Of the many terms used in the Insolvency and Bankruptcy Code (IBC), 2016, the term ‘connected person’ often finds its scope blurred around the edges. However, it is touted as one of the most important terms used in Section 29A of the IBC.

A Connected Person has been defined under Explanation (j) of Section 29A of the Insolvency and Bankruptcy Code, 2016. The explanation given in the provision asserts that:

  1. any person who is the promoter or in the management or control of the resolution applicant; or
  2. any person who shall be the promoter or in management or control of the business of the corporate debtor during the implementation of the resolution plan; or
  3. the holding company, subsidiary company, associate company or related party of a person referred to in clauses (1) and (2).

It further states that clause (3) would not apply to the following:

  1. A scheduled bank, or
  2. An asset reconstruction company registered with the RBI under Section 3 of Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002.
  3. An alternate Investment Fund registered under SEBI.

The identification of Connected Person is important as they are barred from participating in the Resolution Process.

CONNECTED PERSON AND SECTION 29A OF THE IBC:

Section 29A of the Act lays down the ineligibility criteria for submission of a resolution plan. The explanation clause (j) of Section 29A specifically bars a  Connected Party from participating in the Resolution Process. The aim behind inserting it in the 2017 amendment of the act was to protect the creditors and their interests from fraudsters.

The assumption here is that a connected person would try to benefit himself/herself above others (intentionally or otherwise) owing to bias, which affects the overall objective of the act. There is a general presumption that transactions reflected in financial statements are completed at an arm's length basis between independent parties. This presumption may not be valid in the presence of a connected person because the connected person may enter into transactions which an ordinary creditor would not enter into. There is also a higher chance that transactions between connected parties may be affected differently by certain terms and conditions of the resolution as compared to ordinary creditors. A connected person has a higher likelihood of being able to avail benefits such as the extension of free credit on a debt owing to a previous relationship or an expedited claim submission. These benefits adversely affect the interests of ordinary creditors, leaving them at a disadvantage and drastically impacting the efficacy of the resolution process.

CONNECTED PERSON VIS-A-VIS RELATED PARTY:

The terms 'Related Party' and ‘Connected Person’ are defined under Section 5(24) and explanation (j) of Section 29A of the Code respectively. However, while both are barred from participating in the resolution process, the key difference between the 2 lies in the personal relationship a person has with the resolution applicant. The scope of the connected person is wider than that of the related party.

Infact, the definition of a Connected person includes the related party (in respect of the person who is a  promoter or in control or management of the corporate debtor and the person who shall be the promoter or in management or control of the business of corporate debtor while implementing the resolution process). The definition of Related Party in respect to a person was introduced by the amendment of 2018 providing clarity to the scope of connected persons who have to be tested for disqualifications given under paragraph (a) through (i) of Section 29A. In the case of a married individual, the relative of the individual’s spouse will also be included within the scope of a connected person. In retrospect, we find that the amendment of 2018 has widened the scope of a connected person.

THE CURIOUS CASES OF CONNECTED PERSONS

In JR Agro Industries Pvt Ltd v Resolution Professional Swadisht Oils Pvt Ltd, 2018 an appeal was made by JR Agro Industries Pvt Ltd, one of the resolution applicants, whose Resolution Plan was not entertained by the Resolution Professional on the ground that the appellant was disqualified to participate in terms of Section 29A of IBC 2016.

The Appellant contended that it was not connected with the Corporate Debtor namely, Swadisht Oils Pvt Ltd in any manner and also, was not an associated company of M/S J.R. Organics Ltd. It further contended that it was only an operational creditor of the Corporate Debtor and had no other connection with the Corporate Debtor for which it could be treated as a connected person or related party.

In this case, the NCLAT took into consideration a previous judgment passed by the NCLT in which it discussed in detail as to how M/s J.R. Agro Industries (P) Ltd. was disqualified under clause (e) read with clause (j) of Section 29A on the ground that Y.K. Jhunjhunwala, who was a ‘connected person’ of M/s J.R. Agro Industries (P) Ltd. was disqualified to act as Director of M/S J.R. Agro Industries (P) Ltd. due to the following reasons:

i. The annual returns for FY 2014-15 filed by JR Agro showed YK Jhunjhunwala as a promoter and his shareholdings (HUF and self) constituted 15% of the paid-up capital of JR Agro.

ii. In the annual returns for 2015-16, it was stated in the shareholding pattern that 99.96% of the total shares were held by the promoters, meaning only 0.04% shares are held by non-promoters. It ultimately meant that YK Jhunjhunwala was the promoter of JK Agro.

iii. In the annual returns filed for FY 2016-17, the promoters shareholdings were reduced to 70% whereas, in the list of shareholding, the shareholdings of YK Jhunjhunwala stayed the same.

