[Niharika Agarwal and Akshita Bhansali are 3rd year students at Gujarat National Law University]
In Educomp Infrastructure & School Management Limited v. Millennium Education Foundation (4 July 2023), the National Company Law Appellate Tribunal (“NCLAT”) held that an application filed under section 9 of the Insolvency and Bankruptcy Code, 2016 (“IBC”) is maintainable in case of a corporate debtor that is a non-profit company incorporated under section 8 of the Companies Act, 2013. This pivotal ruling consequently sanctions the commencement of the corporate insolvency resolution process (“CIRP”) against a section 8 company. The validity and implications of such an approach are aimed to be analysed in this post.
Background
One of the key issues in the case revolved around the determination of the maintainability of a CIRP against a non-profit company. The corporate debtor contended that the IBC should not apply to section 8 companies, who are unlikely to receive resolution applicants on account of their charitable nature. This would likely lead to their liquidation, defeating the intention of the IBC which is to promote the resolution of financially distressed entities as a going concern, thereby ensuring their viability rather than liquidation. However, while referring to section 3(7) of the IBC, the NCLAT clarified that the definition of a “corporate person” therein includes all companies as defined under section 2(20) of the Companies Act without considering the objective of the company as a distinguishing factor. Hence, section 8 companies would squarely fall within the ambit of the IBC, allowing for the initiation of CIRP. The tribunal’s position is however based on only a plain reading of the provisions and lacks an in-depth consideration of the intricacies surrounding section 8 companies and the implications of application of the IBC framework to them.
Complexities in Relation to Section 8 Companies
Section 8 of the Companies Act regulates companies dedicated to promoting commerce, art, science, and social welfare, amongst others, with a non-profit objective, in the form of a self- contained code within the broader framework of the Act. These companies have several special privileges distinct from all other companies, such as the capacity to include partnership firms as members, for enhancing the effectiveness of its charitable activities. Most importantly, while section 8 companies are given corporate structures, they are strictly prohibited from distributing dividends to their members, in furtherance of their non-profit objective.
Yet, it is crucial to recognize that section 8 companies, are meant to enjoy a legal standing equivalent to other companies registered under this Act as affirmed in Sha Hindumull Dalichand v. Madras Kirana Merchants Association. However, this is for all purposes beyond those explicitly addressed in section 8. This underscores the importance of understanding the legislative intent behind section 8 and its unique role in fostering altruistic endeavours and prescribing specialised laws for protection of the same.
Given this background, while section 8 companies may fit within the definition in section 2(20) of the Act, it is imperative to consider the difference in terms of treatment of assets and funds in section 8 when contemplating CIRP proceedings against them, instead of a sweeping application of the IBC to them.
Conflict between Section 8 and IBC
Section 8 of the Companies Act also explicitly provides for a procedure to be followed in the management of the assets and income of the company in case of winding up and amalgamation. Sections 8(8) and 8(10) of the Companies Act allow for amalgamation only with another company registered under the section and having similar objects. In the same vein, even in case of winding up under section 8(9) of the Companies Act, after the satisfaction of any debts or liabilities of the company, any remaining assets are either transferred to another section 8 company having similar objects or alternatively sold with proceeds being credited to the Insolvency and Bankruptcy Fund formed under section 224 of the IBC. These are exceptional provisions carved out specifically to protect the non-profit character of the assets of the company.
