IBC overrides Electricity acts Non-Obstante Clause: Supreme Court

Case Details: Paschimanchal Vidyut Vitran Nigam Ltd V. Raman Ispat Private Limited & Ors.

Citation: Civil Appeal No. 7976 of 2019

Hon'ble Judges/Coram: S. Ravindra Bhat and Dipankar Datta, JJ.

Decided On: 17.07.2023.

Introduction

A division bench of Justices S Ravindra Bhat and Dipankar Dutta of the Hon’ble Supreme Court held that the provisions of the Electricity Act, 2003 take precedence over the provisions of the Insolvency and Bankruptcy Code of 2016 (“IBC”). The Court clarified that under the IBC, secured creditors have priority in debt recovery above dues payable to state or central government.

 The decision came while dismissing an appeal filed by Paschimanchal Vidyut Vitran Nigam Limited (“PVVNL”), which questioned the release of attached property in favour of the liquidator managing insolvency proceedings. The Court supported the National Company Law Tribunal (“NCLT”) and National Company Law Appellate Tribunal's (NCLAT”) decisions, emphasising the waterfall process under Section 53 of the IBC, which defines the order of debt repayment. The Court also rejected reliance on a previous ruling that favoured the primacy of the Electricity Act, claiming that it ignored the IBC requirements. The appellant was given ten weeks to file their claims as a secured creditor.

Background of the Case

PVVNL is a subsidiary company of Uttar Pradesh Power Corp. Ltd. The dispute arrised out of outstanding electricity bills due to Raman Ispat Pvt. Ltd. to PVVNL. As a result, PVVNL obtained an order of attachment of Raman Ispat's property in its favour.

At the commencement of the liquidation process of Raman Ispat, the liquidator argued before the Hon’ble NCLT that the attached property should be freed since any dues owed to PVVNL will be allocated in accordance with the IBC. The liquidator had requested that the property be released so that it may be auctioned and the earnings used to settle outstanding debts in accordance with the IBC. The Hon'ble NCLT, Allahabad Bench, in its, affirmed the Liquidator's views and observed the asset belongs to the Corporate Debtor's Liquidation Estate.

The matter was then Challenged before Hon’ble NCLAT, the bench agreed with the liquidator's assessment and ordered the property to be released. Dissatisfied with this ruling, PVVNL moved to the Supreme Court, claiming that the Electricity Act took precedence over the IBC and that it could reclaim its dues under the act independently, even outside of the liquidation process.

The Hon’ble Supreme Court Held

The court addressed a specific legal question, whether dues accruing to a Distribution Licensee can be recovered under the mechanism envisaged under the Electricity Act, 2003 and the UPERC Electricity Supply Code, 2005, and thus override the liquidation proceedings and the waterfall mechanism of dues repayment provided under the IBC.

The Hon’ble court observed that the mechanism for recovering outstanding electricity dues under the Electricity Act and the Supply Code cannot function while the borrower is in insolvency or liquidation proceedings as a result of the moratorium period granted to the Corporate Debtor under the IBC.

The Court centred its consideration on the 'Waterfall Mechanism' outlined in Section 53 of the IBC. In liquidation processes, this method defines the order of priority for debt payments. Notably, government obligations, including those owed to the Central and State Governments, are prioritised lower than those owed to secured creditors.

The bench opined that the provisions of the IBC have precedence over the requirements of the Electricity Act, even though the latter contains particular provisions with non-obstante clauses. The Court emphasised that the earlier case, Rainbow Papers Ltd. (State Tax Officer v. Rainbow Papers Ltd., 2022 (13) SCR 808) did not considered the 'waterfall mechanism' under Section 53 which envisages higher priority given to the secured creditors.

