The latest amendment, which makes the insolvency professional more accountable on avoidance transactions, was much-needed, but addresses the issue only partially
By Manish Aggarwal
The Insolvency and Bankruptcy Code, in Section 43 to 51, provides for avoidable transactions, with the primary purpose of identifying and reversing transactions which are prejudicial to the interest of the creditors. These transactions are classified as transactions that 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 for creditors and maximisation of the value of the assets. As per the Insolvency and Bankruptcy Board of India (IBBI) regulations, it is the duty of the IP to determine avoidance transactions, form an opinion, and, in time, file an avoidance application with the adjudicating authority (AA) for necessary relief. The law currently requires the IP to scrutinise transactions within a ‘lookback’ of two years for related-party transactions and one year for other transactions, for the period immediately preceding the insolvency proceedings.
It is observed that many companies, plagued with mismanagement and diversion of funds, have ended up 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 companies, 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 emphasises the need for identification of avoidance transactions in the 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 a ‘tick the box’ approach towards avoidance transactions. In another case, a 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 given 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 her to identify in a timely manner such 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 the CIRP of one of the large real estate developer, where the Supreme Court—under avoidance transactions—restored certain land parcels that were given as security against debt owed by related parties, which enhanced creditor recoveries due to timely identification and action on part of the IP.
While the latest amendment is good, and strengthens the effectiveness of the IBC, it addresses the issue only 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 the ‘lookback’ period is lost amidst delayed admission, with significant lapse of time between the initiation of CIRP and admission of CIRP, thereby reducing the effectiveness of the scrutiny. For an effective coverage, the regulator may evaluate revision in the ‘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-maximisation for the stakeholders.
The author is Partner and head (energy & infrastructure M&A), and head (special situations group), KPMG in India
Views are personal