Corporate insolvency: Rethinking irregular transactions

Source– The post is based on the article “Corporate insolvency: Rethinking irregular transactions” published in the Business Standard on 26th October 2022.

Syllabus: GS3- Indian Economy

Relevance– Insolvency process

News- The article explains the impact of recent SC judgement on insolvency process.

In Anuj Jain Vs Axis Bank Ltd, the Supreme Court (SC) upheld the recovery of 758 acres of land valued at over Rs 5,300 crore  lost through irregular transactions.

Till June this year, 786 applications have been filed to claw back Rs 2,21,104 crore allegedly lost through irregular transactions by firms undergoing the corporate insolvency resolution process.

Which are irregular transactions identified by IBC Code, 2016?

The first set is known as avoidance transactions. It comprises preferential transactions, undervalued transactions and extortionate transactions. The Code mandates the liquidation process to disregard these transactions.

The second set is known as fraudulent transactions. It comprises fraudulent trading or wrongful trading. The Code requires the liquidation process to recover the loss made through these transactions.

How reversing of avoidance transactions may promote the objectives of the Code?

Reversing avoidance transactions may be a key source of additional value in corporate insolvency over and above the existing assets of the firm.

It maximises the value of the assets of the firm. If it is not possible to get away with avoidance transactions with impunity, no one would resort to such opportunistic behaviour. The possibility of the firm getting into stress is minimised.

The code requires resolution plans to consider the order of priority for distribution of liquidation proceeds. If someone resorts to avoidance transactions, a junior stakeholder may take precedence over a senior stakeholder. It creates a disincentive for avoidance transactions.

The insolvency code also makes the directors of the firm liable for the loss to creditors that arise from the time when a director knew or ought to have known that there was no reasonable prospect of avoiding CIRP. It incentivises the firm as well as directors to seek resolution in the early days of stress when the possibility of rescue is higher.

A Sizable amount has been lost by firms through irregular transactions. IBBI newsletter for December 2021 quarter, indicates that firms going through CIRP have lost at least 10% of claims admitted against them through irregular transactions during the lookback period.

Resolution processes are likely to result in liquidations of firms where relatively more value has been lost through irregular transactions. Avoiding irregular transactions will avoid the liquidation  of firms and keep them alive.