[Kumari is a student at National Law University, Delhi.]
The Insolvency and Bankruptcy Code 2016 (IBC) provides for the reversal/avoidance of certain transactions undertaken by the corporate debtor (Debtor) during a certain period immediately preceding the commencement of the corporate insolvency resolution process (CIRP). It identifies 4 such transactions, viz. preferential transactions, undervalued transactions, transactions defrauding creditors, and extortionate credit transactions (Sections 43-51). The idea is that the management, anticipating CIRP in the foreseeable future, might have made certain transactions on the Debtor’s assets to secure certain vested interests. Such transactions diminish the overall value of the Debtor. In the eventual CIRP/liquidation, they jeopardize the interests of the creditors at large (mostly unsecured creditors). Therefore, the IBC provides for a mechanism to reverse/avoid these transactions and recover the proceeds therefrom, for which avoidance applications are filed before the NCLT.
Recently, in Venus Recruiters v UOI (Venus’) the Delhi High Court held that such applications cannot be filed and adjudicated after the approval of a resolution plan (Plan), primarily because, under Section 60, the NCLT has jurisdiction only regarding insolvency resolution and liquidation. On the Plan’s approval, the insolvency resolution ends, and therefore, the NCLT lacks jurisdiction beyond that.
This article, although appreciating Venus’ ruling, argues that, instead of completely disallowing such applications beyond resolution/Plan’s approval, the appropriate course of actions on those applications should be left to be proposed by the Plan. Then, once the NCLT sits to approve the Plan, it should positively make some order (final or interim) regarding those applications whether it is pleaded or not (something that the NCLT did not do in the case that led to Venus). Thereafter, that order should determine the fate of those applications. This course of action is in line with the objectives of such applications and the scheme of the IBC.
Objectives of avoidance applications – punishing the wrongdoers or mere recovery?
The UNCITRAL guide on Insolvency says that avoidance provisions aim to prevent fraud, treat all creditors equitably, and prevent sudden loss of value of the Debtor’s estate right before insolvency. They also help create a code of fair commercial conduct that is part of appropriate standards for the governance of commercial entities. However, in the Indian context, the BLRC Report considers proceeds from avoidance applications merely as a source of additional value in liquidation to satisfy the creditors’ claims. Further, the Report of the Insolvency Law Committee 2020 observes that the transactions underlying these applications are improper trading activities, hence these applications may often be misunderstood as aiming to preserve commercial morality. However, it clarifies that it is not what they are meant for. Their primary objective is just to swell the asset pool to augment the recovery to creditors.
So, though the UNCITRAL guide considers the establishment of fair commercial conduct/appropriate standards, etc. as important objectives of these applications, the Indian position does not attribute those objectives to avoidance applications. It is clear that they are meant just to augment the recovery to creditors. This is plausible because Part II, Chapter VII of the IBC already contains penal provisions for punishing the wrongdoers. Thus, for those transactions that also fulfill the Chapter VII requirements, the IBBI can anyway initiate criminal proceedings against the wrongdoers under Section 236.
One needs to keep in mind the above objective of avoidance applications before any analysis. Let us now turn to the substantive provisions regarding AAs and highlight a gap in that regard.
Adjudication of avoidance applications – a gap?
A Debtor’s life can follow either of these 2 routes: CIRP-to-liquidation or CIRP-to-resolution. In total, 3 possible stages can be identified, viz. CIRP, liquidation, and post-resolution. Now, avoidance applications are generally filed by the resolution professional (RP) or the liquidator. During CIRP, the RP shall file them before the NCLT by the 135th day of CIRP (Regulation 35A, IBBI (IRP) Regulations, 2016 (IRP Regulations)). During liquidation, the liquidator can file them anytime in the process. However, there is no provision for filing post-resolution. Rightly so, because Sections 43-51 allow the RP to file these applications, and once resolution ends, he no longer remains the ‘RP’. So, in that regard, Venus rightly held that they cannot be filed after resolution.
However, this article is more focused on the adjudication aspect. As opposed to filing, no timeline is prescribed for adjudication of these applications for any of the 3 stages. Pertinently, avoidance provisions are provided under the ‘Liquidation Process’ chapter, so, they can be adjudicated during liquidation. Further, despite being positioned under the liquidation chapter, the wordings of these provisions do not bar, and in fact, allow the adjudication of these applications during CIRP. In Jaypee Infratech, Orchid Pharma, etc., the NCLTs had adjudicated them during the CIRP.
The gap in the law lies regarding the adjudication of these applications post-resolution. The next section evaluates this gap and reconciles it with the scheme of the IBC.
Avoidance applications in CIRP v/s in liquidation
Avoidance applications are envisaged during CIRP as well as liquidation, however, there is a major difference between the two regarding the allocation of the proceeds from such applications. Understanding this difference is important to appreciate the gap the law has left on the adjudication of these applications beyond resolution.
