Navigating Avoidance Actions in Corporate Insolvency
(4th year B.A., LL.B. (Hons.) student at National Law University, Jodhpur)
The Insolvency and Bankruptcy Code, 2016 (IBC), has rules for dealing with certain transactions that can cause financial problems. These transactions are called avoidance transactions. The people in charge of handling insolvency cases, known as insolvency professionals (IPs), have the power to recover money or assets that were lost because of these questionable transactions. For example, when a company is facing financial trouble, its owners might transfer valuable assets to family members or other companies to protect them from creditors or to pay back some important creditors. To protect the interests of lenders, the IBC includes regulations to prevent certain transactions, like preferential, undervalued, extortionate, and fraudulent deals, during the process of resolving the company’s financial issues. However, despite the rules, IPs have found it difficult to fully recover the lost money or assets in real-life situations.
In this regard, the National Company Law Appellate Tribunal (NCLAT) in the case of Kapil Wadhawan v. Piramal Capital & Housing Finance Ltd. & Ors (2023) ibclaw.in 320 NCLAT, has given decision on the issue of whether the approval of a Resolution Plan by the National Company Law Tribunal (NCLT) empowers the successful Resolution applicant to pursue Avoidance Applications after the plan’s approval, or if Avoidance Applications filed by the Committee of Creditors (CoC) can be pursued following the approval of the Resolution Plan. In this article, the author critically analyses the current decision, and the mechanism of adjudication of avoidance applications under IBC.
Brief Facts of the Case
The appeal was filed against the NCLT Mumbai’s Order, which allowed Piramal Capital & Housing Finance Ltd (SRA) to replace the Corporate Debtor’s administrator in the Avoidance Applications. The Resolution Plan approved by NCLT included a clause stating that Successful Resolution Applicant (SRA) would pursue Avoidance Applications filed by the administrator after NCLT’s approval, with the proceeds distributed to creditors. The ex-promoter of the Corporate Debtor challenged these Orders before the NCLAT.
According to the NCLAT’s interpretation of Section 25(2)(j), Section 26, and Section 36 of the IBC, Avoidance Applications should be treated separately from the corporate insolvency resolution process (CIRP) proceedings. As a result, the approval of a Resolution Plan and the conclusion of the CIRP do not render Avoidance Applications ineffective. This interpretation aligns with a previous Division Bench judgment of the Delhi High Court (DHC) in TATA Steel BSL Ltd v. Venus Recruiter Pvt. Ltd. & Ors. (2023) ibclaw.in 09 HC, which clarified the role of the Resolution Professional (RP) with the conclusion of the CIRP.
In TATA Steel case (supra), the DHC clarified that once the CIRP is completed, the RP no longer holds any authority or duties. However, this rule does not extend to avoidance applications, as the RP retains the power to deal with such cases even after the conclusion of the CIRP. The court observed that the Section 43-51, Section 66 & Section 67 of the IBC address transactions that the resolution professional can avoid and actions against fraudulent transactions by former management. The main purpose is to ensure that more assets are available to creditors and to prevent unfair benefits. The Act considers the process of investigating these transactions as supplementary and should not cause delays in resolving the corporate debtor’s situation. However, examining and resolving these transactions can be time-consuming and complicated, particularly when there are incomplete records. Unscrupulous individuals who forced the company into insolvency should not misuse the time frame provided by the IBC. It is essential for the resolution professional to carefully evaluate and manage these transactions to achieve fair and just outcomes.
The DHC also observed that the resolution applicant is not entitled to keep the funds obtained from avoiding the transactions. However, the benefits resulting from the avoidance applications do not belong to the restructured corporate debtor, as it is no longer responsible for those transactions after the resolution process. When the resolution applicant agreed to take over the corporate debtor, they had no expectation of receiving additional funds through avoidance applications. The primary objective of the avoidance application is to increase the asset pool available to the creditors, especially financial institutions that have already accepted reduced amounts. As public funds are involved, any proceeds obtained from the avoided transactions must be distributed among the CoCs based on the decision of the adjudicating authority.
