[The Viewpoint] Venus Recruiters' Case, The Fate of Avoidance Applications finally resolved by the Division Bench of the Delhi High Court

In an interesting turn of events, the Delhi High held that avoidance/preferential transactions can survive beyond the conclusion of the corporate insolvency resolution process.
Rajani Associates - Devesh Juvekar, Dikshat Mehra
Rajani Associates - Devesh Juvekar, Dikshat Mehra

The Division Bench of Delhi High Court on January 13, 2023 has finally decided the fate of avoidance/preferential/undervalued applications filed under the Insolvency and Bankruptcy Code, 2016 based on the Venus Recruiters Private Limited & v Union of India & Ors case. The Division Bench held that avoidance/preferential transactions can survive beyond the conclusion of corporate insolvency resolution process (“CIRP”) and that the Resolution Professional ("RP") will not be functus officio for perusing the avoidance applications and can continue to pursue such applications.

Before getting into the factual matrix, it is important to understand that under the Insolvency and Bankruptcy Code, 2016 ("Code"), the RP is required to file applications before the Adjudicating Authority ("AA") for avoidance of certain transactions (avoidance/preferential, undervalued, etc) that have taken place immediately prior to the commencement of the corporate debtor's insolvency.

The amounts involved in such kind of avoidance/ preferential etc applications are generally substantial, since most of the transactions called into question involve siphoning of funds, preference/ avoidance/ undervaluation etc in dealings with related parties and other fraudulent conduct of persons in charge of the corporate debtor. The objective behind avoidance/preferential applications is to widen the creditors’ asset pool by bringing back the assets unlawfully diverted from the corporate debtor, at the expense of other creditors.

Once the resolution plan is approved by the Committee of Creditors, ("COC"), all stakeholders run into an urgency in obtaining the approval of the AA for the resolution plan. In the attempt to obtain approval of the resolution plan, the hearing of other applications, especially the undervalued, avoidance etc always seemed to take a back seat and most of the times are kept pending by the AA.

Keeping in view of the above, in or around November 2020, an interesting question that had arisen under the Code, where the Delhi High Court, in Venus Recruiters Private Limited v Union of India & Ors when a Single Judge of the Delhi High Court had held that applications filed by RP under sections 43 (preferential transaction), 45 (under valued transaction), 50 (extortionate transactions) and 66 (fraudulent trading) of the Code during the pendency of the corporate insolvency resolution process ("CIRP") cannot be continued, post approval of resolution plan by the AA, unless specified in the plan.

Brief Facts

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 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, 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 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 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 former RP, whereafter the petitioner was impleaded. The said order of impleading the petitioner was challenged by way of a writ petition before the Delhi High Court on the ground that the proceedings by the NCLT in the avoidance application are without jurisdiction and cannot be continued post approval of plan by AA.

The Court formulated the following questions for itself, namely:

i. Whether an RP can continue to act beyond approval of the Resolution Plan?

ii. Whether an avoidance application can continue after approval of resolution plan? and

iii. Who would benefit from the adjudication of such application post approval of resolution plan?

To this the Hon’ble Delhi High Court held that the answer to questions (i) and (ii) had to be in the negative. Further, on (iii), the Hon’ble Delhi High Court held that proceeding to avoid transactions must be to the benefit of the creditors and not to the benefit of the corporate debtor/ resolution applicant, post the approval of the plan.

Interestingly, the interpretation of the above Venus Recruiters judgment fell for consideration before the NCLAT in the judgment titled 63 Moons Technologies Limited (Formerly Known as Financial Technologies (India) Ltd) v. The Administrator of Dewan Housing Finance Corporation Ltd & Ors wherein it was held that it was not for the CoC to decide the beneficiaries of an avoidance application, and such decision is to be taken by the Adjudicating Authority. Neither of said two judgments prevented the continuation of an avoidance application, especially if such a clause is expressly mentioned in the resolution plan.

