Abstract

On 15th April 2021, a three-judge bench of the Supreme Court pronounced their judgment on the question of whether an entry in the balance sheet of a company could have the effect of extending the limitation period for initiating proceedings under the Insolvency and Bankruptcy Code, 2016 (“IBC”). The Supreme Court answered this question in the affirmative and clarified at length the correct legal position in this regard. This article attempts to analyse the import of the judgement on the rights available to the creditors who are more often than not unaware of their rights with respect to the treatment of liability in the books of a company. The article also attempts to clear the understanding with respect to entries made in the balance sheet of a company in light of this judgement wherein it is held that while preparing of a balance sheet is a statutory requirement, acknowledgement of a liability therein is not.  

Introduction

On 17th August 2020, the Central Government notified the Insolvency and Bankruptcy Code (Second Amendment) Act, 2018 which introduced Section 238A into the IBC.[1] Section 238A was inserted into the IBC with an intention of making applicable the provisions of the Limitation Act, 1963 (“Limitation Act”) to the proceedings under the IBC.  Section 238A was to ensure that the IBC is not used to give time barred debts a ‘second lease of life’.[2] Given the procedural and clarificatory nature of the Section, the Courts have held that the Section would have a retrospective application.[3]

Over the past few years, the interaction between the provisions of the IBC and the Limitation Act, 1963 resulting from Section 238A has given rise to several intriguing questions of law. One such question is whether an entry into the Balance Sheet of the Company could be treated as an ‘acknowledgement in writing’ for the purposes of Section 18 of the Limitation Act. The Supreme Court answered this question in the affirmative in its judgement in Asset Reconstruction Company v. Bishal Jaiswal and Anr [4] and held that by operation of Section 18, that unless adequately caveated in the books of the company, an entry in the balance sheet can amount to an acknowledgement of debt in writing which would start a fresh limitation period for initiating proceedings under the IBC. The present article analyses the dicta of the Supreme Court and explains significance of the judgement for corporate debtors and creditors.

 Application of Section 18 of the Limitation Act

Before analyzing and understanding the dicta of the Supreme Court, one must bear in mind the basic requirements and nuances of Section 18 of the Limitation Act. Section 18 of the Limitation Act is reproduced below:

“18. Effect of acknowledgment in writing.—(1) Where, before the expiration of the prescribed period for a suit or application in respect of any property or right, an acknowledgment of liability in respect of such property or right has been made in writing signed by the party against whom such property or right is claimed, or by any person through whom he derives his title or liability, a fresh period of limitation shall be computed from the time when the acknowledgment was so signed

                       ………..”

The following pointers summarize in a nutshell the law w.r.t. Section 18.

>  Section 18 of the Limitation Act states that an acknowledgement in writing by a party of a subsisting liability or right has the effect of starting a fresh limitation period from the date on which the acknowledgement was signed for filing an action.[5] Such an acknowledgement does not create a fresh cause of action but merely renews or extends the existing cause of action.[6]

> In order to claim the benefit of the Section, a party  has to show that following requirements have been fulfilled:

A. There must be an acknowledgement of liability in respect of property or right;

B. The acknowledgement must be in writing signed by the party against whom such right or property is claimed (or by any person through whom he derives his title or liability; and

C. The acknowledgement must be made before the expiration of the period prescribed for a suit or application (other than application for the execution of a decree) in respect of such property or right.[7]

>  For Section 18 to apply, the acknowledgement need not be accompanied with a promise to pay and can be express or implied. The only requirement is that the acknowledgement must indicate the existence of a jural relationship.[8]

Pre-existing law on the application of Section 18 to entries in balance sheets and books of accounts

The Supreme Court[9] as well as various High Courts[10]  have held that an entry in the balance sheet of a company was capable of extending the limitation period notwithstanding the fact that the balance sheet was not addressed to the creditor and was prepared under the compulsion of the law.[11] These cases, however, did not involve proceedings initiated under the IBC.

