top of page

TREATMENT OF RECOVERIES ARISING OUT OF AVOIDANCE APPLICATIONS UNDER IBC

[Neelabh Niket is a 4th year B.A., LL.B. (Hons.) student at Hidayatullah National Law University in Raipur]


Introduction


The introduction of the Insolvency & Bankruptcy Code, 2016 (‘IBC’) in India has truly been one of the most effective legislations to be passed in over a decade. The Code’s stress on resolution of distressed entities in a time-bound and determined manner has ensured their revival and catapulted them back into the main economy.


In furtherance of its objectives, the Act contains several provisions to protect and recover the assets and capital belonging to the Corporate Debtor(‘CD’) which were unscrupulously embezzled from it by the erstwhile management of the CD- collectively called as ‘avoidance applications’. The purpose behind avoidance applications is to widen the creditors’ asset pool by bringing back the assets unlawfully diverted from the corporate debtor, and prevent unjust enrichment of one party at the expense of other creditors. The Code contains four types of avoidable transactions that are to be avoided- preferential, undervalued, fraudulent and extortionate transactions. While the Act provides detailed mechanism for getting back such monies out of the pockets of people unjustly enriched by the transaction, it does not state as to who would be the recipient of such recovery. In other words, there is no clarity as to who would have claim over such recovery proceeds; whether it will be the creditors of the CD or the Successful Resolution Applicant (SRA). Via this article, one seeks to understand the true beneficiary of recovery proceeds emanating from the successful execution of the avoidance application.


Jurisprudence & the Current Law


In this context, it is pertinent to notice and appreciate the past rulings of the National Company Law Tribunal (‘NCLT’) & the Constitutional Courts as to how they have interpreted and answered this question. The question, for the first time came up before the Single Bench in the Delhi High Court in the case of Venus Recruiters v. Union of India. (Venus Recruiters). The Hon’ble Delhi High Court took the view that any recovery arising out of the avoidance application belongs solely to the creditors of the Corporate Debtor and is not meant to be enjoyed by the Corporate Debtor in its new avatar, after the approval of the Resolution Plan.

However, a contrary view was taken by the NCLT, Mumbai in the case of Administrator of Dewan Housing Finance Corporation Limited v. CoC of Piramal Capital wherein it held that the Committee of Creditors (“CoC”) in its commercial wisdom had taken conscious decision to allow recoveries arising out of fraudulent transactions to be vested with the SRA, while keeping those received via avoidance applications with itself, and thus it was not for the Adjudicating Authority to substitute its wisdom in place of the CoC. This ruling came to appealed before the Hon’ble NCLAT in the case of 63 Moons Technologies Limited v. Committee of Creditors of Dewan Housing Finance Corporation Ltd (‘63 Moons’). The Tribunal overruling the decision of the NCLT held that CoC’s decision to approve the resolution plan as submitted by DHFL, containing intelligible bifurcations of recoveries under two similarly placed sets was illegal and unlawful. In simple words, it was not permissible to distribute the proceeds of the avoidance application and those arising out of the fraudulent transaction to two different entities under the resolution plan. Relying on Venus Recruiters, it held that the outcome of the avoidance transaction under Sections 43, 45, 47, 49, 50 & 66 of the Code cannot be given to the Successful Resolution Applicant and it must go to the Corporate Debtor’s Creditors. This decision of the NCLAT has been stayed by the Hon’ble Supreme Court on appeal, and is pending for decision.


Recently, the Division Bench of the Delhi High Court in the case of Tata Steel Bsl Limited vs Venus Recruiter Private Limited approved the view of the Single Bench and held the following,

“The amount that is made available after transactions are avoided cannot go to the kitty of the resolution applicant. The benefit arising out of the adjudication of the avoidance application is not for the corporate debtor in its new avatar since it does not continue as a debtor and has gone through the process of resolution. This amount should be made available to the creditors who are primarily financial institutions and have taken a haircut in agreeing to accept a lesser amount than what was due and payable to them.” (Emphasis Supplied)


Analysis


· Commercial Wisdom of CoC Supreme


After a perusal of the abovementioned judgements, it cannot be denied that in most cases, it is the creditors of the CD who would be entitled to receive the proceeds recovered from the Avoidance Applications, however the same cannot be taken as a thumb rule. There may be instances where even the SRA may be allowed to receive the recovery amount basis commercial considerations and agreement as agreed with the CoC. The Hon'ble Appellate Tribunal in the case of JSW Steel Ltd v Mahender Kumar Khandelwal has held that the treatment of proceeds of avoidance applications is within the commercial wisdom of the CoC and stated that such commercial understanding should be given effect without any modification.


