Under Insolvency and Bankruptcy code, the application for initiation of corporate insolvency Resolution Proceedings can be initiated by

1) Financial Creditor under section 7(1)

2) Operational Creditor under section 9(1)

3) Corporate Debtor under section 10(1)

Financial creditor means as per the section 5(7)  the person to whom the financial debt is owed or legally assigned to. Financial debt means the amount of loan disbursed against the consideration of time value of money as per section 5(8). Operational Creditor is one who has supplied goods or services to the Corporate Debtor.

In order to consider a debt as Operational debt, it should fulfill the following conditions

1. Amount should be classified as claim

2. Claim should fall within the definition of a debt as defined under section 3(11) meaning it should be by way of a liability or obligation due from any person

3. Debt should fall within the scope of definition of Operational Debt as per section 5(21) of the code

In other words in order to classify the amount of debt as Operational debt, it should be a claim in respect of provision of goods or services including employment or a debt in respect of the payment of dues arising under any law for the time being in force and payable either to the Central Govt or State Govt or any local authority

Once the application is filed in front of the Adjudicating Authority, the Adjudicating Authority will have 14 days’ time to ascertain the default and either admit or reject the application. The Adjudicating Authority before rejecting the application, provide reasonable opportunity to the applicant to rectify the defects in the application within 7 days’ time and if the applicant is not able to cure the defects, the application is liable to be returned.

Once the application is admitted, the order of Moratorium and order of Public announcement and appointment of Interim Resolution Professional will takes place. If the order of moratorium is pronounced under section 14 of the code, the following provisions will be applicable

Subject to the Provisions of Sub-section (2) and (3) on the Insolvency Commencement date, the Adjudicating Authority shall by order declare moratorium for prohibiting all of the following namely:-

a) The institution of suits or continuation of pending suits or proceedings against the Corporate debtor including execution of any judgement decree or order in any court of law, tribunal, arbitration panel or other authority

b) Transferring,encumbering,alienating or disposing off by the Corporate debtor any of its assets or any legal right or beneficial interest thereon

c) Any action to foreclose,recover or enforce any security interest created by the Corporate debtor in respect of its property including any action under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security interest Act, 2002 (54 of 2002)

d) The recovery of any property by an owner or lessor where such property is occupied by or in the possession of the Corporate debtor

As per the above provisions, once order of Moratorium is declared all enforcement measures like suit filing, continuation of existing suits or proceedings and all recovery measures like initiation of recovery action under SARFAESI Act etc. are stopped. Similar recovery of any property by an owner or lessor from the Corporate Debtor is also stopped.

The object of the Moratorium is to provide a calm period during which a peaceful negotiation will takes place between Creditor and Debtor to resolve the insolvency of the Corporate Debtor

But these measures will come into force only when the application is admitted and Adjudicating Authority by an order declares Moratorium. This moratorium will continue to be in effect till the completion of the corporate insolvency resolution process or the approval of a resolution plan by the adjudicating authority or the resolution passed by the Committee of Creditors to liquidate the corporate debtor whichever is earlier.

Now the question is if the secured Creditor has sold the assets of the Corporate debtor to recover its dues after the insolvency commencement date but before declare the order of Moratorium or the secured Creditor has sold the assets after filing the application for initiation of corporate insolvency Resolution process under section 7, 9 or 10 but before admitting the application by the Adjudicating Authority what would be position in such case?

The above question was well settled in the decided case of NUI Pulp and Paper Industries Private ltd Vs. M/s Royce Trading GMBH Company.

In this case M/s Royce Trading GMBH (Operational Creditor) had filed an application under section 9 of the Code against the corporate debtor M/s NUI Pulp and Paper Industries for the reason of non-payment of certain invoices. The application had been filed for recovery of an amount of Rs. 7,64,54,283 infront of the Hon’ble National Company Law Tribunal, Chennai. The Corporate debtor had pleaded in the first hearing there is a dispute in respect of debt and requested for certain time to file reply.

In return the Operational Creditor had argued that they are afraid of possibility of selling away some of the assets of the Corporate debtor by its Directors of M/s NUI Pulp and Paper Industries  before admission of application and this would cause irreparable loss to the Stakeholders and also would defeat the purpose of the code.

