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Personal Loan ≠ Financial Debt

SUPREME COURT OF INDIA
M/s Radha Exports (India) Pvt. Ltd. v. K.P. Jayram & Anr.
Civil Appeal No. 7474 of 2019 | Date: 28th August 2020
FACTS
In the present case, M/s Radha Exports Pvt. Ltd. (hereinafter referred to as “the Appellant”) has filed an appeal under Section 62 of the Insolvency and Bankruptcy Code, 2016 (hereinafter referred to as “I&B Code, 2016”) before the  Supreme Court of India against the judgement of National Company Law Appeallate Tribunal based on the following grounds.
In the year, 2002-2003, the Appellant, a proprietorship concern took an aggregate sum of Rupees 2.10 Crores and in the year 2004-2005 an aggregate sum of Rupees 10 Lakh as an unsecured and free of interest loan from K.P. Jayaram (hereinafter referred to as “the Respondent”) for its business purposes. Thus, they had total liability of Rupees 2.20 Crore against the Respondent.
However, the Appellant contended that, they have already repaid Rupees. 80,40,000/- to the Respondents between the year 2003-2004, which was also confirmed by the Respondents in a letter written to the Deputy Commissioner of the Income Tax. Therefore, they had total net liability of Rupees 13,960,000/- only (22,000,000 – 80,40,000) against the Respondents.
Thereafter, in the year 2004, the Appellant converted its Proprietorship into a Private Limited Company and the whole business was transferred to the company along with its Assets and Liabilities, as a result of it the Appellant Company had total loan liability of Rupees 1,11,85,350/-.  
Now, during the incorporation of their Private Limited Company, the Respondent requested them to convert the sum of Rupees 90,00,000/- from out of their outstanding loan as share application money for issuance of shares in the name of the Respondent No.2, and the same was confirmed by the Respondents by their letter addressed to the Deputy Commissioner of the Income Tax. Therefore, they had remaining net liability of Rupees 21,85,350/- only (1,11,85,350 – 90,00,000) against the Respondents.
Thereafter, in the year 2005-2006, they paid Rupees 43,25,000/- including the remaining amount of Rupees 21,85,350 to the Respondent to discharge themselves from the liability against Respondent.
However, in the year 2007, Respondent No. 2 resigned from the Board of Appellant’s Company and requested Appellant to transfer her Share Application money of Rs. 90,00,000/- in the name of Mr. M Krishnan (Promoter of the Appellant) and treat it as personal loan from Respondent No. 2 and the same was confirmed in the letter written to the Income Tax Authorities.
Therefore, based on the above reasoning Appellant contended that they had no outstanding liability after the payment of Rupees 21,85,350/- was made to the Respondents. However, Respondents in the year 2012 send a legal notice to them demanding a sum of Rupees 1,49,60,000 /- stating it as an outstanding debt. However, Appellant refused the claim and because of it in the year 2013, Respondents filed, a winding-up petition under Section 433 (e) and (f) and Section 434 of the Companies Act, 1956 before High Court of Madras, which was later transferred to the NCLT, Chennai Bench.
Before the NCLT, Respondents contended that they have not received any payments from Appellant for satisfaction of the outstanding debt and the letters attributed to them, which were addressed to the Income-tax Authorities were also forged. Further, they claimed that signature of Respondent No.2 on the resignation letter and the application for the Director Identification Number (DIN) was also forged.
Thereafter, the NCLT after hearing arguments of both the parties, rejected the claims made by Respondent, as allegations of forgery and fraud does not fall under the ambit of Section 433 and 434 of the Companies Act, 1956 and because of it the petition was dismissed stating that Respondents have failed to comply with Section 7(3)(b) of I&B Code, 2016. However, NCLT while dismissing the application gave them liberty to file a fresh petition.
Thereafter, the Respondent filed an application under Section 9 of the I&B Code, 2016, before the NCLT Claiming to be an operational Creditor. However, NCLT again dismissed the application stating that, they cannot be considered as Operational Creditor. However, while dismissing the application NCLT again gave the liberty to file a fresh petition.
Thereafter, the Respondents, in the year 2018, filed a fresh application under Section 7 of the I&B Code, 2016, as a Financial Creditor, claiming principal amount along with the interest. The NCLT recorded the details of the payments made by the Appellant to the Respondents and also considered the letters written by Respondents to the Income Tax Authorities. However, The Appellant contended that the Respondents cannot be considered as Financial Creditor of the Company under Section 7 of the I&B Code, 2016, and the application filed by them is barred by limitation.
