Circumstances where Resolution Process can be Declared Void after Initiation

[Shreya Routh is an Executive at Vinod Kothari & Company]

Gains through unjust fraud are never secured. The same goes for a company against which a process of corporate insolvency has been initiated. If the sole intent for initiation of a case is to defraud the creditors, there can be no possibility of revival of the company. The Insolvency and Bankruptcy Code, 2016 (the “Code”) comes with the basic motive of rehabilitation of the company with involvement of the stakeholders. If the corporate insolvency resolution process (“CIRP”) has been initiated with the intention of deceiving the stakeholders, there seems to be no reason why the adjudicating authority should allow for continuation of the process. In this post, we shall consider various circumstances under which a CIRP can be declared as void.

Intention to Defraud Creditors

As stated above, one of the basic intentions of the Code is protection of the stakeholders which largely involves the creditors of a company. If a CIRP has been initiated with the sole intent of defrauding any creditor, then such process must be declared void. The Code discusses the consequences that follow if the CIRP is initiated fraudulently or with malicious intent for any purpose other than for the resolution of insolvency or liquidation. The relevant provision has been mentioned herein for ready reference:

65(1) If any person initiates the insolvency resolution process or liquidation proceedings fraudulently or with malicious intent for any purpose other than for the resolution of insolvency, or liquidation, as the case may be, the Adjudicating Authority may impose upon a such person a penalty which shall not be less than one lakh rupees, but may extend to one crore rupees.

Although the Code makes provision for penalty, it nowhere clarifies whether the CIRP will continue to exist or not. Where the process has been initiated with a mala fide intention, it becomes challenging to rectify the situation.  Rather the very purpose for which the process has been initiated becomes frustrated. Under such backdrop, continuation of the process seems neither ethical nor realistic.

Inherent Power of the National Company Law Tribunal (“NCLT”)

Rule 11 of the National Company Law Tribunal Rules, 2016 states: “Nothing in these rules shall be deemed to limit or otherwise affect the inherent powers of the Tribunal to make such orders as may be necessary for meeting the ends of justice or to prevent abuse of the process of the Tribunal.”

Where the Code provides for penal provisions under circumstances where CIRP has been initiated with a malicious intent, the Rules state that the NCLT may take such steps as may be deemed necessary to prevent abuse of the process of the Tribunal. The question that arises is whether the NCLT can, in its inherent power, declare a CIRP to be void when it is initiated with mala fide intent.

In APC Credit Rating Pvt Ltd vs. ROC, NCT of Delhi and Haryana, the National Company Law Appellate Tribunal (“NCLAT”) held that “the inherent power, as provided under Rule 11, is for making such order for meeting the ends of justice or to prevent abuse of justice, ….. But such power can be exercised during hearing of an application/appeal, and not after disposal or for review of its own order”.

Accordingly, it may be observed that section 65 applies to the period when the adjudicating authority determines the eligibility of the case for acceptance under the Code. If found fraudulent, the NCLT shall impose fine and if the case appears prima facie to be true, the application is accepted.

After initiation of the CIRP, if the insolvency professional discovers the fraudulent intent, it is the duty of such professional to report the same to NCLT. Based on the report, the NCLT may, in order to avoid abuse of law and in exercise of its inherent power, consider the CIRP to be void.

Circumstances under which Fraud may Exist

  1. Escaping the option of applying under section 10 of the Code

For the purpose of initiating a CIRP under section 10 of the Code, the corporate applicant must, along with the application, furnish a special resolution passed by shareholders of the corporate debtor approving filing of the application. Where there exists an intention to defraud the creditors, obtaining an approval from the shareholders may prove to be an obstacle.

A financial creditor or an operational creditor for that matter may easily file the application without the need for any approval of the shareholders, and when such creditors are related parties of the corporate debtor the application should be well scrutinized before admission. The idea may just be to escape filing under section 10. The entire set up of so-called distress and intention of revival might just be a scheme plotted together by the related party and the corporate debtor for ease of process and with least interference of the shareholders.

