The Insolvency and Bankruptcy code 2016, section 43 to 51 provides for avoidable transactions with primary purpose of identifying and reversing transactions which are prejudicial to the interest of the creditors. These transactions are classified as transactions which are in the nature of preference payments, undervalued transfer of assets of the Corporate Debtor, fraudulent and extortionate transactions done with an intent to displace the rights of the creditors thereby causing loss to them. Such transactions are to be identified by the Insolvency Professional (‘IP’) during the Corporate Insolvency Resolution Process (‘CIRP’) of the Corporate Debtor, with an intent to reverse/cancel them to ensure enhanced recovery to creditors and maximization of the value of the assets of the Corporate Debtor. As per IBBI (Insolvency and Bankruptcy Board of India) regulations, it is the duty of the IP to determine avoidance transactions, form an opinion and in time file an avoidance application with Adjudicating Authority (‘AA’) for necessary relief. The law currently requires the IP to scrutinize transactions within the lookback of two years for a related party transaction and one year for other transactions for the period immediately preceding the insolvency proceedings.
It has been observed that many companies, plagued with mismanagement and diversion of funds have ended in a distressed situation leading to insolvency proceedings making it imperative to identity the cause of default. For instance, in the CIRP of one of the large housing finance company’s, as part of avoidance transactions audit, it was observed that large amounts of funds were disbursed to entities with minimal operations and inadequate loan documentation and were potentially fraudulent in nature. It is therefore essential to undertake corrective actions, in the interest of stakeholders.
The law emphasizes the need of identification of avoidance transactions for collective interest of the creditors and therefore it is important that these duties are performed by an IP with utmost diligence and in a time bound manner. In a recent judgement an IP filed avoidance application after filing of the resolution plan, the AA raised concerns on the conduct of the IP and ‘tick in the box’ approach towards avoidance transactions. In another case, Hon’ble High Court raised concerns over filing of avoidance application after management handover to the successful RA.
In view of such instances, amendments to CIRP regulations introduced on July 14, 2021 are relevant as they aim to ensure discipline, accountability, and transparency in the insolvency process. The amended regulations require an IP to file CIRP Form 8 with details pertaining to avoidance transactions within prescribed timelines thus making IPs more accountable. While the law empowers the IP, it also casts a duty on him/her to timely identify transactions and seek reliefs from the AA. It is pertinent to note that while IPs are expected to exercise their professional appropriate judgment and diligence to undertake the evaluation, they may require assistance of independent experts in examination and quantification of complex transactions.
Timely identification and reversal of avoidance transactions can result in better recovery to the creditors. One may draw reference from CIRP of one of the large real estate developer, where the Hon’ble Supreme Court under avoidance transactions restored certain land parcels, which were given as security against debt owed by related parties, which enhanced creditor recoveries due to timely identification and action on part of IP.
While the latest amendments are good enablers to strengthen effectiveness of IBC, it only addresses the issue partially. It has been observed that in various instances applications have been filed by the IP, but relevant avoidance proceedings have been delayed and continued beyond the approval of plan by the AA.
Further, there are also instances wherein lookback period is lost amidst delayed admission with significant lapse of time between initiation of CIRP and admission of CIRP, thereby reducing effectiveness of the scrutiny. For an effective coverage, the regulator may evaluate revision in lookback from the ‘date of default’ in payment to creditors.
Overall, the amendment is a step in the right direction and is expected not only to aid IBBI in effective monitoring but also enhance accountability of the IPs in delivering value maximization for the stakeholders.
(This article has been published by The Financial Express on 05 August 2021)