Venus Recruiters Private Limited v. Union of India: Process of avoidance applications in CIRP demystified

The Insolvency and Bankruptcy Code, 2016 (Code) has gone through multiple legislative amendments and judicial interpretations. These have either cleared the mist around the insolvency resolution process or have, at times, created more problems than they solved.

Balancing the legal rights and equities of all affected in a corporate insolvency resolution process (CIRP) is a tricky affair. Tribunals and courts, in their constant strife to strike a fair balance between conflicting interests and equities, have swung the pendulum of judicial disposition from one end to the other.

The latest example of this is the judgment of the High Court of Delhi in Venus Recruiters Private Limited v. Union of India and Ors dated November 26. The Court decided the question of whether an application filed under Section 43 of the Code, for avoidance of preferential transactions, can be adjudicated upon by the National Company Law Tribunal (NCLT), after the approval of a resolution plan and conclusion of CIRP.

The Court also analysed certain other connected aspects such as: (1) whether a resolution professional (RP) can continue to act beyond the approval of a resolution plan; (2) who would get the benefit of adjudication of such applications after the approval of a resolution plan; and (3) whether the Court should exercise its extraordinary writ jurisdiction, when there is an alternate remedy available under the Code.

Preferential transactions under the Code

A preferential transaction, under Section 43 of the Code, means a transaction made by an insolvent debtor with its creditor(s) during the relevant/‘look back’ period, which puts such creditor(s) in a better position than it would have been if the insolvent debtor were to be liquidated and its assets distributed in accordance with the Code. The legislature has adopted an objective criteria for determining preferential transactions, by which the Code not only reduces the ambiguity while determining the question of preferential transactions, but also significantly reduces the effort to be put in by courts to adjudicate.

Brief facts leading up to the writ petition

The dispute in Venus Recruiters arose with the allegation of a preferential transaction in an agreement between Venus Recruiters Private Limited (petitioner) and the erstwhile corporate debtor, Bhushan Steel Limited (respondent). The allegation, regarding the objectionable payment of 10% service charge paid to the petitioner under the agreement, was pointed out by way of a Forensic Audit Report which was submitted to the RP on April 3, 2018. However, the CIRP against the corporate debtor commenced in July 2017 before the NCLT (Principal Bench, New Delhi) and the successful resolution plan was filed for approval before the NCLT on March 28, 2018.

An application for, inter alia, reversal of the aforesaid transaction (avoidance application) was filed by the RP under Section 43 read with Section 25(2)(j) [duty of RP to file application for avoidance of transactions] of the Code, on April 9, 2018. The judgment on the approval of the resolution plan was reserved by the NCLT on April 11, 2018, and pronounced on May 18, 2018.

Pertinently, the avoidance application was heard for the first time only in July 2018, i.e. after the resolution plan was duly approved, and subsequently, a fresh memo of parties was filed by the counsel of the ‘Former RP’, whereafter the petitioner was impleaded. The said order of impleading the petitioner was challenged by way of a writ petition before the Court on the ground that the proceedings by the NCLT in the avoidance application are without jurisdiction.

Findings of the Court

NCLT had no jurisdiction after the conclusion of the CIRP

One of the preliminary objections taken by the respondents was with respect to the jurisdiction of the Court to adjudicate upon the matter, when there is an alternative remedy available to appeal to the National Company Law Appellate Tribunal (NCLAT) under Section 61 of the Code. To decide this issue, the Court examined Section 60 of the Code, which gives the NCLT the jurisdiction to entertain cases in relation to insolvency resolution and liquidation of corporate persons. Therefore, the moot question before the Court was whether the subject matter of the writ petition was in relation to insolvency resolution or not.

In this regard, the Court observed that once a resolution plan stands approved by the NCLT and the management of the corporate debtor is handed over to the successful resolution applicant, the NCLT has no further jurisdiction to adjudicate, except on issues pertaining to the resolution plan itself (if any). Therefore, the Court held that since the resolution plan was approved by the NCLT on May 15, 2018, the CIRP came to an end on that date and the NCLT lacked jurisdiction to adjudicate upon the avoidance application subsequently. Hence, the writ petition was maintainable before the Court.

