The Concept of Related Party under Insolvency and Bankruptcy Code

Abhishek Bhushan Singh

INTRODUCTION

The 2018 amendment of the Insolvency and Bankruptcy Code passed on 6th June 2019 added the definition of "Related Party" with respect to an individual under section 5 (24A). Prior to this amendment, the Insolvency and Bankruptcy Code defined the term related party only with respect to the Corporate Debtor under section 5(24).

The word "related party" is defined in detail in Sections 5(24) and 5(24A) of the Code. In the context of a Corporate Debtor, a related party is somebody who can act in a managerial or directing role. A related party can own a significant portion of the Corporate Debtor's stock or make decisions for the CD, its subsidiaries, holdings, or associate company.

A related party to the CD who is also a financial creditor of the CD has no right of representation, participation, or vote in a meeting of the COC, 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 benefit the CD in any way.

The ordinance is based on the recommendations of a 14-member committee led by corporate affairs secretary Injeti Srinivas, which found that the IBC lacked a clear definition of "related party in regard to an individual" (or relatives).

The committee stated in their report that "With respect to persons considered as related parties in the context of an individual, the committee noted that the Code does not specifically define the same." According to the committee, the term "related party" was frequently employed in the context of a corporate debtor or other company under the Code."

However, it stated that sections 28 and 29A of the Code, as well as rule 33 of the Liquidation Regulations, employ the term 'related party' in a way that might encompass individuals such as promoters, directors, or the liquidator.

If a company's director is a member or director of another company, the other company becomes a related party under Section 2 (76) (iv) of the Companies Act, 2013. Section 5 (24) (d) of the Code contains a similar clause. However, it is written primarily from the perspective of the corporate debtor. It's also worth noting that Section 5 (24) (m) of the Code is the most broadly drafted, indicating the draftsman's position on the reality of inter-relationships between the two entities. Despite the fact that related parties may have claims and may even file for corporate insolvency resolution, such parties cannot drive the insolvency resolution process because it would be fraught with conflicts of interest.

The Case of J.R. Agro Industries P. Limited v. Swadisht Oils P. Ltd

NCLT Allahabad, in this case, observed that "It would not be reasonable to operational creditors if claim of related party is given priority over operational creditors," Because the related party and the corporate debtor shared a common directorship and promoters in the instant case, and in light of international practices, including the UNCITRAL legislative guide to insolvency law, NCLT concluded that a related party's claim, whether in the form of a loan, should rank below operational creditors' claims and be treated on par with equity shareholders under Section 53 (1) (h) of the Code.

Voting Rights of Related Party in COC

A related party to the CD who is also a financial creditor of the CD has no right of representation, participation, or vote in a meeting of the COC, 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 judgments do not benefit the CD in any way. A financial creditor who is a related party has assigned its obligation to another Financial Creditor who is not a related party but is a member of the COC in a few instances. The court has opposing viewpoints on these related parties' activities.

In the instant case of Synergy Casting Limited, Synergies Dooray, was a sister firm of the corporate debtor and hence had no voting rights. It did, however, allocate a large portion of its debt to Millennium Finance Ltd., which was given a seat on the COC. Edelweiss objected to the assignment, claiming that it was meant to weaken Edelweiss' vote power. The court determined that there was no connection between Synergy Casting and Millennium Finance Ltd. and that the Applicants' argument that the COC's agenda would be detrimental to the corporate debtor was incorrect because no other creditors opposed to such an assignment. The Adjudicating Authority did not evaluate the objectives of the corporate debtor and its associated party since the IBC only deals with summary processes, and mens rea cannot be asserted before it.

NCLT, on the other hand, took a different stance in the case of Fortune Pharma. In this case, the CIRP was started by the Corporate Debtor under Section 10. The Corporate Debtor's connected parties had transferred their obligations to a non-related party through various assignment agreements in order to reduce SBI, the Applicant's voting share from 100% to 50%. The court emphasised the directors/promoters of the Corporate Debtor's thorough preparation of the execution of the assignment deeds with the goal of reducing the Applicant's voting rights. By assigning its debt to another party without a concrete cause for the other party's acceptance of the debt, a related party cannot abruptly become a non-related party.

Related- party Transactions

Related party transactions are ones that take place between two parties who have a prior relationship with one another. In the case of Phoenix Arc Private Limited v. Spade Financial Services Limited, the Supreme Court recently held that the intent of section 21 of the Insolvency and Bankruptcy Code, 2016 ("IBC") would be defeated if related parties are only determined "in presaenti," or on a case-by-case basis. In order to safeguard creditors, the above-mentioned Cod allows for the avoidance of a few transactions. The resolution professional is tasked with reviewing the Corporate Debtor's transactions throughout the lookback period to identify avoidable transactions under rule 35A of the Insolvency and Bankruptcy Board of India (Insolvency Process for Corporate Persons) Regulations, 2016 (CIRP Regulations). A preferential transaction or an undervalued transaction made by the Corporate Debtor to a related party within a period of two years preceding the commencement of the CIRP process would be an avoidable transaction. The resolution professional will have to disclose this transaction to the adjudicating body. In order to provide fair treatment to creditors throughout the CIRP, the adjudicating authority may issue an order vesting back the property or the amount thus transferred.

The prospect of related parties eroding the value of the Corporate Debtor is adequately guarded against under the IBC, whether during the lookback period of two years prior to the bankruptcy initiation date, during the CIRP, or even through payments and benefits under a resolution plan. The robust framework for identifying avoidance transactions entered into with related parties and provisions to protect the interests of stakeholders of a Corporate Debtor is at the heart of achieving one of the most important goals of the IBC: resolving insolvency while maximising value, preserving assets, and safeguarding the interests of all stakeholders of the Corporate Debtor.