The Insolvency and Bankruptcy Board of India’s (IBBI) latest discussion paper on fraudulent or malicious initiation of the Corporate Insolvency Resolution Process (CIRP) has placed a new responsibility on insolvency professionals (IPs) which includes identifying potential abuse of the insolvency process, conducting due diligence and, where warranted, approach the adjudicating authority under Sections 60(5) and 65 of the Insolvency and Bankruptcy Code (IBC).
“Recently, the Board has received information from law-enforcement and regulatory agencies indicating that the CIRP framework is being misused in a few cases.…IPs, given their access to the books, records and CoC proceedings of the corporate debtor, are under a non-delegable duty to examine such indicators and place them before the Adjudicating Authority,” IBBI said.
Legal experts are now weighing how IPs should distinguish genuine red flags from ordinary features of distressed corporate finance.
‘IP cannot act on mere suspicion’
The discussion paper, issued on August 14, seeks stakeholder comments on a proposed circular that IBBI says is intended to strengthen the integrity of CIRP. The regulator has pointed to instances where insolvency proceedings may allegedly have been used for purposes other than resolution or liquidation, including settling debts outside the ordinary recovery process, mitigating tax or other statutory liabilities, avoiding regulatory scrutiny or investigations, and monetising or ring-fencing assets.Manmeet Singh, partner at Cyril Amarchand Mangaldas, said the proposed framework should not result in Section 65 applications being filed merely because one or more indicators are present.
“While the IPs may not always have evidence to conclusively establish fraudulent initiation, yet at the same time the IP cannot act on mere suspicion and any application must be backed by at least some material making out a prima facie case of fraudulent initiation,” Singh said.
He suggested that the standard could be compared with the approach adopted for initiating proceedings concerning preferential and other transactions under Regulation 35A of the CIRP Regulations. He also pointed to the US approach to bad-faith insolvency filings, where the party alleging bad faith must first establish a prima facie case before the burden shifts to the debtor.
Anoop Rawat, partner and national practice head – insolvency & restructuring, said that the proposed guidance could create behavioural pressure on IPs to file applications simply to protect themselves from regulatory scrutiny.
“The establishment of malicious or fraudulent intent may require proof of mens rea and cannot be a prima facie exercise of judgment by IPs relying upon the mere existence of the indicators set out in the draft circular,” Rawat said. “The existence of an explicit circular obligating the IPs to file such applications after making a considered opinion may behaviorally force the IPs to err on the side of caution and file applications, to avoid any personal regulatory scrutiny,” he added.
Vijay Nair, senior partner at KNM & Partners Law Offices, said, “Section 65 should be invoked only when, after examining the available material and the surrounding circumstances, the IP forms a considered opinion that the CIRP was initiated for a purpose other than genuine resolution. Otherwise, indiscriminate applications could dilute the exceptional nature of Section 65.”
Experts seek wider net, caution against treating commercial realities as CIRP abuse
Under the proposed framework, IPs would be expected to remain alert to a series of indicators, including companies with negligible operations or assets, substantial related-party exposures, qualified audit opinions, links to regulatory or enforcement proceedings, a single creditor acquiring or holding a dominant position in the Committee of Creditors (CoC), clusters of connected companies entering CIRP around the same time, weak participation in the resolution process and inadequate valuation support. The list, however, is expressly described as illustrative and non-exhaustive.
Legal experts have suggested that the list should capture a wider range of transactions that could indicate an attempt to manipulate the insolvency process, while cautioning that such indicators should not be treated as conclusive evidence of fraud or malice.
Singh said IBBI could consider circumstances suggesting ever-greening or round-tripping of loans, such as where debt enters the corporate debtor and moves out shortly afterwards, or where a default occurs soon after a loan is extended or a guarantee is called.
He, however, stressed that IPs must examine each red flag on its merits and assess its commercial substance and bona fide. “Very often ARCs aggregate debt before taking the borrower into insolvency and therefore, IPs should examine such transactions on merits and exercise caution before rushing to paint legitimate commercial transactions as being the basis of a malicious initiation,” Singh said.
Rawat pointed to special purpose vehicles or project-specific subsidiaries with limited operations, related-party loans arising from group treasury arrangements, clusters of connected companies entering CIRP because of group-wide financial stress, and recurring resolution applicants in integrated businesses or thin markets. “The correct approach, therefore, is not to expand the list but to treat it as illustrative and non-exhaustive,”
Rawat said, adding that no single indicator or combination of indicators should replace a considered, evidence-based determination that CIRP was initiated for a purpose other than resolution or liquidation.
Nair suggested that the list could additionally cover unusual last-minute restructuring or assignment of debt before CIRP, suppression of material information, unexplained changes in creditor structure immediately before initiation, and transactions that appear designed to manufacture control over the CoC.
However, Nair said these indicators should remain expressly non-conclusive, with the IP considering factors including materiality, timing, commercial rationale and documentary evidence, while giving stakeholders an opportunity to explain the circumstances before filing a Section 65 application.
Experts call for clearer legal thresholds
Nair said the draft could be strengthened by clarifying the threshold for treating conduct as a red flag, reporting suspected abuse and ultimately establishing fraud or malicious intent.
He suggested that indicators such as last-minute restructuring or debt assignments, suppression of material information, unexplained changes in creditor structure and transactions apparently designed to manufacture control over the CoC could be considered. But he stressed that these indicators should remain non-conclusive, with timing, commercial rationale, documentary evidence and an opportunity to explain the circumstances forming part of the IP’s assessment.
For Singh, another area deserving explicit attention is Section 29A, which restricts certain related parties of promoters from becoming resolution applicants. “It would be important to specifically refer to Section 29A barring related parties of the promoter from becoming resolution applicants since there is abuse happening notwithstanding the restriction under the Code,” he said.
“In its current shape, the draft circular only tells the IPs what to look for and where to report it for the purposes of Section 65 but fails to acknowledge the structural disincentives and legal issues associated with challenges by IPs to malicious or fraudulent initiation of CIRP,” said Rawat.
“In applications under Section 7 and 9 of IBC, the financial creditors are required to and the operational creditors may (and they often do) nominate the interim resolution professional to be appointed. In each of these routes, the IP owes their appointment to the applicant creditor that initiated the process. Expecting an IP nominated by the applicant creditor to turn around and file a Section 65 application against their appointer may be practically unrealistic. The only scenario in which an IP may be structurally incentivized to consider such evaluation is when the CIRP is admitted under a Section 10 application, where the corporate applicant lacks the power to nominate an IP,” Rawat concluded.
The IBBI paper itself emphasises that the proposed circular is explanatory and is not intended to create a new substantive obligation beyond existing statutory duties. It is designed to promote consistency in how IPs discharge those duties.
The regulator has invited stakeholder comments until August 24.