Thereafter, The NCLT bench after hearing arguments of both the parties and after considering bank statements produced by the Appellants showing that payments were made to the Respondents and the fact that Respondent was not able to produce any counter evidence against the Appellant, decided that Appellant had already paid outstanding debt to the Respondent and further, the application filed by Respondent was barred by limitation and therefore, dismissed the application.
However, Respondent aggrieved by the order of NCLT, filed an appeal before the Appellate Tribunal to admit the application filed under Section 7 of I&B Code, 2016, against Appellant. Therefore, Appellants filed a correlation Statement of payment entries to prove that, they have already paid the outstanding debt to the Respondent.
However, Appellate Tribunal after hearing arguments of both the parties, agreed with the contention of the Respondent and stated that the amount of Rupees 53,05,000/- shown in correlation Statement by Appellants were amounts, that were paid to other Financial Creditors and not to the Respondents.
Further, if the Appellant had already paid the outstanding debt, then there was no reason for them to argue that, outstanding debt is not payable, as the application filed by them is barred by limitation and therefore, they had the option to just refuse the claim instead of defending it. However, the mere fact that Appellant has argued that application filed by Respondent is not valid shows that, there is existence of debt, which needs to be adjudicated upon.         
Hence, aggrieved by the decision of Appellate Tribunal the Appellants filed an appeal before the Supreme Court of India under Section 62 of the I&B Code, 2016.
ISSUES BEFORE THE SUPREME COURT
The following issues came before the Supreme Court for adjudication: 
1. Whether the Respondents were Financial Creditors of the Appellant Company?
2. Whether the Claim of Respondents is barred by law of limitation?
DISCUSSION AND FINDINGS
With regards to the First Issue,
The Appellant contended that, they have already paid the entire outstanding debt to the Respondent by the end of 2006. Further, the application filed by Respondent is not valid as they cannot be considered as Financial Creditor under Section 7 of I&B Code, 2016, as the mere transfer of share of Rupees 90,00,000 in the name of promoter of the company cannot be considered as Financial Debt under Section 5 of I&B Code, 2016.
However, the Respondent contended that they have not received any payment from the Appellant for the loans advanced to them of Rupees 2.20 Crore, as the amount of Rupees 53,05,000/- shown in correlation Statement by Appellants were amounts, that were paid to other Financial Creditors and not to the Respondents.  Further, the letter produced before NCLT addressed to Income Tax Authorities were also forged and they have not confirmed any payments from the Appellants. 
Thereafter, Supreme Court after hearing arguments of both the parties, agreed with the contention of Appellant and stated that, in regards to the validity of application filed under Section 7 of I&B Code, 2016, Court decided relying on the judgment of Innovative Industries Ltd. v. ICICI Bank and Anr that, existence of Financial Debt is must to file application under Section 7 of I&B Code, 2016 to initiate CIRP against Appellant and in case, if Financial Debt does not exist then, application filed under Section 7 will not be valid.
The judgment given in Innovative Industries Ltd. is as follows –
“28. When it comes to a financial creditor triggering the process, Section 7 becomes relevant. Under the explanation to Section 7(1), default is in respect of a financial debt owed to any financial creditor of the corporate debtor it need not be a debt owed to the applicant financial creditor. Under Section 7(2), an application is to be made under sub- section (1) in such form and manner as is prescribed, which takes us to the Insolvency and Bankruptcy (Application to Adjudicating Authority) Rules, 2016.
The speed, within which the adjudicating authority is to ascertain the existence of a default from the records of the information utility or on the basis of evidence furnished by the financial creditor, is important. This it must do within 14 days of the receipt of the application. It is at the stage of Section 7(5), where the adjudicating authority is to be satisfied that a default has occurred, that the corporate debtor is entitled to point out that a default has not occurred in the sense that the debt, which may also include a disputed claim, is not due. A debt may not be due if it is not payable in law or in fact”
Now, Supreme Court in order to decide that, whether a Financial Debt exists in the present case or not, observed the findings made by NCLT regarding the letters written by Respondents to the Income-tax Authorities, confirming the request made to the Appellant to convert the sum of Rupees 90,00,000/- from out of their outstanding loan as share application money for issuance of shares in the name of the Respondent No.2, at the time of incorporation of  Private Limited Company and the request of Respondent No 2, while leaving the Board of Appellant Company to transfer such share in the name of Promoter of the Appellant Company as Personal Loan. 
Thereafter, Supreme Court after considering the above-mentioned facts carefully analysed Section 5 (8) of the I&B Code, 2016 and decided that, any amount to qualify as Financial Debt should be disbursed against the consideration for Time value of Money, and therefore, the Personal Loan issued to Promoter or Director of the Company cannot be considered as Financial Debt, as it is not disbursed against the consideration for Time Value of Money.
