Supreme Court clarifies MSME promoter rights in insolvency, sets aside NCLAT order: R. Raghavendran vs. C. Raja John & Ors. (2023)

Date of the Judgment: 13 September 2023
Citation: 2023 INSC 849
Judges: Sanjay Kishan Kaul, J. and Sudhanshu Dhulia, J.
Can a promoter of a Micro, Small & Medium Enterprise (MSME) be exempt from competing with other resolution applicants to regain control of their company during insolvency proceedings? The Supreme Court recently addressed this question, clarifying the extent of the National Company Law Appellate Tribunal’s (NCLAT) powers in such cases. This judgment clarifies that while MSMEs receive certain considerations, promoters cannot be automatically exempted from competition during the resolution process. The bench comprised Justices Sanjay Kishan Kaul and Sudhanshu Dhulia, with the majority opinion authored by Justice Sanjay Kishan Kaul.

Case Background

The case revolves around Springfield Shelters Pvt. Ltd., an MSME, where insolvency proceedings were initiated on February 12, 2020. R. Raghavendran, the Resolution Professional, is the appellant, and C. Raja John, the promoter of the MSME, is the first respondent. The NCLAT had initially questioned the MSME status of the company, but later affirmed it was indeed an MSME before the insolvency process began. The National Company Law Tribunal (NCLT) had rejected the resolution plan submitted by the promoter, C. Raja John, citing his ineligibility under Section 29A(e) of the Insolvency and Bankruptcy Code, 2016 (the Code), as the company was initially not considered an MSME. However, the NCLAT’s finding that the company was an MSME changed the scenario, making the promoter’s plan eligible for consideration. Following this, the Resolution Professional sought to act on the order, leading to a contempt proceeding by the promoter alleging non-compliance with the NCLAT order.

Timeline

Course of Proceedings

The NCLT initially rejected the resolution plan submitted by the promoter, C. Raja John, because the company was not considered an MSME, which led to the promoter being disqualified under Section 29A(e) of the Code. The NCLAT, however, overturned this decision, finding that the company was indeed an MSME before the insolvency process began. This changed the situation, making the promoter’s plan eligible for consideration. Subsequently, the Resolution Professional sought to act on this order. The promoter then filed contempt proceedings before the NCLAT, alleging that the Resolution Professional was not acting in accordance with the NCLAT’s order, specifically citing the observations in paragraphs 32 and 34 of the NCLAT order. The Resolution Professional had initiated a process to invite other resolution plans, which led to the contempt proceedings and a stay on the e-voting results. The core issue was whether the observations in paragraphs 32 and 34 of the NCLAT order were valid, especially in light of the NCLAT’s judgment in “Saravana Global Holdings Ltd. & Anr. Vs. Bafna Pharmaceuticals Ltd. & Ors.” which had been upheld by the Supreme Court.

Legal Framework

The case primarily involves the interpretation of the Insolvency and Bankruptcy Code, 2016, particularly concerning the rights and obligations of promoters of MSMEs during insolvency proceedings. Section 29A of the Code specifies the ineligibility criteria for resolution applicants. However, there are specific exceptions for MSMEs, allowing their promoters to submit resolution plans. The core issue is the interpretation of observations made by the NCLAT in the context of MSMEs, specifically whether promoters of MSMEs can be exempted from competing with other resolution applicants. The judgment also refers to Section 12A of the Code, which allows for the withdrawal of insolvency proceedings under certain circumstances, such as a settlement with creditors.

Arguments

Arguments of the Appellant (Resolution Professional):

• The Resolution Professional argued that the observations in paragraphs 32 and 34 of the NCLAT order, which suggested that MSME promoters need not compete with other resolution applicants, were not in line with the law.
• The appellant contended that the NCLAT’s observations were based on a misinterpretation of the “Saravana Global Holdings Ltd. & Anr. Vs. Bafna Pharmaceuticals Ltd. & Ors.” case.
• The Resolution Professional argued that the process of inviting other resolution plans was necessary to ensure the maximization of the value of the corporate debtor’s assets, which is a key objective of the Code.
• The appellant sought to conduct e-voting on the resolution plans received, including the promoter’s plan, to comply with the Code.