Conclusion

This judgement clarifies and strengthens the IBC's hierarchy of creditors claim, providing a fair and equitable distribution of assets during the liquidation process. The Supreme Court’s interpretation has emphasized that the IBC accords higher footing to the dues payable to secured creditors compared to dues payable to the Central or State Government. The Hon’ble Court held that electricity dues from the said corporation do not from part of Government dues and has placed it as a secured creditor, thereby PVVNL cannot be classified under the Government dues within the meaning of section 53(1)(e) of the IBC. The waterfall mechanism under section 53 of IBC ensures that the creditors of a company are paid in a fair and orderly manner thereby protecting the interests of the stakeholders.

This Article has been compiled by Anurag Tewari (Associate)

You can direct your queries or comments to the author at info@factumlegal.com

Disclaimer-

The contents of this article should not be construed as legal opinion. This article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances. We expressly disclaim any financial or other responsibility arising due to any action taken by any person on the basis of this article.

 

LIABILITY OF DIRECTORS UNDER SEBI ACT AND RELATED REGULATIONS

Securities and Exchange Board of India (SEBI) is a regulatory body established under the Securities and Exchange Board of India Act, 1992 (“the Act”). That one of the main functions of SEBI is to regulate the securities and commodities market which is also mentioned in the Preamble of SEBI and is reproduced hereinbelow:

"...to protect the interests of investors in securities and to promote the development of, and to regulate the securities market and for matters connected therewith or incidental thereto.”

To carry out the said function SEBI has issued various regulations such as prohibition of fraudulent and unfair trade practices, issue and listing of securitized debt instruments and security receipts, prohibiting insider trading, issue of capital and disclosure requirements, etc. for the purpose of closely monitoring the companies and the way they handle and use these securities. The Act and the related regulations provide for the directors’ liability (whether managing/ nominee/ independent director) in cases generally where fund was illegally mobilized, secretly or illegally inside crucial information of a company was revealed to any outsider or where public announcement of new issue of listed securities was not made.

Important provisions pertaining to directors’ liability.

·         Section 27 of the SEBI Act provides where an offence has been committed then person in-charge of the said activity or having specific individual involvement will be held liable unless the person proves otherwise that he was not involved in such act and that he had no knowledge or had not consented to the act and should not be held liable. This person can be any officer, director, manager or secretary and their involvement shall be treated and punished in the same exact manner.

·         Regulation 25 of SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 provides for the duties of independent directors as they review the performances of the remaining board and shall only be held liable in cases when the independent director had the knowledge, and the act was performed with his consent/lack of diligence/connivance and not otherwise.

·         Regulation 26 of SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 prohibits any director or officer or shareholder to enter into any contract by himself or on behalf of another person related to securities of listed entity without prior approval.

·         Regulation 3 of SEBI (Prohibition of Insider Trading) Regulations, 2015 prohibits revealing of any unpublished price sensitive information regarding the securities to anyone including other insiders as well until and unless it is for legal obligations. The person doing so even if a shareholder or a director shall be held liable for contravention. Setting a code of conduct for fair disclosure as per Regulation 8 and formulating and getting approved the trading plan along with making the unpublished price sensitive information generally available to public also set upon the liability of persons disobeying the provisions.

·         SEBI (Issue and Listing of Debt Securities) Regulations, 2008 provides for a stronger and closely monitored debt securities market where in order for the issuer (company, public sector undertaking or statutory corporation) to issue debt securities to the public at large (public issue), it has to issue an offer letter (prospectus or shelf-prospectus) whereby subscription to debt securities are invited from the public. The issuer can never be a defaulter or a person “debarred by the SEBI” be it any officer, promoter, shareholder or a director.

·         The SEBI (Prohibition of Fraudulent and Unfair Trade Practices Relating to Securities Market), Regulations, 2003 prohibits any kind of act which is fraudulent or deceptive and which induces any person generally a potential investor to deal or apply with the securities of that company whether directly or indirectly. Misleading prospectus or announcements for the same are also covered under this Regulation. The directors and officers must not fail from the duties assigned to them and they are collectively held responsible/liable so far, their involvement in the said act is concerned.

