(First published on Linkedin)
In a recent case, the NCLT dismissed an IBC application for corporate insolvency, ruling that the financial debt was unenforceable due to the absence of a special resolution u/s 186. Similarly, in other cases, the NCLT had reinforced this stance by rejecting a debt for exceeding the limits set by Section 186.
Section 186 of the Companies Act, 2013 restricts companies from extending loans, guarantees, or acquiring securities beyond prescribed limits without a special resolution passed by shareholders.
The doctrine of indoor management has traditionally protected outsiders dealing with companies from internal irregularities. But what happens when this doctrine intersects with the strict requirements of Section 186 of the Companies Act in the context of insolvency proceedings under the IBC and such debt is invalidated? What are the larger ramifications under other laws?
Certain Illustrative Absurdities if Debt is invalidated:
1. Tax Implications: If a financial debt is invalidated due to non-compliance with Section 186, would it mean that the interest payments on such debt is liable to be disallowed as deductions for the corporate debtor? Would it also mean that there cannot be an “interest income” in the hands of the creditor, if such debt is rendered ultra vires?
2. SEBI Regulations: In cases of optionally convertible debentures, would it mean that the corporate debtor could prevent conversion into equity shares of such invalidated convertible debt?
3. FEMA Compliance: If the debt in question was an External Commercial Borrowing (ECB) compliant with FEMA, would it mean that such invalidation will render compliance under FEMA otiose, and therefore, corporate debtor be liable to penal consequences?
4. Recasting Accounts: Would it also mean that the any concerned person or regulator could petition the NCLT for the corporate debtor’s financial statements to be re-cast under section 130 of the Companies Act, 2013 on the basis of such invalidated debt?
5. End-Use Restrictions: End-use restrictions on debt are often imposed to ensure funds are used for specific purposes. So, would it mean that the corporate debtor is free to use the funds without any end use restrictions if a debt is invalidated?
Taking the NCLT’s interpretation that non-compliance with Section 186 can invalidate a financial debt leads to a cascade of unintended ramifications. Such a stance threatens to create a legal quagmire where the stability of financial agreements is undermined, and absurd situations arise. As NCLT navigates the complexities of insolvency law, it is crucial to strike a balance between compliance and practicality. The potential for these absurdities calls for a reassessment of how the intersection of corporate law and the IBC are carefully navigated by the NCLT.