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This article has been submitted by Rajvansh Singh, a 3rd year B.A. LL.B (Hons.) student of National Law University, Odisha.

The Insolvency and Bankruptcy Code, 2016 [1] (“IBC or Code”) was enacted with an aim to facilitate resolution of corporate bankruptcy in a time-bound manner. The IBC for the first time made a classification between financial and operational creditors. The vires of the distinction between financial creditor and the operational creditor have been contested, as the IBC is totally inclined towards financial creditor.

The matter was placed before several courts but was far from being settled conclusively. The High Court of Calcutta in Akshay Jhunjhunwala v. Union of India [2] upheld the classification made in the IBC. More recently, the Supreme Court in Shivam Water Treaters v. Union of India [3] directed the High Courts to refrain from entering the debate pertaining to the validity of the IBC and would further not debar the petitioner from challenging the constitutionality of the IBC before the Supreme Court. A two-judge bench of the Supreme Court encountered a petition that assailed the constitutional validity of various provisions of the IBC.

The Supreme Court relying on R.K. Garg v. Union of India [4] and Bhavesh D. Parish v. Union of India [5] held that legislation especially pertaining to economic matter is based on experimentation and thus cannot anticipate every possible abuse. There may be some fallacies and inequities in the legislation but on that account, it cannot be struck down. The court should judge the constitutionality of such legislation by its objective and not by its inequities. Thus, the code is such kind of legislation, the constitutional validity has to be determined accordingly. Further, the court held that “the experiment conducted in enacting the Code is proving to be largely successful”. “The defaulter’s paradise is lost.”

TEST FOR ARTICLE 14

The Article 14 of the Constitution of India 1950 [6] talks about ‘equality among equal’ and ‘reasonable classification’. It a well-settled law that when legislation is challenged as being violative of the principle of equality, have been settled by this time and again. Since equality is only among equals, no discrimination results if the court can be shown that there is a reasonable difference, which separates two kinds of creditors so long as there is some relation between the creditors so differentiated, with the object sought to be achieved by the legislation. More recently, a constitution bench of the Supreme Court in Shayara Bano held that legislation could be struck down as being manifestly arbitrary. [Emphasis supplied]

CLASSIFICATION OF CREDITORS 

Mr. Rohatgi argued assailed the legislative scheme behind section 7, stating that there is no real difference between a financial creditor and financial creditor and the classification has no reasonable nexus to the object of the code. The Supreme Court referred to BLRC Report [7] (“Report”) and the Insolvency and Bankruptcy Bill [8] (“Bill”) to describe the rationale to differentiate between financial creditor and operational creditor. The Report and the Bill mention that the procedure for the initiation of the corporate insolvency resolution process differs for both the creditors. This is because the operational debt tends to be small amounts and may not be reflected accurately on the records of information utilities at all times. On the other hand, financial creditors have electronic records of the liabilities filed in the information utilities which in case of default are easily verifiable.

COMMITTEE OF CREDITORS

Mr. Rohatgi raised an issue that that section 21 and section 24 of the Code are discriminatory and manifestly arbitrary as the ‘operational creditors’ does not have a single vote in Committee of Creditors. The committee of creditors is endowed with the primary responsibility of the financial restructuring plan.  This is done by examining the viability of a corporate debtor after taking into account all available information as well as the evaluation of all alternative investment opportunities that are available. Since the financial creditor is in the business of money lending, banks, and financial institutions are best equipped to assess the viability and feasibility of the business of the corporate debtor. Further, the financial creditor has trained employees to assess viability and feasibility, they are in a good position to evaluate the contents of a resolution plan. Whereas, the operational creditor who provide goods and services, are involved only in recovering amounts that are paid for such goods and services.

Further, the NCLAT while looking into viability and feasibility of resolution plans that are approved by the committee of creditors, always gone into whether operational creditors are given roughly the same as financial creditors, and if they are not, such plans are either rejected or modified. It may be seen that a resolution plan cannot pass muster under section 30 (2)(b) read with section 31 unless a minimum payment is made to operational creditors, being not less than liquidation value.

