India: Venus Recruiters' case, the fate of avoidance applications and possible solutions

A. Introduction:

Much has already been written on the ratio of the Venus Recruiters Private Limited Vs Union of India & Ors¹ and its impact². In brief, in this case, a single Judge of the Delhi High Court observed that in the context of prosecution of avoidance applications³, once the resolution plan is approved by the Adjudicating Authority ("AA") under the Insolvency and Bankruptcy Code 2016 ("Insolvency Code"), the corporate insolvency resolution process ("CIRP") comes to an end; and consequently, the resolution professional ("RP") cannot continue to exercise any authority whatsoever. As a result, the avoidance applications would not survive. In this note, we discuss the importance of avoidance applications, the exceptions carved out by this case, and suggest practical solutions to use these exceptions.

B. Prosecution of Avoidance Applications:

The Insolvency Code⁴ requires the RP to file applications for avoidance of certain transactions that have taken place immediately prior to the commencement of the Corporate Debtor's insolvency, on the basis that they are either preferential, undervalued, extortionate and fraudulent or wrongful transactions⁵.

The amounts involved in the avoidance applications are usually significant, since most of the transactions called into question involve siphoning of funds, preference/ undervaluation in dealings with related parties and other, fraudulent conduct of persons in charge of the corporate debtor, in the run up to the insolvency. Reversal of such transactions can contribute a significant sum in the CIRP of a corporate debtor, present a value proposition for resolution applicants; and optimize recoveries of the creditors. Various courts have also observed that the avoidance applications are for the benefit of the creditors of the Corporate Debtor⁶.

In practice, once the CIRP of a corporate debtor commences, avoidance applications are one of the many applications filed before the AA, by or against the RP. Once the prescribed process for resolution is completed and a resolution plan is approved by the CoC, there is a degree of urgency in obtaining the approval of the AA for the resolution plan. In the effort to obtain approval of the resolution plan, the hearing and disposal of other applications connected to the corporate debtor, including avoidance applications, remains pending.

Venus Recruiters:

In brief, the Venus Recruiters' case dealt with a situation in which the RP had filed an avoidance application under Section 43-51 and 66 of the Insolvency Code after the resolution plan was approved by the committee of creditors; and this application was being prosecuted before the AA, after the AA had approved the resolution plan under Section 31. Importantly, the RP had filed an application seeking to implead a party to the avoidance application after the approval of the resolution plan under Section 31; and the AA had allowed this impleadment. The party so impleaded had challenged the AA's order before a Single Judge of the Delhi High Court. In this background, the Delhi High Court was considering the following question –

...whether under the Insolvency and Bankruptcy Code, 2016 (hereinafter, 'IBC'), an application filed under Section 43 for avoidance of preferential transactions can survive beyond the conclusion of the resolution process and the role of the RP in filing/pursuing such applications?

The principle that seems to have emerged from this case is that upon approval of a resolution plan by the AA, the RP becomes functus officio and has no power to act on behalf of the corporate debtor. An appeal against the order has been filed and is pending hearing before a Division Bench of the Delhi HC⁷.

The case, and those following it, have however carved out certain exceptions that can be used effectively to ensure that the corporate debtor retains the ability to prosecute avoidance applications. These are discussed in the next section.

Exceptions in Venus Recruiters:

i. Provisions in the Resolution Plan:

One of the most significant aspect of the Venus Recruiters' case was that the resolution plan approved by the AA, did not contain a provision which would permit the RP to continue to function for a specific purpose⁸ or continue the avoidance application. Noting this, the Delhi HC observed as follows:

".....this is however subject to any clause in the resolution plan to the contrary, permitting the RP to function for any specific purpose beyond the approval of the resolution plan. In the present case, no such clause has been shown to exist."

The Court's observation in the Venus Recruiters' case that "[t]he RP cannot wear the hat of the 'Former RP' and pursue an avoidance application in respect of preferential transactions after the hat of the Corporate Debtor has changed and it no longer remains a Corporate Debtor"⁹, has to be read in the context of the facts of the case, namely, that the resolution plan did not contain a provision which would permit the RP to continue to function for a specific purpose.

This approach has also been adopted by the National Company Law Appellate Tribunal ("NCLAT") in a later decision of Interups Inc. vs Kuldeep Kumar Bassi and Ors.¹⁰, when it was considering a challenge to an approval of resolution plan, inter alia, on the ground that an avoidance application was pending. The NCLAT observed that the bar on AA's jurisdiction to entertain and decide avoidance applications was subject to a provision in the resolution plan. The resolution plan that the NCLAT was considering did permit the RP to continue and pursue the avoidance applications after the approval of the plan¹¹, and hence the NCLAT did not find such pendency of applications to be a ground for rejecting the plan.

Consequently, it becomes important for resolution plans to contain specific provisions to allow the RP or any other specified entity to continue prosecution of avoidance applications.

ii. Petitioner in Venus Recruiters' case was impleaded post resolution plan approval

Another important factual aspect in the Venus Recruiters' case was that the petitioner before the Delhi High Court was impleaded in the avoidance application by means of an amendment, after the approval of the resolution plan; and had not been a party to the original application, which was filed before the approval of the plan. In fact, it was the order allowing this impleadment that was challenged before the Delhi High Court. In this regard, the Court observed that "an RP cannot continue to file applications in an indefinite manner even after the approval of a Resolution Plan under Section 31¹²."

