º¬Ðß²ÝÉçÇø

The advent of the Insolvency and Bankruptcy Code, 2016 (IBC), was a significant development to tackle the non-performing asset problem in India. Bad loans at public sector banks stood at INR2.67 trillion (USD30.4 billion) with a gross non-performing asset ratio of 5.43% at the end of March 2015. It is in these circumstances that º¬Ðß²ÝÉçÇø parliament enacted the IBC, which came into force (provisions related to corporate insolvency) on 1 December 2016. A key issue discussed by the Bankruptcy Law Review Committee (BLRC) was the role of the resolution professional in identifying and reversing fraudulent transactions. It was proposed that the insolvency resolution professional (IRP) should file cases for reversing such transactions and recover the lost value.

The recommendations of the BLRC are covered in section 66 of the IBC. Section 66 provides that, if it is found that the business of the company has been carried out with the intent to defraud creditors, or for any fraudulent purpose, the National Company Law Tribunal (NCLT) may order such persons who were knowingly parties to the transaction to make contributions to the assets of the company.

An application under section 66(1) can be made by the IRP. Further, section 66(2) provides that the NCLT may direct directors of the company to contribute if such a director knew or ought to have known that the company was likely to be admitted into the corporate insolvency resolution process, and did not exercise due diligence in minimising the potential loss to creditors.

The provision draws some inspiration from section 213 of the UK Insolvency Act, 1986, which prescribes that if a liquidator finds that the business of the company was carried on with intent to defraud creditors, the liquidator may apply to the court to declare that any person who was knowingly party to such fraudulent transaction is liable to contribute to the company¡¯s assets as the court thinks fit.

An important aspect of dealing with fraudulent transactions under insolvency laws in India and the UK is whether a third party can be made liable to contribute towards the assets of the company if such a party knowingly participated in effecting fraud through the company.

Position in UK

The issue was recently considered by the UK Supreme Court in Bilta (UK) Ltd v Tradition Financial Services Ltd. The court was dealing with a missing trader intra-community VAT fraud where companies such as Bilta (UK) were fraudulently used to create VAT liabilities against UK tax authorities. Bilta was placed under liquidation and its liquidator brought a claim against Tradition Financial Services, a broker involved in fraudulent spot trading involving Bilta.

The Supreme Court held that section 213 of the UK Insolvency Act applies to persons outside the company who were knowingly involved in carrying out the fraudulent transactions. On reading section 213, it was clear that contributions could be sought from outsiders who knowingly participated in perpetrating fraud through a company. Accordingly, the court dismissed the appeal filed by Tradition.

Position in India

In Gluckrich Capital Pvt Ltd v the State of West Bengal & Ors (the Gluckrich Capital judgment), the Supreme Court of India was dealing with an application seeking clarification of an order that approved the findings of the Tripura High Court, in Sudipa Nath v Union of India. The Tripura High Court held that the NCLT does not have the power to direct third parties to make contributions under section 66(1), and that the only recourse available to the IRP is to initiate civil action against third parties for their involvement in fraudulent transactions. The SC affirmed that a remedy against a third party is not available under section 66 of the IBC.

So, as per the interpretation of the Gluckrich Capital judgment, IRPs cannot seek contribution from third parties under section 66 of the IBC.

Conclusion

Section 213 of the UK Insolvency Act, which is similar to section 66(1) of the IBC, has been interpreted to mean that the courts possess broad authority to order contributions to the insolvent estate from any person ¨C whether internal or external to the company ¨C who has knowingly participated in fraudulent trading. The recent affirmation by the UK Supreme Court ensures that the insolvency estate can be replenished by those who have unjustly benefited or facilitated the fraud, thereby enhancing creditor protection and upholding the integrity of the insolvency process.

A broader interpretation of section 66, encompassing third parties who may have benefited from fraudulent transactions, would benefit the IBC and enhance the recovery of assets dissipated through collusion with outsiders. It remains to be seen whether a larger bench of the SC will reconsider the position taken in the Gluckrich Capital Judgment.

Rishabh Jaisani is a partner and Renjith Nair is a principal associate at Shardul Amarchand Mangaldas & Co