The above reasons cemented YK Jhunjhunwala’s position as that of a promoter of JR Agro, which made him a connected person as per Section 29A. Furthermore, Section 29A came into effect on 23rd November 2017 and the returns were filed soon after 25th December 2017. There were no changes in the shareholding pattern as well as the management of JR Agro. It seemed that the Annual Returns were subject to manipulation by the appellant to escape from the rigours of Section 29A.

The Resolution Professional also submitted that the JR Agro is disqualified under clause (e) read with clause (j) of Section 29A; the reason being that JR Agro held 43% shares in JR Organics Ltd. As per the balance sheet of JR Agro for the financial year 2016-17, JR Agro held 5,31,350 shares (amounting to 43%) of JR Organics; which in turn made YK Jhunjhunwala a shareholder at JR Organics Ltd. Hence, the shareholding of JR Agro in JR Organics Ltd shows that JR Organics is an associate company of JR Agro as per the definition of Associated Companies given in Section 2(6) of the Companies Act, 2016.

Section 29A of the IBC considers associated companies as connected persons as per explanation (iii) of Section 29A.  The NCLAT upheld the judgment given by NCLT and held that Appellant was disqualified in view of Section 29A (c), (e), and (j) of the IBC 2016.

Another case is that of ArcelorMittal India Private Limited v Satish Kumar Gupta and Others, 2018. An application was submitted by creditors of Essar Steel India Limited (ESIL) before the NCLT under Section 7 of the IBC. The NCLT accepted the application and passed an order of moratorium. The Resolution Professional published 'a request for proposal' for submission of resolution plans. The CoC requested the NCLT to extend the duration of the CIRP by 90 days beyond the initial period of 180 days. The NCLT accepted it. ArcelorMittal India Private Limited (AMIPL) and Numetal Limited submitted their resolution plans.

The Resolution Professional found both AMIPL and Numetal to be ineligible under Section 29A of the IBC. The ground for rejection of AMIPL was that ArcelorMittal Netherlands BV (a connected person of AMIPL) was a promoter of Uttam Galva Steels Limited (Uttam Galva). The account of Uttam Galva turned out to be an NPA. Likewise, the plan submitted by Numetal was refused on the contention that Aurora Enterprises Limited (AEL), one of the shareholders of Numetal was owned by Rewant Ruia, who was believed to be acting in concert with his father, Ravi Ruia. Ravi Ruia was a promoter of ESIL. His account got declared as NPA. Following this, the Resolution Professional invited fresh plans for resolution, wherein AMIPL, Numetal, and Vedanta Resources Limited also submitted their plans.

AMIPL and Numetal filed a petition against the decision of the Resolution Professional. The NCLT upheld the decision of RP. The same was challenged in NCLAT and the Supreme Court.

The Supreme Court held that when the resolution plan is submitted by the resolution applicants, the stage of ineligibility gets attached to it from that day itself. It further held that the Resolution Plan submitted by Resolution Professional cannot be challenged by the Resolution Applicant. The Supreme Court held that the Resolution Professional does not have the power to reject the Resolution Plan and all the plans must be presented before the CoC for their consideration. With regard to the eligibility of Numetal and AMIPL, it was held that they are ineligible to participate in the Resolution Process as per Section 29A as they both have not paid their respective NPAs before the submission of Resolution Plans. The SC on the request of the CoCs gave the resolution applicant one more opportunity to submit their resolution plans upon payment of their respective NPAs.

The clauses under the IBC were designed to find the best possible way out for a distressed business - meant to be more inclusive in approach. Ensuring that a thorough process was at the center of the resolution process, the detailed explanation for who constitutes a connected party cast a net wide enough to ensure that the only interests in consideration were those of the Resolution Professional, ergo, the distressed business.

A frequently heard argument contests the utility of such an all inclusive definition of ‘connected persons’. The argument finds that the very institution of insolvency resolution seems inaccessible, and excludes all those who are invested in the business. However, over time, this definition has been a gatekeeper, ensuring the resolution professional is focused on arriving at the most efficient solution to the case, instead of verifying the authenticity of each resolution applicant.

If you'd like to further explore the workings of the IBC and how different terms are defined, we recommend you read:

Unravelling IBC Ordinance 2020

Definition & concept of a 'Related Party'

Who is a 'Politically Exposed Person'

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