VHVK E Newsletter October 2022
Oct 2022
Volume VI Issue 5
VHVK Law Bulletin
We are pleased to bring you this fifth issue of VHVK Law Bulletin for 2022 with reports on the following recent developments in law, including business law issues:
- Guarantor can initiate insolvency proceedings against principal debtor (NCLT)
- Scope of judicial intervention in government tenders clarified (Supreme Court)
- “Group companies” concept referred to larger bench (Supreme Court)
- Customs duty recovery subject to moratorium protecting corporate debtor (Supreme Court)
- Failure to pay license fee for intellectual property can give rise to insolvency proceedings (National Company Law Appellate Tribunal)
- Anti-Corruption Bureau under Chief Minister’s control struck down (Karnataka High Court)
Surety entitled to launch insolvency proceedings against principal debtor
Guarantors that make payments to creditors can bring insolvency proceedings under the Insolvency & Bankruptcy Code, 2016 (IBC) against principal debtors. Affirming sureties’ right of subrogation, the National Company Law Tribunal (NCLT) (Kolkata) ruled in Orbit Towers P Ltd v Sampurna Suppliers P Ltd1 that sureties would be financial creditors and bring insolvency proceedings against principal debtors.
Orbit Towers that had provided third party guarantee to Indian Bank for the liabilities of Sampurna Suppliers made payments to Indian Bank, due to default by Sampurna. To recover the payment from Sampurna, the principal debtor, Orbit brought an insolvency action against Sampurna under the IBC. Orbit relied on its right of subrogation under the Indian Contract Act, 1872 (sections 140 & 141), which enable a surety that has paid on behalf of a principal debtor to steps into the creditor’s shoes. The surety would be entitled to all the remedies available to the creditor, including any security interest in assets.
Upholding Orbit’s effort, NCLT recognized sureties as financial creditors under IBC and held they can bring insolvency action against debtors in default.
Courts can intervene to correct patent flaws in government tender process
The Supreme Court clarified judicial intervention is permissible in award of government contracts when the tender process is clearly vitiated by improper considerations. In Jai Bholenath Construction v Chief Executive Officer, Nanded Zilla Parishad,2 the court set aside a contract awarded under a “corrigendum” and revocation of the contract earlier granted to the appellant.
The contract for construction of staff quarters at a Primary Health Centre was originally awarded to the appellant, Jai Bholenath Construction, which was the lowest bidder when the tenders were opened. At the time the tender from another bidder, LD Constructions, was rejected because the bidder had not submitted the necessary documents and the bid was defective/incomplete. More than two months later, the Nanded Zilla Parishad revoked the contract awarded to Jai Bholenath and instead, gave it to LD Construction under a document titled “Corrigendum.” The ostensible grounds for the action were LD Construction rectified the earlier defects in its tender documents and quoted the lowest price.
Holding the belated award of contract to LD Construction was improper, the Supreme Court set aside the contract and reinstated the contract earlier given to the appellant, Jai Bholenath. In doing so, the Supreme Court clarified that the caution sounded in N G Projects Ltd v Vinod Kumar Jain3 against court interference with award of contracts must not be applied too broadly or rigidly. When contracts are awarded to unqualified bidders or for palpably extraneous considerations, courts can intervene. The ruling can strengthen accountability in the award of public contracts and promote better governance.
Larger bench of the Supreme Court to consider “group companies” concept
The question whether courts/arbitrators can also include affiliate or group companies in cases involving corporate litigants has been referred to a larger bench of the Supreme Court. This occurred recently in Cox & Kings Ltd v Sap India P Ltd.4 The development unsettles the position laid down in 2013 in Chloro Controls India P Ltd v Severn Trent Water Purifications Inc5 that in appropriate cases, group companies can be included in legal disputes involving affiliates.
It is business reality that corporate enterprises operate through several entities, usually termed “group companies.” These companies perform distinct activities or engage in different lines of business. When there are legal disputes, it is often a practical necessity for third parties to involve not merely the entity directly involved in the transaction, but also affiliates, in particular the “parent” or holding companies. Holding companies, in general, exercise control over the group and also have the financial capacity – an important consideration for parties seeking financial remedies against corporate groups.