Role of the RP cannot continue beyond the CIRP period

The Court primarily relied upon Regulation 35A (timeline in which the RP shall form an opinion on whether the corporate debtor has been subjected to any questionable transactions) and Regulation 39 [RP has to submit the details of all the questionable transactions along with the resolution plan for approval to the committee of creditors (CoC)] of the Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations, 2016 (CIRP Regulations).

On a conjoint reading of the aforesaid Regulations, along with Sections 43 and 44 of the Code, the Court opined that the formation of opinion by the RP on questionable transactions “cannot be an unending process”, and has to be in accordance with the timelines under Regulation 35A.

The Court also placed reliance on the judgment of the Supreme Court in Committee of Creditors of Essar Steel India Ltd. through Authorised Signatory v. Satish Kumar Gupta to reaffirm that the role of the RP is finite in nature, and is not adjudicatory, but administrative. The continuation of the RP beyond the approval of the resolution plan would be in conflict with the very purpose and intent behind the appointment of an RP, i.e. to enable insolvency resolution.

The Court also deferred to Section 23 of the Code to observe that the RP manages the operations of the corporate debtor during the CIRP and therefore, the role of the RP commences from the initiation of CIRP and ends after the approval of the resolution plan. Thereafter, the RP has no connection with the new management of the corporate debtor and if such role of the RP is continued, it would result in an interference in the conduct of such new management. Once the new management takes over, “the hat of the corporate debtor has changed”, the jurisdiction of the NCLT is exhausted and the RP cannot be permitted to pursue avoidance applications as the ‘Former RP’ of a corporate debtor, which is no longer in existence.

The Court further clarified that the process of determination of questionable transactions would run parallel to the other steps involved in the CIRP. The RP is mandated to submit all details in relation to such transactions to the NCLT, along with the resolution plan. This being the only purpose of Section 25(2)(j) read with Section 26 (filing of an avoidance application shall not affect the CIRP) of the Code, it cannot be said that the RP can continue to prosecute such applications after the approval of the resolution plan. Hence, the Court arrived at the conclusion that avoidance applications cannot survive beyond the conclusion of CIRP, as the same will be contrary to the ethos of the Code.

Benefits from an avoidance application have to be given to the creditors

Section 44 of the Code was analysed to hold that avoidance applications are meant to give some benefit to the corporate debtor’s creditors and not to the resolution applicant or the corporate debtor “in its new avatar”. The amounts from such applications have to be factored in the resolution plan to enure to the benefit of the CoC. The Court opined that if such applications continue beyond the conclusion of the CIRP, no benefit would be given to the creditors, and the RP ought not to be permitted to give any indirect benefit to the erstwhile corporate debtor and its new management.

It was further observed that adjudication of avoidance applications after the approval of the resolution plan would virtually result in the NCLT stepping into the shoes of the new management and making decisions on its behalf. Holding that the NCLT is not empowered to do so, the Court concluded that it is the decision of such new management whether or not to continue with a prior transaction or agreement. Thus, if in the opinion of the RP or CoC, any transaction is, inter alia, preferential, then an order in this behalf must be passed by the NCLT before the approval of the resolution plan.

Conclusion

The judgment comes as relief for various third parties to questionable transactions who were being dragged into protracted litigation, even after conclusion of the CIRP. On the flip side, though the judgment seeks to reiterate the importance of timelines under the Code, it may have the effect of putting a question mark on the efficacy of the avoidance process itself, as it will be extremely difficult to achieve a final decision on the avoidance of transactions within the timeframe for conclusion of CIRP.

Considering its far-reaching consequences, as the judgment will also be applicable to all types of questionable transactions other than preferential transactions, this matter is likely to be carried to the Supreme Court. It remains to be seen how the Apex Court deals with the issue and settles the position. For now, parties to such questionable transactions will have some respite.

Authors are lawyers at IndusLaw.