Sole Proprietorship & the Insolvency and Bankruptcy Code of 2016: Lawyers Advice

Sole proprietorship is a specimen of a business being owned by a single person who carries an unlimited liability. Its foundation lies in the fact that there is no legal divide between the sole proprietorship and the proprietor. This implies it has no legal identity of its own. This is remarkably in contrast with say a company that has a separate legal entity, hence, can sue and be sued in its own name.

This becomes a crucial concern when viewing matters related to insolvency and bankruptcy which is governed by the comprehensive Insolvency and Bankruptcy Code, 2016. Seemingly, a proprietorship firm can neither initiate insolvency proceedings, nor can any be initiated against them. The same was observed by the Delhi High Court in Miraj Marketing Corporation V. Visakha Engineering and Ors.(R.F.A. No. 349 of 2003). A suit was brought in the name of Miraj Marketing Corporation by an authorised representative. There was however no mention of the proprietor’s name. The trial court held that a proprietorship firm is no legal entity so no suit can be filed in its own name, which was later on upheld by the High Court.

Relevant Provisions in the Insolvency and Bankruptcy Code, 2016
The main reason why it came into force was to protect the interests of creditors and facilitate faster debt recovery or liquidation process. According to section 6, this process can be initiated by two categories of creditors(financial and operational). Additionally, corporate debtors themselves can also initiate it but sole proprietorship doesn’t fall under this category.

Chapter II of the Code lays down the mechanism of initiating the Corporate Insolvency Resolution Process. Section 9 of the Insolvency & Bankruptcy Code (IBC) of 2016 which is of relevance here, provides for an operational creditor to apply to the Adjudicating Authority to initiate the resolution. Now, the definition in section 5(20) emphasises it to be a ‘person’ to whom an operational debt is owed. Here, the term “person” is what needs scrutiny. Precisely, under section 3(23), a “person” is stated to include individuals, other entities and yet another body established by statutes. Since there is no mention of “sole proprietorship”, its whereabouts under this code is unsettled. However, the section does make a mention of ‘an entity established under a statute’. So, if it is registered under statutes like the Micro, Small and Medium Enterprises Development Act, 2006, it could provide a basis under which the legal existence of a sole proprietorship might be substantiated.

National Company Law Tribunal’s Conundrum
There have been numerous interpretations as to whether sole proprietorship firms fall under the purview of section 3(23) of the Insolvency and Bankruptcy Code, 2016. In Sai Kripa Associates V. Kstar Naturalle Resources Private Limited (CP-IB-1438/ND/2018), the operational creditor issued reminders to its corporate debtor regarding an outstanding payment. The corporate debtor’s main contention was that since the operational creditor is a sole proprietorship firm, it has no legal identity hence the application was not maintainable in law. Considering that, the tribunal dismissed the petition stating that the application should have been brought in the proprietor’s name and not in the sole proprietor’s concern.

A chain of similar orders was followed by various benches of the NCLT. They furthered the same reasoning that if a sole proprietorship firm is unregistered, it can’t be given the stature of a legal entity, hence it has no right to sue or be sued. Conversely seen was the Kolkata bench’s observations in Kishore and Company V. Sri Balaji Metallics (P.)Ltd. (CP(IB) No. 165/KB/2018). The corporate debtor objected to the maintainability of the application as it was a sole proprietorship concern. But the Tribunal held the objection to be untenable.

But later again in R.G. Steels v. Berrys Auto Ancillaries (P) Ltd. (IB-722/ND/2019), the New Delhi bench of NCLT ruled that section 3(23) doesn’t include sole proprietorship and dismissed the petition as the Operational Creditor was a sole proprietorship hence not entitled to approaching NCLT on its own. Although the presence of a dispute over the debt amount was also one of the reasons.
With such varying motions, the dilemma over such matters doesn’t end.

The Recent Trajectory
The judgments so far have been quite conflicting in nature. But recently, the National Company Law Appellate Tribunal did try to eliminate concerns with regard to the maintainability of applications filed by sole proprietorships under the Insolvency and Bankruptcy Code, 2016. In Neeta Saha V. Ram Niwas Gupta and Ors. (Company Appeal(AT) (Insolvency) No. 321 of 2020), the operational creditor filed a case against the corporate debtor who took up the defense that since a sole proprietorship is not a legal entity, it cannot fall under the definition of “person” in section 3(23) of the Code. However, the proprietorship cited that the application was also made through in the proprietor’s name. Consequently, it was maintained that since section 2 makes a mention of the word ‘includes’, it is inclusive rather than exhaustive, hence, Sole Proprietorship firms must be taken into consideration.

Even though the NCLAT held that section 2 of the Code would apply to proprietorship firms. Yet a clear direction has not been given as to whether sole proprietorship can make a filing in its own name or continue in the proprietor’s name as a precautionary measure. With this line of approach, it has regarded the definition of a ‘person’ stated in section 3(23) as inclusive and interpreted the intent of the legislation accordingly. However, greater clarity is still the need of the hour. Nonetheless, the incorporating attitude of NCLAT is indeed a welcoming gesture for the sole proprietorship firms.

As regards Sole Proprietorship, subjects like insolvency and bankruptcy are of immense importance. The former is a legal state where the liabilities exceed assets, while the latter is a legal procedure to solve insolvency. Although the procedure might seem imprecise but with some precautions there is a resolve. And with the recent hospitable viewpoint put forth by the Tribunal, the way ahead for proprietorship seems more secure.
Authored By: Adv. Anant Sharma & Ayushi Shrivastava