Arguments of the Respondent No. 1 (Promoter):

• The promoter argued that the NCLAT’s observations in paragraphs 32 and 34 were valid and based on the principles laid down in the “Saravana Global Holdings Ltd. & Anr. Vs. Bafna Pharmaceuticals Ltd. & Ors.” case, which was upheld by the Supreme Court.
• The promoter contended that since the company was an MSME, he should be given a chance to regain control without having to compete with other resolution applicants.
• The promoter argued that the order of the Supreme Court in C.A. No. 5344 of 2019, upholding the NCLAT order in Bafna’s case, meant that the principles of merger of the order as enunciated in “Kunhayammed & Ors vs State Of Kerala & Anr.” reported as (2000)6 SCC 359 would apply.
• The promoter sought a chance to settle the matter through a one-time settlement (OTS) proposal with the financial creditors.

Innovativeness of the argument: The promoter’s argument that the Supreme Court’s order upholding the NCLAT order in Bafna’s case implied that the principles of merger would apply, was a novel attempt to strengthen their case for preferential treatment as an MSME promoter.

Issues Framed by the Supreme Court

The Supreme Court did not frame specific issues in a separate section. However, the core issue before the court was:

1. Whether the observations made by the NCLAT in paragraphs 32 and 34 of its order, which suggested that MSME promoters need not compete with other resolution applicants to regain control of the corporate debtor, were legally sustainable.

Additionally, the court dealt with the sub-issue of whether the NCLAT’s observations were a correct interpretation of the judgment in “Saravana Global Holdings Ltd. & Anr. Vs. Bafna Pharmaceuticals Ltd. & Ors.”

Treatment of the Issue by the Court

The following table demonstrates as to how the Court decided the issues

Authorities

The Supreme Court considered the following authorities:

Cases:

1. Saravana Global Holdings Ltd. & Anr. Vs. Bafna Pharmaceuticals Ltd. & Ors. (NCLAT): This case was the basis of the NCLAT’s observations regarding MSME promoters not needing to compete with other resolution applicants. The NCLAT had held that in exceptional circumstances, if the corporate debtor is an MSME, it is not necessary for the promoters to compete with other resolution applicants to regain control of the corporate debtor.
2. Kunhayammed & Ors vs State Of Kerala & Anr. (2000) 6 SCC 359 (Supreme Court of India): This case was cited by the respondent to argue that the Supreme Court’s order in C.A. No. 5344 of 2019, upholding the NCLAT order in Bafna’s case, meant that the principles of merger of the order would apply.

Legal Provisions:

1. Section 29A of the Insolvency and Bankruptcy Code, 2016: This section specifies the ineligibility criteria for resolution applicants. The court noted that there are specific exceptions for MSMEs, allowing their promoters to submit resolution plans despite certain ineligibilities.
2. Section 12A of the Insolvency and Bankruptcy Code, 2016: This section allows for the withdrawal of insolvency proceedings under certain circumstances, such as a settlement with creditors. The court noted that the observations in the Bafna case were made in the context of a settlement under this section.

Judgment

The Supreme Court allowed the appeal and set aside paragraphs 32 and 34 of the NCLAT order. The Court clarified that the observations made in the Bafna case were specific to situations where a settlement was reached before the constitution of the Committee of Creditors (CoC) or under Section 12A of the Insolvency and Bankruptcy Code, 2016. The Court held that the NCLAT had misinterpreted the Bafna case by applying it broadly to all MSMEs, stating that the promoters of MSMEs are not automatically exempt from competing with other resolution applicants. The Supreme Court also noted that the Resolution Professional cannot be faulted for calling for other proposals, which should include the proposal given by the promoter, to ensure that the assets of the corporate debtor are maximized. The court granted a two-month window to the promoter to pursue a one-time settlement (OTS) proposal with the financial creditors, but made it clear that if the OTS does not materialize, the Resolution Professional is free to declare the results of the e-voting on all the proposals.

What weighed in the mind of the Court?

The Supreme Court’s decision was primarily influenced by the need to maintain the integrity of the insolvency resolution process as outlined in the Insolvency and Bankruptcy Code, 2016, which emphasizes the maximization of the value of the assets of the corporate debtor. The Court was keen to ensure that the special considerations given to MSMEs do not undermine the fundamental principles of the Code. The Court also emphasized the importance of a fair and transparent process, which includes allowing other resolution applicants to compete, to ensure the best possible outcome for the corporate debtor and its creditors. The Court’s reasoning was also influenced by the need to clarify the legal position regarding the rights of MSME promoters in insolvency proceedings, to avoid confusion in future cases.

