Issue 24 Full Page

Insights

No Limited Liability = R.I.P Entrepreneurship

Insights – No Limited Liability = R.I.P Entrepreneurship

The latest

In July, 2017 a bankruptcy court ruled that a promoter cannot escape liquidation of her personal assets by simply filing for bankruptcy. This ruling has opened up a Pandora’s Box for the professionals and entrepreneurs alike.

Facts of the case

In the said case, Schweitzer Systemtek India Private Limited voluntarily filed the bankruptcy petition after it defaulted on a loan of Rs. 4.5 crores given by Dhanlaxmi Bank.

The loan had been taken by Schweitzer Systemtek India Private Limited from Dhanlaxmi Bank and the Promoter had pledged her personal properties. The Bank had then assigned the loan and the security to Asset Reconstruction Company – Phoenix ARC. The petition in NCLT Mumbai was filed by Phoenix ARC as a creditor against Schweitzer Systemtek India (Corporate Debtor).

Contention of Parties

Schweitzer India (Corporate debtor) contended that once the application was “admitted” u/s 10 of the IBC, 2016, then, the moratorium period commenced wherein no action could be taken against the corporate debtor. Till the insolvency resolution process is completed, no assets or properties could be taken possession of or sold by the creditor(s).

On the other hand, the Phoenix ARC (Creditor) contended that Schweitzer India’s action to prohibit the creditor from taking over possession of assets was with malafide intention suggesting possible misuse of the moratorium period provided under the insolvency resolution process.

MORATORIUM UNDER IBC, 2016

A 180 – 270 day period from the date of insolvency commencement. During this, there is a prohibition on instituting any legal suit or proceeding or sale or disposal of assets or lien on the assets of the corporate debtor.

Insights – No Limited Liability = R.I.P Entrepreneurship

Order of the Tribunal

The NCLT, Mumbai while finding the case as being fit for being “admitted” u/s 10 of the Insolvency & Bankruptcy Code, 2016 also noted that the moratorium period under the insolvency resolution process was intended to be used as an effective tool in insolvency resolution. The tribunal further noted that there have been instances of it being misused by the corporate debtor to thwart the recovery proceedings.

But the most important question that was decided in this case – Whether properties /assets not owned by the Corporate Debtor (but are personal properties of the Promoters) shall come within the ambit of the moratorium period where they cannot be sold or disposed of to recover dues?

The Tribunal decided on the basis of plain reading of Section 14 of the IBC, 2016 that moratorium shall be declared to prohibit any action to recover or enforce any security by the corporate debtor in respect of ‘its’ property.

Simply put, the “no action on assets or properties” during the moratorium will apply only for asset/properties owned in the name of the corporate debtor companies. Personal properties of the promoters will not fall under the ambit of moratorium.

The NCLT order in Schweitzer India case has expressly made it possible for creditors (instead of waiting for the six-month waiting period) to go ahead and sell the promoter’s personal property, which was pledged with the banks.

Insights – No Limited Liability = R.I.P Entrepreneurship

Merit of the case VS Spirit of the Law?

This case is touted to have far reaching impact on not only other similar cases pending in various benches of NCLT, but also impacts the psyche of the entrepreneur who seeks to start a company and scale up operations.

Though legal professionals are of the view that the order of the NCLT is entirely based on the merits of the case and strict interpretation of the insolvency resolution provisions, the larger issue of the spirit of the insolvency resolution process being followed, especially when voluntary IRP petition is filed seems to have been overlooked.

Many promoters, who are facing proceedings in the NCLT Bench, are staring at property /asset losses even before the stipulated period expiry of the moratorium period. Attaching the personal assets of a promoter is a violation of the basic principle of limited liability based on which entities like limited liability companies and Partnership firms. Only entities such as “One person companies” have the concept of limited liability wherein only the equity of the promoter is at risk. This stifles entrepreneurial and risks taking ability of individuals.

Insights – No Limited Liability = R.I.P Entrepreneurship

The way ahead

Limited liability is a double edged sword – while the liability is limited only to the extent of shares or stakes held by the promoters in the startup companies, there have been cases where it has been misused to the advantage of the promoters. As it is, the concept of limited liability has several exceptions as contained in the statute itself be it the Companies Act and the Income Tax Act; and also by the judicial pronouncements.

Creators of Legal statutes and precedents have the onerous task of ensuring the legislations are created with a fine balance in such a way that the concept of limited liability is optimally used.

Banks insist on creating personal guarantees thereby holding leash on the Promoters to ensure they take responsibility of the repayment. Further, they have been directed to devise appropriate loan recovery mechanism based on the reasonable satisfaction of lenders claims. Till such time, the Promoters will have to take the brunt of the loan recovery process, especially where their personal assets are pledged.

Source:
Schweitzer Systemtek India Private Limited Vs Phoenix ARC, NCLT Mumbai
TCP/1059/397-398/CLB/MB/MAH/2016