Dr Subhash Chandra – NCLT Case:
Technical Member: Substance and not Form
Judicial Member & Third Member: Form and not Substance.
The Technical member went deep into the substance of the financial arrangement and came down heavily against it. Whereas the Judicial Member as well as the Third Judicial Member discarded the substantive approach and went for literal legal interpretation. It is well established that in taxation as well as financial arrangements, one must see the substance of the transaction and not the form. However, in the Dr Subhash Chandra case, Form seems to have been given 2:1 vote over Substance dissected by Technical Member. Am I right?
Introduction
In the matter of Indiabulls Housing Finance Limited vs. Dr. Subhash Chandra, the National Company Law Tribunal (NCLT) faced a critical divergence of opinion between the Learned Member (Judicial) and the Learned Member (Technical). This divergence was ultimately referred to a Third Member, Hon'ble Member (Judicial) Shri Nilesh Sharma, for a binding opinion. However, the "Form" (literal legal interpretation of the statutory definition of "associate" under Section 79(2)(g) of the Insolvency and Bankruptcy Code, 2016) prevailed by a 2:1 majority over the "Substance" (purposive interpretation and commercial control dissected by the Technical Member).
While the Technical Member went deep into the substance of the financial arrangements and commercial proximity to prevent the evasion of statutory consequences behind a corporate veil, both the Judicial Member and the Third Member strictly adhered to the literal text of the statute, holding that the legislature chose legal ownership and control, rather than commercial influence, as the statutory standard.
The Technical Member's Approach: Primacy of Substance and Purposive Interpretation
The Learned Technical Member, Ms. Reena Sinha Puri, adopted an expansive, substantive, and purposive approach to interpreting the provisions of the Insolvency and Bankruptcy Code, 2016 (IBC).
• Purposive Construction of "Associate": The Technical Member focused heavily on Section 79(2)(g) of the IBC, which defines an "associate" of a debtor. She argued that this provision must receive a purposive and meaningful construction. In her view, a narrow or literal interpretation would lead to anomalous and absurd consequences. Specifically, she noted that a person who qualifies as an associate in their individual capacity could easily evade the statutory consequences (such as voting exclusions or transaction scrutiny) by routing transactions and dealings through a corporate entity.
• Piercing the Corporate Veil: The Technical Member's approach was rooted in the belief that the law must look through the "façade of a corporate structure or veil" to prevent the very mischief that the statute seeks to avoid. She dissected the financial arrangements to show that even if the debtor did not directly own more than 50% of the share capital of certain entities (such as Lemonade and Corpcall), these entities were effectively controlled by associates of the debtor.
• Two Limbs of Section 79(2)(g): The Technical Member outlined that Section 79(2)(g) stands on two limbs: the Sole Ownership Limb (where the debtor alone holds more than 50% of the shares) and the Control Limb (where the debtor, along with his associates, controls the board or the company). By analysing the commercial proximity, family connections, and business relationships, the Technical Member concluded that these entities were indeed associates, and their voting rights in the repayment plan process should be restricted to maintain the integrity of the insolvency process.
The Judicial and Third Members' Approach: Strict Literal Interpretation and Statutory Boundaries
In contrast, the Learned Judicial Member, Sh. Ashok Kumar Bhardwaj, and the Third Member, Sh. Nilesh Sharma, discarded the substantive approach in favor of a strict, literal legal interpretation.
• Strict Adherence to Statutory Definitions: The Judicial Member and the Third Member held that the statutory definition of "associate" under Section 79(2)(g) cannot be expanded merely because the entities are alleged to have family, business, or commercial proximity with the Personal Guarantor (PG). They emphasized that the statutory boundaries are clear and unambiguous.
• Legal Ownership vs. Commercial Influence: The Third Member explicitly stated that the "Legislature has adopted legal ownership and control, not commercial influence, as the statutory standard". Since no material was produced showing that the Personal Guarantor, either individually or together with his statutorily defined associates, owned more than 50% of the share capital or exercised legal control over the Boards of the concerned entities, they could not be legally classified as "associates".
• Limits on Judicial Scrutiny and Supplying Omissions: The Third Member relied on established judicial precedents, including the Supreme Court's ruling in Arcelor Mittal India Pvt. Ltd. v. Satish Kumar Gupta, to emphasize that statutory ineligibilities and definitions under the Code must be determined strictly in accordance with the language enacted by the Legislature. He noted that courts and tribunals cannot supply omissions in legislation merely because a broader or more substantive interpretation appears desirable. The legislative intention must be gathered strictly from the words enacted.
