India: Corporate Insolvency - Extension Of Liability On Directors And Parent Company

Last Updated: 20 November 2018
Article by Sindhuja Kashyap and Mohana Roy

Introduction

Corporate insolvency and bankruptcy has been the subject matter of various legislations in India, some of which are the Companies Act 2013/1956, SARFAESI Act 2002 and Sick Industrial Companies Act 1985. However, these legislations failed to comprehensively address the issues surrounding the insolvency process specifically amongst others the time taken to resolve insolvency, investor confidence and the situation of non-performing assets.  The implementation of the Insolvency and Bankruptcy Code 2016 ("IBC 2016") is a significant reform which provides for a robust framework and time-bound road map to deal with distressed or failed businesses; a welcome contrast from the previous, seemingly never-ending process.

While for the layman the words insolvency and bankruptcy may be interchangeable, these stand as two different financial conditions in the legal world. Insolvency can be mere short term inability of the company to meet its liabilities during the course of their business whereas bankruptcy takes place when the courts get involved to determine insolvency and gives an order to resolve the same. IBC 2016 provides a very clear distinction between both the processes. A corporate entity faces insolvency on account of cash flow insolvency or balance sheet insolvency. In case of cash flow insolvency the company is unable to pay debt as it falls due and in balance sheet insolvency the total liability exceeds its realisable assets.

IBC 2016 prescribes new approach towards insolvency which helps in early determination of insolvency by moving from erosion of net worth to payment defaults. Thus, default of payment of more than INR 1 Lakh can invoke the insolvency process against the debtor under IBC 2016. Further, IBC 2016 seeks to reorganise corporations within the prescribed timeframe, failing which the entity shall be liquidated and wound up. During the insolvency resolution process there may arise circumstances pointing towards dubious transactions conducted by the corporate debtor which may seem to contribute towards its own insolvency

IBC 2016 vests power in the resolution professional to question such transactions of the corporate debtor and inform the NCLT accordingly. Further, NCLT has the power to scrutinize the questioned transaction and extend liabilities as arising from such transaction on any person so involved. This article focuses only on the extension of liability on directors and parent company, therefore only such statutory provisions have been analysed.

Statutory Extension of Liability

IBC 2016 ensures to safeguard the interest of the creditors and in doing so it extends the liability to the persons involved in transactions leading otherwise. IBC 2016 extends the liability on two kinds of transactions namely, preferential transactions undertaken before the commencement of insolvency but during the twilight period and fraudulent or wrongful trading carried out during the corporate insolvency resolution process.

General extension of liability

As per Section 48 read with Section 45 and Section 46, if the liquidator or resolution professional on an examination of a preferential transaction of the corporate debtor held during the twilight period determines that such transaction was undervalued, in that case it shall inform the adjudicating authority. Adjudicating authority in case of such applications shall make an order to declare the transaction void and reverse the effect of such transactions.

Twilight period as detailed out in Section 46 shall mean such transaction made with any related party within two years and with any other person within one year preceding the insolvency commencement date. Section 5(24) of the IBC Code 2016 provides for broad and extensive definition of related party which includes the director of the corporate debtor and a body corporate which is a holding company of the corporate debtor.

As per section 48(1)(c), the adjudicating authority may direct any person to pay such sums, in respect of benefits received by such person, to the liquidator or the resolution professional as the case may be. Thereby, it is evident that the order of the adjudicating authority is aimed at reversing the effect of the undervalued transaction and requiring the person who benefits from such transaction to pay back any gains made as a result of such transaction. Section 48(1)(c) uses the word "such person" wherein there seems no distinction between natural and legal person. Therefore, both directors and parent company can be brought in the ambit of the order passed under this section in case it is established that either of them have made benefits from such preferential transaction.

In the case of Tristar Consultants vs. M/s. VCustomer Services India Pvt. Ltd. & Anr.1 the Delhi High Court has clearly held that directors are agents of the company to the extent they have been authorized to perform certain acts on behalf of the company. They owe no fiduciary or contractual duties or any duty of care to third parties who deal with the company and liability would arise only if they derive any personal benefit while purporting to act on behalf of the company. Therefore, the judiciary has accepted the extension of liability as a general norm in cases where the directors obtain personal gain/benefit from any transactions while acting on behalf of the company.

Section 66 deals with the second transaction under scrutiny by this Code i.e. fraudulent or wrongful trading during the corporate insolvency resolution process. As per section 66(1), if during the corporate insolvency resolution process or liquidation process, it is found that any business of the corporate debtor was carried out with the intention of defrauding creditors or for any fraudulent purpose then, the resolution professional shall make an application to the adjudicating authority informing the fraudulent transaction. Adjudicating authority upon receiving such application may pass an order that any person who were knowingly parties to the carrying on of the business in such manner shall be liable to make such contributions to the assets of the corporate debtors as it may deem fit. Section 66(1) extends liability on "any person" who were knowingly party to such transaction, thereby bringing both directors and parent company under its ambit if it is proved before the adjudicating authority that either of them were knowingly party to such fraudulent/wrongful transaction. In case the same is proved, they may be called upon to make "such contribution" as the adjudicating authority deems fit. The word "such contribution" has been left to the discretion of the adjudicating authority thereby not limiting the liability in any manner.

