Section 65 penalty set aside by NCLAT in a recent insolvency case under IBC

Section 65 penalty set aside by NCLAT in a recent insolvency case under IBC

Insolvency proceedings rejected by NCLAT due to default amount falling below statutory threshold

In a significant ruling, the National Company Law Appellate Tribunal has upheld the decision of the Indore Bench of the National Company Law Tribunal to reject a Section 7 application, which was filed by Tanay Securities & Services Pvt Ltd., a financial creditor, under the Insolvency and Bankruptcy Code, 2016. The NCLAT also set aside the penalty imposed on the appellants under Section 65 of the IBC. This judgment offers valuable insights into the interpretation of the statutory thresholds for initiating insolvency proceedings and the conditions under which penalties under Section 65 can be imposed.

Background of the Case

Tanay Securities & Services Pvt Ltd. filed a Section 7 application before the NCLT, seeking the initiation of corporate insolvency resolution proceedings against a corporate debtor for defaulting on a financial debt of Rs. 4.08 crore. The financial creditor contended that the corporate debtor had failed to make repayments, and therefore, insolvency proceedings should be initiated.

However, upon scrutiny, the NCLT discovered that the corporate debtor had already repaid a significant portion of the debt, leaving a disputed balance of Rs. 19.19 lakh, which was below the statutory threshold of Rs. 1 crore for initiating insolvency proceedings under Section 4(1) of the IBC. Consequently, the NCLT rejected the application and imposed a penalty under Section 65 of the IBC, reasoning that the petition was not maintainable. The financial creditor then appealed to the NCLAT, which examined the legality of both the rejection of the Section 7 application and the imposition of a penalty.

Section 7 Application and the Threshold of Rs. 1 Crore

The NCLAT's primary consideration was whether the statutory requirements for filing a Section 7 application were met. Section 7 of the IBC allows financial creditors to file applications to initiate CIRP if the debtor has defaulted on a financial debt. However, Section 4(1) of the IBC sets a threshold, stating that the default amount must exceed Rs. 1 crore for insolvency proceedings to be initiated.

In this case, the NCLT had noted that while the total claim amounted to Rs. 4.08 crore, the debtor had repaid most of the sum, leaving only Rs. 19.19 lakh in dispute. Since this remaining amount was below the Rs. 1 crore threshold, the NCLT concluded that the Section 7 application could not be entertained.

The NCLAT agreed with the NCLT’s finding, emphasizing that the statutory criteria for debt and default under the IBC were not satisfied in this instance. Therefore, the rejection of the Section 7 application was upheld.

Imposition of Penalty under Section 65 of the IBC

The NCLT had also imposed a penalty under Section 65 of the IBC, which allows the tribunal to penalize applicants who file insolvency petitions with malicious intent, for an ulterior motive, or with an intent to defraud creditors. Section 65 ensures that the insolvency process is not misused by creditors for improper purposes.

The appellants, in their defence, argued that the application was filed in good faith, as there was a genuine dispute regarding the unpaid balance, and there was no malicious intent in filing the petition. They asserted that the NCLT’s own acknowledgment of the debt’s existence further supported their claim of bona fide intention.

On the other hand, the respondent countered that the application was filed by the shareholders and co-promoters of the corporate debtor, suggesting that the petition was initiated for reasons other than insolvency, such as internal disputes. The respondent contended that the imposition of a penalty was justified, given the lack of merit in the application.

The NCLAT, after considering both arguments, concluded that while the application had been rejected due to the failure to meet the threshold requirement, there was no evidence of fraudulent or malicious intent on the part of the appellants. The tribunal highlighted that the dispute involved a relatively minor amount, and no improper purpose was evident in the filing of the petition.

As a result, the NCLAT set aside the penalty imposed under Section 65, holding that the appellants had not misused the insolvency process and that the imposition of a penalty was unwarranted in this case.

Legal Implications

This judgment reinforces the importance of adhering to the statutory thresholds under the Insolvency and Bankruptcy Code. It clarifies that applications under Section 7 must meet both the conditions of "debt" and "default" exceeding Rs. 1 crore for insolvency proceedings to be initiated. Moreover, it highlights that penalties under Section 65 should only be imposed in cases where there is clear evidence of malicious intent or misuse of the insolvency process, which was not established in this case.

The NCLAT’s ruling is a reminder of the need for financial creditors to carefully assess the merits of their claims before approaching the tribunal and the significance of the statutory limits under the IBC in maintaining the integrity of the insolvency framework. The decision also serves as a safeguard against the misuse of the insolvency process for purposes other than the resolution of genuine financial distress.

While the NCLAT upheld the rejection of the Section 7 application, it rightly set aside the penalty, underscoring the principle that insolvency proceedings should be initiated in good faith, in accordance with the law, and without any ulterior motives.