Telangana State Trade Promotion Corporation Vs. A.P. Gems & Jewellery Park Pvt. Ltd. & Anr. - The expression ‘Control’ in Section 29A(c) of the ‘I&B’ Code symbolizes only the Positive Control.

NCLAT (21,09.2021) In Telangana State Trade Promotion Corporation Vs. A.P. Gems & Jewellery Park Pvt. Ltd. & Anr. [Company Appeal (AT)(CH) (Ins.) No.54 of 2021] held that;

• Hence, while the default rule under the first proviso to Section 21(2) is that only those financial creditors that are related parties in praesenti would be debarred from the CoC, those related party financial creditors that cease to be related parties in order to circumvent the exclusion under the first proviso to Section 21(2), should also be considered as being covered by the exclusion thereunder.

• It must be borne in mind that the expression ‘control’ in Section 29A(c) of the ‘I&B’ Code symbolizes only the positive control i.e. that the mere power to block special resolutions of a Company cannot amount to control. In reality, the word ‘control’ juxtaposed with the term ‘management’ means ‘De facto control of actual management or policy decisions that may be or are in reality taken.

Excerpts of the order;

# 2. The ‘Adjudicating Authority’ (National Company Law Tribunal Hyderabad Bench) while passing the impugned order dated 04.01.2021 in I.A. 555 of 2020 in CP (IB) No.143/7/HDB/2019 at paragraph 57 to 61 had observed the following:

• 57 “It is the case of the applicant the respondent no.3 is having 11% voting share in the Corporate Debtor and it is also the fact that balance amount of Rs.5,93,23,625/- is payable by Corporate Debtor to respondent no.3 vide loan agreement dated 09.05.2006. It is a fact that respondent no.3 is a shareholder in the Corporate Debtor and having voting share of 11%. We have to examine whether respondent no.3 is a related party or not in the light of the above definition. We observe that respondent No.3 squarely fits into the definition of ‘related party’ under section 5(24) (a), (h), (j), (l) and (m) of the Code. From the record submitted to the Tribunal it is observed that out of four directors of the Board of Directors, two directors are nominated by respondent no.3. We are of the view that the role and responsibility of the Directors is to protect the interests of the Corporate Debtor and not to merely sit in the Board meetings of the corporation. They have a fiduciary role to protect the interests of the Corporate Debtor and are responsible for shareholders of the Corporate Debtor at all times. The Board is responsible to the shareholders of the Corporation. Therefore, the claim of the Resolution Professional that they are only nominated members and they do not have much say in the functioning of the company is untenable. Every director has responsibility to protect the interests of shareholders. Accordingly, the Directors nominated by the corporation have to oversee the functioning of the Corporate Debtor. Besides they are also responsible to protect the interests of the shareholders, in this case, respondent no.3. We, therefore, cannot go by the submission made by the Resolution Professional as well as respondent no.3 that they are merely nominated members on the Board and they do not have much say in the functioning of the Corporate Debtor.

• 58. Therefore, we are not in agreement with the views of the Resolution Professional as well as respondent no.3 in this regard that they are only nominee-directors and that they do not have much say in the functioning of the Corporate Debtor. Further on a close perusal of the Companies Act, Listing Regulations, it is evident that disentitling of a shareholder, who is a related party from exercising his voting rights in respect of any resolution relating to any contract or arrangement to which such related party is a party. Therefore, we are not in a position to accept the contention of respondents no.1 and 3 that nominee-directors does not have significant influence on the functioning of the Corporate Debtor as untenable and not acceptable. Based on Article 62 of the Articles of Association, respondent no.3 clearly falls into the definition of ‘related party’ as defined clauses (a), (h), (j) and (m) of section 5(24) of the Code. We, therefore, came to the conclusion that respondent no.3 falls under the definition as aforesaid.

