Dissecting the Insolvency Code: Attachment by Enforcement Directorate of a Corporate Debtor’s assets

Authored by:
–Adimesh Lochan, Arjun Gupta & Sahil Kanuga, Nishith Desai Associates

INTRODUCTION

Being a nascent law, the Insolvency and Bankruptcy Code, 2016 (“IBC”) has faced several challenges in its interpretation and implementation due to overlap of certain aspects with other statutes in force. One such issue is the overlapping implementation of the IBC with the Prevention of Money Laundering Act, 2002 (“PMLA”). Both PMLA and IBC are special legislations, enacted for specific purposes. However, situations such as the attachment of assets of a corporate debtor (“CD”) during its corporate insolvency resolution process (“CIRP”) often may lead to an apparent conflict between the application of PMLA and IBC.

In the recent past, there has been a rising trend of attachment of assets of a CD by the Enforcement Directorate under the PMLA, during the subsistence of CIRP of the CD. Post such attachment, resolution professionals (“RPs”) have approached National Company Law Tribunals (“NCLTs”) to seek release of such attached assets in order to effectively continue with the ongoing CIRP. However, through various orders,[1] the NCLTs and National Company Law Appellate Tribunal (“NCLAT”) have directed RPs to approach special courts designated under the PMLA to seek release of such attached assets.

In one such order, the NCLAT had relied upon a judgment of the Delhi High Court (“Delhi HC”) in Deputy Director, Directorate of Enforcement Delhi v. Axis Bank & Ors. (“Axis Bank”).[2] The Delhi HC in Axis Bank, amongst other things, held that the object and purpose of PMLA is distinct from that of IBC and therefore, both statutes must be harmoniously interpreted rather than one having an overriding effect over the other.

Section 14 of the IBC imposes a moratorium on the institution and continuation of legal proceedings against a CD after the commencement of its CIRP. However, the Delhi HC categorically held that such a moratorium will not have any impact on the powers of the ED to attach the assets of the CD after the commencement of CIRP.

The Delhi HC did not specifically discuss the issue of whether an NCLT has the requisite jurisdiction to entertain an application seeking release of assets attached under the PMLA after the commencement of CIRP. However, NCLTs and the NCLAT have relied upon the judgment in Axis Bank to hold that they do not have the requisite jurisdiction to entertain such applications.

CONFLICT BETWEEN PMLA AND IBC

Post pronouncement of the judgment in Axis Bank, Section 32A of the IBC was added with the objective of (a) absolving the CD for any liability in respect of any offence committed prior to the commencement of the CIRP; and (b) protecting assets of the CD from any action in relation to such offence. The protection under Section 32A comes into effect upon the approval of a resolution plan or sale of liquidation assets. As a result, an order of attachment of the assets of the CD post commencement of the CIRP is rendered redundant if such attached assets are sold through a resolution plan approved by the NCLT. However, if the ED attaches assets of the CD during the pendency of the CIRP, such attachment is likely to have a detrimental effect on the CIRP. In this write up, we discuss the ramifications of such attachments.

ANALYSIS

Strict timelines

The foremost objective of the IBC is to ensure insolvency resolution in a time bound manner. In foreign jurisdictions which have a robust insolvency regime, the entire process of insolvency resolution may get completed within 4 – 6 months. If the assets of a CD are attached during the CIRP and consequently, its RP is compelled to approach a judicial forum to secure release of the attached assets, considerable resources are allocated and spent in the process. Further, if a substantial portion of assets or a significant asset of the CD is attached, the CIRP itself cannot proceed without securing the release of such asset/s. Accordingly, the final adjudication of such applications is likely to prolong the timeline for completion of a CIRP.

If the RP is compelled to file such an application before a special court, the timeline for a CIRP will be further extended as proceedings under special courts are not time-bound. Therefore, in order to complete the proceedings within the time limit specified under the IBC, it is imperative that the assets of a CD are not attached during the CIRP.

Maximisation of asset value of the CD

Under the IBC, when a CD is sold as a going concern, the sale proceeds are utilized to repay its creditors. Therefore, value maximisation of the CD would result in an optimal repayment plan for all the creditors. If the RP loses possession of assets of the CD due to attachment by the ED, such assets might not be available for valuation in order to compute the fair market value/liquidation value (“FMV/LV”) of the CD. Considering that an acquirer would be pegging its bid to the FMV/LV computed by the RP, the CD is likely to receive inferior bids from an acquirer if significant assets of the CD remain attached by the ED during the CIRP. The attachment adds a layer of complexity to the CIRP process.