The board of directors needs to exercise more control and monitoring wherein funds are being raised by the public so that unfair practices and trading is not followed. It is not just the managing or executive director who is responsible to look after the affairs of the company but also the entire the board of directors as the board represents the interest of the company, shareholders and promoters which make them the trustees and in-charge of the company. Any disobedience of the duties shall attract liability which is although limited but can land them in prison if committed under the personal capacity such as fraud or willful misrepresentation.

Relevant Judgments

Following case laws have discussed a director’s liability under the SEBI Act and related regulations.

·         Sayanti Sen v. SEBI (2019): [1]- The said case dealt with the issue of secured redeemable non-convertible debentures and whether the company Silicon Projects India Limited “SPIL” made public issue of securities without complying the provisions of the Companies Act, 1956 and SEBI Act, 1992. The company made an offer of non-convertible debentures which was in violation of SEBI Act and Companies Act. The directors of the company were found to be indulging in fund mobilizing activities and following this SEBI released its order against the directors of the company regarding their debarment and refunding the monies to the investor. These directors included appellant and several other directors. The appellant, however, in the show cause notice said that she was never made any signatory to the board meetings and never attended one. The other director was, however, directly responsible for the said allegations and the whole-time director asked the faulty director to first pay off the amount found to be illegally raised and afterwards called appellant and other directors also to do the same. To this appellant used her defense of non-involvement and succeeded where the court held that a director can only be made liable when he/she is directly involved and had the knowledge of the act which appellant did not have and therefore, calling her to pay off the liability will be violating Section 27 and 11B of the SEBI Act. The section only involves those who were in-charge of the said act. There is no vicarious liability automatically on the directors (whether managing/ nominee/ independent director) when the company is an offender. Only the directors at default can be called to pay for the alleged amount.

·         Pranab Kumar Roy v. The Securities Exchange Board of India (2023): - [2] This case deals with the non-compliance of the regulations mentioned in Companies Act, 2013 and 1956 and of SEBI Act and SEBI Regulations by company’s directors. The accused no. 1 is this case is the company which neither filed the prospectus of public issue of security nor the Draft Red Herring Prospectus. The DRHP is a comprehensive document companies have to file when they wish to get the shares listed on the stock exchange via an Initial Public Offering (IPO). This prospectus generally contains the information about the business operations of the company, financial statements, and stock holding information, risks that would potentially arise while investing in the company, the objectives on which the company operates and so on.

The accused no. 2-11 are the directors/promoters/manager/key management personnel/persons in charge of the business of the accused company and are responsible for the day-to-day affairs of the company. The accused directors joined the Board after the allotment of the said Non-Convertible Debentures.

The petitioner in this case did not know anything about the said allotment and did not even attend the meeting for said allotment. Soon after such an allotment the directors who were accused resigned and it was revealed that the issue of securities was not as per the compliances and hence the company was asked to return the money taken from the investors back to them.

It was held by the Hon’ble Calcutta High Court that such a director or officer cannot be made an officer in default when he had no knowledge of the act. Section 27 of SEBI Act and Section 2(60) of the Companies Act, 2013 does not apply to the Petitioner. As no materials could be placed before this court that the petitioner was involved in the day to days affairs of the accused No. 1/Company, the petitioner cannot be held liable.  

 

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[1] Sayanti Sen v. Securities Exchange Board of India, 2019 SCC OnLine SAT 132.

[2] Pranab Kumar Roy v. Secirities Exchange Board of India, 2023 SCC OnLine Cal 731.

 

Implications of Alleged Fraud: Auditors disqualification under section 140(5) of Companies Act, 2013.

Case Details: Union of India vs Deloitte Haskins and Sells LLP

Citation: MANU/SC/0518/2023

Hon'ble Judges/Coram: M.R. Shah and M.M. Sundresh, JJ.

Decided On: 03.05.2023.

Introduction

In a landmark decision, the Supreme Court of India addressed the constitutionality of Section 140(5) of the Companies Act, 2013 and upheld its validity. In its judgement, the court stated that the provision does not violate Articles 14 and 19(1)(g) of the Indian Constitution by being arbitrary, excessive, discriminatory, or otherwise unconstitutional. The ruling emphasises the importance of auditors in safeguarding the interests of stakeholders and validates the constitutionality of Section 140(5) in cases of auditor fraud.

