Related Party under Insolvency Bankruptcy Code

The term related party is defined under section 5(24) of the Insolvency & Bankruptcy Code, 2016. The description of the same in the code in within the context of commutative relationship b/w between the related party and the corporate debtor. The definition was earlier followed as per the Companies Act, 2013 as there was no definition of related party in the Insolvency & Bankruptcy Code, and was brought in the code by the Insolvency and bankruptcy code (Amendment) Ordinance, 2018.

Particularly, The Insolvency and Bankruptcy Code under sections 5(24) and 5(24A) has given an exhaustive definition of the term ‘related party.’ A related party in terms of a Corporate Debtor can be anyone who can act in the capacity of managerial or directorial nature which means, a related party can have a shareholding of a substantial amount of shareholding in the corporate debtor or to be in such a dominant position to make decisions for the Corporate Debtor or its subsequent subsidiaries, holdings or an associate company.

A related party includes within itself the following as per the definition in the code:

1. Key managerial personnel of the corporate debtor or a relative of key managerial personnel of the corporate debtor;

2. A limited liability partnership or partnership firm in which a director, partner, or manager of the corporate debtor or his relative is a partner, and whose partners or employees in the ordinary course of business, acts on the advice, directions, or instructions of a director, partner, or manager of the corporate debtor;

3. Anybody corporate 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;

4. A director or partner of the corporate debtor or a relative of a director or partner of the corporate debtor;

5. A private or public company in which a director, partner or manager of the Corporate Debtor is a director and holds along with relatives, more than two per cent of its paid-up share capital

6. Holding, associate or subsidiary of the Corporate Debtor or a subsidiary of a holding company to which the corporate debtor is a subsidiary

7. An LLP where a director, manager, partner of the Corporate Debtor or their relative is a partner

8. Any person holding 20% voting share in the Corporate Debtor or the Corporate Debtor holding 20% voting share in any person

9. A person on whose instructions a director, manager or partner is accustomed to act

10. A person who can control the composition of the board of director. 

In addition, any person who is associated with the corporate debtor on account of—

• (i) participation in policy-making processes of the corporate debtor; or

• (ii) having more than two directors in common between the corporate debtor and such person; or

• (iii) interchange of managerial personnel between the corporate debtor and such person; or

• (iv) provision of essential technical information to, or from, the corporate debtor.

The noteworthy part is that the drafters drafted section 5(24)(m) to be interpreted in broader and wider terms, in context of usage and application of the draft. As, noted earlier it should be reiterated that focus is pertinent on It on the inter-relationship between two entities.  Therefore, these two entities having more than two directors in common or have an interchange of managerial personnel or participation in policy making processes, shall be considered to be related parties of each other.

Related- party Transactions

Related party transactions are those types of transactions between two parties which have a pre-existing relationship with each other. The Supreme Court, recently, in the case of Phoenix Arc Private Limited v. Spade Financial Services Limited, REED 2021 SC 02501, held that the intent of section 21 of the Insolvency and Bankruptcy Code, 2016 ("IBC") will be defeated if related parties are just determined "in presaenti" i.e., on the present basis. The  above-discussed Cod provides for avoidance of a few transactions in order to protect the creditors. As per under rule 35A of Insolvency and Bankruptcy Board of India (Insolvency Process for Corporate Persons) Regulations, 2016 (CIRP Regulations) the resolution professional is entrusted with the duty to review the transaction of the Corporate Debtor during the lookback period to identify avoidable transactions. 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. This transaction will have to be reported by the resolution professional to the adjudicating authority. The adjudicating authority may pass order to vest back the property or the amount so transferred in order to give a fair treatment to the creditors during the CIRP.

Representation (or voting rights) of Related Party

The Interim Resolution Professional is required to call for claims from the creditors against the corporate debtor & when there is the collation of such claims the IRP forms the Committee of Creditors under section 21 of the Code which thereby construe the CoC as absolute-in control of the corporate debtor after the commencement of the CIRP and therefore being responsible to make all the managerial and directorial decisions for the corporate debtor

The section 21(2) of the Insolvency and Bankruptcy Code, a related-party to the corporate debtor who is also a financial creditor of the corporate debtor shall have no right of representation, participation or voting in a meeting of the Committee of Creditors. The Reason for the same has been to protect the rights of the other Financial Creditors and make sure that the decisions made by the Committee of Creditors do not favour the corporate debtor in any way, as interest of related party is concerned with the decisions. In addition, there have been a few incidents where a financial creditor who is a related party has assigned its debt to another Financial Creditor who is not a related party but is a valid member in the Committee of Creditors. The matter has been in court wherein, the court has opposing views regarding this particular above-mentioned action of related parties.

