Can a Sole Proprietorship Initiate Insolvency Proceedings under the IBC?

[Sahithi Uppalapati is a III Year, B.A.LLB (Hons.) student at NALSAR University of Law, Hyderabad]

The recent decisions of various benches of the National Company Law Tribunal conflict on the issue of whether a sole proprietorship concern is covered under the term ‘person’ under section 3(23) of the Insolvency and Bankruptcy Code, 2016, which is determinative of who is  entitled to initiate a corporate insolvency process. This post highlights these various conflicting decisions and analyzes their validity and implications. 

Recently in R.G. Steels v. Berrys Auto Ancillaries (P) Ltd. [IB-722/ND/2019], the New Delhi Bench of the National Company Law Tribunal (NCLT) ruled that section 3(23) of the Insolvency and Bankruptcy Code, 2016 (IBC), which defines the term ‘person’, does not include a sole proprietorship concern within its ambit. It observed that it was prima facie evident that the operational creditor (M/s RG Steels) was a sole proprietorship concern, and hence was not entitled to approach the NCLT on its own. Coupled with the fact that there was a pre-existing dispute between the operational creditor and corporate debtor with regard to the amount of debt and rates thereon, the NCLT ruled that the petition was not maintainable. 

Prior to this decision, the same line of reasoning has been shared by the same Bench of the NCLT in Sai Kripa Associates v. K star Naturalle Resources Private Limited [CP-IB-1438/ND/2018], wherein it was observed that since the operational creditor was a sole proprietorship concern, the petition should have been filed in the name of its sole proprietor and not in the name of proprietorship concerned. Hence, the petition was dismissed. 

These two cases are in sharp contrast with the observations made by Kolkata Bench of the NCLT in Kishore and Company v. Sri Balaji Metallics (P.)Ltd. [CP(IB) No. 165/KB/2018]. In that case, the corporate debtor objected on the ground that the petition has been filed by a sole proprietorship concern. In response to this, the NCLT noted that the application filed by M/s. Kishore and Company, being represented by its sole proprietor, is legal and is maintainable. The objection regarding the maintainability raised on the side of the corporate debtor was found to be unsustainable.

These decisions raise concerns of whether a sole proprietorship concern can initiate insolvency proceedings under the IBC.

The legal Conundrum – Section 3(23) of the IBC

Section 5(23) of the IBC defines operational creditor as a “person” to whom an operational debt is owed and includes any person to whom such debt has been legally assigned or transferred. Section 3(23) of the IBC defines person as (a) an individual; (b) a Hindu Undivided Family; (c) a company; (d) a trust; (e) a partnership; (f) a limited liability partnership; and (g) any other entity established under a statute, and includes a person resident outside India. Since a sole proprietorship concern neither resembles the entities listed therein, nor is it an entity established under a statute, it is presumed to fall outside the definition of a person, and hence from that of a creditor. 

Validity of the Conflicting Interpretations

The difference in these interpretations supplied by various benches of the NCLT is matched with a variance in the legal position taken by other courts on whether a sole proprietorship concern is a legal entity.  In Svapn Constructions v. IDPL Employees Cooperative Group Housing Society Ltd. and Ors, the Delhi High Court held that a sole proprietorship is not entitled to file a suit under its own name as it is not a separate legal entity. Hence, it ruled that the petition should be filed by the sole proprietor in his name and on behalf of his sole proprietorship firm. On the other hand, in Devendra Surana v. Bank of Baroda, the Calcutta High Court observed that a natural person and his sole proprietorship firm do not enjoy the benefit of being treated as separate legal entities and are the same legal entity. Hence, it ruled that the liability of the sole proprietorship firm is that of the natural person carrying on business under its name. 

There is no clear position on the question whether a sole proprietorship concern is a legal entity or not. The answer to this question will determine whether a sole proprietorship concern can file a petition in its own name. 

Implications on Insolvency Resolution Process of Sole Proprietorship Concerns

Even if we accept the interpretation that a sole proprietorship concern is not a legal entity and hence cannot file a petition in its own name, can an exception be made under the IBC to admit petitions filed in the name of sole proprietorship concerns, considering its broad objects?

In Edelweiss Asset Reconstruction Company Ltd. v. Bharati Defence and Infrastructure Ltd. [2017 SCC OnLine NCLT 2060], the NCLT (Mumbai) observed that “the purpose and object of the Code is to straighten the credit system in the country and augment the growth of the growing country, if at all this Bench, for any reason, makes mole out of the mountain to dismiss petition despite the petition is otherwise furnished with all material as mandated, then we don’t know whether we do injustice to the corporate debtor or not but it is obvious the purpose and object of the Code would be knocked down and the cause of the country at large will get eclipsed.” 