Observations of the National Company Law Appellate Tribunal on this point

In V. Padmakumar v. Stressed Assets Stabilisation fund (“V. Padmakumar”)[12], the National Company Law Appellate Tribunal (“NCLAT”) had previously held, by a majority of 4:1 (Justice A.I.S Cheema delivered a dissenting judgement), that an entry in the balance sheet of the company would not have the effect of renewing the limitation period.[13] The NCLAT stated that since the balance sheet was prepared under compulsion of a statute, it could not be treated as an acknowledgement. Subsequently, a three judge bench of NCLAT in Bishal Jaiswal v. Asset Reconstruction Company[14] arrived at the conclusion that the judgement of the majority was directly contrary to the law laid down by the judgements of the Supreme Court and various High Courts on this point  and required reconsideration.[15] Since the judgement in V. Padmakumar was given by a larger bench of five judges, the same could not be overruled and the matter was referred to a larger bench.[16]  However, upon entering reference, the larger bench held that the three judge bench had no power to refer the matter to a larger bench and in essence reiterated the reasoning it adopted in the V. Padmakumar case.[17]

Problems with the approach of the NCLAT

The reasoning and conclusion of the NCLAT is difficult to accept and problematic for multiple reasons:

1. Firstly, the judgements passed by the NCLAT clearly ignored the law laid down by the Supreme Court on this point and incorrectly proceeded to hold that an entry in a balance sheet could not serve as an acknowledgement for the purposes of Section 18 of the Limitation Act.

2. Secondly, the requirement that the document constituting an acknowledgment must not be prepared in pursuance to a mandatory statutory duty is not found in the Section. The NCLAT had by its judgements effectively added an additional requirement for the invocation of Section 18 of the Limitation Act which is completely alien to the Section. The NCLAT being a judicial forum, cannot read into the statute, more onerous requirements than those already set out.

3. Thirdly, the NCLAT placed reliance on the judgement of the Supreme Court in Babulal Vardharji Gurjar v. Veer Gurjar Aluminium Industries Limited (P) Ltd. to hold that Section 18 does not apply to proceedings under the IBC. However, as clarified by the Apex Court in Laxmi Pat Surana v. Union Bank of India[18] the Court in Babulal Vardharji Gurjar did not completely rule out the application of Section 18 of the Limitation Act to applications under IBC. Further there is nothing in Section 238A of the IBC restricting the application of the Limitation Act to only Section 5 and Article 137.

4. Fourthly, the purpose of Section 238A was to ensure that time barred debts are not given a second lease of life. In other words, the purpose of the Section was to exclude claims which were lost as a result of acquiescence, laches or inaction by a party.[19] A party which did not bring an action but whose debt has been acknowledged by the Company in its Balance Sheet can hardly be treated or viewed as being at par with a party which has acquiesced or has given up its right to recover its dues.

5. As a result of the NCLAT’s judgement, financial and operational creditors could not initiate proceedings under the IBC despite their debt being acknowledged by the Corporate Debtor in its Balance Sheet. Litigants faced with a unique situation wherein an entry in a balance sheet would act as an acknowledgement for the purposes of a recovery under other legislations or through a civil suit but not for an application under Section 7 or Section 9 of the IBC. Therefore, for the same debt or liability, there were situations wherein even though the limitation period was extended for the purposes of a suit for recovery, it was not extended for the initiation of proceedings under the IBC.

Proceedings before the Supreme Court: 

The Judgement of the Supreme Court arose out of an appeal filed against the judgement by the five judge bench of the NCLAT in Bishal Jaiswal v. Asset Reconstruction Company. The Supreme Court disposed off the appeal along with other appeals which involved the same question of law.

Reasoning of the Supreme Court

The Supreme Court accepted the arguments advanced by the Appellant and overruled the judgement of the NCLAT in the V. Padmakumar case. The Supreme Court identified two questions which needs to be answered in the appeal:

1. Whether Section 18 of the Limitation Act was applicable to proceedings initiated under the IBC.

2. Whether an entry in the balance sheet amounts to an acknowledgment in writing?

The Supreme Court held that it was settled law that Section 18 of the Limitation Act was applicable to the proceedings under the IBC. The Court noted the use of the phrase “as far as may be” in Section 238A and held that there was nothing in Section 238A of the IBC to suggest that Section 18 cannot be applied to proceedings under the IBC.[20] To fortify their conclusion in this respect, the bench referred to two previous judgements pronounced by the Supreme Court wherein Section 18 had been applied to proceedings under the IBC. [21]

Statutory provisions re the Balance Sheet under the Companies Act, 2013

After confirming that Section 18 of the Limitation Act would be applicable to the proceedings under the IBC, the Supreme Court characterized the duty and purpose of the preparation and filing of the balance sheet. While the Court accepted that the preparation of the financial statements including the balance sheet and directors report was pursuant to a statutory duty under the Sections 92, 128, 129, 132, 134 and 137 of the Companies Act, 2013, it held that the same did not preclude the balance sheet from acting as an acknowledgement.[22]

