In view of the Judgment dated July 15, 2025, passed by the Hon’ble National Company Law Appellate Tribunal (“NCLAT”) in Pancham Studios Private Limited vs. Konark Aquatics and Exports Private Limited,Company Appeal (AT) (Ins.) No. 406 of 2024 (“Company Appeal”), the present Article discusses whether violation of Section 186 (2) (a) of Companies Act, 2013 (“2013 Act”) can deter initiation of insolvency proceedings despite debt and default having been well established by the lender.

The entire issue stems from Section 186 (2) (a) of 2013 Act which provides that “no company can directly or indirectly give any loan exceeding sixty percent of its paid up share capital free, reserves and securities premium account or one hundred percent of its free reserves and securities premium account, whichever is more”. 

Brief Background

Konark Aquatics and Exports Private Limited (“Corporate Debtor” or “Respondent”), having registered office in Odisha, is engaged in the business of sea food processing and exports. The loan accounts of the Corporate Debtor were already classified as non-performing asset by the secured creditors.

In view of financial constraints, Pancham Studios Private Limited (“Financial Creditor” or “Appellant”) agreed to disburse inter corporate loan (interest free) to discharge the liabilities of the other secured financial creditors. As per the arrangement agreed between the parties, the inter corporate loan was to be repaid after the settlement of the outstanding liabilities (owed to the secured creditors) of the Corporate Debtor under the one time settlement scheme.

While the financial obligations towards the secured creditors were settled, Corporate Debtor failed to discharge the dues of the Financial Creditor despite repeated reminders/demand notices. As a result, a petition (“Company Petition”) under Section 7 of the Insolvency and Bankruptcy Code, 2016 (“IBC”) was filed before the Hon’ble NCLT, Cuttack Bench which was dismissed vide Order dated November 29, 2023.

Grounds for dismissal of the Company Petition
Hon’ble NCLT, while dismissing the Company Petition held that (a). the inter corporate loan by the Financial Creditor cannot be termed as a financial debt (as it is interest free and the amount was not disbursed against the time value for money) and (b). the loan sanctioned by the lender was in violation of Section 186 (2) (a) of the 2013 Act.  

Filing of Company Appeal by the Financial Creditor

In the Company Appeal filed, seeking setting aside of the above Order, the following were advanced as primary contentions:

1. No dispute has been raised by either of the parties in relation to the disbursement of the amount.
2. The amount in question is clearly reflecting in the financial statement (as unsecured loan) of the Corporate Debtor without any qualification and/or caveat. As a result, entries in the financial statement constitutes the acknowledgement/admission of debt.
3. Interest free loan granted by the Financial Creditor for the purposes of discharging financial liabilities and improving the financial health of the Corporate Debtor has the commercial effect of borrowing.
4. Section 186 (2) of the 2013 Act is to protect shareholders/stakeholders of a financial creditor so as to safeguard granting of excessive loans by the management of the financial creditor (beyond the capacity).
5. In such a scenario, violation of the provision can only be challenged by shareholders/stakeholders and not the Corporate Debtor, who being the beneficiary/recipient of the sums advanced (which it is required to repay) has no locus to assail a transaction on account of violation of Section 186 (2) of the 2013 Act.
6. While penal measures have been provided in view of violation of Section 186 (2) of the 2013 Act, it does not render/invalidate the transaction qua the third party borrower

Defence by the Corporate Debtor

Contentions advanced by the Corporate Debtor were as follows:  

1. Disbursement of loan by the Financial Creditor was in violation of Section 186 of the 2013 Act as foremost, the loan was granted without any interest. Further, as the loan sanctioned by the Financial Creditor exceeded sixty percent  of its paid up share capital, it required prior approval by means of special resolution passed in the general meeting. However, no such  general meeting was held for the purpose of passing of special resolution.
2. As the loan was sanctioned Loan without entering into any agreement and without any interest, it cannot be treated as a financial debt.

Conclusion drawn by the Hon’ble NCLAT

Upon hearing the submissions of the parties, the Hon’ble NCLAT concluded as follows:

1. An entry in the balance sheet of the Corporate Debtor without any qualification / caveat is an acknowledgment of debt by the Corporate Debtor, having commercial effect of borrowing.
2. As significant reliance was placed by the parties and the Hon’ble NCLT upon violation of Section 186 (2) of the 2013 Act by the Financial Creditor, it was noted that the said violation for which penal measures have already been provided under sub – section (13) of Section 186 of the 2013 Act cannot result in granting any leeway to the debtor. 
3. Under no such circumstance/scenario, the Corporate Debtor can be granted any protection under Section 186 of 2013 Act, thereby allowing it to evade its financial liability. The debtor is required to repay the amount which is due and payable.
4. Thus, once the debt and default stands well established in a petition filed under Section 7 of the IBC, which in the present case is evident from the financial statements/balance sheet of the Corporate Debtor, Hon’ble NCLT committed patent error while dismissing the Company Petition.

Accordingly, the Order passed by the Hon’ble NCLT was set aside.  

Implication of the Judgment

The Judgment passed by the Hon’ble NCLAT in the Company Appeal has fortified the position that even though there may be flagrant violation of Section 186 of the Companies Act, 2013, it cannot result in granting any protection to the debtor, especially when it has been well established that there is an existence of debt and default – thereby shredding the belief that non-compliance of any nature on the part of the lenders can act as an anchor for the debtor to evade its liability/obligations.

IBC, being a special legislation, is neither a debt recovery tool nor is it required to determine the legality of the transaction under any other law. The only respite that can be availed by the debtor is when it is able to establish that the debt arises from a transaction which itself is illegal/void. Hence, the moment the creditor is able to establish that there is an existence of debt and default, the petition filed under Section 7 of the IBC is required to be admitted (subject to just exceptions).