In a subsequent case of S. Rajendran, RP of Empee Distilleries Limited and Ors vs South (India) Hotels Private Limited and Ors¹³ before the NCLT, Chennai Bench, the AA while considering an objection on the maintainability of an avoidance application on the basis of the Venus Recruiters' case, held that it had no applicability in the case of avoidance applications filed prior to the approval of the resolution plan. The relevant portion of S. Rajendran's case reads–

...Further, in relation to the issue of maintainability of the present Application as raised by the Learned Senior Counsel for the Respondents in the matter of Venus Recruiters, after careful consideration of the said judgment, we find that the ratio decidendi of the same cannot be made applicable in the light of the facts of the present case owing to the reasons that in the matter of Venus Recruiters the Application for avoidance of transaction was filed after application seeking approval of the resolution plan was approved by the Adjudicating Authority and based upon the same the findings were given. However, in the present case, the present Application was filed on 27.06.2019 i.e. much prior to the approval of the Resolution Plan by the CoC

Although the avoidance application in S. Rajendran's case was dismissed on merits (and has been appealed against), the observations of the AA remain relevant, and may provide a logical solution, given that the disposal of the avoidance applications is at the discretion of the AA. If any applications are to be filed or continued after the approval of the resolution plan, it is best that the resolution plan provides some mechanism for their continuance and prosecution.

C. Legislative Action:

A discussion paper¹⁴ published by the Insolvency Law Committee of the Ministry of Corporate Affairs on the proposed amendments to the Insolvency Code, has considered two points that may provide solutions. The first option contemplates the addition of an explanation to Section 26 of the Insolvency Code to clarify that "proceedings for avoidance of transactions and wrongful trading can continue after the approval of a resolution plan by the AA in CIRP".¹⁵

The other suggestion for reform is insertion of provisions that "mandatorily specify the manner of undertaking proceedings for avoidance of transactions and wrongful trading if such proceedings are to be continued after approval of the plan"¹⁶. The discussion paper also suggests that the resolution plan can specify whether such applications can be continued by the former resolution professional, or whether any other person/entity will continue the prosecution.

The acceptance of either of these recommendations would provide practical solutions to the issues that the Venus Recruiters' case has raised. The prosecution of avoidance applications is usually for the benefit of the creditors, and their continuance is crucial in achieving the object of the Insolvency Code, i.e., "maximisation of value of assets".¹⁷

D. Practical Solutions:

Given the lack of clarity on the legal solution pending final resolution of the litigation in the Venus Recruiters' case, or legislative changes, practitioners may have to find interim solutions. Particular concerns have arisen where some AAs have been dismissing avoidance applications, after the approval of the plan, merely relying on the Venus Recruiters' case, without even considering whether the plan contains a provision which would permit the erstwhile RP to continue such avoidance applications¹⁸.

On this account, it is prudent for the RPs to file avoidance applications, as early as possible in the CIRP, and diligently prosecute them, by bringing their pendency to the notice of the AA at every opportunity. In particular, the RP should inform the AA of such pendency during the final hearings of the resolution plan, and request that they be heard and disposed of. The RP should avoid filing any avoidance applications (or adding new parties to existing applications), after the approval of the plan, unless there are specific provisions in the plan allowing him/her to do so.

Most resolution plans already provide for the manner of allocation of any proceeds received from successful avoidance application. As further measures, while drafting the resolution plan, resolution applicants should consider making specific provisions for at least the following: (i) continuation of the avoidance applications, as well as of the liability of the respondents against whom an avoidance application is pending; (ii) persons who would continue the prosecution of such avoidance applications – for example, the former RP, the resolution applicant or a monitoring agency; (iii) obtaining of approvals from lenders or the monitoring committee, if any, for such continued prosecution.

E. Conclusions

Avoidance applications are crucial to any CIRP process, since they attempt to claw back funds that the corporate debtor has lost on account of misfeasance by the erstwhile management or promoters. It hence makes commercial and economic sense to ensure that avoidance applications are not dismissed for technical reasons.

Until there is further clarity from case laws or legislation, practitioners should consider adopting proactive strategies to ensure that the prospect of receipt of funds from successful avoidance applications remains alive.

Footnotes

1. 2020 SCC OnLine Del 1479

2. https://law.asia/avoidance-applications-in-jeopardy/

3. Filed under Section 43-51, 66, and 67 of the Insolvency Code

4. Section 25(J)

5. Section 43-51, 66, and 67 of the Insolvency Code

6. Venus Recruiters' case and 63 Moons Technologies Limited Versus the Administrator of Dewan Housing Finance Corporation Limited & Ors (CA (Ins) No. 454 of 2021, 455 of 2021 and 750 of 2021, NCLAT decision dated 27th January, 2022). The NCLAT's order in DHFL's case has been stayed by the Supreme Court of India by an order dated 11th April, 2022.

7. LPA No.37 of 2021 & LPA No.43 of 2021

8. Para 77 of the Venus Recruiters' case

9. Para 92 of the Venus Recruiters' case

10. MANU/NL/0082/2021

11. Para 9 of Interups Inc's case

12. Para 77 of the Venus Recruiters' case

13. MANU/NC/3444/2021

14. Discussion paper on proposed changes to the Corporate Insolvency Resolution and Liquidation Framework under Insolvency and Bankruptcy Code, 2016, dated 23rd December, 2021.

15. Para 2.1 (b) of the discussion paper dated 23rd December, 2021

16. Para 2.1 (c) of the discussion paper dated 23rd December, 2021

17. Object of the Insolvency Code

18. Niraj Agarwal Vs Amrit Fresh Pvt Ltd (IA (IB) No.878/KB/2020 in CP (IB) No.263/KB/2018)

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.