The Supreme Court upheld the ratio of its previous judgements as well the judgements of the High Court wherein it was accepted that an entry in the balance sheet could be an acknowledgement in writing under Section 18 of the Limitation Act.[23] The Supreme Court, whilst affirming the dicta of the Calcutta High Court[24] and the Delhi High Court[25], held that simply because the balance sheet is prepared by the Corporate Debtor under the compulsion of a statutory duty under the Companies Act, 2013, the opposing party/creditor cannot be precluded from relying upon entries found thereto as an acknowledgement for the purposes of Section 18 of the Limitation Act. The Court explained that even though there is a compulsion to prepare a balance sheet under the law, there is no compulsion to make or include any particular entry in the balance sheet.[26]

Accordingly, the Supreme Court set aside the judgements of the NCLAT in V. Padmakumar and the case of Bishal Jaiswal v. Asset Reconstruction Company for failing to take note of the law laid down by the Supreme Court and the High Courts on this point.[27]

Caveat identified by the Supreme Court 

The Supreme Court has however refrained from laying down an absolute rule and has added a caveat to the application of Section 18 to entries in the balance sheet. It has held that every entry relating to a debt would not qualify as an acknowledgement for the purposes of Section 18 and that an entry must be  understood in the context which it occurs and in light of the notes annexed to the balance sheet.[28]

Current Legal Position  

In light of the reasoning of the Supreme Court, the law on the question of limitation can be summarized as follows:

1) The limitation period for filing an application under Section 7 or Section 9 of the IBC would be three years from the date on which the ‘default’[29] has occurred since the two Sections do not contemplate a ‘suit’ but rather an ‘application. Therefore by virtue of Article 137 of the Limitation Act, the limitation period for filing such an application would be three years from the date of the default.[30]

2) However, the three year period would restart if the debt has been acknowledged in the balance sheet of the company. The answer to the question whether a particular entry in the balance sheet qualifies as an acknowledgement or not depends on the facts and circumstances of the case and must be read with the notes annexed to the balance sheet.

Key take-aways for Corporate Debtors and Creditors:

There are two key take-aways from the judgement for creditors and corporate debtors:

1. Creditors must be vigilant and ensure that the corporate debtor includes an entry acknowledging its liability towards the Company. Further, a number of debts which may have been written off by in the books of the creditors on account of being time-barred may still be recoverable if the debt has been acknowledged in the books of the corporate debtor.

2. Corporate debtors and companies must be careful of the entries being made in their books of accounts and balance sheets in lieu of amounts of debt taken by them. In case of a disputed sum which the corporate debtor has no intention of admitting, the entries in the books of accounts and balance sheet must be accompanied with proper caveats.

Conclusion:

The interpretation and the reasoning adopted by the Supreme Court in its judgement is in line with the intent behind the introduction of Section 238A as well as the ratio of the pre-existing case law on this point. The judgement serves as a much needed clarification on this point of law and effectively sets at rest all the controversy and debate surrounding the judgements by the NCLAT. As a result, several financial and operational creditors, who were previously prevented by the judgements passed by the NCLAT from initiating proceedings under the IBC despite their debts being acknowledged in the balance sheets of the corporate debtor, can now initiate proceedings under the IBC by relying upon Section 18 of the Limitation Act. Finally, taking the import of the judgement, the companies while preparing their balance sheet should incorporate appropriate caveats/notes which highlight the contingent nature of the entry.

Authors:

Vatsala Rai, Counsel
Ravilochan Daliparthi, Associate

Footnotes:

