Parties cleverly attempted to convert operational debt into financial debt: NCLT junks Section 7 petition

The National Company Law Tribunal (NCLT) on Monday held that an operational credit cannot be converted into a financial debt by way of a Memorandum of Understanding (MoU) if the financial creditor is not eligible to advance a loan as per the terms of Section 186 of the Companies Act [Jambudwip Exports and Imports Limited v. UP Bone Mills Private Limited]..The Bench comprising of Justice Abni Ranjan Kumar Sinha and LN Gupta held,"....the amount advanced by the Applicant Company to the Corporate Debtor for purchase of certain goods was neither disbursed as loan per se nor the conversion of the said advance into an Inter-Corporate Loan through the instrument of an MoU is in accordance with the law. Further, it is observed that by executing the MoU dated 10.05.2019, the parties have cleverly attempted to convert an Operational Debt into a Financial Debt.".The applicant in the case (financial creditor) gave an advance amount of almost ₹19 crore to the corporate debtor against a purchase order. Due to financial issues, the corporate debtor could not deliver the goods or repay the advance along with interest of ₹8,53,459.Pursuant to this, the financial creditor and the corporate debtor signed an agreement to convert the advance amount into an inter-corporate loan payable in instalments. In furtherance to the agreement, both the parties signed an MoU stating the terms of the payment along with interest.Again, due to a financial crunch, the corporate debtor failed to repay the amount, after which the applicant filed for the initiation of the Corporate Insolvency Resolution Process (CIRP) under Section 7 of the Insolvency and Bankruptcy Code, 2016 (the Code)..As per Section 186(2) of the Companies Act, 2013 (Act), no company is allowed directly or indirectly to give a loan to any entity exceeding 60% of its paid-up share capital, free reserves and securities premium account or 100% of its free reserves and securities premium account, whichever is more. In addition, as per Section 186(3) of the Act, where the loan amount exceeds the given limit, then the loan can only be disbursed after attaining prior approval by way of a special resolution passed at a general meeting..In its order, NCLT minutely examined the transaction in order to find whether the loan was granted within the limits specified under Section 186(2) of the Companies Act. After perusal of the balance sheet of the company, the Bench observed that the company was eligible to disburse a loan to any entity upto ₹8.85 crore only. Thus, the advance amount disbursed was in breach of the limit specified under Section 186(2) of the Act. In addition, the Bench observed that no special resolution was passed at a general meeting as required under Section 186(3) of the Act..Since the advance given by the company to the corporate debtor was beyond the limit prescribed under the Companies Act, it was held that it cannot be enforced as debt. In addition, the NCLT held that the conversion of the said advance into an inter-corporate loan through an MoU was not in accordance with the law. Thus, the petition stood dismissed..Advocate Yashu Gupta appeared for the applicant, while Advocate Brahm Datt Verma represented the respondent..[Read the order]