported by reasons represents a meaningful check on the Committee of Creditors’ powers while preserving the primacy of commercial wisdom. The clarification that Committees cannot be constituted with single operational creditors in the absence of financial creditors upholds the fundamental architecture of the Code, which places resolution and liquidation decisions in the hands of creditors best equipped to make them.

These principles serve the broader objectives of the insolvency regime: providing time-bound resolution, maximizing asset value, and balancing stakeholder interests. While operational creditors occupy a subordinate position within the Committee structure, the statutory framework incorporates minimum protections to ensure they are not entirely excluded from meaningful recovery. The limited scope of judicial review respects commercial wisdom while ensuring compliance with statutory mandates and procedural fairness.

As insolvency jurisprudence continues to evolve, these foundational principles established by the NCLAT and Supreme Court will guide future cases. The emphasis on reasoned decision-making, proper Committee constitution, and balancing stakeholder interests will shape how corporate insolvencies are resolved and liquidations are conducted. For creditors, corporate debtors, and insolvency professionals, understanding these principles is essential to navigating the insolvency process effectively and ensuring that outcomes align with the statutory framework and commercial realities.

References

[1] Insolvency and Bankruptcy Code, 2016, § 33, No. 31, Acts of Parliament (India). Available at: https://www.indiacode.nic.in/show-data?actid=AC_CEN_2_11_00055_201631_1517807328273&orderno=39 

[2] IBC Laws, “Section 33 of IBC – Insolvency and Bankruptcy Code, 2016: Initiation of liquidation.” Available at: https://ibclaw.in/section-33-initiation-of-liquidation/ 

[3] Insolvency and Bankruptcy Code, 2016, § 24, No. 31, Acts of Parliament (India). Available at: https://ibclaw.in/section-24-meeting-of-committee-of-creditors/ 

[4] Jaipur Trade Expocentre Pvt. Ltd. v. Metro Jet Airways Training Pvt. Ltd. and Ors., Company Appeal (AT) (Insolvency) No. 1224 of 2023, NCLAT New Delhi (Dec. 21, 2023). Available at: https://ibclaw.in/jaipur-trade-expocentre-pvt-ltd-v-metro-jet-airways-training-pvt-ltd-and-ors-nclat-new-delhi/ 

[5] V. Duraisamy v. Jeyapriya Fruits and Vegetables Commission Agent & Ors., (2023) ibclaw.in 405 NCLAT. Available at: https://www.scconline.com/blog/post/2023/07/08/corporate-debtor-cannot-constitute-committee-of-creditors-with-a-single-operational-creditor-under-ibc-nclat/ 

[6] Committee of Creditors of Essar Steel India Ltd. v. Satish Kumar Gupta & Ors., (2020) 8 SCC 531 (India). Available at: https://ibclaw.in/summary-of-landmark-judgment-of-supreme-court-in-committee-of-creditors-of-essar-steel-india-limited-vs-satish-kumar-gupta-ors-under-ibc/ 

[7] Insolvency and Bankruptcy Code (Amendment) Act, 2019, § 30(2)(b), effective from August 16, 2019. Available at: https://www.snrlaw.in/operational-creditors-in-insolvency-a-tale-of-disenfranchisement/ 

[8] Swiss Ribbons Pvt. Ltd. v. Union of India, (2019) 4 SCC 17 (India). Available at: https://www.lexology.com/library/detail.aspx?g=28bf9d14-8644-4ea9-aba0-58fc8848b0ba 

[9] The Legal School, “Section 33 of IBC: A Detailed Overview of Liquidation Procedure.” Available at: https://thelegalschool.in/blog/section-33-ibc 

The post Decisions of Committee of Creditors to Liquidate under IBC: A NCLAT Judgment Analysis appeared first on Bhatt & Joshi Associates.

