Avoidable Transactions & Role of Liquidator over Exclusion Contracts: IBC

    The primary goal of Insolvency and Bankruptcy Code (hereinafter IBC) is to protect corporate debtors (hereinafter CD) in distress as well as to provide an efficient debt recovery mechanism in order to protect the creditors. If any company defaults on its payments and becomes insolvent, IBC confers upon the Financial or operational creditors the right to initiate Corporate insolvency resolution process (hereinafter CIRP) by filing an application before National Company law Tribunal (herein after NCLAT)- the adjudicating authority, to come up with a resolution plan. If the plan is not approved, or if the creditors want the company to be liquidated, liquidation process can be initiated under section 30 of IBC [1]. The adjudicating authority while initiating the liquidation process also appoints an interim resolution professional (Liquidator). The liquidator is responsible to supervise the liquidation process, he is conferred with charge of all the assets and can dispose of them, so as to facilitate the debt recovery. The liquidator is also considered to be representative of the entire body of creditors and its workers, and shall collect all the dues and dispose of the assets in an impartial manner.

    Section 36 of IBC [2], enumerates that the liquidator shall have ownership rights over the assets and any other property belonging to the CD. Furthermore, he would also have the right over any claims of the CD and can also evade a few contracts. Now, any corporate entity in its normal course of business enters into several transactions and contracts with different parties. These contracts may also include those which confer, upon the third-party, certain liabilities towards the CD under specific circumstances such as delivery of defective goods, or poor-quality goods. If such dues are not claimed before liquidation, the liquidator steps in the shoes of CD to collect. Therefore, it is pertinent to ask- to what extent can the liquidator move to collect the dues from a third party, if there is an exclusive term in the contract exempting the full liability or substantially mitigating it.

    The sanctity of any contract is based on law and consensus between the parties entering the contract. Thus, entering into the agreement binds the parties, violation of which imposes a legal effect on them. The terms of the contract signed and agreed upon is also highly regarded by the judicial authorities.[3] However, there exists certain other contracts wherein a party might have been in a dominant position, or the party may be desperate to sign the contract. In such situations the dominant position holds the power and calls the shots. The Indian contract Act, 1872 (hereinafter ICA) renders such contracts voidable.

    When any two sophisticated parties with a sound financial background enter into contract, then it’s not easy for the courts to infer which party dominated whom. Usually in such cases, the Court follows the common practice of reviewing the terms of the contract, and concludes accordingly. In this article, the author would discuss the scope of exclusion clauses in commercial contracts under IBC, and the role of liquidator with regard to such contracts.

    Avoidable transactions

    For the insolvency code to function efficiently it is essential for distressed CDs to avoid certain transactions or contracts, so that it doesn’t create any obstruction when the company goes into liquidation. These measures have been introduced in IBC to prevent the practice where the company’s promoters’ group may transfer valued assets by virtue of exclusion contracts to other companies for their own benefit. Thus, NCLAT confers upon the NCLT the power to repudiate such transactions and contracts.

    Preferential transaction

    Section 43 of IBC[4] prohibits any transaction which results in transfer of any valued asset property of CD to a particular creditor/guarantor with regard to any past liability or obligations, since such transaction would confer a special benefit to that creditor or surety thereby violating the equitable distribution of assets in the liquidation process. The liquidator can file an application before adjudicating authority for avoidance of such transactions.

    Undervalued transactions

    Section 45 of IBC[5] prohibits undervalued transactions, it involves transactions such as giving a gift to a person by CD or entering into a contract which involves transferring of one or more assets to a party for consideration which is highly disproportionate to the actual value of the assets. However, such transactions should occur outside the CD’s course of business. The courts in their several decisions on the same issue have laid down a few parameters to determine as to what would constitute as undervalued transactions.

    Transactions defrauding creditors

    Section 49 of IBC[6] enumerates provisions relating to transactions defaulting creditors, this provision is similar to undervalued transactions wherein CD deliberately enters into contract to keep away the assets from certain creditors who are entitled to make a claim against the same. However, the essential distinction between the two is presence of intent; it should be proved before the adjudicating authority that the CD deliberately affected the right of persons in respect of their claims.

    Extortionate credit transactions

    Section 50 of IBC prohibits entering into extortionate transactions, it is different from the other avoidable transactions- unlike them it does not involve transfer of valued assets; instead it involves receipt of credit by the CD. The primary instance of such a transaction would be the entity availing credit at exorbitant interest rates. In the case of Shinhan Bank v. Sugnil India Private Limited and others [7] the NCLT observed that charging 65% of interest at a credit transaction would amount to extortionate credit transaction. Furthermore, the court observed that in common practice, 24% interest rate is charged for private loans and credit.