It is important to develop a robust and vibrant market for stressed assets. In turn, this will create and promote a strong pool of investors willing to acquire assets under the IBC. One of the fundamental considerations for an investor operating in the stressed assets space is the availability of unencumbered assets which are not subject to any litigation. In the CIRP of Bhushan Power & Steel Ltd., the acquirer (Jindal Steel and Power Limited) submitted a resolution plan which was approved by the NCLT. However, certain assets which were acquired under the successful resolution plan had been attached by the ED under the PMLA. In spite of the protection available under Section 32A of the IBC, the ED continues to challenge the sale of the attached assets before the Supreme Court. Even after three years from the approval of the successful resolution plan, the fate of the assets acquired under the IBC is still subject to the outcome of the proceedings before the Supreme Court.

The propensity and frequency of attachment orders issued by the ED in respect of CDs undergoing CIRP can (a) dissuade stressed asset investors from acquiring CDs using the IBC route; and (b) invite inferior bids, thereby compelling the creditors to accede to excessive haircuts.

Unless there is clarity on the validity of a sale under the IBC route, the entire legislative framework might face the same fate as its predecessors like SARFAESI and RDDBFI.[3]

Avoiding multiplicity of proceedings

The IBC was introduced as an independent and self-contained code to consolidate all proceedings pertaining to insolvency resolution before a single forum, i.e., the NCLTs. In furtherance of this objective, Section 60(2) of the IBC states that even if creditors of a CD have a claim against a guarantor, such a claim would have to be instituted before the same bench of the NCLT which is supervising the CIRP of the CD. Further, Section 60(5)(c) of the IBC states that ‘any question of priorities or any question of law or facts, arising out of or in relation to’ a CIRP must be adjudicated exclusively by the NCLT.[4]

The scope of adjudication in an application seeking release of assets attached by the ED does not extend to a determination of legality or validity of an attachment order under PMLA. Instead, the scope is limited to a determination as to whether an attachment order is sustainable pursuant to Section 14 and Section 32A of the IBC. As per Section 60, such an application is, prima facie, a question of law and/or priority arising out of or in relation to a CIRP. Therefore, such applications must be adjudicated by an NCLT itself.

However, the NCLTs in the aforementioned orders, have refused to entertain such applications. Instead, the NCLTs have directed RPs to approach the special court under PMLA to secure such release. If an RP is compelled to approach a different forum, it will cause multiplicity of proceedings and defeat the purpose and object of the IBC. Therefore, it is imperative that all such applications are entertained and adjudicated by the NCLT without involving a separate forum like the special court under the PMLA.

We acknowledge and thank Rakshita Shukla (Graduate, Institute of Law, Nirma University) for her assistance on this article.

Reference:

[1] Ashok Kumar Sarawagi v. Enforcement Directorate, Government of India (2022) ibclaw.in 337 NCLAT; Kiran Shah v. Enforcement Directorate (2022) ibclaw.in 10 NCLAT; Varrsana Ispat Limited Vs. Deputy Director of Enforcement [2019] ibclaw.in 67 NCLAT.

[2] [2019] ibclaw.in 06 HC (Judgment dated April 02, 2019).

[3] Securitisation and Reconstruction of Financial Asset and Enforcement of Security Interest Act, 2002 and Recovery of Debts due to Banks and Financial Institutions Act, 1993 (Now ‘The Recovery of Debts and Bankruptcy Act, 1993’).

[4] Section 63 of the IBC reads as:

“No civil court or authority shall have jurisdiction to entertain any suit or proceedings in respect of any matter on which National Company Law Tribunal or the National Company Law Appellate Tribunal has jurisdiction under this Code. Civil court not to have jurisdiction.”

Disclaimer: The Opinions expressed in this article are that of the author(s). The facts and opinions expressed here do not reflect the views of IBC Laws (http://www.ibclaw.in). The entire contents of this document have been prepared on the basis of the information existing at the time of the preparation. The author(s) and IBC Laws (http://www.ibclaw.in) do not take responsibility of the same. Postings on this blog are for informational purposes only. Nothing herein shall be deemed or construed to constitute legal or investment advice. Discussions on, or arising out of this, blog between contributors and other persons shall not create any attorney-client relationship.