Introduction

The Insolvency and Bankruptcy Code, 2016 (hereinafter referred to as “the Code”) represents a watershed moment in India’s commercial jurisprudence, fundamentally transforming how financial distress and corporate insolvency are addressed in the country. Since its enactment, the Code has been instrumental in establishing a clear framework for determining creditor rights, prioritizing claims, and facilitating the revival or liquidation of distressed corporate entities. However, the application of the Code to various financial arrangements has been subject to extensive judicial interpretation, particularly concerning the distinction between genuine financial debt and commercial investments that share profit and risk. One of the most contentious areas that has emerged in insolvency jurisprudence relates to joint venture arrangements and whether investments made under such collaborations qualify as financial debt under the statutory definitions provided in the Code. This question carries significant practical implications because the classification determines whether an investor can initiate insolvency proceedings as a financial creditor or whether their claim must be treated differently. The National Company Law Appellate Tribunal’s judgment in RealPro Realty Solutions Pvt Ltd vs Sanskar Projects and Housing Ltd [1] has provided crucial clarity on this issue, establishing important precedents for distinguishing between genuine creditor-debtor relationships and joint venture partnerships.

The significance of this distinction cannot be overstated. Financial creditors, as defined under the Code, enjoy privileged status in insolvency proceedings, including the right to trigger the Corporate Insolvency Resolution Process (CIRP) and participate in the Committee of Creditors with voting rights. Conversely, entities that are deemed to be business partners or investors rather than creditors do not enjoy these rights, regardless of the quantum of money invested or the terms of repayment stipulated in their agreements. The judicial interpretation of these arrangements therefore has far-reaching consequences for how businesses structure their collaborations and how courts evaluate the substance of financial transactions beyond their formal documentation.

The Legislative Framework: Understanding Financial Debt and Financial Creditors Under the IBC

Defining Financial Creditors

The architecture of the Insolvency and Bankruptcy Code rests fundamentally on the distinction between different classes of creditors and their respective rights in insolvency proceedings. Section 5(7) of the Code defines a “financial creditor” as any person to whom a financial debt is owed, including persons to whom such debt has been legally assigned or transferred [2]. This definition appears straightforward on its face, but its practical application requires a detailed understanding of what constitutes financial debt in the first place. The classification as a financial creditor is not merely a matter of nomenclature; it determines the substantive rights available to a claimant in insolvency proceedings, including the critical ability to initiate CIRP and participate in decision-making through the Committee of Creditors.

The legislative intent behind creating this distinct category of financial creditors stems from the recognition that entities that provide debt capital to businesses have different economic interests and risk profiles compared to those who supply goods and services. Financial creditors typically assess the viability of the corporate debtor’s business before extending credit, monitor the financial health of the debtor during the term of the loan, and have a continuing stake in the debtor’s solvency. This ongoing relationship and assessment capability justifies their privileged position in the resolution process, where they collectively determine the fate of the corporate debtor through the Committee of Creditors.

The Concept of Financial Debt

Section 5(8) of the Code provides an elaborate definition of “financial debt” that forms the cornerstone for determining who qualifies as a financial creditor. The provision states that financial debt means a debt along with interest, if any, which is disbursed against the consideration for the time value of money. This central concept of “consideration for the time value of money” serves as the defining characteristic that separates financial debt from other forms of commercial obligations. The provision further includes within its ambit various specific categories including money borrowed against payment of interest, amounts raised through debt securities, amounts due under deferred payment arrangements, amounts due under finance leases, and amounts raised under securitization or factoring transactions [3].

The legislative emphasis on “time value of money” as the determinative factor reflects a sophisticated understanding of financial economics. The time value of money recognizes that money available at present is worth more than the same amount in the future due to its potential earning capacity. When a lender provides funds to a borrower, the compensation for parting with liquidity and bearing the risk of non-repayment is typically structured as interest or a fixed return that reflects this time value. This distinguishes genuine lending from equity investment or profit-sharing arrangements where returns are contingent on business performance rather than being compensation for the passage of time.

The inclusive nature of the definition in Section 5(8) ensures that various modern financial instruments and arrangements can be brought within the fold of financial debt, provided they meet the core requirement of being consideration for the time value of money. This approach prevents sophisticated parties from structuring transactions in ways that avoid the application of the Code while maintaining the economic substance of a lending arrangement. However, it also means that courts must look beyond the form of transactions to examine their true economic character, particularly in cases involving hybrid instruments that combine features of both debt and equity.

