This article is written by Pragya Bajpai, pursuing a Certificate Course in National Company Law Tribunal (NCLT) Litigation from LawSikho. The article has been edited by Aatima Bhatia (Associate, LawSikho) and Dipshi Swara (Senior Associate, LawSikho).
The Insolvency and Bankruptcy Code, 2016 (“IBC” or “Code”) is a comprehensive law dealing with reorganisation and insolvency resolution of corporate debtors, partnership firms and individuals in a time-bound manner. The basic legislative intent behind the mechanism of the Corporate Insolvency Resolution Process (“CIRP”) under the Code is to resolve the debt and the insolvency status of the company as opposed to dissolving or shutting down the company under the winding-up proceedings of the Companies Act, 2013. The foundational objectives of the Code as stated in its preamble and the sacrosanct nature of the order of those objects as reiterated by the Supreme Court in its judgement wherein the first objective of IBC is to resolve the debt of the corporate debtor, and the second objective is the maximization of the value of assets of the corporate debtor, and the third objective of the Code is to promote entrepreneurship, availability of credit, and balancing the interest of the stakeholders.
Insight into Corporate Insolvency Resolution Process
As noted above, one of the objectives of the CIRP is the maximization of assets of the corporate debtor, therefore, the CIRP process must avoid any such circumstance which diminishes the valuation of the corporate debtor. The entire concept of the moratorium which puts on hold all other recovery proceedings going against the corporate debtor, in itself centres around the idea that the valuation of the corporate debtor should not diminish during the CIRP. Based on the exact principle that is to maximize the value of assets available to the creditors, the Code places similar provisions to ensure that there are no such unnecessary or fraudulent transactions, having taken place prior to the CIRP that can in any capacity diminish the value of the corporate debtor.
Such transactions are quoted as “avoidable transactions” under the Code and as the word suggests, these transactions are pre-insolvency transactions that should be cancelled or avoided during the CIRP. Once, CIRP or liquidation process has been initiated, it is on the Resolution Professional (“RP”)/ Liquidator to investigate the affairs of the corporate debtor and to scrutinize the entire books and records of the company and look through each and every transaction of the corporate debtor and see whether any such transaction can be termed as an “avoidable transaction”. In case the RP/Liquidator determines any such transaction, he must file an application for the avoidance of such transaction before the Adjudicating Authority i.e. National Company Law Tribunal (“NCLT”).
Avoidable transactions is a blanket term that includes transactions mentioned between Section 43 to Section 51 of the Code and they are classified into the following four categories:
- Preferential transactions
- Undervalued transactions
- Fraudulent transactions
- Extortionate transactions
In this blog post, we shall be discussing extortionate credit transactions and their legal process and precedents in detail.
Legal Framework of Extortionate Credit Transactions
The provisions relating to extortionate credit transactions are mentioned under Sections 50 and 51 of the Code. Section 50 defines extortionate credit transactions as those transactions entered into by the corporate debtor requiring exorbitant payment to be made by the corporate debtor in receipt of financial or operational debt during the period within two years from the insolvency commencement date. The RP or the liquidator may make an application to the NCLT for the avoidance of such transactions. It is important to note that Section 50 provides that the time period preceding two years from the date of the transaction is the “look-back period” and only those extortionate credit transactions taking place during such a period can be avoided.
Further, Regulation 5 of the Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations, 2016 (“CIRP Regulations”) qualifies the following terms of a transaction to be extortionate:
- Terms that require the corporate debtor to make exorbitant payments in respect of the credit provided.
- Unconscionable terms under the principles of law relating to contracts.
Moreover, the explanation to Section 50 clearly explains those transactions which shall be an exception to such extortionate credit transactions. It states that any debt extended by a financial services provider under any law for the time being in force will not be considered an extortionate credit transaction.
If the Adjudication Authority on examining the application for the avoidance of extortionate credit transactions is satisfied that the terms of such transactions involved receipt of exorbitant payment from the corporate debtor, then the following orders shall be made by NCLT to set aside such transactions:
- restore the position as it existed prior to such transaction;
- set aside the whole or part of the debt created on account of the extortionate credit transaction;
- modify the terms of the transaction;
- require any person who is, or was, a party to the transaction to repay any amount received by such person; or
- require any security interest that was created as part of the extortionate credit transaction to be relinquished in favour of the liquidator or the resolution professional, as the case may be.