The above decision of Venus by a Single Bench ran into several ramifications, which led to various legal and practical challenges. In practice, the Venus Recruiters case somewhere helped parties in delaying the adjudication process, until the approval of the resolution plan, so that the maintainability of such applications could be challenged later.

Regrettably, the above judgement obstructed the right of the corporate debtor/creditor/RP to pursue avoidance applications after the approval of the resolution plan, unless provision was made in the final resolution plan. Considering the ambiguity, many resolution plans stipulated the manner of continuation of avoidance applications and treatment of proceeds expected from there.

Given the above Venus Recruiters case which had raised challenges, the Division Bench of Delhi High Court on January 13,2023 has finally decided the fate of avoidance/preferential/undervalued applications filed under the Code and has held that avoidance/preferential transactions can survive beyond the conclusion of CIRP and that the RP will not be functus officio for perusing the avoidance applications and can continue to pursue such applications thereby setting aside the single Judges order of the Delhi High Court referred above which had earlier held that such applications cannot continue, post conclusion of CIRP by RP. The Division Bench of the Delhi High Court has held the following in a nutshell:-

  1. CIRP and avoidance applications, are, by their very nature, are a separate set of proceedings wherein, the former, being objective in nature, is time bound whereas the latter requires a proper discovery of suspect transactions that are to be avoided by AA;

  2. The endeavour of the Code and its rules and regulations is to ensure that all processes within the insolvency framework are time efficient. Avoidance application can be filed even after the resolution plan filed before the AA and till the approval of the plan.

  3. Timelines to file such applications by RP under CIRP (like avoidance, preferential etc), may only be treated as directory and not mandatory;

  4. While the law mandates a resolution plan to necessarily provide for the treatment of avoidance applications, if the same are pending at the time of submission of resolution plans, it cannot be accepted that avoidance applications will be rendered infructuous in situations wherein the resolution plan could not have accounted for avoidance applications due to exigencies that delayed initiation of such action;

  5. It follows that RP will not be functus officio with respect to adjudication of avoidance applications. There being a clear demarcation between the scope and nature of the CIRP and avoidance application within the scheme of the Code, the RP can continue to pursue such applications;

  6. NCLT / NCLAT can hear and adjudicate on avoidance applications, notwithstanding that the CIRP has concluded;

  7. The provisions pertaining to suspect transactions exist specifically to benefit the creditors of the corporate debtor by enhancing the asset pool available for resolution of the corporate debtor and

  8. The amount made available by the adjudication of avoidable transactions cannot go to the kitty of resolution applicant, or to the corporate debtor in its new avatar. This amount should be made available to the creditors who are primarily financial institutions and have taken a haircut in agreeing to accept a lesser amount than what was due and payable to them.

Conclusion:

Under pre-packaged insolvency resolution process under the Code, the AA was always entrusted with providing for manner of continuation of avoidance of preferential, undervalued, extortionate and fraudulent transactions.

In our view, nothing in the Code ever prevented continuation of such applications after approval of the resolution plan so long as the following two criteria were met, firstly, when the approved resolution plan provided for continuation of such proceedings, and secondly, that the proceeds of such avoidance applications must necessarily enure to the benefit of the creditors of the corporate debtor.

Considering its far-reaching consequences and clearing the ambiguity, this recent judgment of the Division Bench of Delhi High Court will be now seen as a huge relief for various CIRP’s as the avoidance/preferential etc applications can now continue to be heard even after approval of the plan by AA, de-hors the fact, whether provisions for continuance of such applications are made in any plan or not. In any event, the CIRP regulations effective June 14, 2022 now specifically provide that going forward any resolution plan shall specifically make a provision for way the proceedings in respect of avoidance transactions, if any, or fraudulent or wrongful trading under the Code, will be pursued after the approval of the resolution plan and the way the proceeds, if any, from such proceedings shall be distributed.

Devesh Juvekar is a Partner and Dikshat Mehra is a Principal Associate at Rajani Associates.

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