Avoidance Transactions Under Indian Insolvency law: Moving Towards a Creditor-Centric Paradigm
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Under the Insolvency and Bankruptcy Code (‘IBC’) in India, avoidance transactions are essentially transactions undertaken by the corporate debtor prior to the initiation of the Corporate Insolvency Resolution Process (‘CIRP’) to defraud its creditors or to benefit related parties as well as its own management. Sections 43 and 66 of the IBC regulate how preferential and fraudulent transactions are to be accounted for by the Resolution Professional (‘RP’) and the Committee of Creditors (‘CoC’) during the CIRP.
Recently, a division bench of the Delhi High Court in Tata Steel BSL Ltd. v Venus Recruiters (‘Tata Steel’) has brought about a significant change to the adjudication of avoidance transactions under the IBC, holding that avoidance applications which are initiated by the RP shall continue irrespective of the finalisation of the Resolution Plan and the conclusion of the CIRP. The decision in Tata Steel was the result of an appeal against the decision of a single judge of the Delhi High Court in Venus Recruiters v Union of India (‘Venus’), which had held that once the CIRP had concluded, any avoidance applications filed before the Resolution Plan were to be rendered infructuous.
In this post, we argue that the shift in the legal position taken by the Delhi High Court in Tata Steel is a step towards ensuring that the goals of the IBC are accentuated. These goals are to (i) maximise the assets of the corporate debtor, (ii) provide a time-effective insolvency resolution process, and (iii) ensure that the corporate debtor can continue as a going concern. In this endeavour, the provisions of the IBC seek to provide the maximum support to potential Resolution Applicants, who submit their resolution plans to the Committee of Creditors (‘CoC’) to stake their claim to take over the reins of the corporate debtor. Moreover, we argue that the decision in Tata Steel will decrease the haircuts that financial creditors have to suffer, which have cast a dark cloud over the value of the CIRP for creditors.
The law on avoidance transactions pre-Tata Steel: an unsettled terrain
In 2020, Tata Steel emerged as the successful Resolution Applicant, after its resolution plan was accepted by the CoC in the CIRP of Bhushan Steel Ltd. Before the finalisation of the resolution plan, the RP had filed avoidance applications under sections 43 and 66 of the IBC, for preferential and fraudulent transactions in favour of Venus Recruiter Private Limited.
Section 26 of the IBC clarified that any applications filed for avoidance transactions by the RP shall have no bearing on the CIRP. However, in its Venus decision, a single judge of the Delhi High Court decided that once the CIRP is completed, the pending avoidance applications cannot be adjudicated further. The decision in Venus squarely contradicted the position under section 26 of the IBC, and resulted in a paradigm where creditors had to bear the brunt of suspicious transactions undertaken by the corporate debtor, which would reduce their overall recovery. Further, it circumscribed the adjudication of avoidance transactions within the CIRP itself, which presented a number of problems.
First, since avoidance transactions are complex to adjudicate, and require an in-depth assessment of the allegations of fraud or preferential treatment (which cannot be conducted in a summary fashion by the court), adjudicating avoidance applications within the CIRP timeline could cause severe delays to the insolvency proceedings. Moreover, with such claims being prematurely closed off as a result of the decision in Venus, a significant hurdle presented itself to have such applications adjudicated effectively and within a tight timeframe, with a view to allow creditors to get their fair share. Second, even after an avoidance application is decided, parties can file an appeal to the decision, potentially causing further delays to a stymied CIRP.
These problems were highlighted by the report of the Insolvency Law Committee in May 2022 (‘ILC Report’), which cautioned that avoidance proceedings did not have any prescribed timeline under the IBC, and if such proceedings were to be concluded prematurely before the finalisation of the resolution plan, it would jeopardise the interests of creditors and unjustly benefit corporate debtors along with the counter-parties undertaking such preferential transactions. It recommended that avoidance transactions should be factored into the resolution plan itself, so that creditors can account for the proceeds from such transactions into the finalised resolution plan.
Subsequently, amendments to the IBBI (Insolvency for Corporate Persons) Regulations 2016 and the IBBI (Liquidation Process) Regulations 2016 were carried out in order to harmonise the findings from the ILC Report, and to facilitate avoidance proceedings even after the approval of the resolution plan, or liquidation of the corporate debtor, as the case may be. However, the decision in Venus continued to pose a judicial hurdle, as it remained the decision laying down the interpretation binding upon National Company Law Tribunals (‘NCLTs’) with respect to avoidance transactions. The decision of the Delhi High Court, in Tata Steel, has finally provided clarity to the paradigm of avoidance transactions under the IBC, and addressed the contradiction between the prevailing position under Venus and section 26 of the IBC It has re-aligned the position on avoidance transactions with the goals which the IBC seeks to pursue, ie value maximisation of the corporate debtor’s assets, ensuring the operation of the corporate debtor as a going concern and a timely resolution of insolvency proceedings.
The Delhi High Court’s decision in Tata Steel: Reinforcing the foundational principles of the IBC
In Tata Steel, the Delhi High Court referred to the ILC Report and clarified that avoidance applications are not affected by the approval of the resolution plan, or by the completion of the CIRP. Significantly, it held that the role of the RP does not become functus officio in so far as the avoidance applications are concerned. While the RP’s role comes to a conclusion on the successful resolution of the corporate debtor, the RP’s role in avoidance proceedings is distinct and independent since the adjudication of avoidance transactions requires the court to enter into the complex domain of preferential and fraudulent transactions, which require in depth adjudication of such issues, and is therefore time consuming. The rationale which the Court provided for overturning the position taken in Venus was to disallow corporate debtors who undertook such avoidance transactions to walk away scot-free, unjustly benefiting from such transactions while leaving their creditors in the lurch.
From a policy perspective, the decision of the Court in Tata Steel is a welcome one and long overdue. Not only does the Court’s interpretation resonate with the principle to separate avoidance proceedings from the CIRP under section 26, it also allows for creditors to account for such transactions in factoring in the overall proceeds and recoveries in the resolution plan of the corporate debtor.
Further, with the rise in haircuts under the IBC becoming a cause for concern (as was also pointed out in the IBBI’s annual report of 2020-21), the Delhi High Court’s creditor-friendly approach is another welcome step towards ensuring that creditor’s interests would not be sacrificed on each occasion to the goal of ensuring that the corporate debtor continues as a going concern. Allowing avoidance proceedings to continue beyond the completion of the CIRP will contribute to creditors getting their fair end of the deal, while still looking out for the best interests of the corporate debtor in the process of balancing competing interests.
Sumit Chatterjee is a commercial dispute resolution lawyer at Arista Chambers. The author would like to thank Mr. Vinamra Gogia (Intern, Arista Chambers and final year student, Symbiosis Law School Hyderabad) for excellent research assistance.
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