Balance Sheet as Valid Acknowledgement of Debts: Flawed Reasoning to a Judicious Conclusion?

[Malika Tiwari is a 4^th year B.Com., LL.B. (Hons.) student at Institute of Law, Nirma University, Ahmedabad]

Section 18 of the Limitation Act, 1963 (“the Act”) provides for the admission of debts owed by a debtor to its creditor by providing a written acknowledgement, duly signed by him or his authorised agent. Such an acknowledgement marks the commencement of a fresh period of limitation for the creditor for making an enforceable claim seeking repayment of the debts due from the debtor. The consideration of balance sheets of a company as valid “acknowledgement of debts” for the purposes of section 18 of the Act has long been in question for deciding matters under the Insolvency and Bankruptcy Code, 2016 (“the Code”). The Supreme Court recently decided this issue in Asset Reconstruction Company (India) Limited v. Bishal Jaiswal. It upheld the consideration of balance sheets as a valid acknowledgment of debts while setting aside the order of the National Company Law Appellate Tribunal (“NCLAT”) in V. Padmakumar v. SAFS.

This post seeks to examine the Bishal Jaiswal ruling in detail and to lay down the flaws inherent in the reasoning adopted by the Supreme Court in light of the idea and objective of section 18 of the Act.

Examining the Bishal Jaiswal Ruling

The factual matrix in Bishal Jaiswal pertained to the non-payment of debts owed by Corporate Power Ltd. (“the Corporate Debtor”) to ARC (India) Ltd. (“the ARC”). The ARC claimed that the balance sheets of the Corporate Debtor are a valid periodical acknowledgment of its debts, and the mere fact that the filing of balance sheets is a mandate under the law does not vitiate this position. The said contention was duly accepted by the NCLT. However, on reference, the issue was refused to be addressed by the five-member bench of the NCLAT.

The Corporate Debtor contended that the ARC is bringing forth a dead claim before the tribunal, for the limitation period of three years had already passed since the declaration of its account as a non-performing asset. It referred to the case of Vijayalakshmi v. Hari Hara Ginning and Pressing that held that an acknowledgment under the Act follows only from the clear intention of accepting the debts and of extending the limitation period, which cannot be assumed from mere entries of the balance sheets. Further, it also referred to the case of A.C. Bagchi v. Harishpur Tea Company wherein the Gauhati High Court highlighted the need to prove the entries of the balance sheet with the help of additional evidence, stating that such entries alone are insufficient to establish the existence of a debt.

The Supreme Court observed that the consideration of balance sheets as a valid acknowledgment of debts for the purposes of the Act cannot be refuted. The same was supported by relying on the case of Mahabir Cold Storage v. CIT, wherein it was held that since the registers of a company constitute prima facie evidences,the balance sheet does tantamount to be a valid acknowledgment of debt. Further, reliance was also placed on the case of A.V. Murthy v. B.S. Nagabasavann, which adopted the same position with regard to the dishonor of cheques under section 138 of the Negotiable Instruments Act, 1881, stating that a fresh period of limitation may begin when a debt is shown in the duly signed balance sheet of the debtor.

Finally, the Supreme Court referred to the judgment of Calcutta High Court in Bengal Silk Mills Co. v. Ismail Golam Hossain Ariff. Accordingly, it held that although the filing of balance sheets is a mandate under the Companies Act, 2013, the same does not necessarily result in acknowledgment of debts. It reasoned that the annexed notes and the auditors’ reports, both of which are to be read with the balance sheets, can clearly state with reasons that a particular entry in the balance sheet does not constitute an acknowledgment of debt. Therefore, the status of balance sheets as valid acknowledgment of debts needs to be examined depending upon the facts of each case while considering the mention of such non-acknowledging statements in the annexed notes or the auditor’s report.

Analysing the Flawed Reasoning Behind a Judicious Conclusion

The ruling in the Bishal Jaiswal is tainted with certain legal blemishes. Although the conclusion of the judgment to the effect that the factual matrix of different matters should be given due consideration for deciding the validity of balance sheets as acknowledgments is completely apposite for the issue, the intermediate holding of the Court undermines the very spirit of the limitation law.