WATERFALL PROCESS

It was argued that the waterfall process as mentioned in section 53 is arbitrary because the operational creditor is ranked below all other creditors including unsecured financial creditors. The Supreme court opined that priority to the unsecured financial creditor has been given for promoting the availability of credit and developing a market for unsecured financing. Thus, this would increase the availability of finance and reduce the cost of capital which in turn will promote entrepreneurship and lead to faster economic growth. This rationale creates an intelligible differentia between financial debts and operational debts, which are unsecured.

CONCLUSION

The Operational creditor initially viewed the code, hoping it may enable the corporate debtor to pay up long-standing operational debts. However, the code became a draconian law as the bill favored financial creditor over operational creditor. Although the judgement has cleared the air of constitutionality surrounding the classification of the creditor as laid in the code, it failed to provide teeth to the operational creditor.

Financial creditors are not neutral parties. The sole aim of every financial creditor being a commercial entity is to ensure that maximum dues are recovered. The dues of the operational creditor are a secondary concern at best. Thus, the restructuring plan drafted will always be in favour of the financial creditor. The only safeguard that is available to operational creditors is under Section 30 (2) (b) of the Code, which provides that a resolution plan has to ensure that the operational creditor receives at least the amount which would have been paid to the operational creditors if the corporate debtor had been liquidated i.e. the operational creditors must at least receive the liquidation value. As mentioned in the judgement the operational creditor is often an individual or small enterprise, a small amount has a huge impact on the balance sheet and may hamper their business, which in turn destroy small scale traders.

END NOTES

[1]http://www.mca.gov.in/Ministry/pdf/TheInsolvencyandBankruptcyofIndia.pdf

[2] https://indiankanoon.org/doc/118451667/

[3] https://www.financialexpress.com/economy/high-court-bars-nclt-from-passing-order-in-shivam-water-case/925372/

[4] https://indiankanoon.org/doc/1033021/

[5] https://indiankanoon.org/doc/907493/

[6] http://www.legislative.gov.in/sites/default/files/COI-updated-as-31072018.pdf

[7] https://ibbi.gov.in/BLRCReportVol1_04112015.pdf

[8]http://www.mca.gov.in/Ministry/pdf/TheInsolvencyandBankruptcyofIndia.pdf

This article is written by Piyush Rathi, a 3rd year B.A. LL.B (Hons.) student from NALSAR University of Law.

INTRODUCTION

In today’s corporate world, complying with all the corporate laws has garnered quite some importance because of the principle of Good Governance. Non-compliance of the same invites both – civil and criminal penalties. For the smooth functioning of the company’s business, the Companies Act (henceforth the Act) provides for under section 411 the compounding of such offences by the Tribunal, Regional Director and any officer authorized by the Central Government, the punishment of which is provided in the act with “fine only” or “fine or imprisonment”. The interpretation of this section, i.e., Section 411 and this section read with Section 451 which concerns with repeated default was recently in dispute in the case of Pahuja Taki Seed v Registrar of Company, NCT of Delhi & Haryana [1]  and was decided by National Company Law Appellate Tribunal, New Delhi on 27^th September 2018.

BRIEF FACTS OF THE CASE

This case is an appeal filed by the Appellants, companies along with its officers, in the National Companies Law Appellate Tribunal (henceforth NCLAT), New Delhi for the application which was dismissed by the National Company Law Tribunal (henceforth the Tribunal) New Delhi III through a common order.

23 applications with regards to the compounding of offences were clubbed together by the Tribunal and a joint order was passed with regards to the dismissal of all the applications on mainly 3 counts, which became the reason for appeal in the present case. The questions for determination were:

1. Whether the Companies Act 2013 (hereinafter the Act) bars the filing of a joint application for compounding of offence by defaulting company along with its officers in default?
2. Whether an offence punishable under the relevant provisions of the Companies Act, 2013 with ‘imprisonment or fine’, if repeated within a period of three years results into mandatory imprisonment for the defaulters and whether the same can be compounded or not?
3. Whether the Tribunal has jurisdiction to compound offences where the fine prescribed for such offence does not exceed Rs. 5,00,000/-?