[1] Section 34, Insolvency and Bankruptcy Code (Second Amendment) Act, 2018
[2] Report of the Insolvency Law Committee, March 2018 at pp. 72-73 [at paras 28.1 to 28.3] quoted with approval in B.K. Educational Services Private limited v. Parag Gupta and Associates, (2019) 11 SCC 63 at pp. 644-45 [at para 11] and Jignesh Shah v. Union of India, (2019) 10 SCC 750 at pp.760-761 [at para 8]
[3] B.K. Educational Services Private limited v. Parag Gupta and Associates, (2019) 11 SCC 63 at pp. 649-653 [at para 22]; Babulal Vardharji Gurjar v. Veer Gurjar Aluminium Industries Limited (P) Ltd., (2020) 15 SCC 1 at p. 42 [at para 26].
[4] 2021 SCConline SC 321.
[5] Food Corpn. of India v. Assam State Coop. Marketing & Consumer Federation Ltd., (2004) 12 SCC 360 at p.366 [at para 14 ].
[6] Khan Bahadur Shapoor fredoom Mazda v. Durga Prasad, (1962) 1 SCR 140 at pp. 144-145.
[7] State of Kerala v. T.M. Chacko, (2000) 9 SCC 722 at p. 725 [at para 8].
[8] Food Corpn. of India v. Assam State Coop. Marketing & Consumer Federation Ltd., (2004) 12 SCC 360 at p.366 [at para 15].
[9] Mahavir Cold Storage v. CIT, 1991 Supp (1) SCC 402 [ at para 12]; A.V. Murthy v. B.S. Nagabasavanna, (2002) 2 SCC 642 at p. 644 [at para 5]
[10] S. Natarajan v. Sama Dharma, 2012 SCC OnLine Mad 2776; N.S. Atwal v. Jindal Steel and Power Ltd., 2013 SCC OnLine Del 3902 [at para 11]; Shahi Export Pvt. Ltd. v. CMD Built Tech Pvt. Ltd., (2013) SCC OnLine Del 2535 [ at para 7]; Commissioner of Income Tax v. Shri Vardhman Overseas Ltd., 2011 SCC Online Del 5599 [ para 17] ; N.S. Atwal v. Jindal Steel and Power Ltd., 2013 SCC OnLine Del 3902 [at paras 11 and 12]; Al-Ameen Limited v. K.P. Sethumadhavan, 2017 SCC OnLine Ker 11337 [ at paras 7 to 14];  Zest Systems Pvt. Ltd. v. Center for Vocational and Entrepreneurship Studies, 2018 SCC OnLine Del 12116 [at paras 5 and 6]; Agni Aviation Consultants v. State of Telangana 2020 SCConline TS 1462 [at paras 100 and 101].
[11] Bengal Silk Mills v. Ismail Golan Hussain Arif, AIR 1962 Cal 115 [ at paras 9 and 11]  South Asia Industries (P) Ltd. v. Krishna Shamsher Jung Bahadur Rana, 1972 SCC OnLine Del 185 [at para 46]; Bhajan Singh Samra v. Wimpy International Ltd., 2011 SCC OnLine Del 4888 [ at para 13 to 17]
[12] 2020 SCC Online NCLAT 417
[13] Ibid [at para 22]
[14] Bishal Jaiswal v. Asset Reconstruction Company 2020 SCConline NCLAT 681.
[15] Ibid [at para 31].
[16] Ibid [at para 32] citing Pradeep Chandra v. Pramod Chandra, (2002) 1 SCC 1 wherein the Supreme Court had laid down the rule of judicial discipline which needs to be followed in such cases.
[17] Bishal jaiswal v. Asset Reconstruction Company and Anr., Company Appeal (AT) (Insolvency) No. 385 of 2020, [ Judgement dated 22nd December 2020]
[18] 2021 SCConline SC 267 [at paras 40 and 41].
[19] Report of the Insolvency Law Committee, March 2018 at p. 72 [at paras 28.2]
[20] Asset Reconstruction Company v. Bishal Jaiswal & anr. 2021 SCCOnline SC 321 [at paras 8 to 10]
[21] Sesh Nath Singh and anr. v. Baidyabati Sheoraphuli Co-operative Bank Ltd. and Another, 2021 SCCOnline SC 244; Laxmi Pat Surana v. Union Bank of India 2021 SCCOnline SC 267.
[22] Asset Reconstruction Company v. Bishal Jaiswal & anr. 2021 SCCOnline SC 321 [at paras 26 to 32]
[23] Ibid [at paras 35 to 42]
[24] Bengal Silk Mills v. Ismail Golan Hussain Arif, AIR 1962 Cal 115 [ at paras 9 and 11]
[25] South Asia Industries (P) Ltd. v. Krishna Shamsher Jung Bahadur Rana, 1972 SCC OnLine Del 185 [at para 46];
[26] Asset Reconstruction Company v. Bishal Jaiswal & anr. 2021 SCCOnline SC 321 [at para 32]
[27] Ibid [at paras 43 to 45]
[28] Ibid [at paras 32 and 34] relying upon Pandam Tea Company in re, 1973 SCCOnline 93 [at para 4]
[29] As per Section 3(12) of the IBC, “default means non-payment of debt when whole or any part or instalment of the amount of debt has become due from any person and includes a financial debt and operational debt.”
[30] Gaurav Hargovindbbhai Dave v. Asset Reconstruction Company, (2019) 10 SCC 572 at p. 574 [at para 7]