Preventing Fraudulent and Malicious Initiation of Insolvency Proceedings in India
In this Chambers Expert Focus article, AZB & Partners’ Abhijnan Jha and Bhagya K Yadav discuss how Indian law takes action against those who bring insolvency proceedings on a fraudulent or malicious basis.
Abhijnan Jha
Bhagya Yadav
In the context of the corporate insolvency resolution process (CIRP), “fraudulent and malicious intent” refers to proceedings initiated for purposes other than insolvency resolution or liquidation. In India, this issue is addressed in the Insolvency and Bankruptcy Code 2016 (IBC).
Section 65 of the Insolvency and Bankruptcy Code
Section 65 of the IBC provides for stringent action against persons who initiate the CIRP with fraudulent or malicious intent. The penalty imposed for such offences amounts to a fine of up to INR10 million.
This article attempts to shed some light on this provision by focusing on issues such as the locus standi of a party when raising objections, the discretion vested with the National Company Law Tribunal (NCLT) as the Adjudicating Authority under the IBC, and the powers of the Adjudicating Authority under Section 65.
Who can raise objections?
Although Section 65 is silent on this issue, the Adjudicating Authorities have purposively interpreted said provision. As such, the right of a third party to intervene in the proceedings has been recognised where necessary to draw attention to collusive and fraudulent initiation. Examples of such decisions can be seen in the case of Ahluwalia Contracts v Srishti Infrastructure (28 June 2022) and the case of Rakesh Taneja and Ors v Wave Megacity Centre Private Limited (6 June 2022).
How much discretion does the Adjudicating Authority have?
Section 65 stipulates imposition of a penalty to protect the corporate debtor and places a duty on the Adjudicating Authority to ensure that every precaution is exercised so that the CIRP is not used for any purpose other than resolution of insolvency or liquidation – see Hytone Merchants Private Limited v Satabadi Investment Consultants (30 June 2021). This means that the Adjudicating Authorities must determine whether an application seeking initiation of insolvency proceedings has been filed fraudulently or maliciously for collateral purposes.
The National Company Law Appellate Tribunal (NCLAT) has held that the Adjudicating Authorities are not mandated to admit an application under Section 7, even if all ingredients thereof are satisfied (see the aforementioned Hytone v Satabadi case). They should instead exercise discretion carefully to prevent and protect the corporate debtor from being dragged into the CIRP in cases where applications are filed with mala fide intentions or for any purpose other than the resolution of insolvency or liquidation.
In 2022, the Supreme Court of India held in the case of Vidarbha Industries Power Ltd v Axis Bank Limited that Section 7(5)(a) of the IBC confers discretionary power on the Adjudicating Authority to admit an application of a financial creditor for initiation of the CIRP under Section 7 of the IBC. The Supreme Court of India is currently considering the validity of the Vidarbha v Axis Bank judgment (12 July 2022) in Maganlal Daga HUF and Anr v Jag Mohan Daga and Ors (Civil Appeal Diary No 38798/2022).
“No penalty can be imposed unless a prima facie case of fraudulent or malicious institution of insolvency proceedings is established.”
The discretion entrusted with the Adjudicating Authority under Section 65 requires a prima facie satisfaction for levying a penalty. In this respect, the NCLAT has held that no penalty can be saddled under Section 65 without recording an opinion that a prima facie case of fraudulent or malicious institution of proceedings has been established – see M/s James Hotels Ltd v Punjab National Bank (7 September 2017).
Notably, the Adjudicating Authority is also empowered to accept assistance from the appropriate authorities when formulating a prima facie opinion (see the aforementioned case of M/s James Hotels Ltd v Punjab National Bank). In fact, the Adjudicating Authority can also order an investigation into the affairs of a company under Section 210(2) of the Companies Act 2013, pursuant to prima facie satisfaction upon finding of fraudulent or malicious initiation of proceedings (see the aforementioned case of Rakesh Taneja and Ors v Wave Megacity Centre).
“If a corporate character is used for the purpose of defrauding others, the court can ignore the corporate character and look at the reality behind the corporate veil to ensure justice.”
The Adjudicating Authorities have also held that if a corporate character is used for the purpose of committing an illegality or for defrauding others, the authority/court can ignore the corporate character and look at the reality behind the corporate veil in order to issue the necessary orders to ensure justice. Prior to the aforementioned case of Hytone v Satabdi, a similar view was taken by the NCLT in the case of Anurag Sharma and Anr v Ravi Kant Gupta and Ors (30 September 2018).
Pertinently, Section 65 does not make any distinction between the stages of pre-admission or post-admission in the CIRP – see judgment of M/s Om Logistics Ltd v M/s Ryder India Pvt Ltd (30 May 2022). Indeed, it may be apposite to decide objections under Section 65, which relate to the very initiation of proceedings under Sections 7, 9 or 10 of the IBC, at a pre-admission stage.
Proposed Amendments to the Insolvency and Bankruptcy Code by the Ministry of Corporate Affairs
On 18 January 2023, the Indian government’s Ministry of Corporate Affairs (MCA) invited comments from the general public on certain proposed amendments to the IBC.
Interestingly, the MCA took note of the fact that – even though Section 65 provides for a penalty in the case of fraudulent or malicious initiation of admission proceedings – no penalty is imposed on other proceedings filed before the Adjudicating Authority. As such, the MCA has suggested that the Adjudicating Authority should also have the power to impose a penalty where it believes that a person has filed frivolous or vexatious applications under other applicable provisions of the IBC.
“It will be intriguing to see how the proposed amendments to the IBC square up against the intent and purpose of Section 65.”
The MCA has also stated that it is mandatory to admit an application filed under Section 7 where occurrence of a default is established. The MCA has proposed that Section 7 is amended to clarify that, when considering an application for initiation of the CIRP by the financial creditors, the Adjudicating Authority need only be satisfied that a default has occurred and that procedural requirements have been fulfilled for this specific purpose (and nothing more). Where default is established, it is mandatory for the Adjudicating Authority to admit the application and initiate the CIRP.
The world of Indian finance law awaits the outcome of the challenge raised in Maganlal Daga HUF and Anr v Jag Mohan Daga and Ors with interest. It will also be intriguing to see how the proposed amendments to the IBC square up against the intent and purpose of Section 65, which requires Adjudicating Authorities to look at factors beyond the existence of a debt and a default in repayment when determining whether applications have been filed fraudulently or maliciously and for collateral purposes.
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