In the case of Synergies Dooray, REED 2018 NCLAT Del 12516, Synergy Casting Limited, was the sister concern of the corporate debtor, hence, did not have any voting rights. However, it assigned a major share of its debt to Millennium Finance Ltd. who got a seat in the CoC. Edelweiss challenged this assignment alleging that the assignment was made to reduce Edellweiss’s voting share. The court held that there was no relationship between Synergy Casting and Millennium Finance Ltd. and the Applicants claim that the agenda of the CoC would be prejudicial to the corporate debtor was not correct since none of the other creditors objected to such an assignment. The intentions of the corporate debtor and its related party were not considered by the Adjudicating Authority since IBC deals with summary proceedings mens rea cannot be raised before it.

On the other hand, in the case of Fortune Pharma, REED 2019 NCLT Mum 02565, NCLT had an opposing view. In this case the Corporate Debtor had initiated the CIRP under Section 10. The related parties of the Corporate Debtor through several assignment agreements had transferred their debts to a non-related party in order to reduce the voting share of SBI, the Applicant, from 100% to 50%. The court pointed out the meticulous planning on the part of the directors/promoters of the Corporate Debtor of execution of the assignment deeds with the intention to bring down the voting rights of the Applicant. A related party cannot suddenly become a non-related party by assigning its debt to another party with no concrete reason for acceptance of this debt by the other party.

Disclosure of Related Party Essential under the purview of section 29A of the IBC, 2016

Disclosure of Related Party is essential, as Section 29A of Insolvency and Bankruptcy Code elucidates about due diligence. A Resolution Professional has to look upon the eligibility criteria of each applicant in the Resolution Process. Section 29A of the IBC specifically states that the Related Party is ineligible to participate in the Resolution Process.  The very aim, and motive behind the insertion of ineligibility criteria is to restrict such entities or persons who could be an adverse impact during the entire process of insolvency resolution. The participation of Related parties in the resolution process will affect the other creditors' interest as the related party would try to gain over other creditors hence, profiteering the corporate debtor. That’s the reason also that they are not granted voting rights in the Resolution Process as no participation means no voting rights. So, it is important for the interest of the Committee of Creditors and to create an impartial surrounding that related parties do not participate in such a resolution process. Well, disclosure of related parties is essential for Section 29 of the IBC because the very aim of the code is to protect the very interests of creditors.

Litigation Checks

There are cases where NCLT has given decisions on the participation of Related parties in the Resolution Process. In the case of Ruchi Soya Industries Limited, REED 2019 NCLT Mum 09507, Adani Wilmar was declared as the highest bidder by the Committee of Creditors. Meanwhile Patanjali Ayurveda the second-highest bidder raised a claim against Adani Wilmar regarding his ineligibility to contest in the Resolution Process. The basis of such contention was that the wife of the Managing Director of the Adani Wilmar was the daughter of the Promoter.

Also, in Arcelormittal India Private Limited v. Satish Kumar Gupta and Others, REED 2018 SC 10541, Arcelor Mittal, and Numetal, the bidders were held ineligible in the context of the Related Party clause. The reason behind it was that Rewant Ruia, the son of Essar Steel promoter was the beneficiary in Numetal and Arcelor Mittal was the owner of 29.05% stakes in the defaulter Uttam Galva. However, the Supreme Court has that if the applicant clears off all its dues, then they can become eligible as a resolution applicant under section 29A. Because its earlier judgment, SC has delved into the meaning of the word ‘management’. To noteworthy point, while interpreting section 29A(c), SC has held that the expression ‘management’ would refer to the de jure management of a corporate debtor which would ordinarily vest in a board of directors, and would include, ‘manager’, ‘managing director’ and ‘officer’ as defined in the Companies Act, 2013. ‘De jure’ is a Latin phrase meaning ‘by law’, ‘as a matter of law’ etc. [Vasant Rao v. Farooq-Ali, 1995(3) ALT 1 (Andhra Pradesh High Court)] and is in contradiction to the phrase ‘de facto’ which means ‘in fact, in reality, in actual existence, force or possession as a matter of fact’ [Rajasekhar v. Siddalingappa, ILR 1986 Karnataka 2765].

In Pankaj Yadav and Another v. State Bank of India and Another, REED 2018 NCLAT Del 08542, the Adjudicating Authority taking into consideration the facts and circumstances of the case observed that meticulous planning was made by the Director of the ‘Corporate Debtor’ to execute ‘Assignment Deed’ with the sole intention to bring down the voting power to the ‘State Bank of India’ which cannot be regarded as a natural business decision. The Adjudicating Authority also observed that a ‘related party’ cannot suddenly become a ‘non-related party’ because he just washes off his hands and hands over the paper to another party who had no valid reasons for taking up the assignment of a debt.