As pointed out by the Court, yearly filing of financial statements by a company is not a choice. Instead, it is a mandate provided under the Companies Act, 2013. Further, non-filing of the copy of the balance sheet with the Registrar attracts penalty under section 137(3) of the Companies Act. This evinces that the acceptance of entries in balance sheets as valid acknowledgment of debts culminates in such acknowledgment being an obligation for the debtor to be made on a yearly basis, unless the contrary is mentioned in the annexed notes or the auditor’s report. Notably, the objective of the Limitation Act is not to obligate the parties to make acknowledgments or to consider the obligations of the parties as acknowledgments. Rather, it emphasises on the discretionary actions of the debtors of making such acknowledgments. Correlatively, the objective of making balance sheets is not to acknowledge debts for the purposes of the Act, but to strike a balance in accounts and reflect the financial position of the companies.[1] The requirement of the director’s signature on balance sheets is a statutory duty, and hence, does not provide a discretionary option to the debtor of acknowledging its debts. Thus, a balance sheet cannot be termed as valid acknowledgment for the purposes of the Act for the mere reason that it is duly signed by the director of the debtor.[2]

Interestingly, one might argue that since balance sheets portray the existence of a jural relationship between debtors and creditors and show the “true and fair view” of the financial affairs of a company, they cannot be refuted as valid acknowledgments of its debts. However, it is pertinent to note that such acknowledgments constitute admissions of debt merely for the purposes of the Companies Act and, being obligatory for the parties, are not consistent with the idea of section 18 of the Limitation Law.

The 89^th Law Commission Report observed that the Act is interwoven with the principles of justice and convenience. It stated that the purpose of the Act is to ensure that creditors do not get to sleep on their rights and that debtors do not live under the threat of possible action against them for an indeterminate period. Further, the evidentiary value of balance sheet entries under the Indian Evidence Act, 1872, is subject to limitation under the Act. However, the acceptance of financial statements as a valid acknowledgment of debts renders all these caveats of limitation law futile, for it will result in the indefinite continuation of the period of limitation until the liquidation or winding up of the debtors. In other words, this indicates that there will be no effective period of limitation for invoking claims concerning the liabilities specified in the balance sheets of debtors. Such a scenario will provide undue advantage to the creditors, and at the same time, will be highly detrimental for the debtors.  It is true the said disastrous ramification can be prevented by making non-acknowledging statements in annexed notes and auditor’s report. However, the idea of section 18 lies in expressly or impliedly acknowledging the debts to extend the limitation period, and not in making non-acknowledging statements to avoid such extension. The rule of statutory interpretation, which states that the Court should give effect to the legislative intent clearly manifest in a provision, and should not try to amend it under the garb of interpretation should be appreciated in this context.

Moreover, the Calcutta High Court has held in the matter of Pandam Tea Co. Ltd. v. Unknown that balance sheets must always be considered with the Director’s Report to find out the true meaning and purport it holds. It further observed that where a statement is made without intending to admit the existence of a jural relationship between the debtor and creditor, such intention should not be fastened to the said statement by a far-fetched reasoning. Therefore, the Court emphasised the need to determine the true intention behind a particular document before marking it as a valid acknowledgment of debt. Adopting the position that the said need is fulfilled in the absence of non-acknowledging statements in the annexed notes or the auditors’ reports, as is suggested by the Bishal Jaiswal judgment, will be an unfair imposition on the debtors. Clearly, the entries in balance sheets cannot be supplied the far-fetched meaning of being acknowledgment of debts, unless such acknowledgment is out-rightly manifested in them.

Also, accepting the present judgment of the Supreme Court will instigate the companies to unequivocally mention in the notes to accounts and Director’s Reports accompanying all the future balance sheets that the entries therein do not constitute valid acknowledgment of debts. Further, it will place all the existing debtors at a disadvantageous position, for they might not have given non-acknowledging statements with their previous balance sheets considering the absence of the harsh consequences ensuing from the present ruling. This will create a divide between the treatment of past balance sheets and that of future balance sheets. Clearly, the ambit of section 18 of the Act cannot be inordinately widened to include balance sheets as valid acknowledgments, particularly when such inclusion gives rise to legal anomalies as aforesaid.

Conclusion

The conclusion of the Supreme Court ruling that balance sheets cannot be completely disregarded as valid acknowledgment, and that cases are to be decided in light of their peculiar facts and circumstances, is logical and well-founded. However, the reasoning behind the same is flawed, given the objective of the Limitation Law and that of preparing a balance sheet. The existence of a jural relationship between a debtor and a creditor, and hence, a valid acknowledgment of debt for extending the limitation period, cannot be derived from the mere fact that the notes annexed to the balance sheet or the auditor’s report does not mention any non-acknowledging statements. Henceforth, the correct position of law would be to not consider balance sheets as prima facie valid acknowledgment of debts. Rather, the Court should examine the surrounding circumstances including whether the Director’s Report, Auditor’s Report or notes to accounts expressly mention that these entries constitute such valid acknowledgment, or whether the debtor and the creditor have entered into an agreement to the effect that the balance sheet entries of the former will constitute such acknowledgment for the purposes of the Act. Adopting this position will effectively address the instant issue of acknowledgment of debts under the IBC matters while also upholding the inherent spirit of the Law of Limitation.

– Malika Tiwari

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[1] B.B Mitra, The Limitation Act, 1963 (M.R. Mullick ed, Eastern Law House, 19th ed. 1994).

[2] Id.