Brief facts of the case

IL&FS Financial Services Limited ("IFIN") hired Deloitte Haskins and Sells LLP ("Deloitte") and BSR & Associates LLP ("BSR") as statutory auditors.  In 2017, BSR became IFIN's joint statutory auditor after Deloitte's eight-years tenure. 

In September 2018, IFIN Group Companies defaulted on more than INR 91,000 crores in debt, corporate governance and accounting fraud caused this massive debt disaster. Deloitte and BSR performed IFIN's 2017-18 statutory audit. It threatened Indian financial markets and caused stock market sell-offs. Accordingly, the Serious Fraud Investigation Office ("SFIO") examined IFIN and its group companies, issued a report, and brought actions against Deloitte and BSR under Section 140(5) of the Act. BSR submitted a resignation letter arguing that Section 140(5) did not apply to them since they were no longer IFIN's auditors.  In 2018, Deloitte resigned as IFIN's statutory auditors for similar reasons.

BSR and Deloitte argued before the Hon’ble National Company Law Tribunal ("NCLT") that Section 140(5) of the Act does not apply to them because they resigned as IFIN's auditors, NCLT upheld section 140(5).

BSR and Deloitte filed writ petitions before the Hon’ble Bombay High Court challenging the order of the National Company Law Tribunal. The Bombay High Court ruled that no action can be brought against BSR and Deloitte as they are no longer IFIN's auditors. Thus, the matter was brought before the Supreme Court.

The bench observed

·         The bench held that the legislature does not intend for an auditor to be able to resign to escape the consequences of a final order under the second proviso to Section 140(5). In the event that the proceedings are terminated after the auditor's retirement, resignation, or removal, the second proviso to Section 140(5) becomes null and void and the intent of Section 140(5) is defeated. Therefore, Section 140(5) of the Act is neither arbitrary nor beyond its authority.

·         It has been determined that auditors play a very important role in the affairs of the company and must therefore act in the larger public interest and take into account all other stakeholders. Therefore, the provision cannot be deemed discriminatory and in violation of Article 14 of the Indian Constitution.

·         The Supreme Court emphasised Section 140(5), stating that it is a substantive provision resulting from the NCLT's determination that the auditor acted improperly.  As per the statute, for the next five (5) years, the auditor is ineligible to be appointed as auditor of any the company.  As a result, an auditor cannot avoid these repercussions simply by leaving as a company's auditor.

·         However, the penalty of automatic disqualification of auditors and the entire firm, including partners, from becoming the auditor of any other company for five years is grossly disproportionate. In this regard, the Court stated that the ultimate responsibility for disqualification rests with the legislature.

·         It has been held unequivocally that the subsequent resignation of an auditor after a Section 140(5) application was filed does not terminate the proceedings under Section 140(5).

Conclusion

The decision has far-reaching repercussions for the auditing profession and reinforces India's regulatory framework governing auditing practises. The Supreme Court reaffirms auditor accountability and responsibility in ensuring the integrity and reliability of financial reporting by supporting the constitutional validity of Section 140(5) and affirming the NCLT's powers to prosecute against auditors. The Supreme Court has adopted a harsh position against auditor misconduct and collusion by stating that the legal repercussions of fraud cannot be avoided by mere stepping down.  This judgement will undoubtedly serve as a deterrent to professional malpractice not only for auditors but also for other professions.

  This Article has been compiled by Anurag Tewari (Associate)

  You can direct your queries or comments to the author at info@factumlegal.com

  Disclaimer-

The contents of this article should not be construed as legal opinion. This article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances. We expressly disclaim any financial or other responsibility arising due to any action taken by any person on the basis of this article.

