Dilemma with Avoidance Proceedings Post Corporate Insolvency Resolution Process

[By Mayank Bansal & Dev Bansal]

The authors are students at the Dr B.R Ambedkar National Law University, Sonepat.

Introduction

For a successful insolvency regime, the prevention of fraudulent transactions made by the management of the corporate debtor in the hands of certain preferred creditors is crucial to uphold justice. Since these transactions are made prior to the initiation of the Corporate Insolvency Resolution Process (“CIRP”), they reduce the availability of funds for bona fide creditors and other stakeholders to get their dues equitably in the insolvency process. These are called “preferential” or “avoidable” transactions, and The Insolvency and Bankruptcy Code, 2016 (“IBC”) provides for their reversal.

Though IBC empowers the Resolution Professional (“RP”) to initiate proceedings against such transfers before the National Company Law Tribunal (“NCLT”), it is silent on their completion period, and more importantly on a situation where the NCLT is not able to adjudicate on these transactions till the completion of CIRP. Recently, the High Court of Delhi (“H.C.”) in Venus Recruiters Private Limited v. Union of India while facing this issue ruled that avoidance proceedings must be adjudicated before or at the time of approval of the resolution plan, i.e., before the completion of CIRP and not after it, on account of limited jurisdiction of NCLT, finite nature of RP, and that no one seemed to be the beneficiary of the recovery.

 This article seeks to highlight plausible pathways the HC could have followed in response to the encountered issues and assert that preferential transactions can continue beyond CIRP, for which the NCLT is the appropriate authority and RP should only continue with the proceedings. A distribution mechanism for the subsequent recovery has been propounded, and lastly, the question of litigation cost has also been dealt with.

Current Conundrum With Proceedings Avoiding Preferential Transactions

The H.C. in the above case quashed the avoidance proceedings post the approval of the resolution plan. This seems absolutely against the principles of justice since the lapse of time shouldn’t be an obstacle in undoing the unjust; the basic essence of such avoidances.

As stated in the ICSI’s Statement of Best Practices, the avoidance proceedings aim to restore the unjust amount from the defrauding directors, promoters, and creditors, whereas CIRP relates to the resolution of the corporate debtor, and thus the two should be treated separately. Moreover, the Report of the Insolvency Law Committee (“ILC”) suggested that there shall be no prescriptive timelines for the completion of these proceedings, and they may continue beyond the period of CIRP. These proceedings may involve assessing multiple impugned transactions within the clawback period that may take longer than CIRP, and hence, these proceedings should have been allowed to pursue beyond CIRP.

NCLT Should Continue The Adjudication

The H.C. held that the NCLT can only adjudicate the avoidance transactions before or at the time of approval of the plan. However, as ILC suggested NCLT for deciding upon other related facets (such as the distribution of the recovery in such cases) even post CIRP, it is apparent that it may also adjudicate these transactions. Besides this, Rule 11 of the NCLT Rules, 2016 empowers the NCLT with “inherent powers” to pass orders as it may deem fit in given facts and circumstances to ensure equity and justice.

Although Section 63 of the code bars a civil court to adjudicate any issue for which the NCLT is empowered, the stated judgment concluded in leaving the party to their civil remedies outside the IBC. Transferring jurisdiction to a civil court is blatantly against the provision and spirit of the code.

Role Of Resolution Professional

On the locus standi of the RP, the court strictly applied the principle laid down in Committee Of Creditors Of Essar and held that the role of RP is finite in nature and he can’t continue as “former RP” after the completion of the plan.

However, ILC scrutinizing various alternatives suggested that the RP shall continue with the existing practice and remain the appropriate authority to carry on with the preferential transaction. IBC is a newly enacted code and numerous amendments are undertaken in pursuance of the committees’ recommendations and judicial decisions. Therefore, following the ILC’s recommendations, RP should have continued the proceedings.