ANALYSIS   

While interpreting the scope and jurisdiction of the Tribunal in entertaining the cases of compounding of offences, NCLAT overturned the decision of the Tribunal which gave exclusive power to “the Regional Director and officer authorized by central government” to compound offences the maximum amount of which does not exceed Rs 5,00,000/- and the penal punishment as specified in the act is an alternative and not mandatory. Giving the section a plain reading, where pecuniary limitation on the Jurisdiction of the Tribunal in compounding of such cases is non-existent, the appellate Tribunal overturned the restriction put by Tribunal on itself with regards to entertaining such cases and expanded the Jurisdiction of Tribunal to entertain any case where compounding can be allowed as per the act.

A company having separate legal existence, that which is different from that of the shareholder is a well-known principle in Company Law all over the world and acts done by the company can be separated from the acts by its shareholders but the Act has envisaged certain situations in the statute only where this corporate veil can be lifted. In such a situation, the lawmakers realized that it is not the artificial legal personality, i.e., the company that is doing any wrong but it is some person’s non-performance that is making the company responsible. In some of those situations, the lawmakers have envisaged and allowed for a lifting of the corporate veil to make that individual responsible. Here, the legislator has allowed for making the company officials be responsible it also allowed for compounding of their offences those that come within Section 441 that is only those offences the punishment of which is “fine only” or “fine or imprisonment”.

The wordings of Section 441 did not seem to explicitly state the situation of a joint application for compounding of the same offence committed during different financial years by the company and its officers. The Appellate Tribunal in the present case, in the absence of specific bar on ‘joinder of parties’ and the power to decide its own procedure under Section 424, the Ministry of Corporate Affair’s letter dated 31^st Jan 2018 stated that – the intention of the lawmakers with respect to not barring joint compounding applications allowed for joint applications compounding of the same offence committed during different financial years by the company and its officers which previous to this decision separate application used to get filed.

In the final argument, the judicial outcome of which is worth taking note of, pertains to interpretation of Section 451 of the Act. Section 441(6) (b) of the Act restricts the compounding of those offences which are punishable with “imprisonment” or “imprisonment and fine”. Here the wordings of section 451 becomes important which talks about the punishment in case of repeated defaults where the section states that if within 3 years the company or officer commits an offence, the punishment of which the Act deems punishable with “fine or with imprisonment”, twice then for such offence the relevant entity shall be responsible for “twice the fine which is mentioned in the Act in addition to any imprisonment provided for that offence.” This section can be construed in two ways and the implications of both would be very different for the cases to come in future.

One way this section was construed by the judicial members of the Appellate Tribunal is by interpreting the penal provisions of Section 451 to be not of mandatory nature and further restricted the application of Section 451 for those “same offences” that happened within a period of 3 years where previously the offence has been “compounded”. While arriving at the latter conclusion the court read in “the same offence is committed for the second or subsequent occasions” part of Section 451 from explanation A of Section 441 (2) which defines “any second or subsequent offence committed after the expiry of a period of three years from the date on which the offence was previously compounded, shall be deemed to be the first offence.” Further while interpreting the penal provision of the section not mandatory the court construed ‘any’ in Section 451 “in addition to any imprisonment provided for that offence” as one leaving the discretion to the prosecuting authority with the power to punish the defaulter.

This reasoning though having various basic problems but the effect what it seem to have reached is first, curbing the scope of this section to those cases only where the same offences has been compounded earlier and within 3 years of that the same default happened by the company and its officials. Further by making the imprisonment optional and at the discretion it allowed for the company and its official to invoke Section 441 where they can compound the offence committed by them repeatedly subjecting it to the discretion of the tribunal whether on repeated default they want to subject the officials and company with penal consequences. Though it is settled that for the purposes of subjecting company with penal consequences, it would mean for them not being able to compound their offences and not imprisonment.

