Liability of a Proprietorship Firm under the Insolvency & Bankruptcy Code of 2016: Lawyers Advice

The views are conflicting on this subject matter by the varied NCLT benches that whether a proprietorship under section 9 of the Insolvency & Bankruptcy Code (IBC) of 2016 can initiate insolvency and bankruptcy. It is a well-settled law that sole proprietorship firm cannot sue and be sued on its name. A proprietorship firm is not considered a separate legal entity. In Miraj Marketing Corporation v. Vishaka Engineering and Ors, it had been held that insolvency proceedings can’t be initiated within the name of an unregistered proprietorship firm, and not even a sole proprietorship firm can initiate an insolvency proceeding on this own name. There are different statutes which will be applied to a sole proprietor business and registering under them can give valid proof of existence. Such provisions are as follows:

• Shop and Establishment License issued under Shops & Establishments Act.
• GST Registration Certificate issued by the Government of India under the GST Act.
• MSME Registration Certificate issued by the Government of India under the MSME Act.
• Checking Bank Account opened under the name of Proprietary Concern.
• PAN issued under the Income Tax Act of 1961

An operational creditor can apply for the initiation of the Corporate Insolvency Resolution Process (‘CIRP’) under section 9 of the Insolvency & Bankruptcy Code (IBC) of 2016. According to Section 3(23) “Person” Includes:
(a) a private
(b) a Hindu Undivided Family
(c) a Corporation
(d) a Trust
(e) a Partnership
(f) an Indebtedness Partnership and
(g) the other entity established under a statute.
and this definition is inclusive and not exhaustive in nature.

As there’s no clear mention of sole proprietorships in the definition of the operational creditor. Later, The Insolvency and Bankruptcy (Amendment) Act, 2018 as notified on 18 January 2018, added a proprietorship firm to the list. One of the major reasons being that the legislature intended to expand the benefits of the Code to the sole proprietorship firm and the Court must interpret according to the object and purpose of the Code.

In the case of Sai Kripa Associates v. Kstar Naturalle Resources Private Limited, the National Company Law Tribunal, Delhi (2018), dismissed the petition of a proprietorship filed under section 9 of the code. The rationale stated was that a proprietorship is not a legal entity hence it cannot sue and sued on its name. Followed up by this judgment in Kishore and Company v. Sri Balaji Metallics (P.)Ltd CP(IB) No. 165/KB/2018) before the NCLT Kolkata bench, the difficulty during this case was the there was an objection on the application filed under section 9 of the IBC, which is maintainable and legal by the proprietorship if represented by its sole proprietor. Within the case Impact Event Management v. Garodia Automobiles Private Ltd (CP (IB) No. 22/KB/2018) the NCLT took the view that proprietor under section 9 of the IBC can file an application keeping in mind that the proprietor cannot sue and be sued on its name. A contrary view was taken up in Vani Biochem v. Vaayucon Greentech Private Limited, where NCLT, Amritsar upheld that ‘person’ as defined under Section 3(23) of IBC includes per se, individual, a company, and any other entity established under the statue. Citing from the judgment the Hon’ble Tribunal observed that, “the petitioner is a proprietary company and thus would fall within the definition of a person. An Operational Creditor means a person to whom an operational debt is owed/due.” Hence, the petition filed in this case was held to be maintainable.

In another NCLT SKolkata bench judgment i.e. R.G. Steels v. Berrys Auto Ancillaries (P) Ltd, a different view was observed, as stated sole proprietor is not included under the definition of ‘person’ in section 3(23) of the Code, although it includes individual but not a sole proprietor. This judgment of NCLT was overruled by NCLAT, in Neeta Saha v. Mr. Ram Niwas Gupta, (191(IBC)156/2020) where it was held that section 2 of the code provisions IBC applies to ‘proprietorship firm’ and the definition of a person is inclusive. It can be summarised that NCLAT, intended to bring in the sole proprietorship into the ambit of section 9 of the Code by extending the definition in section 2(23).

