No Rights to File Section 7 Application When Debt Assignment is Illegal: NCLAT

No Rights to File Section 7 Application When Debt Assignment is Illegal: NCLAT

Introduction

The National Company Law Appellate Tribunal (NCLAT), New Delhi Bench, has held that when the assignment of debt is found to be illegal and unauthorized, the assignee loses its right to maintain an application under Section 7 of the Insolvency and Bankruptcy Code (IBC). Such an assignee cannot claim the status of a financial creditor.

Factual Background

Two appeals were filed against an order of the NCLT, New Delhi, which had admitted a Section 7 application filed by Respondent No.1. The appellants argued that the One Time Settlement (OTS) entered into by the Cooperative Bank with Respondent No.1 was based on an illegal and unauthorized debt assignment.

The Bombay High Court, in Writ Petition No. 11610 of 2022, had already recorded that the transfer of the loan account of the corporate debtor (Shaila Clubs) in favor of Respondent No.1 was unlawful.

Procedural Background

The NCLAT considered the findings of the Bombay High Court, which had:

• Declared the assignment unlawful.
• Recalled its earlier order approving a compromise based on such assignment.
• Observed that Respondent No.1 had no authority to accept the OTS letter issued by the Bank.

Contentions of the Parties

• Appellants’ Contention: The appellants argued that since the assignment was set aside, Respondent No.1 lost its locus standi to file a Section 7 application.
• Respondent’s Contention: Respondent No.1 contended that it had made payments to the Cooperative Bank on behalf of the corporate debtor, which constituted financial debt, thereby entitling it to maintain a Section 7 application.

Issues

1. Whether an assignee whose debt assignment is declared illegal can file a Section 7 application?

2. Whether payment made by Respondent No.1 to the Bank amounts to “financial debt” owed by the corporate debtor?

Reasoning and Analysis

The Bench of Justice Ashok Bhushan (Chairperson) and Mr. Barun Mitra (Technical Member) held:

• Since the Bombay High Court declared the assignment unlawful, Respondent No.1 cannot claim to be a financial creditor of the corporate debtor.
• To file an insolvency application for default of another financial creditor, the applicant must itself be a financial creditor. Respondent No.1 failed this test.
• Payments made by Respondent No.1 to the Bank were not disbursements to the corporate debtor but were made only to protect its possession of the club premises under a conducting agreement. These payments cannot be classified as “financial debt.”

Outcome

The NCLAT:

• Allowed the appeals, setting aside the NCLT’s admission order.
• Held that Respondent No.1 is not a financial creditor, and therefore, cannot maintain a Section 7 application.

Implications

This judgment reinforces that:

• Validity of debt assignment is crucial in establishing creditor rights under IBC.
• Applicants must clearly demonstrate their status as financial creditors to maintain a Section 7 application.
• Payments made for collateral purposes (such as protecting possession) cannot be construed as disbursement of financial debt.

In this case the appellant was represented by Mr. Arun Kathpalia Sr. Advocate with Mr. Ruby Singh Ahuja, Mr. Devang Kumar, Mr. Jappanpreet Hora, Ms. Diksha Gupta and Ms. Varsha, Advocates. Meanwhile the respondent was represented by Mr. Sandeep Bajaj, Mr. Vipul Gai and Ms. Saumya and Mr. Mayank Biyani, Advocate.