[Opinion] Admissibility of a Loan in IBC in Case of Violation of 186 of the Companies Act 2013

CS Vallabh M Joshi & Esha Tandon – [2024] 167 taxmann.com 758 (Article)

Introduction

The provisions of section 186 of the Companies Act, 2013(Act) state that a Company cannot give a loan to any person or body corporate exceeding 60% of its paid-up share capital, free reserves, and securities premium account, or 100% of its free reserves and securities premium account, whichever is more unless a special resolution has been passed at a general meeting. The challenge arises when a company, being a Financial Creditor (FC) or a Corporate Debtor (CD) under the Insolvency and Bankruptcy Code, 2016 (IBC), breaches this limit without the mandated special resolution.

Questions for Consideration

I. Whether the violation of section 186 of the Act prohibits an FC from invoking IBC against a CD (u/7 of IBC) despite having an established debt and default.

II. Alternatively, can the CD rely on non-compliance with section 186 of the Act as a shield against insolvency?

This article refers orders where the Tribunals have adopted two approaches while determining the admissibility of section 7 of IBC application despite existence of debt and establishment of default.

Analysis of the Law

A. Debt not in accordance with provisions of applicable law is not legally enforceable debt: In the matter of UKG Steels Private Limited v. Exotic Buildcon Private Limited, UKG Steels Private Limited (FC) extended an inter-corporate loan to the Exotic Buildcon Private Limited, the CD that exceeded 60% of the aggregate of its paid-up share capital and free reserves, as per its balance sheet. The FC neither made the disclosure of such an inter-corporate loan in its balance sheet nor was it able to submit a special resolution passed at the Extra-Ordinary General Meeting (EOGM) u/s 186 (3) of the Act. The loan agreement also did not mention the resolution passed by shareholders. FC filed a section 7 application under IBC against the CD.

HON’ABLE NCLT dismissed the application u/s 7 of IBC and stated that the loan given by FC was ultra vires and the loan advanced was not a legally enforceable debt. HON’ABLE NCLT further held that a loan given contrary to the limit prescribed under Section 186 of the Companies Act 2013 is an ultra vires act and is not a legally enforceable debt. CD, enjoying the benefits of an FC’s transgression, lacks standing to contest the breach and its ramifications.

Similarly, in the matter of Jambudwip Exports and Imports Limited v. UP Bone Mills Private Limited. Jambudwip Exports and Imports Limited (FC/lender) initially provided funds as an advance for goods. Subsequently, the said advance was converted into an inter corporate loan by executing a Memorandum of Understanding (MOU). This amount exceeded the limit prescribed under section 186(2) of the Act, and the FC failed to obtain prior approval through a special resolution at a general meeting. Consequently, the HON’ABLE NCLT New Delhi dismissed the FC’s petition, deeming the debt as unenforceable.

In a more recent matter of Proplarity Infratech Private Limited v. Sky High Technobuid Private Limited. The principal bench of HON’BLE NCLT, Delhi (now pending appeal) adopted a similar view. It was alleged by Sky High Technobuild Private Limited, the CD (borrower), that Proplarity Infratech Private Limited, the FC (lender company), had extended the purported loan in excess of the limits set by section 186 without obtaining the necessary shareholder approval. HON’ABLE NCLT ruled that in view of non-compliance with section 186 of the Act, granting of such a loan was an ultra vires act and, therefore, not a legally enforceable debt.

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