The Insolvency and Bankruptcy Code (IBC) has revolutionized India's insolvency resolution framework, providing a transparent and efficient mechanism for resolving distressed businesses. One crucial aspect of the IBC is the regulation of related party transactions, which aims to prevent abuse and ensure fairness in the insolvency process. In this article, we delve into the concept of related party transactions under the IBC and explore the regulatory framework surrounding them.
UNDERSTANDING RELATED PARTY TRANSACTIONS
Section 5(24) of the Insolvency and Bankruptcy Code, 2016 introduces the concept of "Related Party." This provision establishes a commutative association between the related party and the corporate debtor. Initially, the Code did not offer a specific definition for Related Party. However, this was addressed through the Insolvency and Bankruptcy Code (Amendment) Ordinance, 2018. Subsequently, the definition of Related Party under the Companies Act, 2013 was adopted for reference and implementation within the IBC framework. Under the Insolvency and Bankruptcy Code (IBC), a related party to a corporate debtor includes:
- Directors or partners of the corporate debtor, as well as relatives of directors or partners.
- Key managerial personnel of the corporate debtor or relatives of key managerial personnel.
- Limited liability partnerships or partnership firms in which a director, partner, or manager of the corporate debtor or their relative is a partner.
- Private companies or public companies in which a director, partner, or manager of the corporate debtor is a director and holds, along with their relatives, more than two percent of the share capital or paid-up share capital, respectively.
- Body corporates whose board of directors, managing director, or manager, in the ordinary course of business, acts on the advice, directions, or instructions of a director, partner, or manager of the corporate debtor.
- Limited liability partnerships or partnership firms whose partners or employees, in the ordinary course of business, act on the advice, directions, or instructions of a director, partner, or manager of the corporate debtor.
- Persons on whose advice, directions, or instructions a director, partner, or manager of the corporate debtor is accustomed to act.
- Body corporates that are holding, subsidiary, or associate companies of the corporate debtor, or subsidiaries of a holding company where the corporate debtor is a subsidiary.
- Persons who control more than twenty percent of the voting rights in the corporate debtor due to ownership or a voting agreement.
- Persons in whom the corporate debtor controls more than twenty percent of the voting rights due to ownership or a voting agreement.
- Persons who can control the composition of the board of directors or the corresponding governing body of the corporate debtor.
- Persons associated with the corporate debtor due to participation in policy-making processes, having more than two directors in common, interchange of managerial personnel, or provision of essential technical information.
These provisions ensure that a wide range of individuals and entities connected to the corporate debtor are considered related parties under the IBC.
REGULATORY FRAMEWORK FOR RELATED PARTY UNDER IBC
Section 21(2) of the IBC: A related party to the Corporate Debtor who is also a financial creditor of the Corporate Debtor will have no right of representation, participation, or vote in a meeting of the Committee of Creditors, according to Section 21(2) of the Code. This is done to preserve the rights of other Financial Creditors and to ensure that the CoC's decisions do not favour the CD in any way.
Section 29A of the IBC: Due diligence is addressed in Section 29A of the IBC. In the Resolution Process, a Resolution Professional must consider each applicant's requirements for eligibility. The Related Party is expressly prohibited from participating in the Resolution Process under Section 29A of the IBC. The goal of introducing this exclusion is to limit companies or individuals that may have a negative impact on the insolvency resolution process. Section 29 of the IBC requires disclosure of related parties because the code's objective is to protect the interests of creditors. Inclusion of related parties in the resolution process will damage the interests of other creditors since the related party will try to get an edge over other creditors, therefore benefiting the corporate debtor. That is also why they are not allowed voting rights in the Resolution Process, as lack of participation means lack of voting privileges. As a result, it is essential for the benefit of the Committee of Creditors and the establishment of an objective environment that related parties refrain from participating in the process.
