On one of the rare occasions that a 5 member bench of the Hon’ble National Company Law Appellate Tribunal (“NCLAT”) sat, a decision was rendered vide its order dated 12.03.2020 in the matter of V. Padmakumar vs. Stressed Assets Stabilisation Fund (SASF) & Anr. The primary issue for consideration before the larger bench of the NCLAT was whether filing of suit and the resultant decree would extend the period of limitation for the creditor to approach the Adjudicating Authority under the Insolvency & Bankruptcy Code, 2016 (“IBC”). More specifically the question arose whether the date of default can be shifted owing to the abovementioned events. The larger bench unanimously concluded that it cannot be so. In addition to the above primary issue, there was also an ancillary issue which came to be considered and decided by the larger bench of the NCLAT – whether reflection of debt in the books of accounts would tantamount to acknowledgment of debt under section 18 of the Limitation Act, 1963 (“Limitation Act”) and thereby extend the period of limitation. The scope of the present article is restricted to the analysis of the decision given by the NCLAT on this ancillary issue alone.
It is interesting to note that as far as the issue of acknowledgement of debt through recording of debt in books of accounts is concerned, the decision was not a unanimous one – it was a majority decision of 4:1. The majority concluded that as the filing of Balance Sheet/ Annual Return being mandatory under the Companies Act, 2013 (“Companies Act”), it cannot be treated to be an acknowledgement under Section 18. The dissenting judgment on this issue concludes that the recording of debt in the books of account will be valid acknowledgment under Section 18.With respect, the author through this article has attempted to conclude that it is in fact the dissent that is correct and should hold the field.
SECTION 18, LIMITATION ACT
Section 18 of the Limitation Act, to the extent relevant for the purposes of the present article, provides that where, before the expiration of the prescribed period for a suit or application in respect of any property or right, an acknowledgment of liability in respect of such property or right has been made in writing signed by the party against whom such property or right is claimed, or by any person through whom he derives his title or liability, a fresh period of limitation shall be computed from the time when the acknowledgment was so signed.
Explanation (b) to Section 18 further provides that the word “signed” means signed either personally or by an agent duly authorised in this behalf.
MAJORITY DECISION
The decision of the majority can be summarised as follows:
i. As the filing of Balance Sheet/ Annual Return being mandatory under Section 92(4) of the Companies Act, failing of which attracts penal action under Section 92(5) & (6), the Balance Sheet / Annual Return of the ‘Corporate Debtor’ cannot be treated to be an acknowledgement under Section 18 of the Limitation Act.
ii.If the argument is accepted that the Balance Sheet / Annual Return of the ‘Corporate Debtor’ amounts to acknowledgement under Section 18 then in such case, it is to be held that no limitation would be applicable because every year, it is mandatory for the ‘Corporate Debtor’ to file Balance Sheet/ Annual Return, which is not the law
DEBT IN FINANCIAL STATEMENTS – ACCOUNTANCY & LAW
The journey of the final balance sheet, profit & loss account and cash flow statement (together referred to as financial statements) begins with a small step of recording each and every transaction in the ledgers of the company books i.e. the accounts. This entry of transaction is then verified and approved by the Board of Directors through their own internal control mechanism at the end of the financial year. It is at this stage that the company prepares the final balance sheet, profit & loss account and cash flow statements. These financial statements are then audited by the auditors of the company and given their stamp of authenticity.
Given the above practical background, let us focus on few statutory and regulatory provisions pertaining to preparation of the financial statements.
I. AT THE STAGE OF PREPARATION OF ACCOUNTS
In this regard, Section 128(1) of the Companies Act provides that every company shall prepare books of accounts and financial statements which give “true and fair view” of the state of the affairs of the company. Similarly, Section 129(1) mandates that the financial statements shall give a true and fair view of the state of affairs of the company and comply with the accounting standards notified under Section 133. One of the accounting standards notified under Section 133 is Indian Accounting Standard – 1 (“Ind AS – 1”) which clearly provides the following:
“Financial statements shall present a true and fair view of the financial position, financial performance and cash flows of an entity. Presentation of true and fair view requires the faithful representation of the effects of transactions, other events and conditions in accordance with the definitions and recognition criteria for assets, liabilities, income and expenses set out in the Framework”
II. AT THE STAGE OF AUDITING OF ACCOUNTS
After the accounts and financial statements have been prepared as mandated in the abovementioned provisions and audited by the auditors. At this stage it is important to consider one of the duties of the auditors as mandated by Section 143(2). As per the said provision, the auditor has to make an audit report which after taking into consideration the accounts and financial statements, give a “true and fair view” of the state of the company’s affairs. Implicit in this duty is the duty of the auditor to verify transactions and take a prudent decision as to their recognition in the books of accounts. If the transaction appears to be true and fair, the auditor puts her seal of authenticity on it.