Distribution Of Recovery

The H.C. was of the view that post plan’s approval by the Adjudicating Authority, proceeds from preferential transactions would thereafter neither go to the creditors nor the resolution applicant. However, this seems to be in stark contrast to the ILC’s recommendations on the distribution of the avoidance recovery suggesting the adoption of a flexible approach for the same and to leave to the prudence of the adjudicating authority whom to render the benefits, while explicitly mentioning the creditors and the successful resolution applicant among the beneficiaries and even suggesting a distribution mechanism for the former.

At present, there are no concrete provisions on the distribution of such recoveries but recommended to be pursued based on facts and circumstances of the case. Inspired by the U.S. bankruptcy laws, below is an analysis of situations per the ILC’s recommendations.

Creditors as Beneficiary

The key aim of avoiding these transactions is to avoid unjust enrichment of certain creditors over others, which in effect means that creditors’ welfare is paramount in such situations. The bankruptcy laws of countries like the U.S. also advocate creditors’ benefit, either direct or indirect. While dealing with Section 550 of the U.S. bankruptcy code stating such recoveries to be for the “benefit of the estate”, the Court of Appeals has observed this phrase to articulate the creditors as beneficiary and that they must be ‘meaningfully and measurably benefitted’.

In In re Centennial Industries, Inc., the Court of Appeals permitted the debtor to pursue avoidance actions even when the reorganization plan provided for the fixed payments to unsecured creditors over five years, stating that any such recovery will be additional security for the plan’s fulfilment and increase the likelihood of the creditors receiving their future payments.

 Hence, the creditors could have been identified by the HC as the beneficiary, and as far as the manner of distribution among them is concerned, ILC converged on following the waterfall mechanism under Section 53(1) of the IBC, unless an alternate one is found by the Adjudicating Authority to be appropriate.

Resolution Applicant as Beneficiary

A successful revival and reorganization of the defaulting company is one significant aspect of the bankruptcy laws. However, the H.C. after examining Chapter 3 of the ILC Report was of the view that the avoidance applications are not for the benefit of the Resolution Applicant. The Court seems to misinterpret those recommendations since they only called for forbidding them from filing the application to avoid the return that is possibly not factored in the submitted bid; such noninclusion being obvious if they haven’t been adjudicated upon at the time of the bid’s submission.

Section 44 of IBC directs for the recovered property to be vested in the Corporate Debtor. While sections 47 & 49 direct for the restoration of the position as it existed before such transaction, indicating its addition in the pool of assets which may be used for reorganization or repayment of creditors either in liquid or in the form of equity shares.

Sometimes, in pursuance of a resolution plan, a debt for equity swap is undertaken and the creditors’ dues are converted into equity ownership. Hence, the benefit of directing the proceeds in the pool of assets can be three-fold: first, it can increase the financial health of the successor-in-interest; second, operate to proportionally increase the value of the shares of the company thereby benefiting the shareholders; and last, draw indirect benefit for creditors by boosting the applicant’s ability to perform its obligation under its plan. Given these merits, the Delaware bankruptcy court in In re Trans World Airlines, Inc. permitted pursuit of recovery in avoidance actions even when the distribution to unsecured creditors was fixed by the reorganization plan and the amount distributed would have remained unaffected by any such recovery.

Litigation Cost

The last question that tickles here is who will bear the litigation cost, which has no mention in the already passed plan?

 It is hereby suggested that the NCLT while approving the plan, can specify beforehand which party will be entitled to the recovery benefits based on the facts and circumstances and declare that the beneficiary will itself bear the costs if it decides to go for the litigation post CIRP. A high probability of enjoying a handsome benefit will automatically draw them to litigation.

Besides, as the case Bar Council of India v. A.K. Balaji suggests, a third party may also fund this cost since there is no legal bar on such funding in India.

Conclusion

The H.C. misconstrued the ILC Report and set aside the avoidance proceedings while leaving the vulnerable creditors to resort to civil remedies. It thus seems to have set a dangerous precedent against the spirit of the IBC. However, had it kept justice and equity at the forefront, it may have emerged to be a landmark one, filling the lacunae in the adjudication of such proceedings.

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