VHVK E Newsletter August 2023

Directors’ prosecution does not end despite approval of Insolvency Resolution Plan

Criminal prosecution of directors for dishonour of cheques issued by a company would not terminate on approval of Insolvency Resolution Plan (IRP) for the company. This ruling of the Supreme Court in Ajay Goenka v Tourism Finance Corporation ₁ undermines clarity on insolvency resolution, although it is consistent with precedents.

The debtor company (Rainbow Papers Ltd) had issued post-dated cheques to the lender, Tourism Finance Corp, but did not honour cheques. The lender initiated criminal prosecution against the Managing Director under the Negotiable Instruments Act, 1881 (section 138). Meanwhile, the company began insolvency resolution proceedings and secured a Resolution Plan that included the loan obligation to Tourism Finance Corp.

Yet Tourism Finance Corp continued with prosecution of the Managing Director. Rejecting the Managing Director’s plea to quash the prosecution, the Supreme Court referred to section 32A of the Insolvency & Bankruptcy Code, 2016 (IBC) that provides for continuance of criminal proceedings despite the approval of IRP for companies. It is true Section 32A provides for continuity of criminal liability for company-related offences, but its application would be harsh if cheque dishonour is mechanically bracketed with other, more serious offences (such as criminal misappropriation). This is particularly so when the debt has been settled through IRP. Supreme Court’s interpretation warrants a review, as it can distract managements with unproductive litigation and hinder vital business turnaround plans – which the IRP aims to facilitate.

No tax recovery from company director unless guilty of culpable conduct

In Prakash Kamat v Commissioner of Income Tax,₂ the Bombay High Court held tax arrears cannot be recovered personally from directors in the absence of gross negligence, misconduct or other breach of duty to companies. The court relied on the statutory safeguard available for directors under the Income Tax Act, 1961 (section 179) in coming to this conclusion.

The Income Tax Act (section 179) makes directors personally liable for the tax dues of closely-held companies, but only if they are in breach of their fiduciary duties as directors. This could be gross negligence or other culpable conduct (for example, diversion of funds). In Prakash Kamat, the directors demonstrated they were only minority shareholders and were never in control of the company. They had also been removed from office at the time when the tax liability arose. Accepting the submissions and applying the safeguard provided in the Income Tax Act, the court quashed the proceedings against the directors.

Competition Act applies to Institute of Chartered Accountants’ commercial activities

To the extent the Institute of Chartered Accountants of India (ICAI) engages in commercial, non-regulatory activities, it is subject to the anti-competition rules under the Competition Act, 2002;ICAI’s statutory status is immaterial. With this ruling inInstitute of Chartered Accountants of India v Competition Commission of India,₃the Delhi High Court recognized ICAI’s twin functions – regulation of the accounting and audit profession, and commercial activities that include organizing Continuous Professional Education (CPE) programs and book publication.

Competition Commission of India (CCI) commenced an investigation into ICAI’s practices in organizing CPE, specifically whether ICAI abused its dominant position as CPE organizer. ICAI challenged CCI’s action arguing it is a statutory agency that performed regulatory functions; accordingly, it is not an “enterprise” under theCompetition Act, 2002 (section 2).

Accepting CCI’s plea that ICAI is an “enterprise” with regard to its commercial activities, the court rejected ICAI’s challenge to CCI’s jurisdiction. The judgment adopts a nuanced interpretation and upholds CCI’s jurisdiction to look into commercial activities of professional bodies despite their statutory status and the regulatory functions they perform.

Legal claims against debtor company must be included in sale as “going concern”

In Nabhinagar Power v Ram Ratan Modi, Liquidator, ₄the National Company Law Appellate Tribunal (NCLAT) affirmed legal claims made by third parties must be included when liquidators sell the debtor company’s business undertaking as a going concern. The legal claim in Nabhinagar Power was from a customer that alleged breach of contract by the debtor company.

Nabhinagar Power had engaged the debtor company, DC Plant Services, for turnkey services to build a module in its power plant. DC Plant Services did not complete the work and went into liquidation. National Company Law Tribunal (NCLT), Kolkata ordered sale of the DC Plant’s undertaking as a going concern because no Insolvency Resolution Plan was presented. The liquidator identified a buyer and proceeded to complete the sale transaction.

Alleging breach of contract by the debtor company, Nabhinagar Power lodged a claim with the liquidator. The claim which included damages, refund of advance payment and related sums was rejected by the liquidator on the ground the liability had not crystallized. NCLT upheld the liquidator’s order and rejected Nabhinagar Power’s appeal against the liquidator’s decision.

On further appeal, NCLAT reversed the ruling of the liquidator and NCLT and held Nabhinagar Power’s claim must be included in the sale of DC Plant’s business undertaking to the purchaser. The contingent liability arising from the claim would be a part of the sale transaction. The ruling from NCLAT is a valuable precedent for similar issues that will likely come up in the future with other debtor companies. The decision promotes certainty and fairness in insolvency proceedings.

Competitions rules to be revamped under amendments in the pipeline

Competition (Amendment) Act, 2023 received Presidential assent in April 2023 and awaits implementation from a date to be determined by the Central Government. The amendments would significantly revamp competition law rules and expand the metrics for merger pre-approval of mergers and acquisitions. Other changes include reduced timelines for completing the pre-approval procedure and flexibility to modify the transaction structure in mergers to address regulatory concerns.

Presently, pre-approval from the Competition Commission of India is required for mergers/acquisitions, termed “business combinations” (Competition Act, 2002 (section 5)), based on sales volume and/or asset value of the enterprises involved in the transactions. The new rule would also rope in transactions valued at ₹ 2,000 crores or more and involving enterprises that have “substantial operations” in India. Metrics to determine substantial operations will be provided in the rules to be framed by the Government.

A second important change is shorter timeframes for completing the different stages in the pre-approval procedure. This aims to promote efficiency in the process and timely completion of merger/acquisition transactions. A third major change is providing flexibility to companies to modify transaction structures in pending pre-approval applications, to address regulatory concerns. This would also promote efficiency and timeliness by eliminating the need for successive applications.

Disruption of cargo handling in the Bengaluru airport averted

The Karnataka High Court intervened on emergency basis to avert disruption in cargo handling in the Bengaluru airport. In Bengaluru International Airport v Menzies Aviation Bobba,₅a division bench of the High Court set aside a single judge’s order that have could potentially brought cargo handling work at the busy Bengaluru airport to a standstill.

In a writ petition filed by an unsuccessful bidder for the tender for cargo handling and management services at the Bengaluru airport, a vacation judge granted interim orders on 23 May 2023. The interim order would prevent the company that secured the contract from starting work scheduled to begin that night. This would create a vacuum in the cargo handling work. Preparatory work had been completed by the new contractor including the procurement of security clearances and permits. Alternative arrangements could not be made in a matter of hours before the new contractor was scheduled to begin work. This was the situation created by the interim order the single judge granted to the unsuccessful bidder.

A division bench of the High Court took up an appeal against the single judge’s order, at 7pm on the same day – 23 May – by video conferencing. Appreciating the gravity of the situation, the division bench set aside the interim order granted by the single judge and permitted the new contractor to commence work, as scheduled. Swift intervention prevented a potential crisis in the Bengaluru airport, which is among the busiest in the country.