Initiation of Insolvency Proceedings by Sole Proprietorships under the Insolvency & Bankruptcy Code (IBC) of 2016: Lawyers Advice

The recent conflicting decisions of various benches of the NCLT in India have created ambiguity and confusion as to whether sole proprietorships are covered under Section 3 (23) of the IBC as “persons”, a derivative which determines if they can initiate insolvency proceedings. Hence, this article seeks to examine and elaborate on the same.

Sole proprietorship is a form of a business organisation which is owned and managed by one person. These firms aren’t regulated under any one law, thereby making them one of the simplest in terms of registrations and compliances.

The Insolvency and Bankruptcy Code, 2016 –
• Section 3(23) of the IBC defines “person” as (a) an individual; (b) a Hindu Undivided Family; (c) a company; (d) a trust; (e) a partnership; (f) a limited liability partnership; and (g) any other entity established under a statute, and includes a person resident outside India.
• Section 5(7) of the IBC defines financial creditor as a “person” to whom a financial debt is owed.
• Section 5(23) of the IBC defines operational creditor as a “person” to whom an operational debt is owed and includes any person to whom such debt has been legally assigned or transferred.
• Since a sole proprietorship concern neither resembles the entities listed as per Section 3(23) nor is it an entity established under a statute, it is presumed to fall outside the definition of a person, and thereby from that of a creditor.

Judicial Pronouncements –

1. In R.G. Steels v. Berrys Auto Ancillaries (P) Ltd. [IB-722/ND/2019], the New Delhi Bench of the National Company Law Tribunal (NCLT) ruled that –
   • Section 3(23) of the Insolvency and Bankruptcy Code, 2016 (IBC), which defines the term ‘person’, does not include a sole proprietorship concern within its ambit.
   • The Tribunal observed that it was prima facie evident that the operational creditor, M/s RG Steels, was a sole proprietorship concern, and therefore, was not entitled to approach the NCLT on its own.
   • There was a pre-existing dispute between the operational creditor and corporate debtor with regard to the amount of debt and rates thereon. The NCLT ultimately ruled that the petition was not maintainable.
2. In Sai Kripa Associates v. K star Naturalle Resources Private Limited [CP-IB-1438/ND/2018], a case placed upon the New Delhi Bench of the NCLT –
   • The Tribunal observed that, where the operational creditor was a sole proprietorship concern, the petition should have been filed by the sole proprietor, and not in the name of proprietorship.
   • Hence, this petition too was dismissed.
3. In Kishore and Company v. Sri Balaji Metallics (P.) Ltd. [CP(IB) No. 165/KB/2018], a case placed before the Kolkata Bench of the NCLT, a completely opposite observation was made –
   • In this case, the Corporate Debtor filed an objection stating that the petition was not maintainable as the petition was filed by M/s. Kishore and Company, a sole proprietorship concern.
   • The NCLT then observed that this application as filed by the sole proprietorship, being represented by its sole proprietor is legal and maintainable.
4. While examining the stance of the High Courts, in Devendra Surana v. Bank of Baroda (W.P. No. 5521 (W) of 2017), the Calcutta High Court observed that – “a natural person and his sole proprietorship firm do not enjoy the benefit of being treated as separate legal entities and are the same legal entity”. Hence, the Court ruled that the liability of the sole proprietorship firm is that of the natural person carrying on business under its name.

While these conflicting observations as given by various Benches of the NCLT lead to ambiguity and confusion, it is also leading to implications on the sole proprietorship’s insolvency process.

Recently, the NCLAT in the case of Neeta Saha v. Mr. Ram Niwas Gupta (191(IBC)156/2020), overturned the order of the NCLT, New Delhi Bench in the R.G. Steels Vs. Berry Auto Ancillaries (P) Ltd case. The NCLAT held that –

1. As per Section 2(f) of the IBC, provisions of the Code shall apply to proprietorships as well.
2. Hence, on a combined of Sections 2(f) and that of Section 3(23), “person” is inclusive of sole proprietorships.

To conclude, applications filed by sole proprietorships are hence maintainable under the IBC. The view as taken by the Hon’ble NCLAT not only cleared the ambiguity present but also provided sole proprietorships enough recourse under the IBC, such that their insolvency resolution can take place in a timely manner as well.
Authored By: Adv. Anant Sharma & Madhulika Iyer