This diverges significantly from the standard treatment of a company’s assets under the IBC. In instances of CIRP, these assets are either transferred to the resolution applicant or liquidated, with the resulting proceeds being distributed among creditors and members in accordance with the resolution plan or through the established waterfall mechanism under section 53 of the IBC. This process not only violates the requirements of section 8 as provided above, but also the principle laid down in rule 22(4) of the Companies (Incorporation) Rules, 2014, which requires a declaration from the board of directors that:
“no portion of the income or property of the company has been or shall be paid or transferred directly or indirectly by way of dividend or bonus or otherwise to persons who are or have been members of the company or to any one or more of them or to any person claiming through any one or more of them”. [emphasis added]
The words ‘or otherwise’ are broad enough to restrict the indirect distribution of profit through issue of bonus shares, redemption of debentures on premium and sale of property below market value. It also effectively reduces as redundant the issue of preference shares as there is no direct or indirect distribution of profits or distribution of surplus assets in case of winding up to its members. Therefore, when read in light of the provisions of the IBC, a variance can be seen. The implementation of section 53 (g) and (h) of the IBC in the distribution of proceeds from the sale of assets liquidated, among preference and equity shareholders respectively, would amount to a violation of rule 22(4) of the Incorporation Rules.
Distinct Legislative Intent
Moreover, the argument that section 238 of the IBC, containing a non-obstante provision that gives supremacy to the IBC over the Companies Act and the Incorporation Rules, cannot be upheld. It is pertinent to note in this regard that even when amendments were made in the sections 270 and 271 providing a winding up process under the Companies Act to bring it into conformance with IBC, the provisions for winding up under section 8 of the companies legislation were retained. This is indicative of the legislative intent for the procedure under section 8 to stand even after bringing in the IBC.
This is especially noteworthy since an amendment to section 8(9) of the Act was made by Schedule XI of the IBC which replaced “Rehabilitation and Insolvency Fund” with the “Insolvency and Bankruptcy Fund”. This change signifies that it was the sole amendment considered essential to align the Companies Act with the newly enacted IBC. As a result, the procedure under section 8 of the Companies Act must be held to override the IBC in case of non-profit companies, despite the latter being a subsequent enactment.
Keeping in mind the distinctive characteristics of companies under section 8 and its treatment as a code in itself, section 8 must prevail as it specifically addresses processes for the special nature of the companies. This is notwithstanding the fact that IBC is a special legislation created for the purpose of insolvency, given that it prescribes a general insolvency process not moulded to the special needs of a section 8 company. Therefore, even the principle of lex specialis derogat legi generali, as explained in National Highway Authority of India v. Sayedabad Tea Company and Co., demands the protection of this specialised objective of section 8.
Additionally, the overall form of the IBC is based on the concept of “going concern”, i.e., to keep the corporate entity alive by protecting its business operations and value, rather than opting for liquidation. Herein primacy is afforded to the commercial wisdom of the committee of creditors in the CIRP as established in K. Sashidhar v. Indian Overseas Bank. This objective does not match with the essence of a section 8 company which operates primarily for non-commercial, non-profit objectives. Hence, apart from the recognized differences, the overarching framework might not adequately align with the objectives of a section 8 company, and it is probable that numerous implementation challenges will surface.
Conclusion
It can therefore be seen that the question of whether an insolvency petition under the IBC ought to be maintainable as against a section 8 company is not as straightforward as afforded by NCLAT in its order, with far more grave consequences and nuances that ought to have been explored. Beyond a technical and constrictive reading of section 3(7) of the IBC, an exploration of legislative intent, the nature of non-profit companies indicates that treatment of section 8 companies under IBC would result in incongruencies in implementation. It is, thus, argued that the appellate tribunal should have considered these issues in its ruling and that clarification in this behalf is necessary to properly address this question to avoid problems at every step of the CIRP and liquidation. Requisite exceptions should be duly carved out for section 8 companies within the IBC framework to ensure that the objective of the company is not defeated. This is especially in the currently mandated compliances for section 8 companies such as the requirement for government approval for amendment to memorandum or articles, publication of notice, distribution of proceeds of assets, which are in dissonance with the procedure in the IBC. In the meanwhile, insolvency of section 8 companies ought to be proceeded keeping in mind the tenets of section 8.
– Niharika Agarwal & Akshita Bhansali
The Tribunal is correct in its Order, because Section 8 Companies have to work hard to earn and spend the profit for its Social Objectives and not run on losses.
The order referred to in the piece is of the National Company Law Tribunal, not the appellate tribunal (NCLAT).