In the matter of 63 Moons, the CoC of the CD had consciously decided to give up their claims on the proceeds arising out of the fraudulent transaction in consideration of a higher total resolution amount. Thus, in all respects this was a business decision taken by the creditors of the CD, trading off the risk and uncertainty attached to the fraudulent transaction for a guaranteed sum of amount upfront. Further, it is unrealistic to expect the SRAs to bear the litigation expenses for the avoidance application for indefinite years and then divert whatever amount successfully received in the platter of the creditors. The same resolution plan of the DHFL in the 63 Moons was also assailed on the ground whether the SRA could be allowed to substitute the Resolution Professional and pursue the avoidance application on its own in the case of Kapil Wadhwan v. Piramal Capital & Housing Finance Ltd. The Hon’ble Appellate Tribunal held that the SRAs ability to pursue avoidance application post approval of the CIRP stems from the Resolution Plan which must be given primacy and thus there was nothing illegal in it.


· Insolvency Law Committee Reports


One may refer to the Report of Insolvency Law Committee (ILC), published in May 2022 to substantiate this claim. While the report acknowledges that in most cases it is better suited to distribute recoveries amongst the creditors of the corporate debtor, but it also notes that a different course can also be adopted depending on the kind of transaction being avoided, the party funding the action, assignment of claims, creditors affected by the transaction or trading. More importantly, it notes that the resolution plan itself should provide the manner of distribution of expected recoveries, to the satisfaction of the commercial wisdom of the CoC. This decision of the CoC must be given regard and respect by the Adjudicating Authority while deciding applications of avoidance and improper trading.


According to the ILC Report, the CoC has been given the authority to rather negotiate best terms with the SRA and decide as to how these proceeds have to be distributed. Thus, the creditors of the CD are not entitled to the proceeds of avoidance application as a matter of right

· Flawed Interpretation


The NCLAT judgment in 63 Moons at Paragraph 9.97 relied on Section 67 sub-section 2 to interpret that the section indicated that recoveries from avoidance transaction should be distributed among the creditors in order of priority given under Section 53 of the Code. It is difficult to agree with such interpretation of the provision. The section merely provides that where the adjudicating authority has passed an order either under Sub-section 1 or 2 of Section 66 of the Code, against a person who is a creditor of the Corporate Debtor, the AA may by order direct that the whole or any part of the debt owed by the Corporate Debtor to that person and any interest thereon shall be ranked in order of priority of payment under Section 53 after all other debts owed by the Corporate Debtor.


The provision specifically mentions that the debt be ranked in the order mentioned under Section 53, and not the recoveries arising out of the avoidance applications. The Section is only an enabling provision, complementing Section 66 of the Code. It only ensures that, in the event that any amount is received from a creditor via an avoidance application, is not returned to him at the liquidation stage qua his priority in the waterfall mechanism. For instance, where a director is held liable for wrongful trading, and if the CD owes any debt to the director, to give effect to the contribution order under section 66(2), the AA may direct that the debt owed to the director will rank last under Section 53.


Conclusion


After a holistic interpretation of the relevant clauses and recommendations of the ILC Reports, it can be easily made out that the creditors of the Corporate Debtor are not entitled to the proceeds of avoidance application as a matter of right. The same may even be transferred to the Successful Resolution Applicant, depending on the commercial negotiation that may occur between the parties. It can be expected that the Hon’ble Supreme Court will settle this conundrum and allow the appeal filed by DHFL’s SRA to hold its resolution plan valid.

54 views0 comments
bottom of page