But, where there exists a loophole the judiciary system comes to the rescue. In J.R Agro Industries P Limited Vs. Swadisht Oils P Ltd, the Allahabad Bench of the NCLT clearly upheld the fact that the related party of the corporate debtor cannot misuse the provisions of section 53 of the Code 2016 to defraud their creditors. Further, the intent of section 21(2) of the Code in denying voting rights to related parties is to ensure that the corporate insolvency resolution process is driven by external creditors. Even though related parties may have claims, and may even file for the corporate insolvency resolution process, such parties cannot drive the insolvency resolution process, as that would be rife with conflicts of interest.

  1. Existence of dispute

This is perhaps the most frequent of cases when the adjudicating authority declares the CIRP to be void. The NCLT has always had the tendency to refrain from interfering in cases where there exists a dispute. Through various precedents it has made this viewpoint quite clear that in case there is a dispute in the claim based on which a petition is filed, the same shall not be entertained by the adjudicating authority.

In K. Kesava Vs. Ajay Gopaldas Samat (HUF) & Ors, an appeal was filed by K. Kesava, being a shareholder and director of Maxworth Realty India, the corporate debtor, stating that the initiation of CIRP under section 7 of the Code is not valid as the respondents do not fall under the definition of “financial creditors” as stated in the Code and the debt in question is under dispute.  

The respondents had entered into several loan agreements with the corporate debtor both in individual capacity and through the HUF. The appellant contended that, as there were multiple agreements entered into by different entities, the repayment was being done on account as per verbal instructions issued by Ajay Samat from time to time. Payment was made in parts for various agreements. The NCLAT held that the dates on which payment had been made in favour of one or other respondent from time to time is not in dispute. What is in dispute is the debt as claimed, which is not clear as to whether such amount is payable pursuant to such agreement. Thus, there being a dispute about the claim arising out of a particular agreement, and as the respondents have not made it clear that as to against which agreement rupees five crore has been adjusted, it was not a fit case for initiation of corporate insolvency resolution process under section 7, and parties should have been allowed to move before a court of competent jurisdiction for appropriate relief.  Accordingly, all actions of the resolution professional had been declared illegal and set aside.

Again, in Sandeep Anand (Director of G.S Express Private Limited) v. APL Apollo Tubes Ltd, an appeal was filed by the director of the corporate debtor against the order of initiation of CIRP passed by the NCLT, Allahabad Bench. The initial application was filed by one of the operational creditors under section 9 of the Code. Accordingly, the interim resolution professional was appointed and the moratorium began.

On the date of the first hearing, it was revealed that the debt in question has already been repaid and therefore there existed no default. In view of the fact that the parties had already reached settlement and there was no default on the part of the ‘corporate debtor’ and the adjudicating authority has failed to notice the same, NCLAT had no other option but to set aside the impugned order.

Who will apply to the NCLT in case of existence of mala fide intention to defraud creditors?

Considering the provisions of the Code, it is the responsibility of the resolution professional or the liquidator, as the case may be, to report the existence of any fraudulent transactions to the adjudicating authority. But what if the resolution professional does not report such fraud to the adjudicating authority? A question arises on whether the creditors can report such misfeasance.  As discussed earlier, the NCLT may, in order to prevent abuse of justice, take up matter during admission of the case itself. Further, the law does not prohibit creditors from coming forward and report the existence of fraud at any stage during the CIRP. Of course, the adjudicating authority will assess the materiality of the case, but the creditors may take the initiative of reporting the same.

Conclusion

Thus, we see that there are cases where the CIRP has been declared void even after initiation. The real motive is to ensure that the basic crux of the Code is not frustrated and the order of NCLT is not put in a questionable position. The aim must be resolution and steps must be taken to disallow the usage of the Code as a business strategy to cover up misdeeds.

Shreya Routh

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