In the Report of Bankruptcy Law Reforms Committee Volume 1: Rational and design, which was published in November 2015, it had been noted to the committee to make a uniform framework for the insolvency and bankruptcy for all entities. This required a shift within the mandate to incorporate micro, small and medium enterprises, sole proprietorships, and individuals specifically.
Insolvency Law Committee, under the chapter, “Recommendation regarding Personal Insolvency Resolution and Bankruptcy Process”, the definition of the term “proprietorship firms” under Section 2(e) of the Code, said that many jurisdictions do not define the said term ‘proprietorship firm’. The term ‘sole proprietorship ‘or’ proprietorship firm is usually utilized in common parlance, maybe a well-recognized sort of business, and thus, concluded that it’s not necessary to define ‘proprietorship firms’ within the Code.

Notification Dated 24-03-2020
S.O. 1205(E)- In exercise of the powers conferred by the proviso to section 4 of the Insolvency and Bankruptcy Code, 2016 (31 of 2016), the Central Government hereby specifies one crore rupees as the minimum amount of default for the purposes of the said section.
While the threshold limits for personal guarantors specified under Part III of the IBC, specifically, Insolvency Resolution and Bankruptcy for Individuals and Partnership Firms stands unchanged and continues to be Rs. 1000 for initiation of insolvency resolution.

Change brought to threshold limit in initiation of the Corporate Insolvency Resolution Process:
The limit has been increased from rupees 1 lakh to rupees 1 crore for initiating corporate insolvency resolution process. This is a very harsh situation for the smaller creditors to whom defaulted amount is owned less than 1 crore. The implementation of Insolvency & Bankruptcy Code (“IBC” or “Code”) had been quite effective and operational creditors have been benefited ever since inception of the Code. The Hon’ble Supreme Court in Swiss Ribbons (P) Ltd. v. Union of India while discussing the purpose and objective of the IBC, has held that the provisions and the Preamble of the IBC ensures maximum recovery for all creditors, while securing the corporate debtor as a going concern during the insolvency process.

Issues related to change in threshold limit:
• The change in threshold limit also has a loop hole that is, the principal amount should be rupees one crore or interest included with the principal amount should be equal to rupees one crore. It is to be noted that adding of interest in principal amount is not per se illegal if the parties at the time of transacting agreed to it. The problem arises when there was no such agreement at the time of transaction. In Arrow line Organic Products Private Limited’s case, the National Company Law Tribunal Chennai recently clarified that the increase in threshold to initiate CIRP from Rupees One Lakh to Rupees One Crore is prospective in nature and will only be imposed to the new filings and will not be applied on the adjudication of any ongoing cases unless the legislation clearly mentions the same is retrospective. It also observed that the notification 24-03-2020 has nothing to do with cases that are already being filed before the said date as amendment made to increase the threshold is prospective in nature.
• In Foseco India Limited v Om Boseco Rail Products Limited (CP (IB) No 1735/KB/2019), the NCLT Kolkata ruled on as whether the change brought by notification of 24-03-2020 is prospective or retrospective in effect. In this case the issue was raised by the corporate debtor that the said change is retrospective in nature thus the application for CIRP is not maintainable. However, the Tribunal observed that the change in the threshold limit under the Notification applies prospectively and not retrospectively. The Tribunal stated that statutes are prospective unless intended to make it retrospective in nature, either expressly or by necessary implication.
• This change is detrimental for the operational and financial creditors who are at times also MSMEs and the amount of loan or default would also be less in comparison to the default loan in case of an MNC or a bank. Thus, this increase in the amount of loan or default will affect the rights of these operational and financial creditors in this time of financial crisis. Therefore, this change hampers the object of IBC.

After the decision of NCLAT in Neeta Saha V. Ram Niwas Gupta and Ors. (Company Appeal(AT) (Insolvency) No. 321 of 2020), clear conclusion is often drawn that sole proprietor can initiate the insolvency and bankruptcy procedure under section 9 of the IBC. The proprietorship firm can invoke insolvency proceedings against any company for recovery subjected to the fact that it being filed by the sole proprietor. As proprietorship does not have any legal identity of its own. The interpretation of section 3(23) is wide and inclusive as opposed to restrictive interpretation.
Authored By: Adv. Anant Sharma & Alhamra Afroz