This article is written by Harsh Jain. Along with holding degrees in LLB, and LLM, Harsh is NET, JRF qualified. Harsh has successfully cleared Rajasthan Judicial Services, Mains Examination, Gujarat Judicial Services pre, SBI specialist officer scale II online exam and many other competitive examinations. Also, Harsh is pursuing Diploma in Entrepreneurship Administration and Business Laws from NUJS, Kolkata. This article is a guide about your responsibilities as a director during the twilight period and what are the safeguards available to you.
On 4th April 2018, it was reported by the Business Line, The Hindu, that a statement was given by MS Sahoo, Chairman of Insolvency and Bankruptcy Board of India, giving a warning to the directors of companies, which are facing the insolvency process. He said that action would be taken against such directors, who have not discharged their duties towards the creditors during the twilight zone period. Such action will be taken under the Insolvency and Bankruptcy code (IBC).
Under Section 17 of IBC, powers of the board of directors are suspended immediately after the commencement of insolvency proceedings, that is, from the date when an application for initiating corporate insolvency resolution process is admitted by the Adjudicating Authority (see Section 5(12) of the IBC). They are then vested in the interim resolution professional.
If you are a director of a company, as per Section 46 of IBC, you can be held responsible for actions taken up to one year preceding the commencement of insolvency proceedings, and two years in case of related party transactions.
As per Section 66 of Insolvency and Bankruptcy Code, as a director, you have to exercise due diligence in minimizing the potential loss to the creditors during the twilight period.
If you knew or ought to have known that commencement of insolvency resolution process cannot be avoided and you have not exercised due diligence in minimising the potential loss to the creditors, then you will be liable under Section 66 of Insolvency and Bankruptcy Code, to make such contribution to the assets of the corporate debtor as the Adjudicating authority ( National Company Law Tribunal constituted under Section 408 of the Companies Act, 2013) deems fit. In this article, you will get to know various legal aspects related to you as a director of a company and your role, liabilities, defenses, legal provisions applicable and various other dimensions related to your role during twilight period.
What is Twilight period?
It is not defined in Insolvency and Bankruptcy Code, and it may range from a few months to a few years before the commencement of insolvency process.
Section 46, Insolvency and Bankruptcy Code:
Says that where liquidator or resolution professional after examination of transactions of your company, has a opinion that you or your company has at a relevant time given preference in any transactions like undervaluing transactions etc. as mentioned under Section 43 (2), Insolvency and Bankruptcy Code, to any person as mentioned under Section 43 (4), Insolvency and Bankruptcy Code, he will apply to Adjudicating authority for avoidance of such transactions. Adjudicating authority may pass one or more of orders referred to, under Section 44, Insolvency and Bankruptcy Code, like they can declare such transactions void or even reverse the effect of such transactions.
It is deemed that a corporate debtor has given a preference if a property or an interest of the corporate debtor has been transferred for the benefit of a creditor or a surety or a guarantor for or on account of an antecedent financial debt or operational debt or other liabilities owed by the corporate debtor and putting such creditor or surety or guarantor in a position which is more beneficial to him than he would have been in case of distribution of such assets in accordance with the provisions of Section 53 IBC. ( Section 43(2), IBC).
In other words we can say that according to Section 43(2) of IBC, when your company have some legally enforceable financial or operational or other obligation of a creditor/ surety/ guarantor, and your company transfer any property or any of its interest for the benefit of such creditor or surety or guarantor, by which such creditor/ surety/ guarantor comes into a position which is more beneficial to him as compared to the position he would have been if such distribution of such asset had taken place in accordance with the provisions of section 53, IBC, in such a case it is said that your company has given a preference to such creditor/ surety/ guarantor.
As per Section 43 (4) and 46 (1), Insolvency and Bankruptcy Code:
such preference is considered to be given at a relevant time if it was given to a related party ( except if it was just given only for the reason of being employee) during the period of two years before the commencement of insolvency proceedings or to a person other than a related party during the period of one year before the date of commencement of insolvency proceedings.
The time duration of the twilight period:
By analyzing Section 43 and 46, Insolvency and Bankruptcy Code, we can see that Insolvency and Bankruptcy Code has provided for a period of up to 2 years in case of related party and a period of one year in case of other persons where such preferences as prescribed by Section 43 (2) cannot be given.
Which period can be recognized as twilight period:
So in the light of Section 17, 43, 46, and 66 of Insolvency and Bankruptcy Code, we can draw out that, The Twilight zone period is:
- Two years preceding from the date of commencement of insolvency when the preference is given to a related party.
- One year preceding from the date of commencement of insolvency when the preference is given to a person other than a related party.
Legal consequences of not performing duties properly:
- While during normal days, your duty is about the company and its shareholders, but, during the twilight period, you have a duty to protect creditor’s interest before shareholder’s interest. In other words, we can say that twilight period leads to a shift in your duty from shareholders to creditors. If you fail to protect the interest of the creditors, you may be held liable under Section 66 IBC.
