“Insolvency Dilemmas: NCLAT’s Verdict on Section 185 Compliance in CIRP Claims” - MMJC

“Insolvency Dilemmas: NCLAT’s Verdict on Section 185 Compliance in CIRP Claims”

NCLAT Delhi, in the matter of AVJ Heights Apartment Owners Association Vs. India Infoline Finance Ltd have dealt with the question where financial contract which was not in compliance of certain provisions of the Companies Act, 2013 can be admitted as a claim under Corporate Insolvency Resolution process (CIRP)?

The facts were as follows:

• AVJ Developers (India) Pvt. Ltd (hereinafter called Company/Corporate debtor) obtained 3 loans amounting approximately to Rs.131 Crores from India Infoline Finance Ltd (herein after called lender). However, the Company was not able to repay the same.
• A promoter director of the company obtained a loan from the same lender to settle the unpaid loans taken by the company. And the company provided a guarantee and security against a loan taken by the promoter director but had not created any charge on the assets.   This action triggers the provisions of Section 185 because it involves a loan transaction between the company and its director.
• Eventually, the director was not able to repay the loan.  
• The lender filed a petition under section 7 of the Insolvency and Bankruptcy Code, 2016 (IBC) before NCLT and the CIRP was initiated against the Company.
• The intervention petition was filed by the Company before NCLAT to set aside the impugned order stating that the guarantee given was in violation of Section 185 of the Act and hence cannot be enforced against the company. Further the security provided is not registered with ROC and therefore the claim cannot be verified with the books of the company. 

After considering the above facts and examining relevant regulations (regulation 8) of the Insolvency and Bankruptcy Board of India (CIRP Regulations, 2016), NCLAT observed that:

• It is not stated anywhere that verification of the claimants’ records will not be tantamount to verification of records. Furthermore, regulation 8 does not specify that only the corporate debtor’s records shall be examined and verified for the admission of a claim.
• A claim can be admitted as financial debt if the guarantee for the money borrowed by the principal debtor from the creditor is supported by a guarantee agreement.
• In the given case, RP should have admitted the claim as lender has not only filed the documents reflecting transfer of money, creation of obligation by way of guarantee, but also furnished security by way of mortgage.

In brief, the NCLAT held that the claimants’ records should be taken into consideration as regulation 8 does not limit the scope to only examining and verifying the corporate debtor’s records for the admission of a claim.

The next question before NCALT was whether the mortgaged agreement approved by the Board of the Company which is not in accordance with the provisions of Section 185 of the Act be considered by the other parties or not?

In this matter, the court observed that normally the other parties are not privy of the internal document of the company and the claimant has relied on the Board Resolution provided by the other side. However, Section 185 of the Act itself provides for punitive action vide Section 185(4) provides clarity to issue.

Transaction in violation of section 185 of the Act does not in any manner inhibit claimant from filing claim under IBC. That cannot be grounds for rejection of claim. The purpose of IBC is different. For the violation of provisions of Act, the law has different consequences. A similar view was taken by NCLAT New Delhi in the case of Kalpesh Ramniklal Shah Vs. Mundara Estate Developers Ltd. w.r.t filing of application u/s 7 of IBC application and take appropriate proceedings under the IBC.

Conclusion

On the basis of the abovementioned orders of NCLAT, it can be noted that financial institutions which have extended credit based on documents provided by the Company deserve fair consideration. The IBC’s purpose remains distinct from penalizing statutory violations unrelated to insolvency proceedings. NCLAT’s view reinforces the need for a balanced approach—one that upholds legal norms while recognizing the overarching goal of insolvency resolution. Financial institutions can seek relief under the IBC in such cases.

The article is written by Ms. Vrushali Bhave Athavale – Senior Manager – vrushalibhave@mmjc.in and published in the Taxguru.

https://taxguru.in/company-law/nclats-verdict-section-185-compliance-cirp-claims.html