III. AT THE STAGE OF PRESENTATION BEFORE THE SHAREHOLDER
Once the above stages are passed, the final accounts and financial statements are laid before the shareholders in the annual general meeting. The same is also accompanied by a Directors’ Responsibility Statement under section 134(3)(c) of the Companies Act. The purpose of this statement is to state before the shareholders that the directors have made judgments and estimates that are reasonable and prudent so as to give a “true and fair view” of the state of affairs of the company at the end of the financial year and of the profit and loss of the company for that period (Section 134(5)).
IV. TRUE & FAIR VIEW – THE COMMON THREA D
In view of the above, one can now appreciate that true and fair view of the company affairs is one of the most important objectives of preparing the books of accounts and financial statements. This exercise passes through various stages before being presented to the stakeholders. The board of directors apply their mind and the auditors undertake an extensive exercise to authenticate the books. Hence, whatever is recorded in the books of accounts & financial statements as per the standards, is presumed to give a true and fair view (Ind AS – 1). Thus there is a sanctity attached in law to the audited books of accounts.
In fact the same logic is echoed in the words of the Hon’ble Supreme Court in the case of Ishwar Dass Jain vs. Sohan Lal, AIR 2000 SC 426 wherein it was held that the rationale behind admissibility of parties’ books of account as evidence is that the regularity of habit, the difficulty of falsification and the fair certainty of ultimate detection give them in a sufficient degree, a probability of trustworthiness.
V. ACKNOWLEGDEMENT OF DEBT – THE JURISPRUDENCE
The interplay of accounting for debt in the books of accounts and its consequent effect under the Limitation Act can be traced back to an early decision of the Chancery Division in the case of Re Atlantic and Pacific Fibre Importing and Manufacturing Co., Ltd., [1928] Ch. 836 which was approved by the King’s Bench Division in the case of Jones v. Bellgrove Properties Ltd. (1949) 2 KB 700 wherein it was held that a balance sheet prepared and signed by the directors and the auditors as the agents of the company and then presented at the general meeting constitutes a good acknowledgment for the purposes of extending the limitation.
The Indian jurisprudence has taken the previous two cases as the base and has further expounded on the proposition pertaining to debt in the books of accounts being treated as acknowledgment of debt. In fact, the jurisprudence is not limited only to the aspect of period of limitation but the proposition is applied in various other fields of law like taxation, arbitration, civil procedure code, etc. as well.
In terms of Income Tax Act, 1961, the Hon’ble Gujarat High Court in the case of Ambika Mills Ltd. vs. CIT, [1964] 54 ITR 167 (Guj) has held that the liability in respect of those unpaid wages was acknowledged by the assesse company at the end of each year in its balance-sheets and hence those amounts could not be said to have been fictionally stamped with the character of profits/gains as all along they retained the character of liabilities owing to the
annual acknowledgments made by the assessee company.
Similarly, the Hon’ble Madras High Court in the case of CIT vs. Tamilnadu Warehousing Corporation, [2007] 292 ITR 310 (Madras) has held that once it was shown as liability by the assessee in the books of accounts, the department was wrong in holding that it was assessable under Section 41(1) of the Income Tax Act, 1961. So long as it was reflected in the books of accounts, there was no cessation of liability.
The Hon’ble Supreme Court had the occasion to consider the plea of debt being acknowledged under the Negotiable Instruments Act, 1881 in the matter of A.V. Murthy vs. B.S. Nagabasavanna (2002) 2 SCC 642 wherein the Hon’ble Court held that if the amount borrowed by the respondent is shown in the balance sheet,
it may amount to acknowledgement.
Order 12 Rule 6 of the Code of Civil Procedure deals with judgment on admissions. While considering Order 12 Rule 6, the Hon’ble Bombay High Court in the case of Deccan Chronicle Holdings Ltd vs. Tata Capital Financial Services Ltd., MANU/MH/1105/2016 has held that an the admission in the balance sheet of a company unless contradicted or refuted, would operate as an estoppel against the petitioners and would be the decisive factor for passing a decree for admission and the court is empowered to pass a decree on admission by applying the provisions of Order 12 Rule 6 of the Code of Civil Procedure, 1908.
