Avoidable transaction and the offenders window of escape: A perspective

The Insolvency and Bankruptcy Code, 20161 (I&B Code) is a complete code, containing all the necessary provisions for providing a safe haven to corporate debtors under distress. However, the I&B Code being a relatively new enactment, still seems to be working out the kinks. One such ambiguity is that the I&B Code fails to provide a defined procedure for conduct of proceedings that tend to last beyond the duration of Corporate Insolvency Resolution Process (CIRP).

Avoidable transactions or vulnerable transactions, sub-classified into preferential transactions (Sections 43[2]-44[3]), undervalued transactions (Section 45[4]) transactions defrauding creditors (Section 49[5]) and extortionate credit transaction (Section 50[6]) are red-flagged transactions that may be avoided by the corporate debtor for shifting undue onerous burden that places the corporate debtor into distress or defrauds the creditors of the corporate debtor. The resolution professional (RP) in the course of CIRP, is required to identify such vulnerable transactions and files an application before the adjudicating authority for avoiding the said liability. While the said proceedings are an integral part of the I&B Code, they run parallel to the main proceedings which are more focused towards resolution of the corporate debtor and ensuring maximisation of value of assets of the corporate debtor. However, the question as to what happens if the corporate debtor is successfully resolved, thereby concluding CIRP, before the avoidance proceedings are adjudicated or even heard, has not been clearly laid down under the I&B Code. In many of the instances, it has been seen that such proceedings have continued even after the passing of the order under Section 31[7] of the I&B Code (thereby concluding the CIRP), for instance, Bhushan Steel, Essar Steel, etc.

The High Court of Delhi recently identified the present ambiguity in Venus Recruiters (P) Ltd.  v. Union of India[8] (Venus Recruiters). The High Court of Delhi, observed that the present matter raises three important questions:

  1. (i) Whether a RP can continue to act beyond the approval of the resolution plan?

(ii) Whether an avoidance application can be heard and adjudicated after the approval of the resolution plan?

(iii) Who would get the benefit of an adjudication of the avoidance application after the approval of the resolution plan?

While the High Court of Delhi decided the aforesaid questions in a comprehensive manner, the authors herein restrict the scope of the present article to the below mentioned findings/ observations and their implications:

(i) Resolution applicant cannot be permitted to file an avoidance application: A successful resolution applicant (RA) whose resolution plan is approved itself cannot file an avoidance application. The avoidance applications are neither for the benefit of the resolution applicants nor for the company after the resolution is complete. It is for the benefit of the corporate debtor and the creditors of the corporate debtor.

(ii) Avoidance application cannot be adjudicated beyond the period of CIRP: Where preferential transactions are permitted to be adjudicated after the resolution plan is approved, it would, in effect, lead the National Company Law Tribunal (NCLT) to step into the shoes of the new management to decide what is good or bad for the company. Once a resolution plan is approved and the new management takes over, it is completely up to the new management to decide whether to continue a transaction or agreement or not.

The ambiguity and the loose ends

The I&B Code had always envisaged that the avoidance proceedings were to proceed independent of the CIRP proceedings. This can be inferred from Section 26[9] which provides that the filing of an avoidance application by the RP shall not affect the CIRP proceedings. However, the Venus Recruiters[10] judgment has linked the two proceedings that may lead to contradictions within the I&B Code. Correspondingly, Regulation 44 of Insolvency and Bankruptcy Board of India (Liquidation Process) Regulations, 2016[11] (Liquidation Regulations) also states that liquidator shall liquidate the corporate debtor within a period of one-year from the liquidation commencement date, notwithstanding pendency of any avoidance application under Chapter III of Part II of the I&B Code.

While the Venus Recruiters[12] judgment held that the resolved corporate debtor can take any decision in respect of an agreement which is deemed to be not beneficial, including termination of the onerous contracts, the I&B Code does not contain any provision for terminating existing contracts by way of a resolution plan. In fact, the NCLT, Mumbai Bench has specifically held that resolution applicants do not have any right to terminate legally binding contract unilaterally without following the due process for termination as per applicable law under the garb of a resolution plan13. Therefore, the same would have to be done without any assistance of the statutory scheme, for taking over or acquiring the corporate debtors, envisaged under the I&B Code.  The judgment seems to have not factored the views of the Insolvency and Bankruptcy Board of India (IBBI) on avoidable transactions. IBBI has specifically observed that there is a distinction between preferential transactions and undervalued transactions. In preferential transaction, the question of intent is not involved and by virtue of legal fiction, upon existence of the given ingredients, a transaction is deemed to be of giving preference at a relevant time, while undervalued transaction requires different enquiry under Sections 45 and 46[14] where the adjudicating authority is required to examine the intent, to examine if such transactions were to defraud the creditors.

