[The Viewpoint] Avoidance of transactions and liability of promoters under IBC

The IBC does not lay down the parameters to determine the nature and quantum of contributions and leaves it to be determined by Adjudicating Authority.
[The Viewpoint] Avoidance of transactions and liability of promoters under IBC

The Insolvency and Bankruptcy Code, 2016 aims to maximise the value of a company’s assets and secure the availability of assets for its creditors. As a company nears insolvency, the promoters often try to strip away the assets of the corporate debtor to minimise their own losses.

Very often during the resolution process, it is seen that the company has assets of negligible value and creditors are left in the lurch with no recovery prospects.

To protect lenders’ interests, the Code provides for avoidance of preferential (Sections 43 and 44), undervalued (Section 45 to 48), extortionate (Sections 50 and 51) and fraudulent (Section 49 and 66) transactions. The main objective behind these provisions is to make available the assets of the corporate debtor for their resolution, making it run as a going concern, and liquidation. It also ensures that a particular creditor is not placed in a beneficial position vis-à-vis the other creditors.

The parameters and enquiries pertaining to each of these transactions are different and require different sets of inquiries to be conducted by the Resolution Professional and the Adjudicating Authority. For instance, the question of intention is not relevant for a transaction to be categorised as preferential under Section 43, so long as the ingredients given therein are fulfilled. On the other hand, while inquiring into undervalued transaction, the Adjudicating Authority may consider the intent to examine if the undervalued transaction was to defraud the creditors.

Another important aspect is that preferential and undervalued transactions carried out within the specified “look-back” period can only be scrutinised under the Code. The relevant period for transactions made with a related party is two years preceding the insolvency commencement date, and in case of any other person, it is one year preceding the insolvency commencement date.

Even though the Code prescribes a period of 14 days for the Adjudicating Authority to decide the insolvency applications filed under Section 7 and 9, the timelines prescribed under the Code has been held to be directory by the Supreme Court. Therefore, in some jurisdictions, the applications are even decided in 1-2 years.

This sometimes gravely affects the utility of provisions of avoidance of transactions, as by the time application is admitted and the insolvency resolution process is commenced, substantial time elapses and the look back period starts a few days or months before the date of filing the application, or in some cases, even after the filing of the application. In such cases, the Resolution Professional is remediless, as most of the avoidable transactions (entered prior to filing the application) fall outside the look back period. A delayed initiation of insolvency proceedings can also reduce the effectiveness of avoidance provisions.

Further, a preferential transaction might not be considered as offending and liable to be set aside if (i) it is entered into during the ordinary course of the business or financial affairs of the corporate debtor or transferee, or (ii) it results in acquisition of new value for the corporate debtor.

In Anuj Jain, Interim Resolution Professional for Jaypee Infratech Limited v. Axis Bank Limited etc, the Supreme Court held that the expression “or”, appearing as disjunctive between the expressions “corporate debtor” and “transferee” under Section 43(3)(a) ought to be read as “and”, so as to be conjunctive of the two expressions. Therefore, the fact that certain transactions might be in the ordinary course of business of the transferee (the creditor) is not enough to exclude the transactions from being held as preferential. The question would still remain if the transfers were made in the ordinary course of business or financial affairs of the corporate debtor.

In the aforesaid case of Anuj Jain, the Supreme Court held that transactions of mortgage of immoveable property entered into by the corporate debtor, Jaypee Infratech Limited, for securing the loans by a consortium of banks to its holding company, Jaiprakash Associates Limited (JAL), were preferential and liable to be set aside. The Court noted that there had not been any creditor-debtor relationship between the lender banks and corporate debtor. However, the transactions carried the ultimate effect of working towards the benefit and advantage of the borrower i.e., JAL, which obtained loans and finances by virtue of such transactions. The Court also noted that JAL, being an operational creditor, was put in a beneficial position as it received a huge working capital by way of loans and its own liability to its lenders were reduced.

To identify and inquire into these transactions and file applications for their avoidance, the Resolution Professional has been assigned a positive duty under Section 25(2)(j). To avail benefits of these provisions, it is necessary that the Resolution Professional undertakes a thorough study of the books of accounts of the corporate debtor. Tools such as forensic audits can also be adopted to identify such transactions. Further, for setting aside undervalued transactions, an application may also be filed by a creditor under Section 47.

In addition to reversing the effect of such transactions, the Code also fixes liability on perpetrators. Section 66 of the Code enables the Adjudicating Authority to direct any person to make contributions to the assets of the corporate debtor when (i) they are involved in fraudulent trading and (ii) failed in being diligent and minimising the potential loss to the creditors. Section 69 also fixes criminal liability on anyone who is involved in a fraudulent transaction.

The Code, however, does not lay down the parameters to determine the nature and quantum of contributions and leaves it to be determined by Adjudicating Authority as it deems fit, in the facts of a particular case. This calls for more expertise and attentiveness of the Resolution Professionals, as the success of these provisions largely depends on the identification of such transactions. Further, the Adjudicating Authority needs to be guided in its decisions by the objective of creating deterrence to the perpetrators. It, therefore, remains to be seen how the jurisprudence evolves and to what extent the provisions aid the restitution of lost value of assets to the corporate debtor for effective resolution process in securing interest of the creditors.

Yogendra Aldak and Vaishali Goyal are Partner and Associate respectively at Lakshmikumaran & Sridharan.

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