The problem with the reasoning by the judicial members of the Tribunal is that while restricting the scope of Section 451 by incorporating the definition of “same offence committed for second or subsequent occasion” from the explanation of Section 441(2) which was meant for the meaning of which was meant for that section only the judicial members have used the definition of specific clause because the law specifically states “for the purpose of this section any second or subsequent offence would mean..” to read in so as to understand the meaning of a clause which is more generic in nature which cannot be done as expressly barred by the legislature.

Another problem with the decision of the Judicial member is their interpretation of the word ‘any’ in Section 451 in the phrase “in addition to any imprisonment provided for that offence” to be one providing the court with the discretion to punish the defaulter with imprisonment. This interpretation of this section has to be looked in with the context and intention of the legislation.

This section is a new addition to the companies act and was first introduced in Companies Law Bill, 2009 and came in the context when corporate India witnessed a massive corporate governance scandal involving Satyam computers which triggered calls for strengthening corporate governance norms in India, which is why there is a complete change in the text of the section from what was proposed and what we see the section as under Companies Act, 2013. Further, it is to be noted that if the same offence is committed after a period of 3 years this Section would not be attracted and it would be treated as the first offence only that shows the intention of the legislator towards harsher punishment.

In the light of these developments and the penal provision of the statute has to be read on the principle of literal interpretation [2] in this light this section has to be read. The section states that when the offence punishable with fine or with imprisonment has been committed twice within a period of three years then person and company responsible for the same would be liable for twice the fine “in addition to any imprisonment provided for that offence”. Here in the absence of words which subject the application of the section to the discretion of courts and construing the penal provisions of the section through above stated principle it could be interpreted that the lawmakers wanted to provide for the punishment in the statute itself and the term “in addition to” would mean “and” in the present case and “any imprisonment provided for” would mean imprisonment provided for in the respective provisions in the statute which is how a technical member of the Tribunal construed the provision as in the present case.

LOOKING AHEAD: A PARADIGM SHIFT IN THE INDIAN CORPORATE LAW

Where allowing the joint application for the compounding of offence committed by the company and its officials seem to have made the procedure easier and efficient which would have practical time and cost-benefit for corporate entities.

Further by restricting the scope of when can Section 451 be invoked and providing the discretion, to imprison in case of repeated default, with the prosecuting authority/ courts this seem to have provided the companies and officers with more freedom and have further provided them with the scope to misuse the same.

The implication of this case is still yet to unfold but this case seems to have undermined the efforts of Lawmakers and their intention which they had in their mind while adding a Section as harsh as this. The shift from the market-oriented which involved providing more freedoms to the corporate to an emphasis on stricter control through regulations which could be seen from what was recommended in Companies Bill, 2009 and what came out in Company Act, 2013. By restricting the scope of Section 451 it seems that through judicial pronouncement this shift is being overturned.

ENDNOTES

[1] [2018] 147 CLA 491.

[2] Abhiram Singh & Ors. v CD Commachen & Ors, (2017) 2 SCC 629.

This article is submitted by Prateek Kumar Singh, a 4th year B.A. LL.B student of New Law College, Bharati Vidyapeeth.

For a long time, the brick & mortar retailers have been protesting against e-commerce giants like Flipkart and Amazon for offering ‘predatory pricing’, violating the FDI rules and pursuing anti-completive practices. In August 2018 adding fuel to the fire, Flipkart was acquired by Walmart, world’s biggest brick & mortar retailer. This further increased the competition and made the business conditions unfavorable for small domestic retailers who claimed such acquisition will have a negative impact on MSME and employment etc. However, the Competition Commission of India cleared the deal as Flipkart is itself not a retailer but a market place and Foreign direct investments are permitted under such a business model. Press note 3 of 2016, issued by Department of Industrial Policy and Promotion stated that FDI is permitted under automatic route in marketplace model and not in inventory based model [1]. The same has been incorporated in the press note 2 of 2018 [2]. A marketplace model facilitates the transaction between buyer and sellers whereas an inventory model is one in which the e-commerce entity owns the goods in its inventory and sells it to the consumers on a B2C basis. Therefore, FDI is allowed only under the B2B model and not under the B2C model. Time and again it has been protested that the government policies do not favor small retailers instead they were inclined towards large retailers who were reaping the benefits of digital transactions in this sector and therefore the press note 2, 2018 was introduced.