The Venus Recruiters[15] judgment observes that avoidance proceedings are only for the benefit of the creditors of the corporate debtor. However, a perusal of the reliefs contemplated under Sections 44 and 48[16] of the I&B Code leads to an inescapable conclusion that the said provisions are all status quo ante in nature i.e. such directions were required to be issued that would place the corporate debtor in its original position before such onerous contracts were executed, therefore, it is clear that the avoidance proceedings are not just for the benefit of the creditors of the corporate debtor but for the resolved corporate debtor as well. Further, the Report of the Insolvency Law Committee published by the Ministry of Corporate Affairs in February 2020 (ILC Report) leaves the discretion to the adjudicating authority to decide the way the proceeds from the avoidance proceedings are to be distributed among the stakeholders.

At this juncture, it is also pertinent to state that the Supreme Court in Jaypee[17] laid out an elaborate mechanism for identification of avoidance transactions by the resolution professional and the determination of avoidance applications by the adjudicating authorities[18].  As is evident from the Jaypee[19] judgment, the Supreme Court have envisaged a high standard for ensuring that tainted transactions are identified and the proceeds are restored to the benefit of the lenders of the corporate debtor as well as the corporate debtor itself.

Pertinently, the I&B Code imposes no bar for the avoidance proceedings to continue beyond the conclusion of CIRP.  In fact, Regulation 39(2)[20] of Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations, 2016 (CIRP Regulations) provides that the resolution professional must, at the time of approval of the resolution plans, place the resolution plans along with the details of avoidance transactions and orders, if any, passed therein before the committee of creditors. The use of the words “if any” connotes a liberal interpretation to the timeline for such avoidance proceedings and appears to envisage continuance of such proceedings beyond the period of CIRP. Similarly, Form H of CIRP Regulations i.e. Compliance Certificate, also requires the RP to disclose pendency of avoidance applications at the time of submission of the resolution plan for approval before the adjudicating authority. While this argument has been rejected by the High Court of Delhi, it appears that the cumulative effect of Section 26 of the I&B Code, Regulation 44 of the Liquidation Regulations and the aforementioned provisions was not analysed in the judgment. The aforesaid argument also finds favour in the Indian Institute of Insolvency Professionals of India in its report titled Statement of Best Practices 1:”Role of IPs in Avoidance Proceedings”[21] and the ILC Report[22].

Implications and fallouts

The Venus Recruiters[23] judgment has sought to delineate from the present framework of the I&B Code and attempted to link the two proceedings together. The present modification will have a cascading effect resulting in one of the two following eventualities:

Event 1: The adjudicating authority will mandatorily be required to determine the avoidance proceedings prior to approval of the resolution plan under Section 31 of the I&B Code resulting in further delay in resolution of the corporate debtor under CIRP.

Fallout

(a) It appears that the dual objective, namely, timely resolution of the corporate debtor and identification and annulment of onerous and fraudulent contracts, for which the two proceedings were delinked would not be successfully achieved. Essentially, it would lead to a situation where one is achieved at the cost of the other.

(b) Alternatively, the only way in which the aforesaid dual objective would be obtained is if the avoidance proceedings are dealt summarily. However, considering the procedure formulated by the Supreme Court in Jaypee[24], it can safely be stated that the avoidance applications cannot be disposed off summarily and the linkage of the two proceedings may inevitably lead to a cascading effect.

(c) The emphasis on timely resolution emanated from the needs of India’s plagued financial sector. Time-bound resolution, which is critical for the I&B Code to be a success, would be compromised.

(d) It has been noticed by the Supreme Court in Essar[25] that NCLTs have limited infrastructure and the outside time-limit of 330 days is not mandatory. The issue of lack of institution infrastructure, in particular National Company Law Appellate Tribunal (NCLATs) (which was only established Delhi at the time), was also raised in Swiss Ribbons[26]. The Court, while observing that litigants should be allowed to avail remedy under law and cannot be prejudiced due to lack of infrastructure, had received specific assurance from the learned Attorney General at the time that more NCLATs will be established as soon as it is practicable. Since the requirements to dispose off these applications before the conclusion of CIRP has been introduced vide the Venus Recruiters[27] judgment, the NCLT’s would be left with no other alternative but to find justifications to extend the CIRP in order to dispose of these applications.