Logical Reasoning:

The Court considered the NCLAT’s interpretation of the Bafna case, which suggested that MSME promoters need not compete with other resolution applicants. However, the Supreme Court clarified that the Bafna case was specific to situations where a settlement was reached before the constitution of the Committee of Creditors (CoC) or under Section 12A of the Code. The Court found that the NCLAT had misinterpreted the Bafna case by applying it broadly to all MSMEs. The Court emphasized that the primary objective of the Code is to maximize the value of the assets of the corporate debtor, and this objective would be undermined if MSME promoters were automatically exempted from competition. The Court noted that the Resolution Professional was correct to call for other proposals, which should include the proposal given by the promoter, to ensure that the assets of the corporate debtor are maximized. The Court also granted a two-month window to the promoter to pursue a one-time settlement (OTS) proposal with the financial creditors, but made it clear that if the OTS does not materialize, the Resolution Professional is free to declare the results of the e-voting on all the proposals.

The Supreme Court rejected the argument that the principles of merger would apply based on the Kunhayammed case, stating that the Supreme Court had simply upheld the NCLAT order in Bafna’s case without further elaboration. The Court clarified that its previous order in C.A. No. 5344 of 2019, which upheld the NCLAT order in Bafna’s case, did not imply that the principles of merger would apply. The Court stated that it had simply upheld the NCLAT order without further elaboration, and that the NCLAT’s observations in the present case were a misinterpretation of the Bafna case.

The majority opinion was delivered by Justice Sanjay Kishan Kaul, and Justice Sudhanshu Dhulia concurred with the decision.

“In the impugned judgment, it can hardly be disputed that there is no discussion on the special circumstances other than the reference to judgment in Bafna’s case. The impugned judgment is predicated on a broad reasoning as if ipso facto there is no need to call other proposals if it is an MSME.”

“We are, thus, clearly of the view that the appellant cannot be faulted for calling for other proposals in which the proposal given by respondent No.1 was also to be examined, put them to voting before the CoCs and declare the results.”

“Needless to say that beyond the window of two months, if the OTS is not accepted, the appellant will be free to declare the results of the e-voting qua all the proposals.”

Key Takeaways

• Promoters of MSMEs are not automatically exempt from competing with other resolution applicants during insolvency proceedings.
• The observations made in the “Saravana Global Holdings Ltd. & Anr. Vs. Bafna Pharmaceuticals Ltd. & Ors.” case are specific to situations where a settlement is reached before the constitution of the Committee of Creditors (CoC) or under Section 12A of the Insolvency and Bankruptcy Code, 2016.
• The primary objective of the Insolvency and Bankruptcy Code, 2016, is to maximize the value of the assets of the corporate debtor, which requires a fair and transparent process, including competition among resolution applicants.
• Resolution Professionals are not at fault for calling for other proposals to ensure that the assets of the corporate debtor are maximized.
• MSME promoters can still submit resolution plans, but they must compete with other applicants unless a settlement is reached before the constitution of the CoC or under Section 12A of the Code.

Directions

The Supreme Court directed that a two-month window be given to the promoter to pursue a one-time settlement (OTS) proposal with the financial creditors. If the OTS does not materialize, the Resolution Professional is free to declare the results of the e-voting on all the proposals.

Development of Law

The ratio decidendi of the case is that the promoters of MSMEs are not automatically exempt from competing with other resolution applicants during insolvency proceedings. This clarifies the interpretation of the Bafna case and sets the legal position that MSME promoters must participate in a competitive process unless a settlement is reached before the constitution of the CoC or under Section 12A of the Code. This judgment clarifies the legal position and sets aside the broad interpretation of the Bafna case by the NCLAT.

Conclusion

In conclusion, the Supreme Court’s judgment in R. Raghavendran vs. C. Raja John & Ors. clarifies that while MSMEs receive certain considerations under the Insolvency and Bankruptcy Code, 2016, their promoters are not automatically exempt from competing with other resolution applicants during insolvency proceedings. The Court set aside the NCLAT’s order, which had suggested otherwise, and emphasized the importance of a fair and transparent process that prioritizes the maximization of the value of the corporate debtor’s assets. The judgment underscores the need for a balanced approach that respects the special considerations for MSMEs while upholding the fundamental principles of the Code.