• Evidentiary Deficiencies: The defence successfully argued that the financial creditors' attempts to exclude these entities relied on regulatory findings from the Securities and Exchange Board of India (SEBI) that had been formally quashed by the Securities Appellate Tribunal (SAT). The Judicial and Third Members agreed that because these underlying regulatory findings were legally set aside, they could not serve as an evidentiary basis to classify the entities as associates. Furthermore, they noted that newspaper reports and allegations of commercial proximity are hearsay and do not constitute legal proof of ownership or control.
Comparison of Approaches: Substance vs. Form
|
Parameter |
Technical Member's Approach (Substance) |
Judicial & Third Members' Approach (Form/Literal) |
|
Primary Philosophy |
Purposive interpretation; looking at the underlying substance and commercial reality of the transaction. |
Literal interpretation; strict adherence to the plain language of the statute. |
|
Interpretation of "Associate" |
Broad construction to include entities effectively controlled by associates, preventing evasion via corporate structures. |
Strict construction; cannot expand the definition based on commercial, business, or family proximity. |
|
Corporate Veil |
Favors piercing the corporate veil to prevent mischief and identify the real controlling mind. |
Respects the corporate structure unless strict statutory criteria for control or ownership are met. |
|
Standard of Control |
Commercial influence, family proximity, and economic alignment. |
Legal ownership (holding >50% shares) or legal control over the Board of Directors. |
|
Role of the Tribunal |
Active judicial mind that must independently scrutinize and reject plans if the process is substantively compromised. |
Deferential to the commercial wisdom of the creditors, provided literal statutory procedures are met. |
|
Precedential Basis |
Focuses on preventing abuse of the insolvency process and maintaining process integrity. |
Relies on ArcelorMittal and the principle that courts cannot supply omissions in legislation. |
Substance vs. Form in My Opinion
The tension between "substance over form" and "literal legal interpretation" is a classic debate in Indian jurisprudence, particularly in taxation and financial arrangements.
Taxation Jurisprudence: the Supreme Court has historically balanced these two approaches:
◦ McDowell & Co. vs. CTO (1986): The Supreme Court held that colourable devices cannot be part of legitimate tax planning, and dubious methods to avoid tax should not be encouraged. This represented a strong shift toward "substance over form."
◦ Vodafone International Holdings B.V. vs. Union of India (2012): The Supreme Court reiterated the classic Westminster principle, holding that when a transaction is genuine, the court must "look at" the transaction rather than "look through" it. The "substance over form" approach can only be invoked if the transaction is proven to be a sham, fraud, or purely tax-avoidant. If the transaction is legitimate, literal legal form prevails.
Insolvency and Financial Debt: Interestingly, in other areas of the IBC, tribunals and courts frequently give primacy to substance over form:
◦ Definition of Financial Debt: Under Section 5(8) of the IBC, the Tribunal often looks at the commercial effect of a transaction rather than its nomenclature. For instance, the absence of a formal loan agreement or interest clause does not negate the nature of a financial transaction if the commercial intent and the "commercial effect of borrowing" are established.
◦ Consortium and Locus: In cases like the DHFL Wadhawan promoters' insolvency, courts look at the collective nature of consortium agreements and security trustee arrangements to determine the true legal obligations and locus of the creditors.
However, when it comes to statutory disqualifications, ineligibilities, and restrictive definitions (such as Section 29A or Section 79(2)(g) "associate" status), the courts have consistently favoured a strict, literal approach. This is because expanding restrictive definitions through judicial interpretation risks creating commercial uncertainty and overstepping the legislative domain.
Conclusion
In the Dr. Subhash Chandra case, the literal "Form" of the statute was given a 2:1 majority vote over the "Substance" dissected by the Technical Member.
While the Technical Member's dissent represents a robust attempt to apply the "substance over form" doctrine to prevent the potential misuse of corporate structures to bypass insolvency restrictions, the majority decision by the Judicial Member and the Third Member reflects the dominant judicial trend in IBC interpretation. This trend dictates that where the legislature has laid down precise, objective, and quantitative criteria (such as the 50% shareholding threshold or legal board control), the adjudicating authority cannot substitute these with subjective tests of "commercial influence" or "proximity", no matter how compelling the underlying substance of the arrangement may appear
Call of the day is amending the IBC to reflect the well laid down principle of “Substance over Form”. Given the tendency of the judicial Members to give importance to the Form of the transaction rather than the Substance of the transaction, the decision of the Five Member NCLP Bench comprising of 3 Judicial Members and 2 Technical Members would in all probability of on these lines. Else, just Repeal IBC and Indian Contract Act, 1872 and wind up the NCLT and other judicial fora dealing with such cases.