ANALYSIS

1.Ownership and control over the entity

Press note 3 provided that the e-commerce marketplace will not exercise ‘ownership’ over the inventory and more than 25% of sales through the market from one vendor is not permitted.  This condition regarding 25% sales was rendered ineffective as the e-commerce companies created multiple affiliated vendors, sale from each being less than 25%. Press note 2 of 2018 added one more condition that e-commerce entity will not exercise not only ‘ownership’ but also ‘control’ over the inventory. The earlier condition of 25% of sales has also been modified and the new policy provides that if 25% of sales of a vendor is through a market place or group companies, such vendor’s inventory shall be deemed to be controlled by e-commerce marketplace having ownership over the goods and the business model will automatically convert into inventory based model. This measure has been adopted to prevent the alignment of any supplier exclusively with one e-commerce entity. However, this will increase compliance burden on the e-commerce entities to ensure the compliance of threshold by the vendors. Also, the interpretation of the word ‘control’ becomes important and how providing support services like warehousing, logistics, order fulfillment, call center and payment collections which are permitted under press note 2, 2018 will not amount to any sort of control. Prior to the new press note, it was frequently alleged that e-commerce entities were circumventing rules regarding FDI under press note 3, 2016 by holding inventories and influencing by the prices as well. Entities like Flipkart and Amazon with their support entities Flipkart India Pvt. Ltd, E-kart, Amazon seller service, and Amazon wholesale provided huge discounts which were shared by these entities and losses as well giving the power to influence price.

2. Equity holding

Press note 2, 2018 provides “an entity having equity participation by an e-commerce marketplace entity or its group companies… will not be permitted to sell its products on the platform run by such marketplace entity”[3]. This restricts the related parties of e-commerce entities from selling on that marketplace. For eg. Cloud tail which is a joint venture between Narayan Murthy’s catamaran and Amazon can’t sell to Amazon anymore as per the new press note. While the motives seem to be good but it may happen that the e-commerce entity may own minority shares in the retail company without exercising control over them. A clarification is required that whether such ban is a blanket ban or one where only those entities are banned having equity ownership and exercising control over the Board of Directors. Another issue that arises is that Amazon and Flipkart currently have around 30 Private labels on which a lot of money has been already spent for their development. The question is whether the equity ban will also cover these Private labels? An official clarification given by DIPP says that “Policy does not impose any restriction on nature of products which can be sold on the marketplace”. But even after such clarification, the current status of such private labels is unclear. A legitimate contention on behalf of e-commerce entity is that even physical retailers have their private labels. It is a valid practice and e-commerce entities can’t be treated differently for the same.

3. No exclusive relationship with the vendor-

Press note 2 provides that e-commerce marketplace entity will not mandate any seller to sell any product exclusively on its platform. Now the issue is that what if the vendor himself wants to sell exclusively on the e-commerce market place? Whether the aforementioned restriction will cover such cases as well? Such regulation can be a big blow for companies like One plus or Xiaomi who sell exclusively on Amazon and other white good manufacturing companies as well. On the contrary exclusive deals can be beneficial for small retailers for the purpose of cost control and tackling a logistical challenge. Also, the press note provides that e-commerce marketplace entity shall provide services to the vendors on the platform at arm’s length basis and no discriminatory or unfair manner. Such services are not restricted to the fulfillment of logistics, warehousing, and advertising etc. A similar condition regarding cashback has been inserted which says that cash back by the e-commerce entity to its buyer should be fair and non-discriminatory manner. In a nutshell, if a vendor receives certain services, then another vendor placed under similar circumstances must receive similar services. Again the interpretation of the word ‘similar circumstances’ becomes important. In such cases, it will be essential as to what factors will put sellers under similar circumstances.  All these measures have been included to ensure a level playing field for both e-commerce and other retail entities.

