Why the IBC Prevails over the PMLA: Can Section 32A of IBC Sanitise Proceeds of Crime?

[Ritwik is a student at Rajiv Gandhi National University of Law.]

The interplay between Section 32A of the Insolvency and Bankruptcy Code 2016 (IBC) and the Prevention of Money Laundering Act 2002 (PMLA) in distressed asset sales raises a major conflict between the ‘clean slate doctrine’ and the Enforcement Directorate’s (ED) increasing attachment powers after Vijay Madanlal Choudhary and Others v. Union of India and Others (Vijay Madanlal) to confiscate criminal proceeds under the PMLA. Recent NCLAT decisions such as Vantage Point Asset Management v. Gaurav Misra suggest that once a resolution plan is approved under the IBC, the clean title must pass to the buyer notwithstanding the ED’s attachment powers. Yet, the question of whether Section 32A can convert tainted assets into clean capital for a bona fide investor is yet to be decided conclusively. This blog traces the evolution of the current judicial position that favours the IBC framework over the PMLA one despite Vijay Madanlal. In doing so, it contends that the conflict between the two may not fully be harmonised due to their nature as special statutes until certain safeguards under Section 32A are ensured, and recommends the recognition of the supremacy of the IBC over the PMLA regime.

How IBC Weights over the PMLA in this Conflict

To argue why the IBC ought to prevail over the PMLA, it is necessary to first examine the manner in which the Code allocates control over the corporate debtor’s (CD) assets. The IBC makes a conscious attempt to distribute power and jurisdiction by granting it to an interim resolution professional (IRP) instead of the tribunals under Section 18(f)(vi). It can be argued that the same provision includes assets that are subject to a court’s determination of ownership, such that the exercise of a CD’s right beyond the IBC cannot be allowed through the NCLT, and by extension, the NCLAT.

Applying this argument to the extinguishment of a CD’s liability for offences committed prior to the commencement of the CIRP under Section 32A of the IBC, ruling on the CD’s right to an asset which amounts to a criminal proceed under the PMLA may be beyond the NCLT’s jurisdiction. Even if the CD’s liability ceases, it cannot be said that the CD’s right to ownership over the asset is established. Since the IRP regardless has the power to take control of such assets under Section 18(f)(vi) when the ownership is yet to be determined by a court, the conflict between the PMLA and the IBC intensifies as the Supreme Court has taken a firm stance in Vijay Madanlal by upholding the ED’s wide power of attachment of criminal proceeds under the PMLA, and interpreting the definition of ‘proceeds of crime’ to be wide enough to include the value of such property. 

It is probable that this conflict was not envisioned by the legislature at the time of inserting Section 32A of the IBC via the Insolvency and Bankruptcy Code (Amendment) Act 2020. Before the addition of this provision, nearly all NCLAT decisions regarding this conflict, including Rotomac Global Private Limited v. Deputy Director, Directorate of Enforcement, Varrsana Ispat Limited v. Deputy Director, Directorate of Enforcement and JSW Steel Limited v. Mahender Kumar Khandelwal tilted in favour of the regime under the PMLA by unanimously highlighting that the IBC should not be misused for cleansing activities related to crime. Post Vijay Madanalal, it is particularly unclear whether the IBC overrides the PMLA or vice versa since both are special statutes. 

I argue that if the attachment of criminal proceeds by the ED is allowed to continue after an insolvent entity enters CIRP, assets will be frozen and an IRP will be unable to assess the certainty of the title. If that happens, creditors may hesitate in approving plans, and the ‘clean slate’ doctrine as established in Committee of Creditors of Essar Steel India Limited v. Satish Kumar Gupta and Others (Satish Kumar) will be defeated. 

For example, the Supreme Court’s decision in Manish Kumar v. Union of India (Manish Kumar) tilted in favour of giving primacy to the IBC over the PMLA. The court upheld the constitutional validity of Section 32A on the grounds that it is in the stakeholders’ interest to let resolution applicants offer fair value in the resolution plan through the extinguishment of the CD’s prior criminal liabilities so that the new management can start afresh. This position clearly favours the fulfilment of the economic objectives of the IBC over that of the PLMA. This is further substantiated by the Court’s observation that the immunity under Section 32A is premised on certain safeguards such as the transfer of control of the asset to the IRP, which is thereafter subject to the Committee of Creditors’ (CoC) control after a resolution plan is approved. In the Court’s opinion, the new management would this way be entirely different from the old one. 