Involving group companies is a common practice in arbitration; group companies attempt to resist with the plea they are not signatories to arbitration agreements. Supreme Court in Chloro Controls (2013) ruled that group companies can be included in arbitration, when necessary or appropriate, even though they may not be parties to the arbitration agreements. Now almost 10 years later, the issue has been referred for reconsideration to a larger bench of 5 judges. Outcome is awaited. Hopefully, the “group companies” concept recognized in Chloro Controls (2013) will continue undisturbed by the larger bench. The group concept is valuable in promoting effective dispute resolution and greater corporate accountability, and eliminating technical defences that rely on form rather than substance.
IBC moratorium prevails over customs duty recovery proceedings
When a corporate debtor has the benefit of moratorium under the Insolvency & Bankruptcy Code, 2016 (IBC), customs authorities cannot sell the debtor’s imported cargo to recover duty arrears. Delivering this verdict in Sundaresh Bhatt v Central Board of Indirect Taxes & Customs,6 the Supreme Court affirmed the overriding effect of IBC.
Customs authorities attempted to acquire control of the imported goods stored in bonded warehouses on which customs duty had not been paid. Customs officials relied on the Customs Act, 1962 (section 72) and claimed ownership of the goods vested in the government because of the non-payment of duties and the goods can be sold to recover duty arrears. By this time, the debtor (ABG Shipyard Ltd) had been put into liquidation and the liquidator had taken control of its assets.
The Supreme Court held the procedure under IBC would equally govern the imported goods stored in the bonded warehouse; they could not be seized and sold by customs authorities through their powers under the Customs Act. With this ruling, the Supreme Court affirmed IBC trumps over tax legislation when taxpayers are undergoing IBC proceedings.
Insolvency proceedings maintainable for failure to pay intellectual property license fee
In Somesh Choudhary v Knight Riders Sports P Ltd,7 the National Company Law Appellate Tribunal (NCLAT) held that license fee for use of intellectual property represents operational debt. Failure to pay the license fee can be the basis for initiating insolvency proceedings against defaulting debtors.
Global Fragrances P Ltd acquired from Knight Riders Sports P Ltd exclusive right to use “KKR” trademark for its products including deodorants, hair gels, and perfumes. The license agreement provided for payment of Minimum Guaranteed Royalties (“MGR“) by Global Fragrances. Upon Global’s failure to pay, Knight Rider Sports initiated insolvency proceedings against Global. Resisting the proceeding, Global argued license fee for trademark was not operational debt because it was not directly connected with the manufacture of products by Global. This was rejected by the National Company Law Tribunal (NCLT).
On appeal, the Appellate Tribunal affirmed NCLT’s order. NCLAT rejected Global’s reliance on an earlier ruling delivered in 2020 in M Ravindranath Reddy v G Kishan,8 pointing out it had been since been overturned. By doing so, NCLAT affirmed license fee for intellectual property represents operational debt and failure to pay can give rise to insolvency proceedings.
Anti-Corruption Bureau quashed, Karnataka Lokayukta powers restored
In a significant decision in Chidananda Urs v State of Karnataka,9 the Karnataka High Court quashed the constitution of the Anti-Corruption Bureau (ACB) in 2016 and the related transfer of jurisdiction over corruption cases from the Karnataka Lokayukta to ACB. The ruling found both procedural and substantive deficiencies in the creation of ACB and in stripping the Lokayukta of its jurisdiction.
In 2016, the government of Karnataka issued an executive order to create the Anti-Corruption Bureau, which would function under the state Chief Minister’s control. Logically, the government also stripped the Lokayukta of most of its functions. These moves aimed to transfer jurisdiction to investigate and prosecute corruption cases from the Lokayukta, an independent agency created under the Karnataka Lokayukta Act, 1984 and charged with the responsibility to detect corruption in government and initiate action against the persons involved.
ACB, on the other hand, was created by government order and meant to be under government control. The aspects vitiated ACB and were contrary to the Lokayukta Act. On these grounds, the Karnataka High Court quashed ACB and reinstated Lokayukta’s powers. The ruling is certainly welcome for the ongoing fight against political and administrative corruption.
******
VHVK Law Partners
#3 & #4 Lakeside Residency
4 Annaswamy Mudaliar Road
Bangalore 560 042 INDIA
www.vhvklaw.com
Ph: +91 80 2951 2353
VHVK Law Bulletin is issued for information purposes only and does not constitute legal advice. For more information on any of the material covered here and/or their implications for your situation, please obtain competent legal advice.