Event 2: It will be the duty of the RP to ensure determination of avoidance applications before approval of the resolution plan, failing which the avoidance application will be deemed to be infructuous.

(a) This will provide a window of escape to the offenders engaging in fraudulent transactions and further burden the resolved corporate debtor in protracted rounds of litigation for terminating the onerous contracts.

(b) The disposal of avoidance proceedings without a hearing will be a form of blessing towards the illegal/wrongful transactions made by the errant promoters and provide such errant promoters to escape liability. Such a conclusion is completely antithetical to the I&B Code as it does not intend to grant any benefits for the errant promoters.

(c) The only remedy available with the successful resolution applicants would be to terminate the contracts/transactions after implementing the resolution plan. The termination of the said contracts will expose the resolution applicants to protracted rounds of litigation on a contract which, in all likelihood, would be inordinately favourable to the counterparties and also expose the resolved corporate debtor to damages. Ultimately, the resolution of the corporate debtor will become a near impossibility.


  Naman Singh Bagga (2010-2015) National Law University Odisha, now working as Senior Associate at L&L Partners Law Offices and may be reached at e-mail: namansinghbagga@gmail.com.

†† Maneesh Subramaniam (2014-2019), Amity Law School, Amity University, now working as an Associate at L&L Partners Law Offices and may be reached at e-mail: maneesh.ms10@gmail.com.

†† Anurag Tripathi (2009-2014) National Law University Odisha, now working as in-house counsel at an Indian Conglomerate and may be reached at e-mail: anuragnluo@gmail.com.

1 <http://www.scconline.com/DocumentLink/86F742km>.

2 <http://www.scconline.com/DocumentLink/9kKr2L6f>.

3 <http://www.scconline.com/DocumentLink/6k1QKjWn>.

4 <http://www.scconline.com/DocumentLink/G98723Qc>.

5 <http://www.scconline.com/DocumentLink/52aWIpgI>.

6 <http://www.scconline.com/DocumentLink/h2o3bY7O>.

7 <http://www.scconline.com/DocumentLink/gvPKCciX>.

8 2020 SCC OnLine Del 1479

9 <http://www.scconline.com/DocumentLink/KaRKCw3S>.

10 2020 SCC OnLine Del 1479

11 <http://www.scconline.com/DocumentLink/PRN1Rndd>.

12 2020 SCC OnLine Del 1479

13 DBM Geotechnics and Constructions (P) Ltd. v. Dighi Port Ltd., 2019 SCC OnLine NCLT 8142

14 <http://www.scconline.com/DocumentLink/pit9G4eg>.

15 2020 SCC OnLine Del 1479

16 <http://www.scconline.com/DocumentLink/rB6ALe98>.

17 Jaypee Infratech Ltd., Interim Resolution Professional  v. Axis Bank Ltd., (2020) 8 SCC 401 

18 Id., paras 28.1 and 28.2.

19 (2020) 8 SCC 401 

20  <http://www.scconline.com/DocumentLink/LhNrU8Vb>

21 IIIPI in its report, titled Statement of Best Practices 1: “Role of IPs in Avoidance Proceedings”, had observed that the pendency of proceedings will not bar the resolution/liquidation or voluntary liquidation of the corporate debtor. It further observed that the two proceedings should be treated separately and even if the corporate debtor is resolved/ liquidated, the application of avoidance transactions will be carried on.

22 Similarly, ILC Report also states that where the adjudicating authority comes to the conclusion that the avoidance proceedings may not be concluded prior to dissolution of the corporate debtor, due to any countervailing factors, it should also provide the manner of continuation of the proceeding after such dissolution.

23 2020 SCC OnLine Del 1479

24 (2020) 8 SCC 401

25 Essar Steel India Ltd. Committee of Creditors v. Satish Kumar Gupta, (2020) 8 SCC 531

26 Swiss Ribbons (P) Ltd. v. Union of India, (2019) 4 SCC 17 

27 2020 SCC OnLine Del 1479

Join the discussion

Your email address will not be published.

This site uses Akismet to reduce spam. Learn how your comment data is processed.