• 59. When we juxtapose and read the Articles of Association as well as the definition of related party has given in the I&B Code it is evident that two nominee – directors of respondent no. 3 have significant influence in decision making process of the Corporate Debtor. The Articles of Association clearly mention that action on important matters should be taken only by affirmative vote 3(three) or more directors, but there must be included in the qualified majority at least one director nominee by APTPCL.

• 60. Article 62 plays vital role in deciding the subject matter in this case. From reading of Article 62 it is clearly evident that nominee-directors of Corporate Debtor and they cannot now claim that they only nominee-directors and they do not have much role in the Corporate Debtor. Such claim is untenable.

• 61. We are, therefore, not in agreement with the decision taken by the Resolution Professional to include respondent no. 3 as a Member of the CoC. Accordingly, we are of the opinion that TSTPCL falls within the meaning of ‘related party’ as given in the I&B Code and Articles of Association of the Corporate Debtor. Accordingly, we direct that the Resolution Professional shall reconstitute the CoC treating the TSTPCL as a ‘related party’. Accordingly, the IA is disposed of with the above directions to the Resolution Professional.

 

Evaluation 

# 64. In this connection, this Tribunal amply points out the decision of the Hon’ble Supreme Court in Phoenix ARC Pvt. Ltd. V. Spade Financial Services Ltd. & Ors. reported in 2021 Supreme Court Cases at page 475 at spl. Page 517, 518 and 519 wherein at paragraph 77 to 83 it is observed as under: –

• 78. The CoC is comprised of financial creditors, under loan and debt contracts, who have the right to vote on decisions and operational creditors such as employees, rental obligations, utilities payments and trade credit, who can participate in the CoC, but do not have the right to vote. The aim of the CoC is to enable coordination between various creditors so as to ensure that the interests of all stakeholders are balanced, and the value of the assets of the entity in financial distress is maximised.

• 81. These objects underscore the composition of the CoC, guided by Section 21 of the IBC. The objects and purposes of the Code are best served when the CIRP is driven by external creditors, so as ensure that the CoC is not sabotaged by related parties of the corporate debtor(24 Report of the Insolvency Law Committee, March 2018, p 23, para 1.25.) This is the intent behind the first proviso to Section 21(2) which disqualifies a financial creditor or the authorised representative of the financial creditor under sub-section (6) or sub-section (6A) or sub-section (5) of section 24, if it is a related party of the corporate debtor, from having any right of representation, participation or voting in a meeting of the committee of creditors.

• 82. Since the IBC attempts to balance the interests of all stakeholders, such that some stakeholders are not able to benefit at the expense of others, related party financial creditors are disqualified from being represented, participating or voting in the CoC, so as to prevent them from controlling the CoC to unfairly benefit the corporate debtor

 

 

# 65. Continuing further, in the aforesaid decision of the Hon’ble Supreme Court of India at spl. Page 520, 521, 524, 526, 527 and 528 wherein at 1.4 under the caption Related parties – Interpretation in praesenti paragraph 88, 89, 90, 97, 100, 101, 103, 104, 105 it is observed as under:-

• 88. “An issue of interpretation in relation to the first proviso of Section 21(2) is whether the disqualification under the proviso would attach to a financial creditor only in praesenti, or if the disqualification also extends to those financial creditors who were related to the corporate debtor at the time of acquiring the debt.

• 90. Thus, facially, it would appear that the use of the simple present tense in the first proviso to Section 21(2) indicates that the disqualification applies in praesenti. Furthermore, this interpretation would also be supported by a reading of the first proviso to Section 21(2), in light of the definition of ‘related party’ under Section 5(24), which uses phrases such as ‘is accustomed to act’ or ‘is associated’ to define a related party in the present tense.

• 103. Thus, it has been clarified that the exclusion under the first proviso to Section 21(2) is related not to the debt itself but to the relationship existing between a related party financial creditor and the corporate debtor. As such, the financial creditor who in praesenti is not a related party, would not be debarred from being a member of the CoC. However, in case where the related party financial creditor divests itself of its shareholding or ceases to become a related party in a business capacity with the sole intention of participating the CoC and sabotage the CIRP, by diluting the vote share of other creditors or otherwise, it would be in keeping with the object and purpose of the first proviso to Section 21(2), to consider the former related party creditor, as one debarred under the first proviso.