4. Winners, losers and consumers

Undoubtedly the biggest winners are the brick and mortar retailers and other small retailers. They are now provided with better market access and level playing field. The juggernaut of online marketplace will finally stop or at least will provide some ease to the small retailers. Small e-commerce companies or the start-ups can also now compete with the e-commerce giants.  It’s also a win situation for physical retail groups like Future retail and reliance group, now they can with ease converge into online stores. It’s a loose situation for giants like Flipkart and Amazon. It looks like that the government has studied their business model and has killed it systematically. Walmart which has recently invested 16 billion in Flipkart will face the most trouble as under the new policy Walmart may not be able to sell to Flipkart. Apart from this both Amazon and Flipkart has to comply with the press note before 1^st February 2019 which has burdened them with enormous compliance work including reduction of sale through a particular vendor and putting an end to the equity ownership in such vendors.  Consumers will have to face the brunt of these changes as the new policy signifies the end of deep discounts and extensive cash back offers. Consumers might face difficulty as there will be lack of product availability and in certain cases, it will also cause lack of choices, the consumers may have to go through both online and offline stores to discover the best prices which is an inconvenience for certain classes of consumers.

CONCLUSION: THE WAY FORWARD FOR E-COMMERCE GIANTS

E-commerce entities have huge business setup and a complex business model and supply chain. Time period of 35 days from release of press note on 26 December 2018 to 1^st February 2019 is a very small window provided to the e-commerce companies as the compliance work is a mammoth task, in addition to this a lot of clarification is required and also request for certain exclusion may be made by such companies, therefore they require more time. At this point, before 1^st February, these companies should demand multiple clarifications wherever the policy seems to be ambiguous.  E-commerce entities can also ask for exclusions like exemption of joint ventures under the equity holding restriction so that their business model faces less disruption. Further, these companies can also approach the court for intervention regarding the capping rule of 25% sale through a vendor or equity participation or the cashbacks.

Another way of bypassing the cap of 25% of sales through a vendor is by a partnership with the wholesalers who will sell goods to the vendors. All these factors may require structural change and change in investment pattern. A major factor is the will of the government to enforce the policy as in 2016, the e-commerce entities circumvented the rule of 25% sale through a vendor, by creating multiple vendor entities on which they possessed control and therefore possessed control on the inventory. Industry experts are of the view that the model of equity investment has nothing much to offer to e-commerce entities. Going ahead with this model is not possible as equity ownership in the vendor entity is not allowed anymore. Time has come to explore the franchise channel for creating a partnership with vendor entities which will in help bypassing the new policy [4]. It can be rightly said that the era of pure e-commerce is vanishing and a new business model is developing where the online entities are going physical and physical retailers are also going online and this online-offline logistics is creating new retail. However, taking the note that how big Flipkart and Amazon are and how much time they spent in this business, the government may have temporarily restricted them from any collusive practice but such entities can’t be stopped from wielding the power of the data they possess, which will always give them an upper hand in the modern logistical retail market.

END NOTES

[1] Department of Industrial Policy & Promotion, Paragrah 2.2, Press note no. 3 (2016 Series) available at https://dipp.gov.in/sites/default/files/pn3_2016_0.pdf, last seen 21/01/2019

[2] Department of Industrial Policy & Promotion, Paragrah 5.2.15.2.3, Press note no. 2 (2018 Series) available at https://dipp.gov.in/sites/default/files/pn2_2018.pdf, last seen 21/01/2019

[3] Department of Industrial Policy & Promotion, Paragrah 5.2.15.2.4: other conditions, Press note no. 2 (2018 Series) available at https://dipp.gov.in/sites/default/files/pn2_2018.pdf, last seen 21/01/2019

[4] Business model, Investment channel may have to change, The Hindu, available at https://www.thehindu.com/business/business-models-investment-channels-will-have-to-change/article25843938.ece, last seen 21/01/2019

CCLR’s editorial team is proud to have published and released its first volume. The journal can be downloaded from the link below.