It’s not as if the point of view that the financial statements have been made under compulsion of law has not been raised or decided for the first time. The Hon’ble Calcutta High Court as far back as in 1962 has in the case of Bengal Silk Mills Co. Vs. Ismail Golam
Hossain Ariff, AIR 1962 Cal. 115 held that in an appeal arising from a money decree against a company, even statement of a liability in the balance-sheet of the company amounted to admission/ acknowledgement of a debt giving rise to a fresh period of limitation, notwithstanding the fact that the balance sheet was prepared under ‘compulsions of statute and of the articles of association of the company’. This decision has also been followed by the Hon’ble Delhi High Court in the case of Bhajan Singh Samra vs. Wimpy International Ltd [2012] 173 Comp Cases 455 (Del).
More specifically, the Hon’ble Delhi High Court in the case of Shahi Exports Pvt. Ltd. vs. CMD Buildtech Pvt. Ltd., 2013 SCC OnLine Del 3739 has concluded that is hardly necessary to cite authorities in support of the well-established position that an entry made in the company’s balance sheet amounts to an acknowledgement of the debt and has the effect of extending the period of limitation under section 18 of the Limitation Act, 1963.
Finally, the Hon’ble Supreme Court has also held in unequivocal terms that entries in the books of accounts would amount to an acknowledgement of the liability within the meaning of Section 18 of the Limitation Act, 1963 and extend the period of limitation for the discharge of the liability as debt (Mahabir Cold Storage v. CIT, 1991 Supp (1) SCC 402)
A CAVEAT
From the study of the judgments and provisions cited above, one can appreciate that the position is now well settled that an amount reflecting in the books of account is a valid acknowledgment of debt. This is supported by the accounting principles as well. However, it is pertinent to note that there is one important caveat that has been explained by the Hon’ble Delhi High Court. Readers would recollect that at the time of presenting the financial statements before the shareholders, there is a requirement of presenting a directors report as well. Sometimes, the directors in that report or through notes to accounts explain certain entries or transactions. Therefore, in understanding the balance sheets and in explaining the statements in the balance-sheets, the balance-sheets together with the Directors’ report must be taken together to find out the true meaning and purport of the statements. In such a scenario, the Hon’ble Delhi High Court speaking through Justice Sikri (as he then was) in the case of Sheetal Fabrics vs. Coir Cushions Ltd, 120 (2005) DLT 693 laid down that law that statement in the balance sheet indicating liability is to be read along with the Directors’ report to see whether both so read would amount to an acknowledgement. Thus, if the admission in the balance sheet is without any conditions or any strings attached then such an admission would clearly amount to an acknowledgement.
CONCLUSION
The majority members of the Hon’ble NCLAT have not considered the above aspects – both legal as well as accounting – while delivering the judgment on the issue.
The books of accounts hold an important status in the eyes of law and cannot be wished away simply because they are prepared under compulsion of law.
There was a compulsion upon the directors to prepare the financial statements but there was no compulsion upon them to make any particular admission.
They faithfully discharged their duty and in doing so they made honest admissions of the company’s liabilities. Those admissions though made in discharge of their duty are nevertheless conscious and voluntary admissions.
The Hon’ble NCLAT (majority) has unfortunately not dealt with section 128 129, 143 and 134 of the Companies Act, 2013 as well as the decisions cited above.
The sanctity attached in law to the financial statements has been respected when the dispute is in the realm of taxation, company law, insolvency, arbitration, civil procedure code, negotiable instruments, etc. and has rightly stood the test of time.
The minority decision has referred to few aspects discussed above. It is hoped that the majority decision is corrected and the minority view is upheld by the Hon’ble Supreme Court as and when the occasion so arises. Failure to do so would lead to difficulty as this 5 member bench decision on this aspect, by virtue of 4:1, is binding on all the benches of NCLAT and would certainly apply with full force before NCLT benches.
Till then, we can only seek recourse in the words of Chief Justice Hughes (1936) who wrote that dissenting decision is “an appeal to the brooding spirit of the law, to the intelligence of a future day, when a later decision may possibly correct the error into which the dissenting judge believes the court to have been betrayed.”
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