Assignment of Debts under the Insolvency and Bankruptcy Code

[Aayush Mitruka is a lawyer based in Delhi]

Synergies Dooray Automotive, the first corporate entity to be resolved under the new Insolvency and Bankruptcy Code (Code) posed a few very interesting questions and highlighted some grey areas in Code. In the present post I intend to discuss one important issue that came up in the context of assignment of debts.

To put things in perspective, the Code stipulates that after the National Company Law Tribunal (NCLT) admits an insolvency application, the Insolvency Resolution Professional (IRP), among other things, constitutes a committee of creditors (CoC) on the basis of claims received against the corporate debtor. The committee comprises all the financial creditors of the corporate debtor, and they are assigned voting shares based on the size of their debt. However, a related party to whom a corporate debtor owes a financial debt does not have any right of representation, participation or voting in the meetings of the CoC.

Before discussing the issue, it will be beneficial to allude to the brief facts of the Synergies Dooray case. In November 2016, just a week before the Code became operational, Synergies Castings, a sister concern of Synergies Dooray, assigned a major portion of its debt to third-party Millennium Finance by way of three assignment deeds. Note that Synergies Castings had acquired the debt from a consortium of banks by way of a one-time settlement in 2011. In the usual course, Synergies Castings, being a related party would not have been permitted to participate/vote in the meetings of the CoC. Therefore, the maneuvering had secured Millennium Finance (Millennium) a place in the CoC.

Understandably, there is no reason to complain when a creditor (related party or otherwise) assigns its loan to somebody, as that is well within their rights. However the important question is whether the assignee should get a seat in the CoC by virtue of the assignment? The Code does not seem to directly provide any answer in this regard.[1]

This particular question came up for consideration in an application filed by Edelweiss Asset Restructuring Company Limited (Edelweiss) against Synergies Dooray. Edelweiss challenged the assignment and the constitution of the CoC (which included Millennium), alleging that the assignment of debt by Synergies Casting to Millennium was carried out with the ulterior motive of reducing its (i.e. Edelweiss’) voting rights. It was also argued that the assignment deeds were inadequately stamped and unregistered. However, Edelweiss’ argument did not find favour with the NCLT, Hyderabad and while rejecting the application, the NCLT remarked:

“29. Therefore, the assignment deeds between the two entities also legal and permissible. At most it can be said to be similar to “tax planning” rather tax avoiding. Because of this assignment deed, not only the applicant’s share in total debt is reduced, but other financial creditors/Assignees share also proportionately reduced and they did not object to the same but only the applicant agitates with oblique motive/reasons best known to it. Therefore, a fraudulent attempt made to reduce the Applicant’s share in the total voting rights is not a plausible plea by the Applicant. In the absence of any documentary proof/evidence to the claim of the Applicant, the same is liable to be rejected. Accordingly, the bench rejects the above allegations/claim of the applicant.”

[Emphasis supplied]

Although the NCLT held that such an assignment was legal and permissible, it did not delve into the critical aspect of whether such an assignment would secure the assignee a seat in the CoC. The reasoning provided does not appear very convincing. This question ought to have been discussed at length. A reading of the above quoted paragraph also brings to fore that the decision lends it approval to an assignment undertaken even with the sole objective of securing a seat in the CoC because it is akin to “tax planning”. Edelweiss has preferred an appeal before the NCLAT and the matter is currently pending for its decision.

This issue was once again considered by the NCLT, Mumbai in the case of Fortune Pharma Private Limited. Interestingly, in this case, after filing applications initiating the corporate insolvency resolution process (CIRP) but before its admission, two related party creditors assigned their debts to an unrelated third party. Naturally, this diminished the voting share of the applicant creditor, who then filed an application contending that the assignments were executed with an ulterior motive. The NCLT held that disqualification that existed at the time of initiating the CIRP cannot be removed by a mere assignment. It noted that assignment is transfer of one’s right to recover debt to another person and that the rights of the ‘assignee’ are no better than those of an ‘assignor’. Accordingly, the assignee does not get the right to change its status from ‘related’ to ‘unrelated.’

