Who is a Related Party to Corporate Debtor in IBC?

The Insolvency and Bankruptcy Code, 2016 (IBC) has brought a new way of resolving insolvency in India. It shifted the process from being debtor-centric to creditor-centric, where the creditors, through the committee of creditors (CoC), decide the resolution of the corporate debtor.

One of the important aspects under the Code is the concept of a “related party”. The reason is simple – if related parties are allowed to control or influence the resolution process, the very purpose of insolvency proceedings can be defeated. This article explains who is a related party in relation to a corporate debtor under IBC, why the law excludes them from decision-making, and how courts have interpreted this concept.

Importance of the Concept of Related Party to Corporate Debtor in IBC

The insolvency process is aimed at ensuring fair treatment of creditors and revival of the corporate debtor. If promoters, directors, associates, or connected entities who may have contributed to the downfall of the debtor are allowed to sit in the CoC or submit resolution plans, it creates a clear conflict of interest.

Therefore, the Code:

• Prevents related parties from submitting resolution plans (Section 29A).
• Restricts related parties from voting in CoC meetings (first proviso to Section 21(2)).

The purpose is to ensure that the resolution is driven by external creditors who are independent, and not by those who may misuse their position to regain control of the company.

Statutory Definition of Related Party to Corporate Debtor in IBC

Section 5(24) of the IBC provides a detailed list of who will be treated as a related party to the corporate debtor. The definition is wide and covers individuals, companies, partnerships, and entities connected directly or indirectly with the debtor.

Key Categories of Related Parties

1. Individuals directly linked with the debtor
   • Directors or partners of the corporate debtor.
   • Relatives of directors or partners.
   • Key managerial personnel (KMP) or their relatives.
2. Entities connected through ownership or management
   • LLPs or partnership firms where directors, partners, or managers of the debtor or their relatives are partners.
   • Private companies where such persons are directors and hold more than 2% of share capital with their relatives.
   • Public companies where such persons are directors and hold more than 2% of paid-up share capital with their relatives.
3. Entities acting under influence
   • Any body corporate whose board or managers act on the advice or directions of debtor’s directors, partners, or managers.
   • Any LLP or partnership whose partners or employees act under such directions.
   • Any person whose advice or instructions the debtor’s directors, partners, or managers are accustomed to follow.
4. Group companies and subsidiaries
   • Holding, subsidiary, or associate companies of the corporate debtor.
   • Subsidiary of a holding company where the debtor itself is a subsidiary.
5. Control-based connections
   • Any person who controls more than 20% of voting rights in the debtor by ownership or voting agreement.
   • Any person in whom the debtor controls more than 20% of voting rights.
   • Any person who can control the composition of the board of directors or governing body of the debtor.
6. Associative connections based on business relations
   • Persons participating in policy-making processes of the debtor.
   • Entities having more than two directors in common with the debtor.
   • Entities where there is interchange of managerial personnel with the debtor.
   • Entities providing essential technical information to or from the debtor.

The list shows that the law focuses not only on shareholding but also on the substance of influence and control. Even if a party does not directly hold shares, it may still be treated as related if it influences policy-making or supplies key technical support.

Commutative Nature of the Relationship

The term “related party” is commutative in nature. This means that if X is a related party to Y, then Y is also a related party to X. In insolvency proceedings, this ensures that both sides of the relationship are covered, and no one can escape liability by arguing that the relationship is one-sided.

Why Related Parties Are Excluded from CoC

The CoC is the driving force of the insolvency resolution process. It approves the resolution plan, decides on liquidation, and manages the process through the resolution professional. Allowing related parties to vote in the CoC would mean that the debtor’s own people can control the process.

Section 21(2) therefore provides that related party financial creditors may attend meetings of the CoC but shall not have voting rights. The intent is to prevent conflict of interest and ensure that only genuine, external creditors drive the resolution.

Meaning of “Control” under IBC

One of the important tests in deciding related party status is the meaning of “control”. Section 5(24)(j) states that any person controlling more than 20% voting rights is a related party. However, courts have clarified that “control” does not simply mean having veto powers or minority protective rights.

• In Arcelor Mittal India Pvt. Ltd. v Satish Kumar Gupta, the Supreme Court held that control means positive control, i.e., the ability to steer the affairs of the company. Merely having the power to block special resolutions (reactive control) is not sufficient.
  
• The Securities Appellate Tribunal’s view in Subhkam Ventures was endorsed, where it was said that the real test is whether a person is “in the driving seat” of the company, not whether they can merely “apply brakes”.
  
• In Phoenix ARC Pvt. Ltd. v Spade Financial Services, the Supreme Court stressed that the interpretation of control should be purposive, keeping in mind the objective of the Code, so that provisions are not misused.

Thus, control has been understood as active and real influence, not theoretical rights.

Judicial Interpretations and Conflicting Views

The National Company Law Tribunals (NCLTs) have given varied interpretations of control and related party status:

• Sarga Udaipur Hotels and Resorts Pvt. Ltd. v HUDCO (Kolkata NCLT): Even though a creditor had 24.4% shareholding, its influence was only “theoretical”. The tribunal allowed it to participate in the CoC, holding that it was not a related party in the true sense.
  
• Zenith Infra Investment Holdings Pte. Ltd. v Rajneesh Kumar Aggarwal (Delhi NCLT): A 30% shareholder was not allowed to participate in CoC despite having no role in day-to-day management. The tribunal took a conservative approach and did not apply the purposive interpretation stressed by the Supreme Court.

These conflicting views show the uncertainty that still exists in the application of the law, and highlight the importance of consistent interpretation by higher courts.

Exception to the Exclusion Rule

The law also recognises that not all financial investors with shareholding should be automatically excluded. Sometimes, lenders acquire shares due to conversion of debt or restructuring, and excluding them would be unfair.

By way of the 2018 Amendment, an exception was introduced in Section 21(2). The second proviso provides that certain persons will not be excluded if:

• They are regulated by a financial sector regulator, and
  
• They became related parties only because of conversion or substitution of debt into equity before the insolvency commencement date.

The Insolvency Law Committee Report (2018) explained that genuine financial creditors, such as banks or funds that hold equity due to restructuring, should not lose their voice in the CoC.

Later, the 2020 ILC Report clarified that even foreign financial creditors whose managers or advisors are regulated should be included within this protection.

Judicial Interpretation of the Exception

Courts have examined the scope of the second proviso:

• State Bank of India v Gati Infrastructure (NCLT Hyderabad): A financial creditor with 25% equity shareholding was allowed to participate in CoC because its equity holding was a result of compelling circumstances. The tribunal held that the intention of the creditor was only to provide finance, not to control the company.
  
• Zenith case (NCLT Delhi): The tribunal refused to extend such benefit and stuck to a strict view, holding that there were no compelling circumstances for the creditor to hold equity.

These opposite approaches again underline the need for clarity and a uniform standard.

Related Party in Context of Individuals

Initially, the Code did not provide a definition of related party for individuals. This gap was filled by the 2018 Ordinance, which introduced such a definition. For terms not defined in IBC, Section 3(37) makes the Companies Act, 2013 applicable. Section 2(76) of the Companies Act also defines related parties, which is relevant in this context.

Conclusion

The concept of related party under IBC is central to ensuring transparency, fairness, and independence in the insolvency resolution process. Section 5(24) gives an extensive list of categories, while judicial interpretations have stressed purposive reading of “control”.

The exclusion of related parties from CoC voting is meant to prevent conflicts of interest and protect the process from being manipulated by insiders. At the same time, the law provides exceptions to protect genuine financial investors who became shareholders due to debt restructuring or other circumstances.