In Kapil Wadhawan case (supra), the NCLAT clarified that it is compulsory for the RP to initiate the avoidance application, as outlined in Sections 43, 45, and 66, along with Regulation 35A of the CIRP Regulations. In this particular case, this requirement was fulfilled since all Avoidance Applications had been filed by the RP. The NCLAT also referenced Regulation 38(2)(d) of the CIRP Regulations, which mandates that the Resolution Plan must specify how the Avoidance Applications will be pursued and how the proceeds will be distributed after the plan’s approval.
The NCLAT acknowledged that the amendment to Regulation 38(2)(d) applies only to Resolution Plans submitted after its introduction, but its main purpose is to provide legal clarity. In this specific case, since the Resolution Plan explicitly authorized the SRA to pursue avoidance applications, the NCLAT considered this provision binding on all parties involved, including the former administrator.
Moreover, the NCLAT dismissed the Appellant’s argument about the supposed non-maintainability of the Avoidance Applications filed after the CoC’s approval of the Resolution Plan based on delays. The NCLAT clarified that the timeline for filing Avoidance Applications under Regulation 35A is deemed flexible, allowing any application submitted within a reasonable timeframe to be considered valid.
Current Framework of Adjudication of Avoidance Actions: Challenges & Possible Solutions
Challenges in adjudication of avoidance actions are multi-faceted. IPs must overcome the difficulty of meeting the evidential burden of proof, particularly due to inadequate bookkeeping by Indian debtors and limited cooperation from promoters and key employees. Moreover, when forensic audit reports reveal multiple transactions subject to avoidance, the complexity escalates, leading to prolonged litigation involving multiple parties. Delays in adjudication are a significant issue, with NCLTs struggling to adhere to prescribed timelines due to excessive litigation, judge shortages, and a backlog of cases. Avoidance applications often take a back seat, creating a pile-up of unresolved cases. Funding constraints further impede the pursuit of avoidance actions, as companies in CIRP face liquidity crises, and creditors are cautious about allocating funds due to uncertainty about timelines and recoveries, resulting in higher litigation costs. Consequently, creditors have limited resources and little incentive to pursue avoidance actions.
The current process of adjudicating avoidance actions under the IBC is time-consuming and costly, relying heavily on detailed facts. Introducing a settlement mechanism, where the IP negotiates with respondents based on CoC instructions, could offer a faster and more efficient approach. Settling disputes promptly would increase recoveries and benefit the debtor’s asset pool. It would also alleviate the burden on NCLTs, encouraging more proactive pursuit of avoidance actions by IPs and CoCs. However, some risks need consideration, like respondents using insolvency to evade claims or CoCs favouring settlements that favour certain creditors unfairly. To address these issues, the IBC could mandate NCLT approval for settlements and exclude fraudulent and criminal transactions from being settled to ensure proper adjudication and regulatory involvement if needed.
The NCLAT’s decision in the Kapil Wadhawan case provides much-needed clarity on the treatment of Avoidance Applications under the IBC. By affirming the independence of these applications from the CIRP proceedings, the decision upholds the IBC’s goal of safeguarding creditors’ interests and increasing the available asset pool. This interpretation aligns with previous judgments, establishing a strong legal framework for addressing avoidance actions and providing guidance for IPs and CoCs.
However, certain challenges and inefficiencies in the current adjudication process, such as the complexity of gathering evidence and the lengthy resolution of cases, hinder the efficient recovery of assets and delay the resolution process. Introducing a settlement mechanism has the potential to expedite the process and enhance recoveries, but it must be carefully regulated to prevent any abuse.
In conclusion, the NCLAT’s decision marks a significant step in clarifying ambiguity surrounding avoidance actions, but improvements are still needed in the overall framework. Implementing a well-regulated settlement mechanism, along with efforts to streamline evidence collection and reduce delays, can enhance the effectiveness of the IBC in dealing with avoidance transactions and contribute to a more efficient and equitable resolution of insolvency cases.
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