In other words, the NCLT, Mumbai reasoned that since at the inception of the debt it belonged to a related party (who is barred to participate in the proceedings of CoC), the assignment of such a debt will not remove the bar. In my view, though the NCLT was correct in debarring the assignee from participating in the proceedings of the CoC, however the reasoning provided does not appear to inspire much confidence because of the following reasons.

First, it is important to understand that the bar is on the person who is holding the debt and not the nature of the debt per se. It will not be entirely correct to bar somebody (who is otherwise eligible) from voting just because it bought the debt from a related party. Imagine a situation where an original creditor (unrelated) assigns a debt to a related party. Now when this related party creditor assigns a debt to an unrelated X in the usual course of business, will X in this case be barred since at some point in time the debt was held by a related party?  The answer to this has to be in the negative.

Second, this will prove to be counter-productive and have unintended repercussions. It will strongly discourage genuine asset reconstruction companies or other interested parties from buying the debt from any related party creditor. Surely, the Code could not have intended to hinder assignments which are undertaken in the usual course of the business.

Third, how do we exactly deal with situations when a CIRP application is being made by an operational creditor under section 9 of the Code? An operational creditor needs to deliver to the corporate debtor a demand notice as per section 8 before invoking section 9. Do we, in these cases, also allow an assignment before filing of an application? It would be impractical to have a one-size-fits-all approach.

The two views and the approaches adopted by two benches of the NCLT on this critical question throws open a can of worms. Let us try to closely examine this issue.

Assignment is essentially a contractual concept and refers to an agreement by which the rights and obligations of one party can be transferred to another. By virtue of assignment, the assignee steps into the shoes of her assignor and agrees to be both bound by it and is entitled to enforce it. Further, to be valid, an assignment agreement must satisfy the requirements under the Indian Contract Act, 1872 (Act). Accordingly, an assignment agreement can be declared void under section 23 of the Act if the object of the assignment agreement is (a) of such a nature that, if permitted, it would defeat the provisions of any law; or (b) fraudulent; or (c) involves or implies injury to the person or property of another; or (d) the court regards it as immoral, or opposed to public policy.

At this juncture, it is significant to examine if the NCLT (which exercises summary jurisdiction) would have the power to undertake such an investigation or would it be the prerogative of a civil court? The language of section 60(5)(c) of the Code seem to suggest that the NCLT will have the authority since this will be a “question of law or facts, arising out of or in relation to the insolvency resolution or liquidation proceedings of the corporate debtor or corporate person under this Code.”

It cannot be the intention of the Code to allow the promoters to appoint a proxy on the CoC by means of an assignment. It is a well settled principle of law that what may not be done directly cannot be permitted to be done indirectly. However, at the same time it must also be borne in mind that the Code does not aim to discourage any bona fide assignments. In the absence of any guidance in the Code, in order to determine the validity of such assignments, the NCLT ought to investigate the objective behind the assignment. In this regard, the time and the circumstances under which the assignment is made would be one relevant factor. Among other factors, the NCLT may also consider if the assignment is executed in the usual and ordinary course of the business.

This issue undermines the efficiency of the Code and therefore warrants serious consideration. The Code envisages provisions for scrutinizing certain transactions which may compromise the CIRP. One way to address this issue could be by amending the law to include such assignments also within its ambit. Pertinently, under section 240 of the Code, the Insolvency and Bankruptcy Board of India has the power to make regulations. However, since Parliament has been quite proactive in the past in preventing the promoters trying to game the system, it would not be surprising if an amendment is brought in to bring some clarity. It remains to be seen how and when this issue does gets finally elucidated.

– Aayush Mitruka 

[1] Regulation 28 of the IBBI (Insolvency Resolution Process for Corporate Persons) Regulations, 2016 does not address this issue.