• 104. Hence, while the default rule under the first proviso to Section 21(2) is that only those financial creditors that are related parties in praesenti would be debarred from the CoC, those related party financial creditors that cease to be related parties in order to circumvent the exclusion under the first proviso to Section 21(2), should also be considered as being covered by the exclusion thereunder. Mr Kaul has argued, correctly in our opinion, that if this interpretation is not given to the first proviso of Section 21(2), then a related party financial creditor can devise a mechanism to remove its label of a ‘related party’ before the Corporate Debtor undergoes CIRP, so as to be able to enter the CoC and influence its decision making at the cost of other financial creditors.

 

# 66. It must be borne in mind that the expression ‘control’ in Section 29A(c) of the ‘I&B’ Code symbolizes only the positive control i.e. that the mere power to block special resolutions of a Company cannot amount to control. In reality, the word ‘control’ juxtaposed with the term ‘management’ means ‘De facto control of actual management or policy decisions that may be or are in reality taken.

 

# 67. As far as the present case is concerned, this Tribunal points out that, the Appellant’s Managing Director was also a Director of the first Respondent Company. Moreover, the Director nominated by the Appellant, in fact, advises the Appellant / Company in matters relating to the first Respondent / Company. To put it precisely, the part played by the two nominee Directors clearly point out that the first Respondent / Company acts on the advice, direction and instructions of the Appellant in its normal business affairs relating to the first Respondent. As such, this Tribunal is of the earnest opinion that the Appellant ‘squarely comes within the ambit of related party as per clause (f) of Sub Section 24 of section 5 of the Code.

 

# 68. The other important fact that cannot be brushed aside is that the First Respondent had reported the transactions between the Appellant and it, in their ‘Annual Reports’ and ‘Audited Financial Statements’. Besides this, as perceived from the ‘Articles of Association’ and the requisite majority needed for taking important business decisions, the conduct of the business of the First Respondent, the establishment of First Respondent Company, all considered in an integral and cumulative manner will exhibit the noteworthy influence of the Appellant in issues concerning the First Respondent. In this manner also, the First Respondent is treating the Appellant as ‘Related Party’.

 

# 69. The Appellant / Company has a control in regard to the arrangement of ‘Board of Directors’ of the First Respondent / Company and on this score also, the Appellant comes within the purview of ‘related party’ as per clause L of sub section 24 of 5 of the ‘I&B’ Code, as opined by this Tribunal.

 

# 70. It is to be pointed out that the ‘Articles of Association’ point out that action relating to significant matters ought to be taken only by affirmative vote of three or more Directors and in the qualified majority, minimum one Director is to be nominated for inclusion by the APTPCL.

 

# 71. Be that as it may, in the light of the detailed upshot, and considering the facts and circumstances of the instant case in a conspectus fashion and keeping in mind the ingredients of the ‘Articles of Association’ to the effect that the nominee Directors have a vital influence in regard to the working of the ‘Corporate Debtor’, this Tribunal unhesitatingly comes to a consequent conclusion that the Appellant is a ‘related party’ and the view arrived at by the ‘Resolution Professional’ to include the Appellant/TSTPCL as member of the ‘Committee of Creditors’ is clearly unsustainable in the eye of law. In this regard, this Tribunal concurs with a view arrived at by the ‘Adjudicating Authority’ in the ‘impugned order’ that the Appellant is a ‘related party’. Further, the direction issued by the ‘Adjudicating Authority’ in the impugned order that the ‘Resolution Professional’ shall reconstitute the ‘Committee of Creditors’ (CoC) treating the Appellant as ‘related party’ is free from legal errors. Viewed in that perspective, the instant ‘Appeal’ fails.

 

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