Therefore, the payment received for mere transfer of Shares at the request of Payee cannot be considered as Financial Debt under Section 5 (8) of I&B Code, 2016, as Shares of a Company are transferable, as per Companies Article of Association. However, it is not transferred or disbursed against the consideration for Time Value of Money.
Thus, the application filed by Respondent under Section 7 of I&B Code, 2016 was not valid as it is essential for the existence of Financial Debt to file application under Section 7 of I&B Code, 2016 and in the present case the mere payment for transfer of Share, as Personal Loan cannot be considered as Financial Debt. Further, the question of whether the signatures of Respondent were forged or whether the documents were fabricated can be decided based upon forensic evidence in regular suit only and not before NCLT under Section 7 of I&B Code, 2016. Therefore, Supreme Court allowed the Appeal and set aside the order of NCLAT.
 
With regards to the Second Issue,
The Appellant contended that the claim of the Respondents was barred by limitation, as the last payments were made in the year 2006 to the Respondents and the loan amount was advanced to them in the year 2002-2003 and as per clause 19 to 21 under Limitation Act, 1961, the period of limitation is Three Years from the date of issue of loan to file a suit.
Therefore, the limitation period would have started in the year 2007 and the winding-up petition by the Respondents was filed in the year, 2013. Further, as per Article 136 of the Limitation Act, the person making the claim is bound to disclose and explain as to how the debt amount is not barred by the limitation. However, Respondent failed to do so.
Therefore, NCLT decided that, the application filed by Respondent was not valid, as it was barred by limitation. However, Appellate Tribunal did not agree and decided that, if the Appellant had already paid the outstanding debt to the Respondent then, there was no need for them to take the plea that the claim was barred by limitation, as they could have just refused it and therefore, the mere fact that Appellant has argued that application filed by Respondent is not valid, shows that there is existence of debt, which needs to be adjudicated upon.
The Supreme Court of India after considering the arguments placed by Appellant and the decision made by NCLAT, decided relying on the judgment of B.K. Educational Services Pvt. Ltd. v. Parag Gupta and Associates that, the view taken by NCLAT was wrong, as Appellant are permitted to take alternative defences under law and therefore, it was valid for the Appellant to refuse the claim of the Respondents by taking the plea of limitation.
The judgment in the B.K. Educational Services Pvt. Ltd. is as follows –
42. It is thus clear that since the Limitation Act applies to applications filed under Sections 7 and 9 of the Code from the inception of the Code, Article 137 of the Limitation Act gets attracted. The right to sue, therefore, accrues when a default occurs. If the default has occurred over three years prior to the date of filing of the application, the application would be barred under Article 137 of the Limitation Act, save and except in those cases where, in the facts of the case, Section 5 of the Limitation Act may be applied to condone the delay in filing such application. Thus, it was for the Respondents invoking the Corporate Insolvency Resolution Process, to prima facie show the existence in his favour, a legally recoverable debt. The Respondents had to show that the debt was not barred by, limitation, which they failed to do. The Supreme Court affirmed the findings of the NCLT regarding the advancement of loan and the period of limitation. In, court’s view the Appellant tribunal erred in law in reversing the decision of the NCLT and admitting the application.”
Thereafter, Supreme Court of India relying on the judgment decided that, the application filed by Respondent under Section 7 of I&B Code, 2016 was not maintainable, because as per clause 19 to 21 under Limitation Act, 1961, the period of limitation is Three Years from the date of issue of loan to file a suit. Therefore, in the present case the limitation period would have started in the year 2007 and the winding-up petition by the Respondents was filed in the year, 2013. Therefore, the application filed by Respondent was barred by limitation.
AMLEGALS REMARKS 
In the present case, the decision taken by Supreme Court of India was correct because in regards of the First Issue, in order to file an application under Section 7 of I&B Code, 2016, the existence of Financial Debt is must to initiate CIRP against Appellant and in case, if Financial Debt does not exist then, application filed under Section 7 will not be valid
Therefore, the application filed by Respondent under Section 7 of I&B Code was not valid because as per Section 5(8) of I&B Code, any amount to qualify as Financial Debt should be disbursed against the consideration for Time value of Money, and therefore, the mere payment for transfer of Share, as Personal Loan to Promoter or Director of a Company cannot be considered as Financial Debt, as the Personal Loan issued to the Promoter of a Company cannot be disbursed against the consideration for Time Value of Money.
In regards to the Second Issue, the view taken Supreme Court of India was correct because in India, a person is permitted to take alternative defences available to him under the law and therefore, it was valid for the Appellant to refuse the claim by taking plea of the limitation, because the application filed by Respondent was not valid, as it was barred by limitation.
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