Avoidance Proceedings under the IBC: Time for a Tweak in the Regime?

[Arnav Maru is a fourth year B.A. LL.B. (Hons.) student and Bhavya Solanki a second year B.A. LL.B. (Hons.) student, both at MNLU Mumbai]

As the Insolvency and Bankruptcy Code, 2016 approaches its fourth anniversary, it has proven effective in reshaping the Indian insolvency landscape. A 2019 report by CRISIL had highlighted that the Code had greatly benefited creditors, as compared to the legislation it succeeded, and has overall seen more successes than shortcomings. A large contributing factor behind this relative success was the effective reconciliation and updating of previous laws regulating insolvency, the introduction of a time-bound corporate insolvency resolution process, and the creation of a one-stop regime. Although the Code’s many achievements are indisputable, regard must be had to certain shortfalls in the procedure that are causing excessive delays and marring the efficiency of the resolution process.

The Code stipulates a period of 180 days for the completion of the insolvency resolution process, with a leeway of 90 additional days, if necessitated by the circumstances. However, as of December 2019, 366 on going resolution processes had already stretched beyond the period of 270 days, and 22 of those had been going on for more than two years. The World Bank’s Doing Business Report also recorded that the time to resolve insolvency in India had dropped to an average of 1.6 years. This average is still around 300 days more than the one envisaged by the Code. The case of Anuj Jain v. Axis Bank Limited involving the corporate insolvency resolution process (CIRP) of Jaypee Infratech Limited has also brought this problem to light. Two key points of interest arise: first, a corporate debtor may have tunneled out a vast amount of wealth through related-party and other avoidable transactions, as listed under the Code and, second, avoidance proceedings may cause inordinate delays and disrupt the stipulated timeline of the CIRP.

Through this post, the authors seek to introduce a discussion on the possible ways to limit the time consumed by avoidance proceedings under the Code. This will not only strengthen the insolvency process by preventing the value destruction of assets, but it will also prevent the investment of debtor resources into processes that might not be necessary if the chronology of the events is adjusted.  

Revisiting the Avoidance Mechanism

Invoking avoidance rules within collective insolvency proceedings is the generally accepted norm, and non-collective avoidance rules outside of insolvency proceedings have been largely neglected. Contrary to this established position, Prof. Kristin van Zwieten, in her piece titled ‘Related Party Transactions in Insolvency’ has advocated for avoidance proceedings for illegitimate related party transactions outside of insolvency proceedings. She has observed that, compared to the relatively complicated corresponding option of collective insolvency proceedings, which requires a more efficient and well-equipped judiciary, resorting to avoidance tools outside of proceedings could prove to be more beneficial. Such a recourse could avert the threat of value destruction and make the matter easier for the weaker courts to adjudge. It has been further noted in the paper that the law of fraudulent conveyance, bereft of any requirement of collective proceedings, is not something state-of-the-art but finds its origin under the ancient Roman law, referred to as “Actio Pauliana” therein. Contemporary jurisdictions seem to have held on to at least some aspects of this action in the form of “action Pauliana outside bankruptcy”.

While non-collective proceedings go against the fundamental object of the Code, and have generally not been a part of international best practice, the idea of collective avoidance transactions outside insolvency proceedings does hold value in the Indian context. Building on this idea could prove to be of benefit to the overburdened judiciary of India, struggling with a pendency of 1961 CIRPs by the end of 2019. Such a change in position would not be an introduction of an entirely new concept, as private law allows for creditor initiated and controlled avoidance transactions. Section 53 of the Transfer of Property Act, 1882, for example, provides for an option on part of the creditors to declare a fraudulent transaction, made with the intent to defraud creditors, void. The provision subordinates itself to any provision in the insolvency laws prevailing at the time. This, however, is limited in scope and application to the transfer of immovable property.  Considering the above, there is an argument to be made for initiating avoidance proceedings once a default is ascertained but before the CIRP is commenced. The same could have two possible outcomes, both of which will bring a slew of benefits.

First, the corporate debtor might not need the rigorous insolvency process if avoidable transactions place sufficient assets back into the debtors account. In cases other than voluntary initiation of insolvency, it may be in the interest of the debtor to avoid entering insolvency proceedings, if the default can be cured by merely undoing certain transactions, which will, in any case, be undone by the resolution professional once the CIRP commences. Further, it could prove to be a simpler and more cost-effective avoidance tool at the creditors’ disposal who would no longer have to undergo the hassle of forming a committee of creditors and pay the accompanying costs. In addition, the threat of value destruction of the debtor’s estate, which looms large in insolvency proceedings and heightens proportionately to the weakness of the insolvency courts, would be effectively averted. Further, it could also allay the burden of courts and save their valuable time, for mere reversals would not require as close a supervision of the courts as the conduct of corporate insolvency proceedings does. 

Second, even if after undertaking such a process, insolvency is required, the committee of creditors will be in a better position to fulfill its duties, with an increased asset pool. This, in turn, will also avoid getting into the presently unsettled positions: “who will continue the litigation after the expiry of the CIRP period?”; “how will the distribution of proceeds go if realization made after expiry of the CIRP period?”, and the like. Further, it could benefit creditors who would otherwise rank low on the waterfall disbursal of claims to better realize their claims. It may also help maintain the sanctity of the 270-day timeline provided under the Code by excluding the litigation time from its purview.

Tailoring it to the Code

As far as the feasibility of the suggestion is concerned, as already mentioned, a creditor-driven avoidance proceeding is not a novel concept. Financial creditors, who have until now formed a majority of the creditors recovering under the Code, can be imputed with the technical know-how of identifying avoidable transactions. The Code itself makes provision, under section 47, for creditors to approach the adjudicating authority if undervalued transactions go unreported by the resolution professional. Creditors have sufficient incentive as well as the ability to proceed against avoidable transactions. Submitting a list of avoidable transactions along with the application for insolvency would ensure that the adjudicating authority has the earliest notice of the transactions as possible. Further, the right of the corporate debtor to be heard before the admission of claims could be treated as an opportunity for it to settle through cooperation. It is no longer res integra that the CIRP is not an absolute necessity and settlements are a possibility both pre-admission and post, owing to section 12A of the Code.

Conclusion

The Code was enacted to tackle the ‘non-performing asset’ crises by streamlining the recovery process. The legislation has been successful in the regard, and the same is well reflected in the ease of doing business rankings. One of the biggest advantages of the regime has been to minimize judicial intervention and grant more control to the creditors. There are certain ways in which the burden on the judiciary could be further eased to make the private portion of the proceedings more efficient. The suggestion put forward by the authors could act as an additional threshold tool and would help rule out disputes that can be resolved with a relatively simpler and more efficient process.

Arnav Maru & Bhavya Solanki

About the author

Add comment

Subscribe to Blog via Email

Enter your email address to subscribe to this blog and receive notifications of new posts by email.

Top Posts & Pages

Topics

Recent Comments

Archives

web analytics

Social Media