 

 

Avoiding Legal Troubles: The Necessity of Properly Closing Down a Failed Company in India

A common and popular notion today is that the success of young entrepreneurs will be key to India's transformation in the new millennium. While I completely agree, it doesn't mean that young entrepreneurs are not failing at all in India. While we say that the success of startups will lead to India's transformation, we tend to neglect the question: "What about those startups that get closed down within months of their opening? What's happening to them?"

According to Entrepreneurial India, a study released by IBM and conducted by the IBM Institute for Business Value (IBV) based on a survey done in collaboration with Oxford Economics in 2017, nine out of ten startups end up failing in India within their first five years. The IBM study is based on interviews with more than 1,300 Indian executives, including startup entrepreneurs, venture capitalists, government leaders, leaders of established companies, and educational institution leaders, to analyze the macro impact of startups on the economic growth of the country.

In reply to a query in Rajya Sabha, the government stated that information regarding the success or failure of startups is not centrally maintained, but privately conducted surveys and studies give us insight into the closure of startups.

Data published by Tracxn states that Indian startups faced a challenging year, with 2,404 of them shuttering in 2022, more than double the 1,012 that had shut shop in the previous year. As of 30th November, 23,773 startups have been recognized by the Department for Promotion of Industry and Internal Trade (DPIIT) in the year 2022. Edtech faced its harshest year, with 25 funded startups in this sector closing their doors.

The reason for exhibiting all these aforementioned statistics is to make entrepreneurs realize that it is important to plan for the failure of a startup as well. When we start a new business, while we are hoping for a jackpot, we might end up with nothing. An orderly shutdown of the startup, if it becomes necessary, will help protect the founder and the investors from potential liabilities.

For instance, a company "ABC" shut its operations in 2018 and hence, stopped filing its financial statements or annual returns. Mr. Gupta, one of the directors at ABC, then started another venture "XYZ" in 2021. However, in 2021 he was approached by the authorities and was informed that he can no longer act as the director of "XYZ." The reason is that since "ABC" has not filed its has not filed financial statements or annual returns for any continuous period of three financial years despite being an incorporated company, the (former) directors of "ABC" are not only disqualified from being directors at "ABC," but also barred from being a director at any other company for five years. As long as a startup is an incorporated company, it needs to abide by the laws of the land. Hence, it becomes extremely important to dissolve it in a legally sound manner. Consider a man who spends tons of money on the recovery of an already dead person instead of doing the last rites and bidding adieu. Sounds ridiculous, right? But that's exactly what not legally winding up an already closed down company is like. This could lead the directors and promoters of the former company to incur expenses, even when they move on to start a new business, e.g., facing difficulty in taking loans from financial institutions. Further, the Company shall also get its name removed from the register of companies and realise all amount due to the company and make provision for the payment or discharge of its liabilities and obligations, failing so the company and the directors may face civil and criminal penalties. The company also shall also resolve prior tax liabilities failing which company and its directors may encounter penalties and stringent actions may be taken against them by the Department. Voluntary closing down the company will also absolve the directors from their continued liability as sets deadlines for anyone who has a claim against the company. Moreover, the company shall also incur fees for default in furnishing return of income.

A startup carries its own legacy in the form of liabilities, assets, unpaid salaries of employees, claims from vendors, etc., and this legacy needs a proper adieu to protect its founders and investors.

Even though opening of business is easy with Indian Government starting various procedures for ease of doing business by different means zero fees of incorporation for new companies having capital up to Rs. 15 Lacs etc., winding up the business would require more effort. One would need to deregister the business, surrender the GST registration, close company bank accounts, and the list goes on. Employee salary dues, creditor's repayments, and vendor repayments would have to be taken care of according to the priority list provided by the law. One thing that will still continue would be the advertisements, the only difference being that this time they would be to sell those capital assets.

Last but not least, it is natural for founders to find it extremely difficult to come to terms with the fact that their startup is on the verge of shutting down. However, it is important for every entrepreneur finding themselves in such a stage of their career to realize that every new beginning comes from another beginning's end. Failure is simply an opportunity to begin again, and this time even more intelligently.

This Article has been Compiled by Nupur Gupta (Analyst). 

You can direct your queries or comments to the author at info@factumlegal.com

Disclaimer-

The contents of this article should not be construed as legal opinion. This article is            intended to provide a general guide to the subject matter. Specialist advice should be    sought about your specific circumstances. We expressly disclaim any financial or other responsibility arising due to any action taken by any person on the basis of this article.

 

 

 

 

In a game changing move India allows entry of foreign lawyers and law firms in India

In a game changing move India allows entry of foreign lawyers and law firms in India

Bar Council of India has globalised legal industry and allowed entry of foreign law firms and foreign lawyers in India. As India’s economy is performing well despite of a global economic slowdown especially in the developed nations, this move will attract even more investment, more cross-border transactions, more employment opportunities and uniform seamless advice for multinational corporations operating in India.

The Bar Council of India has notified Bar Council of India Rules and Regulation of Foreign Lawyers and Foreign Law Firms in India, 2022 (Rules) which allows the foreign lawyers and Foreign Law Firms to practice foreign law and diverse international law and international arbitration matters in India on the principle of reciprocity in a well defined, regulated and controlled manner as specified in the Rules.

Principle of reciprocity – The said change has been made on the principle of reciprocity so as to promote and strengthen the legal profession in India to keep pace with the globalization and to provide a vibrant and effective framework of legal profession that can cater to the ever changing needs of the people, belonging to different religions, faiths and having different personal laws, migrating from one country to the other and to promote international progress, coherence and unity.

Principle of reciprocity shall mean that Indian lawyers or Indian law firms are being allowed by the concerned counterpart foreign country. The Bar Council of India is responsible for ensuring the reciprocity. The reciprocity rule, however, will not apply if the foreign lawyer or law firm works on ‘fly in and fly out’ basis to advise Indian clients on foreign law.

Registration - A foreign lawyer or foreign law firm shall not be entitled to practice law in India unless he/it is registered with the Bar Council of India under these Rules. Chapter-III of the Rules deal with applications for registration, renewal of registration and matters connected with law practice in India.

Scope of law practice by Foreign Lawyers - A foreign lawyer registered under the rules will be allowed to practice law in India in non-litigious matters. They shall be allowed to practice on transactional work /corporate work such as joint ventures, mergers and acquisitions, intellectual property matters, drafting of contracts and other related matters on reciprocal basis. They shall not be involved or permitted to do any work pertaining to conveyancing of property, Title investigation or other similar works. The foreign lawyers or foreign Law Firms shall not be permitted to appear before any courts, tribunals or other statutory or regulatory authorities. Scope of practice will also include doing work, transacting business, giving advice and opinion concerning the laws of the country of the primary qualification and other areas as specified under Rule 8.

Opening of office and engaging local lawyers - The registered foreign lawyer or foreign Law Firm shall be entitled to do to open law office or offices in India for carrying on law practice in India as mentioned in Rule 8 of Rules and Bar Council of India has to be informed of the details of the office. The registered foreign lawyer or foreign Law Firm to engage and procure legal expertise/advise of one or more Indian Advocates Registered as foreign lawyers, (iii) to procure the legal expertise/advise of any Advocate enrolled with any State Bar Council in India on any subject relating to Indian Laws. But such registered foreign lawyer or foreign Law Firm shall not be entitled to appear before any Indian Court, Tribunal or any other statutory forum except for the maters mentioned under provision of Rule 8 of Rules. The registered foreign lawyer or foreign Law Firm shall also be allowed to enter into Partnership with one or more Foreign Lawyers or Foreign Law Firm registered in India under these rules.

This Article has been Compiled by Ayushi Misra (Senior Associate) and Arun Gupta (Partner). 

  You can direct your queries or comments to the author at info@factumlegal.com

  Disclaimer-

  The contents of this article should not be construed as legal opinion. This article is             intended to provide a general guide to the subject matter. Specialist advice should be     sought about your specific circumstances. We expressly disclaim any financial or other   responsibility arising due to any action taken by any person on the basis of this article.