- Undervalue transactions and preferences which were entered by your company up to two years before the commencement of insolvency process can be declared as void and their effect can be reversed by setting aside such transactions by the Adjudicating Authority ( Section 45, IBC)
- You can be made personally liable to make such contributions to the assets of the corporate debtor as deemed fit by Adjudication authority ( Section 66, IBC).
- You will be liable to make such contributions under if you knew or ought to have known that corporate insolvency resolution process is unavoidable and you did not exercise due diligence in minimizing the potential loss to your creditors [ Section 66 (2)(a), IBC]. This means that you cannot take the defense of lack of awareness. You will be judged on the standards that what you should know as a reasonable competent director and also on the special skills you actually possess.
- You can be held liable for concealment or fraudulent removal of whole or part of a property, or willful concealment, destruction, mutilation or falsification of any book or paper affecting or relating to the property, willfully making any false entry in any such book or paper or other such kind of activity which are considered as prejudicial to the interest of the creditors as a director of a company which has entered the process of insolvency. In such case, imprisonment will not be less than three years, but it can extend up to five years. A fine may also be imposed, which shall be at least one lakh rupees, and extend up to one crore rupees. You may also be punished with both. ( Section 68, IBC)
- The look-back period will be two years for related party transactions and one year for transactions other than related parties. (Section 43 and 46 IBC).
- If you commit a breach of duty, it will expose you to statutory remedies under legislations related to insolvency and company like misfeasance, etc. As per the Eleventh schedule to IBC point number 10, If a petition is filed under Section 272 of Companies Act, 2013, the Tribunal may even wind up the company if you are found guilty of guilty of fraud, misfeasance or misconduct.
Safeguards or defenses for directors/ When you are not liable and what you should do to save yourself:
Regardless of these previously mentioned concerns, neither the courts nor insolvency professionals intend to punish you or other directors who act reasonably and sensibly in securing creditors. You can keep in your mind following practical considerations to minimize the risk of claims:
- You must regularly monitor financial position of the company by preparation of financial statements, projections, and accounts.
- You will not be rendered liable under the provisions of this act, if, you prove that you did not commit any contravention of the provisions of this code or you didn’t have the intention to do so to harm creditors. ( Proviso to Section 68, 69, 70, etc. of IBC).
- If you prove that you have exercised due diligence to protect the interest of creditors, you will not be held liable under this act.
- Explanation to Section 66 provides that due diligence means diligence which can be reasonably expected from a director carrying out similar kind of operations in relation to the corporate debtor. If you have worked in such manner, then you will be deemed to have exercised due diligence.
- You must always take advice from professionals. You must ask your company’s accountant to verify current solvency and cash flow to find out whether you can avoid insolvency or not. You can also consult lawyers to find out inappropriate or unlawful, proposed transactions (if any). You must also seek advice from insolvency professionals to assess new and potential strategies for recovery.
- There should be board meetings and other informal meetings at regular intervals which are attended by all the directors. Minutes should be kept as detailed as possible and briefing papers must be circulated in advance so as a discussion is promoted. If you are absent, then you should keep yourself informed.
- If you are an independent director having concerns about the solvency of the company, you must raise your concerns with other board members and have them minuted. If your concerns are ignored, you may even take independent legal advice. You may also consider resigning as a final step. However, resigning will not save you from liability for wrongful trading.
- Before you incur further liabilities or agree to a large compensation or a pension package for departing management, you first must consider company’s financial situation.
- If you are a director of several groups of companies or a nominee director, you have duties as a parent or appointing company as well as to a subsidiary and its creditors.
- You must keep major creditors and investors of your company informed unless advisers of the company have advised you otherwise.
- You can be given an indemnity in your favor in respect of liabilities, costs, charges, and expenses incurred in the execution of and discharge of your duties in the Articles of association of the company. But, indemnity or insurance cannot save you from your liabilities for negligence, default, breach of duty, breach of trust or fraudulent trading.
- It is not mandatory to obtain a directors and officers insurance coverage under the law. But, it is a popular tool for mitigating some of the risks which you are exposed to as an independent director. Depending on the type and extent of directors and officers insurance cover, extent of protection available to you would vary from case to case.
- You must keep your company’s position under regular review and timely advice of the insolvency expert.
In the context of the directors and twilight zone, there are few aspects which the legal system has touched upon, and there are few issues that remain to be addressed. There is still a situation of confusion and debates are going on that, should first signs of the insolvency have a freezing effect on directors or whether they must attempt to bring the company out of the potential insolvency by accelerating the business of the company. No clear guidelines are explaining what is the exact time when there must be a shift in the duties of the directors.
It is also important to notice that something which is favorable to a particular kind of company may not be appropriate and advisable for another. Hence, your duties and role in the twilight zone, as a director may also differ according to the kind of company you are in.
The twilight period is a challenging time for many distressed companies and their directors like you, as you have to focus your attention on keeping your business afloat. But, at the same time, you must also avoid exposing yourself, and your insures to any kind of personal liabilities and claims by remaining aware of the extra risk that you face.