If 'related party' label done away with to circumvent bar under Section 21(2) IBC then Financial Creditor can be excluded from CoC: Supreme Court

A financial creditor which is not a "related party" to the corporate debtor can also be excluded from the Committee of Creditors(CoC) if it is established that the "related party" label was done away with to circumvent the bar under the first proviso to Section 21(2) of the Insolvency and Bankruptcy Code(IBC), the Supreme Court ruled on Monday. .The disqualification should apply even though the default rule is that the financial creditor must be a "related party" in praesenti (in present) to be disqualified from being included in the CoC, the Court ruled. ."While the default rule under the first proviso to Section 21(2) is that only those financial creditors that are related parties in praesenti would be debarred from the CoC, those related party financial creditors that cease to be related parties in order to circumvent the exclusion under the first proviso to Section 21(2), should also be considered as being covered by the exclusion thereunder," the Court said..The judgment was delivered by a three-judge Bench of Justices DY Chandrachud, Indira Banerjee and Indu Malhotra..The Court was hearing appeals against a January 2020 order of National Company Law Appellate Tribunal (NCLAT) which dismissed the appeal under Section 61 of the Insolvency and Bankruptcy Code, 2016 preferred by AAA Landmark Private Limited and Spade Financial Services Private Limited challenging an order of the National Company Law Tribunal (NCLT). .The NCLT had held that AAA and Spade have to be excluded from the Committee of Creditors formed in relation to the Corporate Insolvency Resolution Process initiated against AKME Projects Limited (Corporate Debtor). .Phoenix appealed to the Supreme Court against the said order challenging the limited aspect on the finding that AAA and Spade are financial creditors. It submitted that though the NCLAT correctly dismissed the appeal filed by Spade and AAA, holding that they are related parties of the Corporate Debtor and are hence to be excluded from the CoC, there is an erroneous finding that they are financial creditors..The appeal by Phoenix challenged the NCLAT order on these grounds: (i) It is contrary to the record; and (ii) both AAA and Spade are not even creditors of the corporate debtor, much less financial creditors. .The Supreme Court held that the exclusion under the first proviso to Section 21(2) is related not to the debt itself but to the relationship existing between a related party financial creditor and the corporate debtor..As such, the financial creditor, who in praesenti is not a related party, would not be debarred from being a member of the CoC, the Court said. "In case where the related party financial creditor divests itself of its shareholding or ceases to become a related party in a business capacity with the sole intention of participating the CoC and sabotage the CIRP, by diluting the vote share of other creditors or otherwise, it would be in keeping with the object and purpose of the first proviso to Section 21(2), to consider the former related party creditor, as one debarred under the first proviso," the Court held. .If this interpretation is not given to the first proviso of Section 21(2), then a related party financial creditor can devise a mechanism to remove its label of a ‘related party’ before the Corporate Debtor undergoes CIRP, so as to be able to enter the CoC and influence its decision making at the cost of other financial creditors, the Court added. .The Supreme Court further noted that it does not agree with the submission that NCLAT exceeded its jurisdiction by considering the second issue relating to the determination of the status of AAA and Spade as related parties."We hold that there is no reason to remand the matter to NCLAT for reconsideration. An order of remand cannot be passed in a routine manner, and it should be passed only if a re-consideration is necessary. An unwarranted order of remand does not serve the cause of justice and merely extends the life of litigation. Remands in commercial matters should not become a ruse to subserve litigation luxuries," the Court said. .Regarding the issue of whether AAA and Spade are financial creditors, NCLT in its July 2019 order had noted that AAA and the Corporate Debtor had entered into multiple agreements regarding the same property without giving any explanation or rationale regarding variation in the consideration. The Supreme Court noted that the transactions were collusive in nature entered with the purpose of diverting properties of the Corporate Debtor to AAA."Since the commercial arrangements between Spade and AAA, and the Corporate Debtor were collusive in nature, they would not constitute a ‘financial debt’. Hence, Spade and AAA are not financial creditors of the Corporate Debtor," it ruled. .Senior Advocate KV Viswanathan appeared for AAA and Spade. Senior Advocate Neeraj Kishan Kaul for Phoenix while Senior Advocate Sanjiv Sen appeared for the Resolution Professional..[Read judgment]