The insolvency regulator has directed insolvency professionals (IPs) to scrutinise corporate insolvency resolution processes (CIRPs) for possible misuse of the insolvency framework and approach the adjudicating authority when there are reasonable grounds to suspect fraudulent or malicious intent.
In a circular, the Insolvency and Bankruptcy Board of India (IBBI) has flagged six indicators that should trigger closer scrutiny by IPs. The purpose of the guidelines is to prevent misuse of insolvency and bankruptcy code (IBC) through proxy or connected entities to gain control of the insolvency process without a genuine objective of resolving the distressed company. The regulator said it had received information from law-enforcement and regulatory agencies about cases where the IBC was allegedly being misused to mitigate tax liabilities, regulatory scrutiny, investigations and penalties, and to monetise or ring-fence assets.
Although the latest circular has narrowed the safeguards proposed in IBBI’s August discussion paper on the same issue. The regulator has dropped three of the nine red flags listed earlier while also softened the language around IPs’ statutory duties under Section 65 of the Insolvency and Bankruptcy Code (IBC). While dropping some indicators, the latest circular asks IPs to remain vigilant and examine circumstances that may indicate misuse. To be fair, the circular also said that the indicators are illustrative and not exhaustive, and that none of them should be treated as conclusive evidence of misuse.
Six Key Indicators
Nirali Mehta, partner at Mindspright Legal, said the circular comes as a caution to IPs and acknowledges that the CIRP framework may be misused for purposes unrelated to insolvency resolution or liquidation. “The circular illustratively mentions six indicators as triggering events for heightened diligence by the IPs. While the role of the IP is to examine the affairs on being triggered by the events and to apply to the adjudicating authority for appropriate directions, the circular grants them the authority to appropriately address the instances of misuse,” Mehta said.
The six indicators include single-creditor CIRPs or creditors taking over debt shortly before initiation and then gaining committee of creditors (CoC) control, clusters of connected companies entering CIRP together, limited competition or common potential bidders, recoveries far higher than admitted claims without proper valuation, links to fraud-related regulatory or enforcement cases, and unexplained related-party loans or investments.
The single-creditor provision is likely to draw attention as the circular specifically flags cases where a creditor takes over debt shortly before CIRP and then dominates the CoC.
Suman Kumar Jha, founder of Corp Legex, said a single-creditor CoC could arise legitimately, particularly where a company has only one major lender, but such cases now warrant closer scrutiny when accompanied by other unusual circumstances. “While single-creditor CIRPs remain legally permissible, IPs are now expected to investigate whether such control is being used to manipulate the insolvency process for purposes unrelated to genuine debt resolution,” Jha said.
Evolution of Safeguards
The August paper proposed that IPs “shall” review any flagged indicators in detail and, if they found that CIRP was initiated fraudulently or with malicious intent, approach the adjudicating authority under Section 60(5) read with Section 65. The final circular retains this requirement but says IPs should approach the authority when, after further enquiry, they have reasonable grounds to believe the process may be serving a fraudulent or malicious purpose.