In the case of Committee of Creditors of Essar Steel India Limited (through authorized signatory) v. Satish Kumar Gupta and Others [ (2020) 8 SCC 531], Arcelor Mittal and Numetal, two bidders in the Essar Steel case, were initially considered ineligible due to their association with related parties. Numetal had Rewant Ruia, the son of Essar Steel's promoter, as a beneficiary, while Arcelor Mittal owned a significant stake in Uttam Galva, a company that had defaulted on its debts. However, the Supreme Court ruled that if an applicant clears all its dues, they can become eligible as a resolution applicant under Section 29A of the Insolvency and Bankruptcy Code (IBC). This means that even if there are related party connections, if the applicant fulfils its financial obligations, they can still be considered eligible for the resolution process. This decision by the Supreme Court highlights the importance of fulfilling financial obligations and clearing dues to address concerns related to related party transactions and become eligible for the resolution process under the IBC. It emphasizes the objective of the IBC to ensure fair and transparent resolution proceedings while providing opportunities for eligible applicants to participate in the process.
Related Party Transactions: Related party transactions refer to transactions between two parties who have an existing relationship with each other. To protect creditors' interests, the Insolvency and Bankruptcy Code (IBC) includes provisions for the avoidance of certain transactions. Rule 35A of the Insolvency and Bankruptcy Board of India (Insolvency Process for Corporate Persons) Regulations, 2016 (CIRP Regulations) assigns the responsibility to the resolution professional to review the corporate debtor's transactions during the lookback period to identify avoidable transactions. Under the rule, if a corporate debtor engages in a preferential transaction or an undervalued transaction (Preferential Transactions are simply transactions in which an insolvent debtor transfers to or for the benefit of a creditor so that such beneficiary receives more than what it might have obtained ordinarily through the payout of the bankruptcy estate, while undervalued transactions are those in which the debtor obtained a value that was either nominal or non-existent, such as a gift, or significantly lower than the genuine worth or market price, provided the transaction happened during the suspect period)with a related party within two years prior to the commencement of the Corporate Insolvency Resolution Process (CIRP), it is considered an avoidable transaction. The resolution professional is required to report such transactions to the adjudicating authority. The adjudicating authority may then issue an order to revert the property or amount transferred through the transaction, ensuring fair treatment of creditors during the CIRP. These provisions aim to prevent preferential treatment and undervaluation of assets in related party transactions, ensuring that the resolution process is conducted in a fair and transparent manner, and creditors are treated equitably.
Related party transactions can significantly impact the insolvency resolution process. They raise concerns about conflicts of interest, potential abuse of the insolvency framework, and the equitable distribution of assets among creditors. Judicial precedents and case studies provide insights into the consequences and implications of related party transactions under the IBC, highlighting the need for robust regulation.
The regulation of related parties and their transactions under the Insolvency and Bankruptcy Code is a vital aspect of ensuring fairness, transparency, and equitable treatment of creditors during the insolvency resolution process. The IBC defines related parties and provides guidelines and safeguards to prevent abuse and protect the interests of stakeholders. By identifying and scrutinizing related party transactions, the IBC aims to prevent preferential treatment, undervaluation of assets, and potential conflicts of interest. The involvement of the resolution professional and the Committee of Creditors (CoC) in reviewing and approving these transactions adds an additional layer of oversight to maintain transparency and adherence to the IBC's provisions. The consequences and implications of related party transactions under the IBC have been a subject of scrutiny and legal interpretation. Judicial precedents and case studies highlight the need to address related party transactions effectively and uphold the integrity of the insolvency resolution process. Mitigating risks and ensuring transparency in related party transactions require the adoption of best practices. Independent valuations, expert opinions, and strengthening governance mechanisms can contribute to a fair assessment of transactions and prevent potential abuse.
In conclusion, the regulation of related party transactions under the IBC plays a vital role in safeguarding the interests of creditors and ensuring a transparent and efficient insolvency resolution framework. Adhering to the regulations and safeguards outlined in the IBC is essential for maintaining trust and confidence in the insolvency resolution process and promoting a level playing field for all stakeholders involved.