Joint Ventures in the Indian Legal Context: Characteristics and Legal Treatment

Understanding Joint Venture Structures

Joint ventures represent a distinct category of commercial collaboration where two or more parties combine resources, expertise, and capital to pursue a specific business objective while sharing both the risks and rewards of the enterprise. Unlike traditional creditor-debtor relationships, joint ventures are characterized by mutual participation in management, shared decision-making authority, and proportional distribution of profits and losses based on agreed formulas. The essence of a joint venture lies in the partnership nature of the arrangement, where parties act as co-venturers rather than as lender and borrower.

In the Indian context, joint ventures have become particularly prevalent in sectors such as real estate development, infrastructure projects, manufacturing, and technology ventures. These collaborations often involve one party bringing financial resources while another contributes land, expertise, regulatory approvals, or market access. The arrangements are typically documented through detailed joint venture agreements that specify capital contributions, profit-sharing ratios, management structures, exit mechanisms, and dispute resolution procedures. However, the terminology used in these agreements does not necessarily determine their legal character for purposes of insolvency law.

The legal treatment of joint ventures under various Indian statutes has evolved through judicial interpretation. Under the Indian Contract Act, 1872, joint ventures are generally treated as a form of partnership, though they may be limited to a specific project or duration. The Income Tax Act recognizes joint ventures as distinct entities for tax purposes in certain circumstances. However, the critical question for insolvency law is whether investments made under joint venture arrangements constitute financial debt that would entitle the investor to the status and rights of a financial creditor under the Code.

Distinguishing Investment from Lending

The fundamental distinction that courts must draw in these cases is between money advanced as a loan (which creates a creditor-debtor relationship) and money invested as capital contribution in a joint enterprise (which creates a partnership or co-ownership relationship). This distinction turns on several factors beyond the mere labeling of payments or the inclusion of repayment clauses in agreements. Courts examine the entire structure of the arrangement, including whether returns are fixed or contingent on profits, whether the contributor has any management rights or obligations, whether risks and rewards are shared proportionally, and whether the agreement contemplates joint ownership of assets or outcomes.

The difficulty in making this distinction arises because modern joint venture agreements often incorporate features that superficially resemble debt arrangements. They may include provisions for return of capital, timelines for such returns, and even specify certain fixed components of return. However, when these provisions are examined in the context of the overall arrangement, particularly clauses relating to profit sharing, risk allocation, and management participation, the true nature of the relationship becomes clearer. The courts have consistently held that the substance of the transaction rather than its form must guide the legal characterization.

The RealPro Realty Solutions Judgment: Facts and Legal Analysis

Factual Matrix of the Case

The case of RealPro Realty Solutions Pvt Ltd vs Sanskar Projects and Housing Ltd presented the National Company Law Appellate Tribunal with a quintessential example of the conflict between joint venture arrangements and claims of financial creditor status under the Code. The appellant, RealPro Realty Solutions Pvt Ltd, had entered into an agreement with the respondent, Sanskar Projects and Housing Ltd, for the development of real estate property. Under the terms of this agreement, RealPro invested substantial funds in the project, with the understanding that it would receive returns based on the project’s profitability and the successful sale of developed units.

When disputes arose between the parties and the project encountered financial difficulties, RealPro sought to invoke its rights as a financial creditor under Section 7 of the Code, claiming that its investment constituted financial debt. The appellant argued that since the agreement specified repayment of the invested amount along with returns, it should be treated as a lending arrangement rather than a joint venture investment. This position, if accepted, would have entitled RealPro to initiate CIRP against Sanskar Projects and participate in the resolution process as a financial creditor with voting rights in the Committee of Creditors.

The respondent contested this characterization, arguing that the agreement clearly established a joint venture relationship where both parties were co-developers sharing the risks and rewards of the real estate project. According to Sanskar Projects, the returns contemplated under the agreement were explicitly linked to the success of the development and sale of property, making them profit-sharing arrangements rather than interest or fixed returns that would characterize a debt relationship. The company emphasized that RealPro had participated in project decisions and had agreed to share both profits and potential losses, which are hallmarks of a partnership rather than a creditor-debtor relationship.

The NCLAT’s Reasoning and Conclusions

The National Company Law Appellate Tribunal, in a carefully reasoned judgment delivered by a coram consisting of Justice Ashok Bhushan (Chairperson), Mr. Barun Mitra (Technical Member), and Mr. Arun Baroka (Technical Member), undertook a thorough analysis of the agreement between the parties and the applicable legal principles. The Tribunal began by articulating a clear definition of joint ventures, stating that a joint venture represents a combination of two or more parties or entities that seeks the development of any enterprise or project for profit and necessarily entails sharing the risks associated with its development [1].

Examining the specific terms of the agreement between RealPro and Sanskar Projects, the NCLAT observed that the arrangement clearly manifested shared liability for profit. The Tribunal noted that when such shared liability for profit is explicitly incorporated into the contractual framework, it becomes evident that both parties are development partners and co-sharers in the development of the subject property. This observation was crucial because it shifted the focus from isolated clauses about repayment to the overall economic substance of the relationship. The Tribunal emphasized that the terms of the agreement laid the foundations of a legal and binding relationship with mutual financial obligations towards each other, rather than a unilateral obligation of the debtor to repay a creditor.

The most significant conclusion reached by the NCLAT was that the appellant, by virtue of the funds invested under the terms of the agreement, could not claim the status and benefits of a financial creditor as defined under Section 5(7) of the Code. This conclusion flowed from the Tribunal’s analysis that the transaction was in the nature of an investment for profit rather than a disbursement for the time value of money. Since the essential characteristic of financial debt under Section 5(8) is that it must be disbursed against consideration for the time value of money, and since the present arrangement was structured around profit-sharing rather than compensation for time value, it did not fall within the definition of financial debt.

The judgment clarified that the mere fact that an agreement specifies certain timelines for returns or uses terminology that might suggest a debt relationship is insufficient to convert a joint venture investment into financial debt. The Tribunal adopted a substance-over-form approach, looking at the economic reality of the transaction rather than being swayed by drafting choices made by the parties. This approach aligns with the broader jurisprudential principle that courts must examine the true nature of transactions, particularly in insolvency proceedings where the classification determines significant rights and priorities among competing stakeholders.

Implications for Real Estate Joint Ventures and Development Agreements

The Real Estate Sector Context

The real estate development sector in India has historically relied heavily on various forms of collaborative financing and joint development arrangements. Given the capital-intensive nature of real estate projects, the long gestation periods involved, and the regulatory complexities of land development, it is common for developers to enter into arrangements with financial partners who provide capital in exchange for a share of the project’s profits. These arrangements have become even more prevalent in the wake of the Real Estate (Regulation and Development) Act, 2016, which imposed stricter controls on project financing and use of customer advances.

Prior to the RealPro judgment and similar precedents, there was considerable uncertainty about whether these development partners could claim financial creditor status if disputes arose. Some parties attempted to structure their arrangements with explicit repayment clauses and interest-like returns, hoping to secure the advantageous position of financial creditors while maintaining the flexibility and profit potential of joint venture arrangements. The RealPro judgment has effectively foreclosed this strategy by clarifying that courts will examine the overall structure of the arrangement rather than isolated provisions.

Practical Consequences for Structuring Collaborations

The judgment has several important practical implications for how parties structure their real estate collaborations and other joint venture arrangements. First, it establishes that parties cannot simply label an arrangement as a loan or include repayment clauses to secure financial creditor status if the underlying economic relationship is one of shared risk and profit. This means that developers and investors must be more deliberate in choosing between genuine financial debt and joint venture structures, understanding that each comes with different rights and remedies in the event of disputes or insolvency.

Second, the judgment provides greater protection to corporate debtors against strategic use of insolvency proceedings by dissatisfied joint venture partners. If every joint venture partner who invested capital could threaten or initiate CIRP proceedings by claiming financial creditor status, it would expose companies to inappropriate use of the insolvency process for commercial disputes. By clarifying that joint venture investments do not constitute financial debt, the judgment ensures that the CIRP mechanism is reserved for genuine cases of financial distress and creditor default rather than becoming a pressure tactic in business disputes.

Third, the decision encourages transparency and proper characterization of relationships from the outset. Parties entering into collaborations must clearly determine whether they are creating a creditor-debtor relationship or a joint venture partnership and structure their agreements accordingly. This clarity benefits all stakeholders by reducing disputes over the nature of the relationship and the rights available to each party. It also ensures that financial statements and disclosures accurately reflect the company’s obligations, including distinctions between financial debt and joint venture investments, aligning reporting with the true economic substance of the arrangements.

The Broader Jurisprudence on Financial Debt Under the IBC

The “Time Value of Money” Test

The RealPro judgment must be understood in the context of the broader jurisprudence that has developed around the interpretation of financial debt under the Code. Indian courts, including the Supreme Court, have consistently emphasized that the defining characteristic of financial debt is that it must be disbursed against consideration for the time value of money. This principle has been applied across various types of transactions to distinguish genuine debt from other commercial arrangements [4].

The time value of money concept recognizes that when a lender provides funds to a borrower, the compensation is primarily for the loss of liquidity and the passage of time, rather than for the commercial success or failure of a particular venture. Interest on a loan, for example, accrues based on time and the principal amount, regardless of whether the borrower’s business is profitable. In contrast, returns under a profit-sharing arrangement are inherently contingent on business performance and are not guaranteed merely by the passage of time. This fundamental distinction guides courts in classifying ambiguous arrangements.

Related Precedents and Judicial Trends

The principles established in the RealPro judgment are consistent with other decisions where courts have examined the nature of investments and contributions in collaborative business ventures. The judiciary has shown a consistent approach of examining the totality of circumstances and the economic substance of arrangements rather than being influenced by the terminology used by parties or isolated contractual provisions. This approach reflects a mature understanding that sophisticated parties may attempt to structure transactions in ways that secure favorable legal treatment while maintaining the economic characteristics of a different type of arrangement.

Courts have also been attentive to the purpose and policy underlying the Code’s distinction between financial creditors and other stakeholders. The legislative design gives financial creditors significant rights and control in the insolvency resolution process because they are understood to be external capital providers who assess and monitor the debtor’s creditworthiness. In contrast, joint venture partners or equity investors are treated as having voluntarily assumed business risks in exchange for potentially higher returns, and therefore should not have the same priority or control as genuine lenders in insolvency proceedings.

Distinguishing Financial Debt from Operational Debt and Other Commercial Obligations

The Operational Creditor Category

While the RealPro judgment focused on distinguishing joint venture investments from financial debt, it is important to understand how both of these categories differ from operational debt. Section 5(20) of the Code defines operational debt as a claim in respect of provision of goods or services, including employment, or a debt in respect of repayment of dues arising under any law for the time being in force and payable to the Central Government, State Government, or any local authority [5]. Operational creditors, while having the right to initiate CIRP under Section 9 of the Code, do not participate in the Committee of Creditors unless their claims exceed certain thresholds, and even then their participation is limited.

The distinction between financial and operational debt reflects different policy considerations. Operational creditors supply goods and services in the ordinary course of business, and while their claims are important, they typically do not have the same ongoing financial stake or monitoring capacity as financial creditors. The Code’s structure recognizes these differences by giving operational creditors the ability to trigger insolvency proceedings (to prevent debtors from ignoring their obligations to suppliers and service providers) while reserving control over the resolution process primarily to financial creditors who are better positioned to assess the viability of revival plans.

Hybrid Instruments and Complex Financial Arrangements

Modern corporate finance increasingly involves sophisticated instruments that combine features of debt and equity, such as convertible debentures, preference shares with fixed returns, and various forms of mezzanine financing. The classification of these instruments under the Code has been the subject of considerable litigation and legal analysis. Courts have approached these cases by examining the predominant characteristics of the instrument and the true economic relationship it creates between the parties.

The key inquiry in cases involving hybrid instruments is whether the compensation provided to the investor is primarily for the time value of money or for assuming business risk. If a convertible debenture pays regular interest and the conversion option is merely an additional feature, it is more likely to be treated as financial debt. However, if the returns are primarily contingent on equity conversion and business performance, with minimal fixed return component, it may be treated more like an equity investment. The RealPro judgment’s emphasis on examining the overall structure and economic substance of arrangements provides guidance for analyzing these complex instruments.

Regulatory and Commercial Implications

Impact on Project Financing and Structuring

The clarification provided by the RealPro judgment has significant implications for how companies structure their project financing arrangements, particularly in capital-intensive sectors like real estate, infrastructure, and manufacturing. Companies and their advisors must now be more careful in distinguishing between genuine debt financing (which may be more expensive but provides clearer creditor protections) and joint venture arrangements (which may be more flexible but do not provide financial creditor rights). This increased clarity should lead to better-structured transactions that accurately reflect the parties’ intentions and rights.

From a regulatory perspective, the judgment reinforces the importance of accurate financial reporting and disclosure. Companies must ensure that their financial statements properly classify different types of funding sources, distinguishing between financial debt, operational liabilities, and capital contributions or joint venture arrangements. This accuracy is important not only for compliance with accounting standards but also because it affects how stakeholders, including potential creditors and investors, assess the company’s financial health and risk profile [6].

Considerations for Insolvency Professionals and Resolution Applicants

For insolvency professionals who must verify and admit claims in CIRP proceedings, the RealPro judgment provides important guidance on evaluating claims from parties who may have provided funds under various arrangements. Insolvency professionals must look beyond the terminology used in agreements and examine the substantive nature of the relationship to determine whether a claimant qualifies as a financial creditor. This requires careful analysis of joint venture agreements, shareholders’ agreements, and other collaboration documents to assess whether the funds were advanced as loans or as investments in a joint enterprise.

Resolution applicants and potential investors in distressed companies also benefit from this clarity. When conducting due diligence on a company undergoing CIRP, they can better assess the nature and priority of various claims. Understanding which parties are true financial creditors and which are joint venture partners or equity investors helps in valuing the company, negotiating with stakeholders, and structuring resolution plans. It also helps in identifying potential challenges to the classification of claims that might affect the resolution process or the enforceability of a resolution plan.

International Perspectives and Comparative Analysis

Treatment of Joint Ventures in Other Jurisdictions

The issue of how joint venture investments are treated in insolvency proceedings is not unique to India. Jurisdictions around the world have grappled with similar questions about distinguishing debt from equity and determining the rights of various types of investors in insolvency contexts. In the United Kingdom, for example, courts have developed extensive jurisprudence around the characterization of instruments and arrangements, emphasizing substance over form and examining the true nature of the commercial relationship between parties [7].

The United States bankruptcy system similarly distinguishes between creditors and equity holders, with important implications for voting rights, priority of claims, and distribution of assets. American courts have examined numerous cases involving hybrid securities and complex financing arrangements, developing principles that look at factors such as subordination provisions, management rights, profit participation, and risk allocation to determine the true character of an investment. While the specific legal frameworks differ, there is a common thread across jurisdictions of examining economic substance rather than being bound by contractual labels.

Lessons from International Best Practices

International experience suggests several best practices that are relevant to the Indian context following the RealPro judgment. First, clear documentation that accurately reflects the intended nature of the relationship is crucial. Parties should avoid mixing debt and equity features in ways that create ambiguity about the nature of the arrangement. Second, consistent treatment across different legal and regulatory contexts (such as tax, accounting, and insolvency law) helps reduce disputes and uncertainty. Third, periodic review and assessment of arrangements can help identify potential classification issues before they become problematic in insolvency or dispute scenarios.

Conclusion

The National Company Law Appellate Tribunal’s judgment in RealPro Realty Solutions Pvt Ltd vs Sanskar Projects and Housing Ltd represents a significant contribution to the evolving jurisprudence under the Insolvency and Bankruptcy Code. By clearly establishing that joint venture investments structured around profit-sharing do not constitute financial debt merely because they include provisions for return of capital or specify timelines for such returns, the Tribunal has provided much-needed clarity for the real estate sector and other industries that rely on collaborative financing arrangements.

The judgment’s emphasis on examining the economic substance of transactions rather than their formal documentation reflects a sophisticated understanding of modern commercial relationships and prevents parties from gaming the system by superficially structuring joint ventures to resemble debt arrangements. This approach protects the integrity of the insolvency process by ensuring that CIRP proceedings are initiated only by genuine financial creditors rather than becoming a tool for commercial disputes between business partners.

For businesses, investors, and legal practitioners, the RealPro judgment underscores the importance of careful structuring and documentation of commercial relationships. Parties must be clear from the outset whether they are entering into a creditor-debtor relationship or a joint venture partnership, and must structure their agreements consistently with that intent. The judgment also highlights the need for proper classification and disclosure of different types of funding sources, including financial debt and joint venture investments, in financial statements and regulatory filings.

Looking forward, the principles established in this judgment will likely influence how courts approach other cases involving hybrid financial instruments and complex commercial arrangements. The focus on substance over form and the examination of whether compensation is for time value of money or for profit participation provides a workable framework for analyzing a wide range of transactions. As Indian insolvency law continues to mature through judicial interpretation, decisions like RealPro contribute to building a coherent and predictable legal framework that balances the rights of different stakeholders while facilitating the core objectives of the Code: maximizing value, promoting entrepreneurship, balancing interests, and ensuring timely resolution of insolvency.

The judgment serves as a reminder that the Code’s careful distinction between different classes of creditors and stakeholders serves important policy purposes. Financial creditors are given privileged status because they are external capital providers who assess creditworthiness and monitor financial health. Joint venture partners, in contrast, are willing participants in business ventures who share both risks and rewards. Maintaining this distinction ensures that the insolvency resolution process functions as intended, with decision-making power vested in those who are best positioned to assess and execute revival strategies. The RealPro judgment’s clear articulation of these principles provides valuable guidance on the treatment of financial debt and joint venture investments for all participants in India’s insolvency ecosystem and contributes to the ongoing development of a robust and effective insolvency regime.

References

[1] RealPro Realty Solutions Pvt Ltd vs Sanskar Projects and Housing Ltd, National Company Law Appellate Tribunal, New Delhi. Available at: https://ibclaw.in/realpro-realty-solutions-pvt-ltd-vs-sanskar-projects-and-housing-ltd-nclat-new-delhi/

[2] The Insolvency and Bankruptcy Code, 2016, Section 5(7) – Definition of Financial Creditor. Available at: https://www.indiacode.nic.in/show-data?actid=AC_CEN_2_11_00055_201631_1517807328273&orderno=7

[3] IBC Laws. “Section 7 of IBC – Initiation of Corporate Insolvency Resolution Process by Financial Creditor.” Available at: https://ibclaw.in/section-7-initiation-of-corporate-insolvency-resolution-process-by-financial-creditor-chapter-ii-corporate-insolvency-resolution-processcirp-part-ii-insolvency-resolution-and-liquidation-for-corpor/

[4] Hiremath, Chetan. “Section 5(8) of IBC – What qualifies as Financial Debt.” LinkedIn Article, December 7, 2023. Available at: https://www.linkedin.com/pulse/section-58-ibc-what-qualifies-financial-debt-chetan-hiremath-2evpc

[5] IBC Laws. “Distinction in Treatment of Financial Creditors vs. Operational Creditors under IBC.” Available at: https://ibclaw.in/distinction-in-treatment-of-financial-creditors-vs-operational-creditors-by-vidushi-puri/

[6] Insolvency and Bankruptcy Board of India. “Discussion Paper on Financial Creditors in Corporate Insolvency Resolution Process.” Available at: https://ibbi.gov.in/Agenda_8_210917.pdf

[7] Legal Service India. “Financial Creditor vs Operational Creditor under IBC.” Available at: https://www.legalserviceindia.com/legal/article-6391-financial-creditor-vs-operational-creditor-under-ibc.html

[8] Indian Kanoon. “RealPro Realty Solutions Pvt Ltd vs Sanskar Projects and Housing Ltd Judgment.” Available at: https://indiankanoon.org/doc/165460821/

[9] Ministry of Corporate Affairs. “The Insolvency and Bankruptcy Code, 2016 – Full Text.” Available at: https://www.mca.gov.in/Ministry/pdf/TheInsolvencyandBankruptcyofIndiaCode2016.pdf

Authorized by Prapti Bhatt

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