Hence the Operational Creditor had filed an application under section 60(5)(C) of the Code read with rule 11 of the NCLT rules and requesting the Hon’ble Tribunal to pass necessary directions to the Corporate Debtor and its Directors not to alienate or encumbering or creating third party interest on the assets of the Corporate Debtor

Based on the argument of the Operational Creditor, the Hon’ble Tribunal  set a timeline for completing the pleadings and adjourned the matter with the following ad-interim direction-

Taking into account the apprehension expressed by the Operational Creditor and till the time either the application is admitted or rejected, the direction has been given to the corporate debtor under Rule 11 of the NCLT rules. As per the direction, the corporate debtor cannot alienate, encumbering or creating any third party interest on the assets of the Corporate Debtor until the application for initiation of Corporate Insolvency Resolution process has been adjudicated by the Hon’ble Tribunal. The Corporate Debtor neither furnished any undertaking nor made any reply or refusal to the fact that they had no such intention.

The Hon’ble Tribunal in this case used its inherent powers provided under rule 11 of the NCLT rules to address the grievance and apprehensions expressed by the Operational Creditor. Rule 11 of NCLT rules, 2016 deals with the inherent powers of NCLT/NCLAT. Rule 11 says-

“Nothing in these rules shall be deemed to limit or otherwise affect the inherent powers of the Tribunal to make such orders as may be necessary for meeting the ends of justice or to prevent abuse of the process of the Tribunal”

The Hon’ble Tribunal vide its order has restrained the Corporate debtor and its Directors from alienating, encumbering or creating any third party interest on the assets of the Respondent until further orders. The Hon’ble NCLT in this case has used its inherent powers conferred under Rule 11 of NCLT Rules 2016 .

 “However, the apprehension of the Applicant can be taken note of till the time either the Application is admitted or rejected, the assets and the accounts of the Company need to be maintained on date except withdrawal of the legitimate expenses required for carrying on the day to-day expenses. Therefore, this Authority in exercise of the powers conferred under Rule 11 of the NCLT Rules, 2016, restrains the Corporate Debtor and its Directors from alienating, encumbering or creating any third-party interest on the assets of the 1st Respondent Company till further orders.”

The order of the NCLT was further confirmed by the Hon’ble NCLAT in appeal. The Hon’ble NCLAT while upholding the impugned order of the NCLT held that it had the inherent power under Rule 11, NCLT Rules, 2016 even at the stage of pre-admission of application to pass appropriate interim orders under Section 7 ,9 and 10 of IBC, as the case may be.

The NCLAT further clarified that once the application is admitted under Section 7 ,9 or 10 of IBC, as the case may be, the order of ‘Moratorium’ under Section 14, IBC would automatically kick-in. On the other hand, if the application was rejected, the interim order would automatically seize to exist.

The above judgement is welcome step. It is quiet useful in cases where the application has been filed in the Hon’ble Tribunal and it is yet to be admitted due to various reasons. There are several instances where Pre-admission of an Insolvency application has taken more than a year and are still pending due to various pre-admission litigations raised by the errant defaulters .In the case of Asset Reconstruction Company limited Vs GPT Steel Industries limited Company, the application filed under section 7 has taken for a long period time. In such cases, the errant defaulter companies try to sell off  or transfer the assets or alienate their assets or create third party interest on the assets which not only cause wrongful lose to the Creditors but also would defeat the purpose of object of the Code . This is useful to ensure that the interest of the Creditors is safeguarded and that the assets of the corporate debtor remain intact until admission of the application.

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Disclaimer: The entire contents of this article have been prepared based on relevant provisions and as per the information existing at the time of the preparation. Although care has been taken to ensure the accuracy, completeness, and reliability of the information provided, I assume no responsibility therefore. Users of this information are expected to refer to the relevant existing provisions of applicable Laws. The user of the information agrees that the information is not professional advice and is subject to change without notice. We assume no responsibility for the consequences of use of such information. This is only a knowledge sharing initiative and the author does not intend to solicit any business or profession.

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