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    Contracts which exclude liability

    The above-mentioned transactions were enumerated in the code itself, however there are cases which do not come under the ambit of avoidable transactions such as clauses of excluding full or partial liability. Under such circumstances, it is pertinent to note the method through which a liquidator proceeds, and whether there is any recourse available to recover such claims and dues.

    Interpretation of “Exclusion clauses” in a contract

    The term exclusion clauses have been elaborately discussed in the excerpt mentioned below:

    “Exclusion clause is one which excludes or modifies an obligation, whether primary, general secondary or anticipatory secondary, that would otherwise arise under the contract by implication of law. Parties are free to agree to whatever exclusion or modification of all types of obligations as they please within the limits that the agreement must retain the legal characteristics of a contract; and must not offend against the equitable rule against penalties; that is to say, it must not impose upon the breaker of a primary obligation a general secondary obligation to pay to the other party a sum of money that is manifestly intended to be in excess of the amount which would fully compensate the other party for the loss sustained by him in consequence of the breach of the primary obligation.” [8]

    This makes it clear that the exclusion clause is not absolutely void, minor modifications and exclusion is permissible. However, if an exclusion is violating the equity principle and imposes arbitrary obligations upon any party, it won’t be deemed valid.

    Contracts that exclude liability fully

    There is not much jurisprudence with regard to exclusion clauses in India, since IBC is also relatively new, thus a lot of reliance is placed in the decisions rendered by the common law rulings, this is also a settled notion practiced by the courts in India. The judicial approach stipulates a basic condition to check the validity of exclusion clauses, it is of the approach that a transaction which is the base of a contract should not be removed or interfered with. For instance, when a computer is sold the delivery of an instrument which is absolutely necessary for the functioning of the computer must also be supplied, it’s the basic condition which if not fulfilled would make the contract meaningless.

    The Supreme Court observed in the case of Skandia Insurance Co. Ltd v. Kokilaben Chandravadan, [9] any exclusion clause in a contract should be read with the whole of the contract so as to find out whether the exclusion clause defeats the main purpose of the contract or not. Accordingly, the liquidator can put forth its arguments before the court that full exclusion of liability is in violation of the basic feature of the Contract and can claim the compensation or the respective claims.

    Can Liquidator amend the contract entered by CD?

    The object of IBC is to resuscitate financially distressed companies, resolution professionals are appointed by the adjudicating authority and committee of creditors. Throughout the process, the RP takes charge of the affairs of the entity as a going concern. The power to amend existing contracts between the CD and other party is enumerated under Section 20(2) of IBC[10] which permits him to do so. However, NCLT in the case of EIH Limited v. Subodh Kumar Agrawal [11] involving trident hotel, the RP after taking over the charge, dishonoured payment to the hotel’s creditors which was in violation of management agreement entered by the CD. NCLT, Hyderabad ruled in favour of the creditor, rendering the contract valid and further stated that the RPs cannot unilaterally amend existing commercial contracts. Thus, this issue is still debatable since the law provides for such power in the provisions.

    Conclusion

    Transactions and contracts which are prohibited under IBC obstruct the CIRP and waste the time and resources of the already distressed entity. Therefore, the author believes that it is essential for the creditors and the contract parties to keep up with the existing financial position of the company, especially those which involve transfer of assets. The provisions related to avoidable transactions enumerated under IBC is to protect both the contracting parties, thus it is encouraged to maintain proper documentation to avoid prolonged complexities and confusion.

    Addressing the role of liquidator in exclusion clauses of contract, the author believes that the liquidator is obligated to recover as much dues and claims as it can, and distribute them equitably so as to successfully execute the liquidation process. 

    REFERENCES

    1: The Insolvency and Bankruptcy Code, 2016, s. 30.

    2: The Insolvency and Bankruptcy Code, 2016, s. 36.

    3: Unnikrishnan A ‘Liquidator’s Claims against Exclusion Clauses in Contracts’, available at: https://ibbi.gov.in/uploads/resources/71c6ae7012046e777830c4e5bdc9485c.pdf (last visited on 11 November 2021).

    4: The Insolvency and Bankruptcy Code, 2016, s. 43.

    5: The Insolvency and Bankruptcy Code, 2016, s. 45.

    6: The Insolvency and Bankruptcy Code, 2016, s. 49.

    7: Order dated July 9, 2019 of the NCLT Delhi in Company Petition No. IB- 492/ND/2018 and Company Application No. 184/2018.

    8: Pollock and Mulla The Indian Contract Act and Specific Relief Acts (Lexis Nexis, 16th edition).

    9: (1987) 2 SCC 654.

    10: The Insolvency and Bankruptcy Code, 2016, s. 20(2).

    11: IA no. 73 of 2018 in CP(IB) no. 248/7/HDB/2017.


    BY SHIVAM SINGH | NATIONAL LAW UNIVERSITY, ODISHA 

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