It is no denial that this fresh reason for dismissing petitions under the IBC will give rise to troubling implications on the insolvency process for sole proprietorship concerns. Dismissing a petition on the sole basis that it should have been filed in the name of the sole proprietor himself, when rest of the requirements for the application are complied with, will fuel the delay in insolvency resolution of such businesses. This would amount to the court making a mountain out of a molehill and going against the purposes of the Code as observed in the above case. Micro, small and medium enterprises such as sole proprietorship concerns have a growing requirement of funds. A delay in recovering their debts will impose a considerable strain on their businesses. The favourable line of reasoning taken by the Kolkata bench of the NCLT that the application being filed under section 9 by a sole proprietorship concern is perfectly maintainable as it is being represented by its owner is yet to gain traction in various other courts. 

Sahithi Uppalapati

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2 comments

  • In AIR 2015 SC 901, the following relevant Paras are instructive:

    1. M/s. Bhagwati Vanaspati Traders, the appellant before us, is a proprietorship concern. Mr. B.K. Garg is its sole proprietor. On 28.4.1995, M/s. Bhagwati Vanaspati Traders purchased one, six years’ National Savings Certificate (hereinafter referred to as, NSC) bearing number 6NS/06DD 387742, by investing a sum of Rs.5,000/-. The above NSC was to mature on 28.4.2001. The maturity amount payable on 28.4.2001 was Rs.10,075/-.

    2. Since M/s. Bhagwati Vanaspati Traders was not paid the amount due on maturity, B.K. Garg made repeated visits to the office from where the NSC was purchased. He was informed, that an NSC could only be issued in the name of an individual, and that, the NSC taken in the name of M/s. Bhagwati Vanaspati Traders, was not valid. He was also informed, that the matter had been referred for advice to the Post Master General, Bareilly, and that, the question of payment of the maturity amount would be considered only after the receipt of inputs from Bareilly. Having waited for a substantial length of time, and realizing that no further action had been taken at the hands of the respondent, B.K. Garg visited the office of the Post Master General, Bareilly. At Bareilly he was informed, that the matter had been referred to the Director General (Post), Department of Posts, New Delhi, and that, he would have to await the decision of the Director General (Post). Having waited long enough, without any fruitful result, M/s. Bhagwati Vanaspati Traders preferred Complaint Case no. 513 of 2004 before the District Consumer Disputes Redressal Forum, Meerut (hereinafter referred to as, the District Forum). The District Forum, by its order dated 1.2.2007 accepted the claim of M/s. Bhagwati Vanaspati Traders, and accordingly, directed the respondent to pay the maturity amount of Rs.10,075/- with 12% interest, from the date of maturity till the date of payment. The respondent was additionally directed to pay, a sum of Rs.5,000/- as compensation, and also cost of Rs.2,000/-, to the appellant proprietorship concern.

    8. To overcome the mandate of rule 17 extracted hereinabove, as also, the decision rendered by this Court in Raja Prameeelamma case (supra), and the proposition of law declared in Arulmighu Dhandayadhapaniswamy Thirukoil case (supra), learned counsel for the appellant placed emphatic reliance on the decision of this Court in Ashok Transport Agency v. Awadhesh Kumar & another., (1998) 5 SCC 567. He invited our attention to the following observations recorded therein:-

    “6. A partnership firm differs from a proprietary concern owned by an individual. A partnership is governed by the provisions of the Indian Partnership Act, 1932. Though a partnership is not a juristic person but Order XXX Rule 1 CPC enables the partners of a partnership firm to sue or to be sued in the name of the firm. A proprietary concern is only the business name in which the proprietor of the business carries on the business. A suit by or against a proprietary concern is by or against the proprietor of the business. In the event of the death of the proprietor of a proprietary concern, it is the legal representatives of the proprietor who alone can sue or be sued in respect of the dealings of the proprietary business. The provisions of Rule 10 of Order XXX which make applicable the provisions of Order XXX to a proprietary concern, enable the proprietor of a proprietary business to be sued in the business names of his proprietary concern. The real party who is being sued is the proprietor of the said business. The said provision does not have the effect of converting the proprietary business into a partnership firm. The provisions of Rule 4 of Order XXX have no application to such a suit as by virtue of Order XXX Rule 10 the other provisions of Order XXX are applicable to a suit against the proprietor of proprietary business “insofar as the nature of such case permits”. This means that only those provisions of Order XXX can be made applicable to proprietary concern which can be so made applicable keeping in view the nature of the case.” (emphasis is ours) Based on the observations recorded in the aforesaid judgment, the second contention advanced by the learned counsel for the appellant was, that in sum and substance, a sole proprietorship concern allows the fictional use of a trade name on behalf of an individual. It was contended, that truthfully only one individual is the owner of a sole proprietorship concern. As such, according to learned counsel, the name of the sole proprietorship concern, can again be substituted with the name of the sole proprietor. If that is allowed, the NSC purchased by the appellant would strictly conform to the mandate of law. According to learned counsel, it makes no difference whether the individual’s name, or the proprietorship’s name is recorded while purchasing an NSC. It was pointed out, that if the respondent was not agreeable in accepting the trade name, the respondent ought to have corrected the NSC by substituting the name of M/s. Bhagwati Vanaspati Traders with that of its sole proprietor, namely, B.K. Garg.

