[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