In liquidation, creditors’ claims are satisfied from the sale considerations of the Debtor’s assets. Therefore, proceeds from avoidance applications also directly go to the creditors (as per Section 53’s waterfall mechanism). However, that is not true in resolution. Here, the Debtor or its assets are not ‘sold’ to the resolution applicant (RA) to meet the creditors’ claims (see Binani Industries). Here, the Plan provides for a careful restructuring of the Debtor. The creditors’ claims are met from the consideration the RA offers for taking over the Debtor as per the Plan. Since the Debtor is not ‘sold’ to the RA, the proceeds of the Debtor’s assets do not go to the creditors. Similarly, the proceeds from the avoidance applications, being assets of the Debtor, would also not directly go to the creditors. It is the Plan that would determine the allocation of those proceeds. The Plan may use those proceeds either in satisfying the creditors’ claims or in restructuring the Debtor (especially when the proceeds are assets and not liquid monies). This is a major difference in the allocation of the proceeds in liquidation and resolution.
Accordingly, since the final Plan is the crux of the resolution, one plausible reason behind lawmakers’ omission regarding the adjudication of these applications post-resolution may be that they wanted the committee of creditors and resolution applicant(s) (CoC-RA) to negotiate in the Plan the future course of action of those applications/proceeds. Here, 2 situations arise: (a) where the NCLT has already ordered on those applications before Plan’s approval, (b) where no such order has been passed.
For situation (a), the wordings of Sections 43-51 make it clear that the proceeds would vest in the Debtor. The Plan would specify whether to use those proceeds to meet the creditors’ claims or to use them in the restructuring of the Debtor. Venus rightly observed that benefits of avoidance applications are meant to form a part of the final Plan that would determine their allocation. However, that is where it stopped. It did not consider the situation (b) and simply held that these applications would not survive resolution. The next section tries to address that.
Proceeds from pending avoidance applications
Regulation 39(2) of IRP regulations requires the RP to present to the CoC all IBC-compliant Plans and the details of avoidable transactions along with corresponding NCLT orders (if any). Thus, it requires the furnishing of details of even those transactions/applications whose outcomes are uncertain. In such a situation, the Plan can, at best, provide that the allocation would be contingent on the outcome of those applications. However, the fact that pending applications are also meant to be deliberated upon by the CoC-RA implies that they must decide in the Plan on how to proceed with the applications. If they conclude that the outcomes of the applications are very uncertain and their costs may outweigh the benefits, they may abandon those applications and the RP may then withdraw them. In that case, the NCLT should allow the withdrawal as these applications are anyway meant to benefit the Debtor/creditors and not to punish the wrongdoers.
However, if the assets underlying the AAs are huge (for example, in Jaypee Infratech, around 858 acres of property was mortgaged by the CD to secure the debt of a related party), the CoC-RA may want an adjudication on the applications before Plan’s approval. The Plan would then become subject to this contingency. Pertinently, in Form-H (compliance certificate under Regulation 39(4) of IRP Regulations, that is submitted along with the CoC-approved Plan for NCLT’s approval), the RP is given an option to specify if the Plan is subject to any contingency or not (point 12, Form H). In such cases, the NCLT should adjudicate the applications before approving the Plan. Alternatively, it may approve the Plan and list the applications for hearing on some later day and duly authorize the RP/RA/CoC to pursue them further.
Venus does not talk about this aspect, but it also did not hold that the NCLT lacks such powers. As per its para 89, the NCLT lacks jurisdiction on avoidance application once the new management takes over the Debtor unless provision is made in the final resolution plan. Even otherwise, it can be argued that the NCLT has inherent powers under rule 11, NCLT Rules, 2016 that can be exercised. Using that power, even the former-RP can be authorized to pursue the applications beyond Plan’s approval, something that Venus expressly prohibited.
Conclusion
Venus should be appreciated for recognizing the gap in the law regarding avoidance applications post-resolution. However, it only addressed this issue partially, probably because it failed to appreciate the reason behind this gap. This article argues that this gap can be filled by recognizing the centrality of a resolution plan in the resolution process. Such centrality of the Plan implies that the appropriate course of action on avoidance applications should be left to be negotiated in the Plan. Thereafter, the Plan, when presented before the NCLT, should necessarily have a statement on whether the CoC-RA wants an adjudication on the applications before the Plan’s approval. Further, in all cases, the NCLT must examine whether adjudication on the applications is possible without unnecessary delay. It should endeavor to adjudicate them at that stage itself. Alternatively, it should, using its inherent powers, approve the Plan, list those applications on some future date, and authorize the RP/RA/CoC to pursue them further. This should be the logical conclusion of those applications instead of the one suggested by Venus.