A decision was recently rendered by a rare sitting of a five-member bench of the National Company Law Appellate Tribunal (NCLAT) in the matter of V Padmakumar v. Stressed Assets Stabilisation Fund (SASF) & Anr.
One of the ancillary issues which came to be considered was whether reflection of debt in the books of accounts tantamounts to acknowledgment of debt under Section 18 of the Limitation Act, 1963, and thereby extends the period of limitation.
The decision was not a unanimous one – it was a majority decision of 4:1. The majority concluded that the filing of balance sheet being mandatory under the Companies Act, 2013, it cannot be treated to be an acknowledgement under Section 18.
The dissent concludes that the recording of debt 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.
The decision of the majority can be summarised as follows:
Filing of Balance Sheet being mandatory under Section 92(4) of the Companies Act, the same cannot be treated to be an acknowledgement under Section 18 of the Limitation Act.
If the argument is accepted that the Balance Sheet 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.
Let us focus on few statutory and regulatory provisions pertaining to preparation of the financial statements.
I. At the Stage of Preparation of Accounts
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 that the financial statements shall present a true and fair view of the financial position, financial performance and cash flows of an entity with faithful representation of the effects of transactions.
II. At the Stage of Auditing of Accounts
It is important to consider one of the duties of the auditors as mandated by Section 143(2) whereunder 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 is the duty 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
The financial statements are laid in the annual general meeting. The same is also accompanied by a Directors’ Responsibility Statement under section 134(3)(c). The purpose of this statement is to state 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.
IV. True and Fair View - The Common Thread
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 financial statements. The board of directors applies its mind and the auditors undertake an extensive exercise to authenticate the books.
Hence, whatever is recorded in the books of accounts & financial statements, is presumed to give a true and fair view. Thus, there is a sanctity attached in law to the audited books of accounts.
This was echoed by the Supreme Court in Ishwar Dass Jain v. Sohan Lal, when it 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, to a sufficient degree, a probability of trustworthiness.
V. Acknowledgment 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 Re Atlantic and Pacific Fibre Importing and Manufacturing Co Ltd, which was approved by the King’s Bench Division in Jones v. Bellgrove Properties Ltd.
Here, 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 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 Gujarat High Court in Ambika Mills Ltd. v. CIT, held that the liability in respect of unpaid wages was acknowledged by the assesse company at the end of each year in its balance sheets and hence those amounts retained the character of liabilities owing to the annual acknowledgments made by the assessee company.
Similarly, the Madras High Court in CIT vs. Tamilnadu Warehousing Corporation, has held that once debt was shown as liability by the assessee in the books of accounts, the department was wrong in holding that it was assessable as income because there was no cessation of liability.
The Supreme Court had the occasion to consider the plea of debt being acknowledged under the Negotiable Instruments Act, 1881 in AV Murthy v. BS Nagabasavanna, wherein it was held that if the amount borrowed by the respondent is shown in the balance sheet, it may amount to acknowledgement.
While considering Order 12 Rule 6, the Bombay High Court in Deccan Chronicle Holdings Ltd v. Tata Capital Financial Services Ltd held that an admission in the balance sheet of a company unless contradicted or refuted, would operate as an estoppel and would be the decisive factor for passing a decree for admission.
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 is decided for the first time. The Calcutta High Court, as far back as in 1962 in Bengal Silk Mills Co. Vs. Ismail Golam Hossain Ariff, held that statement of a liability in the balance sheet amounted to 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’.
More specifically, the Delhi High Court in Shahi Exports Pvt. Ltd. v. CMD Buildtech Pvt. Ltd concluded that it is a 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.
Finally, the 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.
However, it is pertinent to note that there is one important caveat that has been explained by the Delhi High Court. Sometimes, the directors in their report explain certain transactions. Therefore, in explaining the statements in the balance sheets, the directors' report must be taken together to find out the true meaning and purport of the statements.
In such a scenario, the Delhi High Court speaking through Justice AK Sikri (as he then was) in Sheetal Fabrics v. Coir Cushions Ltd, laid down that a 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.
The majority members of the 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 NCLAT (majority) has unfortunately not dealt with Sections 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 Supreme Court as and when the occasion so arises.
Failure to do so would lead to difficulty, as this five-member bench decision 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 to the words of Chief Justice Hughes who wrote that a 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.”
The author is a dually qualified professional. He is a graduate of Campus Law Centre, Faculty of Law, University of Delhi and a Fellow Chartered Accountant. He currently practices law in the courts of Delhi. He can be reached at mail@deepakjoshi.in