Specific extension of liability

Section 66 (2) unlike Section 48 and 66(1), specifies the extension of liability to the directors. As per Section 66(2) the adjudicating authority may pass an order directing the director of the corporate debtor as the case may be to be liable for making such contributions to the assets of the corporate debtor as it may deem fit. Such extension of liability is subject to the fact that the director knew or ought to have known that there was no reasonable prospect of avoiding commencement of insolvency process and they failed to exercise due diligence in minimising the potential loss to the creditors. For the purpose of Section 66 (2), general presumption is in favour of the director i.e. it is presumed that they have exercised the due diligence as is reasonably expected out of a person carrying out the same function as are carried out by such director.

In the case of LIC vs. Escort Limited and Ors2 the Supreme Court held that the corporate veil may be lifted where a statute itself contemplates it or in case of prevention of fraud or improper conduct. As the provisions of IBC 2016 clearly contemplates the extension of liability on its director and parent company, therefore the intention of the legislation would remain unfulfilled if the same is not accompanied with the power to pierce the corporate veil as and when such case arises.

Further, in the case of IDBI Bank Limited vs. Jaypee Infratech Limited3 a petition was filed to declare the transaction entered into by promoters and directors of corporate debtor creating mortgage of property as illegal. It is pertinent to mention that when the account of the corporate debtor was declared as NPA, the directors of the corporate debtor, in utter disregard to their fiduciary duties and duty of care to the creditors of the corporate debtor, mortgaged 858 acres of unencumbered land owned by the Corporate Debtor to secure the debt of the related party i.e. Jaiprakash Associates Ltd (parent company). The value of the land mortgaged by the corporate debtor was estimated to be in the range of 5000 to 6000 crores approximately, as per the valuation report prepared at the time of mortgage of the said land. The mortgage of land was created without any counter guarantee from a related party. The mortgage of land is in nature of asset stripping and entered into with the intent to defraud the creditors of the corporate debtor.4 The impugned transactions, was declared as fraudulent, preferential and undervalued transactions as defined under section 66, 43 and 45 of IBC 2016 as it was carried on during the period of two year preceding the commencement of insolvency. Therefore, the Tribunal passed the order for release and discharge of the security interest created by the corporate debtor in favour of lenders of the parent company and the properties mortgaged by way of preferential and undervalued transactions were made to be deemed to be vested in the corporate debtor.

Therefore, the Allahabad National Company Law Tribunal may not have extended the liability to the directors under Section 48 and 66 however, the intention to reverse the transaction was definitely fulfilled. It is pertinent to note that an assumption that the Tribunal may never extend liability to the directors and parent company shall be an early miscalculation especially when IBC 2016 itself provides such an exclusive right to the Tribunal.

Restriction on extension of liability

It is important to understand whether liabilities extended under Section 48 and 66 are unlimited and whether the extension of the same can be avoided by directors and parent company.

The liabilities extended under Section 48 and 66 are made with an intention to reverse the position of the corporate debtor as it would have stood had the transaction not taken place. Therefore, it can be safely assumed that the extension of liability shall be limited to the amount of such reversal of transaction and not more.

For the purpose of Section 48, in order to avoid the extension of liability one may have to prove that there were no benefits received by them as a result of such undervalued transaction. In case of absence of any benefit, the adjudicating authority cannot pass an order for payment of any amount for such benefits incurred.

For the purpose of section 66, it is important for the person to prove the absence of intention of defrauding the creditors or any such similar fraudulent intentions in relation to such transaction. Further, while the general presumption under 66(2) is in favour of the directors, in case the same becomes questionable, the director needs to ensure to evidence the reasonable due diligence exercised by them in minimising the potential loss and the lack of foreseeability on the commencement of corporate insolvency.

Conclusion

We observe that IBC 2016 has provided for a crystal clear extension of liability on the directors and parent company of the corporate debtor as and when a transaction involving them is brought under question. Such an extension of liability can be made to the extent of reversing the transaction or making reasonable contribution to the assets of the corporate debtor to ensure safeguarding of the creditor's interest. However, same can be avoided if the twilight period is kept in mind and reasonable due diligence is undertaken with lack of fraudulent intention. While there exists no precedent under IBC 2016 extending personal liability on directors or parent company till date, it would not be farfetched to see a judgement on these lines in the near future, given that the cases of Jaypee infrastructure and Religare are still awaiting a verdict.  

Footnotes

1 MANU/DE/7339/2007

2 MANU/SC/0138/1966

3 MANU/NC/5257/2018

4  id

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.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Topics
 
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Mondaq Sign Up
Gain free access to lawyers expertise from more than 250 countries.
 
Email Address
Company Name
Password
Confirm Password
Position
Industry
Mondaq Newsalert
Select Topics
Select Regions
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions