Phoenix ARC vs Spade Financial Services: Why Related Party Creditors Get No Vote on the CoC

On 1 February 2021, a three-judge bench of the Supreme Court decided who is allowed to sit at the table that controls a company's insolvency. In Phoenix ARC Pvt Ltd vs Spade Financial Services Ltd and Ors (AIR 2021 SC 776, Civil Appeal No. 2842 of 2020), the Court interpreted the first proviso to Section 21(2) of the Insolvency and Bankruptcy Code, 2016 (IBC) and held that a financial creditor who is a related party of the corporate debtor has no right of representation, participation or voting in the Committee of Creditors (CoC). The judgement, authored by Justice D.Y. Chandrachud for a bench that also comprised Justices Indira Banerjee and Indu Malhotra, is the leading authority on how far that bar reaches.

The Statutory Question

The Committee of Creditors is the decision-making engine of every Corporate Insolvency Resolution Process (CIRP) under the IBC. It is constituted under Section 21(1) of the Code and is composed of the financial creditors of the corporate debtor. Those creditors vote on the resolution plan, and a plan needs the approval of at least 66 per cent of the voting share under Section 30(4) IBC before it can go to the adjudicating authority. Control of the CoC is, in practical terms, control of the company's fate.

The first proviso to Section 21(2) IBC carves out an exception. It states that a financial creditor who is a related party of the corporate debtor shall have no right of representation, participation or voting in a meeting of the CoC. The logic is straightforward: the IBC's object, declared in its long title in 2016, is to resolve insolvency in a time-bound manner for maximisation of value, and a creditor aligned with the very management that drove the company into default cannot be trusted to vote in the interests of the creditor body as a whole.

The precise question in Phoenix ARC was twofold. First, were Spade Financial Services Ltd and AAA Landmark Pvt Ltd "financial creditors" at all within Section 5(7) IBC, given the nature of their dealings with the corporate debtor, AKME Projects Ltd. Second, even if they were, did the first proviso to Section 21(2) exclude them as related parties under Section 5(24) IBC, when their formal relationship with the corporate debtor had technically ceased before the CIRP commenced on 18 April 2018. The appeal reached the Supreme Court from an order of the National Company Law Appellate Tribunal (NCLAT), and the statute being interpreted is available at indiacode.nic.in in the consolidated text of the IBC, 2016 (Act 31 of 2016).

What the Court Held

The CIRP against AKME Projects Ltd began on 18 April 2018 on an application filed by an operational creditor under Section 9 IBC. Spade and AAA then claimed seats on the CoC as financial creditors, relying on inter-corporate deposits and related arrangements dating back to the period between 2009 and 2013. The resolution professional and the lender Phoenix ARC resisted, and the dispute travelled up to the Supreme Court.

The Court delivered two distinct conclusions. On the first question, it held that Spade and AAA were not financial creditors within Section 5(7) IBC at all, because the underlying transactions were collusive and did not amount to a "financial debt" under Section 5(8) IBC. Spade had extended inter-corporate deposits under a Memorandum of Understanding that recorded interest at 24 per cent, yet only about 12 per cent appears to have been charged, and the Court treated the arrangement, together with AAA's 2012 Development Agreement and a later Agreement to Sell supported by a Side Letter, as devices rather than genuine lending. The NCLAT's description of Spade and AAA as "admitted" financial creditors was held to be plainly erroneous.

On the second question, the Court held that Spade and AAA were in any event related parties of the corporate debtor and were therefore excluded from the CoC by the first proviso to Section 21(2) IBC. The exclusion was affirmed, though on the reasoning the Supreme Court itself supplied rather than that of the NCLAT. The appeals were disposed of accordingly.