Likewise, the Supreme Court in Bhushan Power and Steel Limited v. Union of India (Bhushan Power) otherwise followed suit, but also held that the CD’s role must be scrutinized in the company’s former directors’ trial especially if charges are under Section 70 of the PMLA. Furthermore, the NCLAT’s decision in Directorate of Enforcement v. Manoj Kumar Agarwal (Manoj Agarwal) took the aforesaid positions in Manish Kumar and Bhushan Power one step further by ruling explicitly that it is necessary for ensuring the objectives of the IBC to prevent the attachment of property under the PMLA since keeping the CD a going concern would otherwise be difficult. The NCLAT observed that attachment can prejudicially affect the property’s value, which would then alter the behaviour of prospective applicants, and keep the RP from getting the valuation done. Such positions indicate a consistent trend of prioritizing the objectives of the IBC wherever there is a clash with the PMLA.

Why Section 32A Cannot be Reconciled with PMLA’s Confiscation Regime

I contend that Manish Kumar and Bhushan Power, and consequently Manoj Agarwal fail to sufficiently reconcile with the confiscation regime under the PMLA post-Vijay Madanlal. This stance can be explained through a three-pronged argument.

Firstly, it is not pragmatic to assume that the IRPs, the COC and the NCLT would be able to ensure that the old management is entirely different from the new one when it is established that the asset is already tainted by criminal activity. ArcelorMittal India Private Limited v. Satish Kumar Gupta (Satish Kumar) showed that ‘formal control’ does not always reflect the effective control in large corporate structures with complex cross-holdings. I argue that if Section 29A of the IBC was subjected to judicial scrutiny in Satish Kumar due to its potential for misuse, Section 32A’s requirement to change the management of the asset is just as vulnerable. Hence, along with maintain the sanctity of the ‘clean slate’ doctrine, there must also be a stronger mechanism to ensure that promoters do not engineer insolvency in an entity and initiate CIRP for the purpose of cleansing the asset by utilizing Section 32A to their advantage.

Secondly, Bhushan Power spawns a paradoxical anomaly by reiterating non-prosecution for prior offences post the commencement of CIRP while holding that the CD’s role in the promoters’ trial must be scrutinised. It is wholly unclear how the two can simultaneously occur if the corporate criminal liability is extinguished under Section 32A. It must also be clarified whether extinguishing liability also amounts to extinguishing the possibility of attachment of the proceeds of crime under Section 70 of the PMLA.

Lastly, none of the aforementioned judgements considered that the status of both PMLA as well as IBC as special statutes with provisions for overriding all other statutes. Just as Section 238 of the IBC has that effect, so does the PMLA under Section 71. However, the author argues that the IBC’s non obstante clause is wider since it also overrides instruments, while the PMLA’s does not. Moreover, the Supreme Court in Solidaire India Limited v. Fairgrowth Financial Services Limited has ruled that a later statute should prevail over an older one if two statutes have conflicting provisions. Since the fundamental conflict between the two is such that there remains no room to apply the rule of harmonious construction as explained in in KSL and Industries Limited v. Arihant Threads Limited, the author suggests stakeholders to lay greater emphasis on clarifying which statute should prevail over the other.

The Way Forward

It is clear from the above discussion that Section 32A’s power to extinguish a CD’s liability merits some safeguards. The author suggests that Section 32A protection should only be granted conditional to due diligence safeguards including cross-verification with the ED. Further, distressed sale discounts may be factored into resolution plans to account for litigation uncertainty arising from pending PMLA proceedings. Similarly, where prima facie case exists that the assets in question amount to ‘proceeds of crime’ within the definition of Section 2(1)(u) of the PMLA, then enhanced due diligence by the RP and the CoC should be required to ensure that the successful resolution applicant is genuinely unrelated to the former management. To ensure that the ‘clean slate’ doctrine is upheld in all such cases, the Supreme Court can rely on Satish Kumar to lay down suitable directions ensuring that the old management is not re-packaged into the new. Finally, the Supreme Court must settle the dust by clarifying which of the two statutes prevails over the other. Considering that the validity of Section 32A has already been upheld in Manish Kumar, the author suggests prioritizing the IBC and its objectives over that of the PMLA as long as there are adequate safeguards to ensure that Section 32A is not misused to cleans the proceeds of crime.