The NCLAT ruled that related party status does not impact the priority of claims in the liquidation distribution framework under Section 53 of the IBC.
The National Company Law Appellate Tribunal (NCLAT), Principal Bench led by Justice Ashok Bhushan (Chairperson) and Mr. Arun Baroka (Technical Member) reviewed an appeal and observed that Section 53 of the IBC does not distinguish between related and unrelated unsecured financial creditors in the distribution of liquidation proceeds, and the restriction under Section 21(2) on related parties pertains only to participation in the CoC, not their right to file claims or receive distributions under the liquidation framework.
The appeal before the NCLAT arose from a challenge by an Operational Creditor against the NCLT Mumbai’s order in IA No. 2382 of 2021, which had dismissed the appellant’s request to set aside the liquidator's decision dated 03.09.2021. The dispute centred on the priority distribution of assets in the liquidation process of Brand Connect Communications (India) Pvt. Ltd., which had entered CIRP on 27.03.2018, followed by a liquidation order on 28.01.2019. Both the appellant and the ex-director (Respondent No. 2) had submitted claims in the liquidation proceedings. The appellant sought priority over the financial creditor’s claim on the ground that the latter was a related party, which, according to the appellant, should alter the priority framework under Section 53 of the IBC.
The appellant argued that the financial creditor, being a related party, should be treated as an equity shareholder under Section 53(1)(h) of the IBC, thereby disqualifying it from receiving priority. The appellant relied on precedents, including J.R. Agro Industries v. Swadisht Oils and Arun Kumar Jagatramka v. Jindal Steel and Power Limited and Another, REEDLAW 2021 SC 03546, to support its claim that the debt of related parties should not be treated on par with unsecured financial creditors. However, the liquidator, supported by Respondent No. 2, contended that the latter had ceased to be a director long before the CIRP commencement on 01.10.2013, and therefore could not be classified as a related party. It was further argued that Section 53 provides equal treatment to all unsecured financial creditors, regardless of related party status, a position upheld by the Supreme Court in Swiss Ribbons Private Limited v. Union of India and Others, REEDLAW 2019 SC 01504.
The NCLAT upheld the NCLT’s findings, ruling that Section 53 of the IBC does not differentiate between related and unrelated financial creditors in the waterfall distribution mechanism. The tribunal noted that while Section 21(2) of the IBC restricts related parties from participating in the CoC, it does not bar them from filing claims under Regulation 18 of the IBBI (Liquidation Process) Regulations, 2016. The tribunal distinguished the appellant’s reliance on J.R. Agro Industries by clarifying that the cited precedent pertained to the approval of a resolution plan by the CoC, not liquidation proceedings governed by Section 53.
The NCLAT also dismissed the appellant's reliance on Arun Kumar Jagatramka v. Jindal Steel and Power Limited and Another, REEDLAW 2021 SC 03546, explaining that the Supreme Court’s ruling in that case addressed disqualifications under Section 29A for submitting resolution plans and did not concern the liquidation distribution mechanism. Citing Shailesh Sangani v. Joel Cardoso, the tribunal reiterated that advances by promoters or directors intended to support the company’s financial health constitute financial debt, even if they do not carry interest, as they reflect the time value of money. The tribunal also referenced M.K. Rajagopalan v. Dr. Periasamy Palani Gounder and Another, REEDLAW 2023 SC 05512, reaffirming that while related parties are excluded from the CoC, the CoC retains discretion over differential treatment of creditors under a resolution plan.
In conclusion, the NCLAT confirmed that the liquidator's decision to prioritize the financial creditor’s claim was in accordance with the statutory framework of Section 53 of the IBC. The appellant's claim for priority distribution was rejected, as the tribunal found no error in the adjudicating authority’s reasoning. The appeal was accordingly dismissed, affirming that the distribution of liquidation proceeds must strictly adhere to the prescribed waterfall mechanism under the IBC.
Dr. Atul Singh, Advocate represented the Appellant.
Ms. Honey Satpal, Mr. M.S. Bhardwaj and Mr. Yash Dhyani, Ms. Nandini Choudha, Advocates appeared for Respondent No. 2.
Mr. Yahya Batatawala, Advocate appeared for Respondent No. 1/Liquidator.
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