The entanglement that drove this conclusion was dense. Mr Arun Anand held a sequence of roles tying the two camps together: Consultant to the group from 2009 to 2011, Strategic Advisor from 2011 to 2012, and Group CEO from November 2012 to February 2013, while also being a director and promoter of both Spade and AAA. A company of the Anil Nanda group held roughly 80 per cent of AKME Projects Ltd, and Mr Sonal Anand, a relative, was a director of the corporate debtor from 2007 to 2013. Against that backdrop the Court invoked specific limbs of the related-party definition.

Reasoning

"Is a related party" is read in the present tense, with a purpose

The drafting of the first proviso to Section 21(2) IBC uses the present tense: the bar applies to a financial creditor who "is" a related party. The Court accepted, at paragraphs 94 and 95 of the judgement, that the default rule tracks that tense. A creditor who is not a related party at the time the CoC is constituted is not disqualified merely because the debt originally arose during a period when the creditor was related to the corporate debtor. In praesenti status is the starting point, not antecedent history.

The Court anchored this in purpose. The exclusion in the first proviso, introduced to the IBC in 2016, exists because a related party's commercial interests are presumed to be aligned with the promoters rather than with the general body of creditors. Where that alignment has genuinely ended, the rationale for the bar falls away, and reading the proviso to disqualify every creditor with any historical connection would sweep in parties the statute was never aimed at.

The anti-abuse exception for divestment

The Court then closed the obvious loophole. If related-party status could be shed on the eve of insolvency to buy a CoC seat, the first proviso to Section 21(2) IBC would be worthless. So the Court held that a former related party remains excluded where it has divested its related-party status with the object of entering the CoC. The judgement, at paragraph 94, spoke of parties that cease to be related "with the sole intention of participating in the CoC and sabotaging the CIRP." Such creditors are treated as falling within the proviso notwithstanding their shedding of formal status.

On the facts, Spade and AAA failed this test. Their loss of related-party status was itself a product of the same commercial contrivances that made their transactions collusive, and the Court at paragraphs 97 and 98 affirmed both the NCLAT's finding that they were related parties under Section 5(24) IBC and their consequent exclusion from the CoC.

Protecting the good-faith assignee

A third strand guards genuine commerce. Debts are routinely assigned to asset reconstruction companies and other investors, and the Court recognised, at paragraph 93, that a party who takes an assignment of a related party's debt in good faith does not inherit the disqualification. An assignee is treated as a related party only where the assignment is a device executed in bad faith to circumvent the first proviso to Section 21(2) IBC. This is why Phoenix ARC itself, the assignee-lender that resisted Spade and AAA, was never in peril: its standing as an unrelated creditor was never a contrivance.

Practical Takeaways

For lenders, borrowers, investors and NRIs watching an Indian insolvency, the Phoenix ARC judgement of 1 February 2021 reshapes expectations in concrete ways.

For banks and asset reconstruction companies:

• A promoter-aligned "friendly" lender cannot be parked on the CoC to steer or stall the CIRP. Challenge its status early under the first proviso to Section 21(2) IBC, before the 66 per cent voting threshold in Section 30(4) IBC is applied to any plan.
• Diligence on inter-corporate deposits matters. Spade's MOU recorded 24 per cent interest while only about 12 per cent was charged between 2009 and 2013, and that mismatch helped expose the arrangement as collusive under Section 5(8) IBC.
• When you buy distressed debt, document the commercial rationale. A good-faith assignee is protected under paragraph 93 of the judgement; a sham assignment is not.

For promoters and corporate groups:

• Divesting related-party status shortly before CIRP to claim a CoC seat will not work. The anti-abuse exception at paragraph 94 catches exactly that manoeuvre.
• Cross-directorships and advisory roles count. Mr Arun Anand's positions from 2009 to 2013 were enough to bring Spade and AAA within Section 5(24)(a), (f), (h) and (m) IBC.

For operational creditors and resolution professionals:

• The process that began here under Section 9 IBC on 18 April 2018 shows an operational creditor can trigger a CIRP and then rely on the courts to keep the CoC clean of related parties.