What are exorbitant interest rates?
In the case of Shinhan Bank v. Sungil India Private Limited and Others, wherein the accepted and agreed rate of interest of loans availed by the corporate debtor was 65%; the NCLAT in its ruling considered such transactions as extortionate credit transactions under Section 50 of the Code. The Tribunal further observed that the creditors charging such an exorbitant rate of interest are unsecured creditors and do not fall under the category of financial creditors and therefore they are not covered by the remedies available under the Code and may avail other alternative remedies elsewhere.
The NCLAT has also observed that the maximum rate of interest that may be charged by private individuals is that of 24%. Any transaction requiring exorbitant payment from the corporate debtor shall be termed as extortionate credit transaction and shall be subject to avoidance under Section 50 of the Code.
What is the meaning of the term “unconscionable under the principles of law relating to contracts”?
Another term of the transactions that qualify as extortionate credit transactions are those wherein the terms of the agreement entered into by the corporate debtor are unconscionable under the principles in relation to the law of contract.
Unconscionable contracts are nowhere defined in Indian law, however, unconscionability as a concept has been explained via various provisions under the Indian Contract Act, 1872. Unconscionable contracts are those contracts that heavily favour one party over the other and put them in a position to dominate the other party. Such contracts are voidable at the option of the party whose consent was taken by undue influence. The following terms of transactions are unconscionable under the principles of law relating to contracts:
- Where the agreement entered into by the corporate debtor, where the other party is in a position to dominate the will of the other.
- Where the agreement entered into by the corporate debtor through coercion, misrepresentation or fraud.
- Where the object of the agreement entered into by the corporate debtor is unlawful.
The case of Anamika Singh and Others. Vs. Shinhan Bank and Others can be discussed at this point.In the present case, the corporate debtor undergoing CIRP had availed certain loans at an exorbitant interest rate of 45-60% per annum prior to the initiation of CIRP. Some of these loans were availed during the timeline of the “look-back period” of 2 years preceding the insolvency commencement date and some of the loans were availed even before the stated period of two years. An appeal was preferred before the NCLAT against the order of the NCLT that took into account the application of one of the financial creditors alleging that the loans advanced by the appellants were extortionate in nature under Section 50 of the Code.
The observations made in the present judgement by the Appellate Authority were as follows:
- Loans charged at 45-60% per annum of interest rates are exorbitant. The NCLAT observed that the corporate debtor availed loans from private individuals at exorbitant rates. Moreover, there was no evidence to show if the corporate debtor was in need of such loans or if the loans so availed were approved by the board of directors of the corporate debtor.
- Loan transactions incurred at an exorbitant interest rate within the look-back period of two years are extortionate credit transactions under Section 50 of the Code and are liable to be set aside.
- In regard to the loan availed by the corporate debtor prior to the period of two years preceding the insolvency commencement date, the NCLAT observed that the rate of interest charged under these transactions is exorbitant. Therefore, the NCLAT held these transactions to be illegal and directed the lenders of these loans to recover only the principal amount of these loans as unsecured creditors through alternative remedies as available to them elsewhere.
- Lastly, the NCLAT clarified the scope of power of the NCLT under Section 60(5) of the Code whereunder the Adjudicating Authority has jurisdiction to entertain or dispose of any application or proceeding by or against the Corporate Debtor or
Corporate persons. Therefore, it is not necessary that an application has to be made by the RP or the liquidator under Section 50 of the Code, in order for the NCLT to adjudicate on the matter.
It has been seen how a transaction can be called extortionate under section 50(2) of the code wherein the debtor had to make exorbitant payment with respect to the credit. These terms can be regarded unconscionable as per the Indian Contract Act. In the light of the cases discussed, the current position can be summarised that in order to decide whether a transaction falls under section 50 of the code or not, it is not mandatory that an application has to be filed by a resolution professional. Section 60(5) of the code gives the adjudicating authority the jurisdiction to entertain any application by or against a corporate debtor.
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