    9. We find merit in the second contention advanced at the hands of the learned counsel for the appellant. It is indeed true, that the NSC was purchased in the name of M/s. Bhagwati Vanaspati Traders. It is also equally true, that M/s. Bhagwati Vanaspati Traders is a sole proprietorship concern of B.K. Garg, and as such, the irregularity committed while issuing the NSC in the name of M/s. Bhagwati Vanaspati Traders, could have easily been corrected by substituting the name of M/s. Bhagwati Vanaspati Traders with that of B.K. Garg. For, in a sole proprietorship concern an individual uses a fictional trade name, in place of his own name. The rigidity adopted by the authorities is clearly ununderstandable. The postal authorities having permitted M/s. Bhagwati Vanaspati Traders to purchase the NSC in the year 1995, could not have legitimately raised a challenge of irregularity after the maturity thereof in the year 2001, specially when the irregularity was curable. Legally, rule 17 of the Post Office Savings Bank General Rules, 1981, would apply only when an applicant is irreregularly allowed something more, than what is contemplated under a scheme. As for instance, if the scheme contemplates an interest of Y% and the certificate issued records the interest of Y+2% as payable on maturity, the certificate holder cannot be deprived of the interest as a whole, on account of the above irregularity. He can only be deprived of 2%, i.e., the excess amount, beyond the permissible interest, contemplated under the scheme. A certificate holder, would have an absolute right, in the above illustration, to claim interest at Y%, i.e., in consonance with the scheme, despite rule 17. Ordinarily, when the authorities have issued a certificate which they could not have issued, they cannot be allowed to enrich themselves, by retaining the deposit made. This may well be possible if the transaction is a sham or wholly illegal. Not so, if the irregularity is curable. In such circumstances, the postal authorities should devise means to regularize the irregularity, if possible.

    11. There was seriously no difficulty at all in the facts and circumstances of the present case, to regularize the defect pointed out, because M/s. Bhagwati Vanaspati Traders, is admittedly the sole proprietorship concern of B.K. Garg. The postal authorities should have solicited the change of the name in the NSC, through a representation by B.K. Garg himself. On receipt of such a representation, the alleged irregularity would have been cured, and the beneficiary of the deposit, would have legitimately reaped the fruits thereof. Rather than adopting the above simple course, the postal authorities chose to strictly and rigidly interpret the terms of the scheme. This resulted in the denial of the legitimate claims of the sole proprietor of the appellant concern, i.e., B.K. Garg, of the investment made by him. In the above view of the matter, we consider it just and appropriate, in exercise of our jurisdiction under Article 142 of the Constitution of India, to direct the Senior Superintendent of Post Offices, Meerut, to correct the NSC issued in the name of M/s. Bhagwati Vanaspati Traders, by substituting the appellant’s name, with that of B.K. Garg.

  • Section 3(23) of the IBC defines person as:
    Person INCLUDES
    an individual
    a Hindu Undivided Family
    A Company
    a Trust
    a partnership
    a Limited Liability Partnership; and
    and includes a person resident outside India

    A look at the definition specifies that it is an INCLUSIVE Definition and hence the categories mentioned in the definition are only illustrative and there can be others also which can be covered under the definition. Thus to restrict the definition to those categories which have been enumerated in the definition is not the correction interpretation of the law.

    In order to understand the correct import of the definition, it will be better to understand what the legislature intended by looking at the Notes and other papers associated with the preparation of the Code.

    At Para 6.1 of the Final Report of the Committee on BLRC lists down the following categories of person to whom the provision of the code shall apply:

    Para 6.1 Applicability of the Code

    The Committee considers the following categories of entities to whom the individual insolvency and bankruptcy provisions shall apply:

    Sole proprietorship where the legal personality of the proprietorship is not different from the individual who owns it
    Personal Guarantors
    Consumer Finance borrowers
    Student Loan Borrowers
    Credit Card borrowers
    Farmers
    Micro Finance Borrowers
    Partnership firms

    Thus sole proprietorships are covered under the IBC. If we look at the structure of the Code the word person has been defined only under Section 3(23) and hence if the intention of the framers of the Code was not include Sole Proprietorship under the definition of Person under Section 3(23) then they should not have mentioned that category under Para 6.1 of the Final Report covering such entities under the Part III of the Code – Individual and Partnerships Firms Insolvency and Bankruptcy.

    In view of the foregoing, it is respectfully submitted that the NCLT in its decision erred in coming to the conclusion that a sole proprietorship firm cannot initiate Insolvency Proceedings.

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