The borrower-side lesson is that insolvency is not a tool for recapturing control through aligned creditors. If your business is under recovery pressure, model the real cost of the debt and the alternatives before it reaches a tribunal: our foreclosure calculator and debt consolidation calculator help you compare paying down versus restructuring, while the loan eligibility calculator and the home loan EMI calculator are useful when refinancing is still on the table. For the surrounding recovery machinery, see our glossary entries on the Debts Recovery Tribunal (DRT) and the SARFAESI Act.

This judgement sits alongside two other Supreme Court decisions our desk has explained: how the Court unwound collusive security in Anuj Jain vs Axis Bank, and why a personal guarantor stays liable even after a resolution plan. Read together, they map how the IBC, enacted in 2016, polices who may influence a resolution and who must simply bear its consequences.

FAQ

Does every related party lose its CoC seat under the IBC?

Yes, where it qualifies as a financial creditor. The first proviso to Section 21(2) IBC, as read in Phoenix ARC (AIR 2021 SC 776, decided 1 February 2021), denies a related-party financial creditor any right of representation, participation or voting in the Committee of Creditors. The bar is automatic once related-party status under Section 5(24) IBC is established; it does not depend on proof of actual misconduct in the particular meeting.

What is the test for related-party status under Section 5(24)?

Section 5(24) IBC lists several limbs. In Phoenix ARC the Supreme Court relied on clauses (a), (f), (h) and (m) to capture control, common directing minds, persons on whose advice directors act, and relatives. The Court looked at substance over form, holding that Mr Arun Anand's roles from 2009 to 2013 across Spade, AAA and AKME Projects Ltd brought the entities within the definition despite the absence of a single straightforward shareholding link.

Can a creditor escape the bar by giving up related-party status before CIRP?

No, not if the purpose was to gain CoC entry. The Court held at paragraph 94 that a former related party remains excluded where it divested its status with the sole intention of participating in the CoC and sabotaging the CIRP. Spade and AAA lost their appeal on exactly this ground, because their shedding of related-party status flowed from the same contrivances that made their transactions collusive between 2009 and 2013.

Are inter-corporate deposits always a financial debt under the IBC?

Not automatically. In Phoenix ARC the Supreme Court held that Spade's inter-corporate deposits were not a financial debt under Section 5(8) IBC because the dealings were collusive, citing the MOU's 24 per cent interest against roughly 12 per cent actually charged. A genuine deposit with time value of money can be a financial debt, but a sham structured to manufacture creditor status will fail the Section 5(7) and 5(8) tests.

Does buying distressed debt from a related party disqualify the buyer?

Not if the purchase is genuine. The Court recognised at paragraph 93 that a good-faith assignee of a related party's debt is not disqualified under the first proviso to Section 21(2) IBC. Disqualification follows only where the assignment is a bad-faith device to circumvent the bar. Keeping clear records of commercial rationale and pricing is the practical safeguard for any asset reconstruction company acquiring claims.

Who decides whether a creditor is a related party?

The adjudicating authority, which is the National Company Law Tribunal, decides in the first instance, with appeals to the NCLAT and then the Supreme Court. In Phoenix ARC the Supreme Court affirmed the NCLAT's finding of related-party status under Section 5(24) IBC at paragraphs 97 and 98, while setting aside its separate error in treating Spade and AAA as admitted financial creditors. The resolution professional is expected to flag suspected related parties when constituting the CoC under Section 21 IBC.

Where can I read the full judgement?

The full text of Phoenix ARC Pvt Ltd vs Spade Financial Services Ltd and Ors is reported as AIR 2021 SC 776 and is available on Indian Kanoon at indiankanoon.org/doc/137461156/. The statute it interprets, the Insolvency and Bankruptcy Code, 2016, can be read in its consolidated form at indiacode.nic.in. Both sources were decided and enacted respectively on 1 February 2021 and in 2016.