The Insolvency and Bankruptcy Code, 2016 (IBC Code) subsumed all previous legislation pertaining to insolvency and restructuring. The Code adopted the creditor-in-control model wherein the creditors will manage the affairs of the company under insolvency. One significant feature of creditor-in-possession of the corporate debtor (an entity under resolution) is the ousting of equity-led control of the company. As directors represent the interests of the shareholders of an entity and with a very closely knitted practice of constitution of board members in the Indian corporate regime, this becomes even more significant. Although, it creates a potential issue of non-cooperation of the board with the new creditor-based management (called the committee of creditors under Insolvency and Bankruptcy Code, 2016), supervised by the designated Insolvency Professional. Although, a remedy has been provided under Section 19 (2) of IBC to ensure compliance and cooperation, but with every such application turned into litigation creates a hindrance on the ultimate objective of the legislation, i.e., time-bound, and expeditious restructuring of the company.
In furtherance of the same, the role of directors in a ‘twilight zone’ is underrated yet crucial. Twilight zone is not defined under Indian jurisprudence. The concept is understood from the contemporary comparative understanding which suggests that when a company is nearing insolvency or there is apprehension the financial stability is deteriorating, and the entity is under financial distress leading to the potential insolvency. The duties of the directors towards the shareholders are firmly entrenched and not disputed. However, when the company is nearing the twilight phase, whether the duty of the director shifts from the shareholders to the creditors is a matter of deliberation. One notion suggests that creditors will face the brunt of losses and their potential risk must be minimized by the favourable decisions and due diligence offered by the board. Whereas the more positivist approach suggests that the directors represent the interests of the shareholders, and they have a ‘fiduciary relationship’ with them. Here, the fiduciary relationship signifies the duty of the one party to act in the benefit and interest of others. It can also be argued that the equity investors subscribe to the high risk-high reward theory and in the scenario of initiation of insolvency they are bound to face financial stress.
In a jurisdiction like the United Kingdom, where the duties of the directors are mentioned under the statute itself, sufficient breathing space is provided to them nearing insolvency, however, a duty has been cast upon such director to protect the interests of the creditors when a company is in the twilight zone. The creation of such liability demarcates the responsibilities of the director from the shareholder’s interest to the creditors and this visible shift of the interests is statute-backed in the United Kingdom. This also creates an apparent problem of understanding the initiation of the twilight zone. From the Director’s perspective, there can be bonafide transactions nearing the threshold of the twilight zone which are not benign to the creditors however, due to the duty casted upon them, they might be dissuaded from such duties to be observed.
However, the position under Indian law is different to that of the United Kingdom, certain duties and obligations are imposed upon the directors under the Indian Companies Act, 2013, albeit it does not specifically talk about the shift in interests during the initiation of the twilight zone and direct responsibility of the board towards the creditors. Having said that, comprehending the initiation of the twilight zone is of utmost importance to understand the shift in responsibilities from the Indian insolvency system perspective.
One guiding principle to understand the initiation of twilight zone under the Insolvency Regime is Section 66 (1) of the Insolvency and Bankruptcy Code, 2016 (IBC/Code). Interestingly, under the said provision, a personal liability is also casted upon the director to ensure due diligence and in case of failure of such exercise the director shall be liable to make such contributions to the assets of the corporate debtor. Although, it is not easy to identify the twilight period with acute precision. For instance in Anuj Jain Interim Resolution Professional vs Axis Bank Limited & Ors[1], it was stated “that when the directors of the corporate debtor knew that the defaults were declared Non-Performing Assets (NPA) by majority of creditors and hence directors were fully aware that they were in the twilight zone and insolvency was imminent, they ought to have exercised due diligence in minimizing the potential loss to the creditors but they entered into such transactions which ex facie gave benefits to the related party”.
Although, the twilight zone under this instance was fairly easy to comprehend as most of the creditors declared defaults as NPAs and hence, insolvency was imminent. However, in instances where due to bad-management, failure in assessment of expansion plans, market and industrial related factors and most importantly poor decision making by the promoters may also lead the company into insolvency and therefore the boundary again blurs in such scenario on the liability of the directors. It is undisputed that nearing insolvency, the directors must accord special care to the interests of the creditors as they are the potential risk bearers in such a case.
However, the directors till the very date when insolvency commences are liable only to the shareholders and enjoys fiduciary relationship along with contractual obligation with them, in such an event, casting liability for the interests of creditors especially when directors after conducting requisite due diligence may perform certain transaction which can be classified as avoidance transactions due to commencement of twilight zone without the due ‘fraudulent intent’ of such directors.
Under the Insolvency and Bankruptcy Code itself the look back period for certain transactions can provide assistance in determining the initiation of the twilight period. However, there is a difference between the look back period and twilight zone. As per the scheme of the Code it distinctly provides a remedy for any transaction which falls within the look back period whereas for twilight zone there is no any specific remedy available.
For any transaction to be classified as a preferential, undervalued, or extortionate credit transaction, it need not be entered into during the twilight zone. The point of consideration is that if such a transaction is entered into during the lookback period, then it automatically triggers the respective provisions irrespective of the intent of the director before authorising such transactions. However, Sections 49 and 66 of the Code provide for those transactions which are intended at defrauding the creditor and the element of fraud is essential to establish the intention of such defrauders. For both undervalued and fraudulent transactions, there is no lookback period specified under the respective sections, whereas we have traces for the twilight zone specified in the context of wrongful trading. However, to ascertain such period is still ambiguous.
Hence, there is very limited jurisprudence especially under Indian context to understand the demarcation between the commencement of twilight zone. Lack of judicial precedents and clear demarcation under the statutes does not help the case either. Although certain principles have been derived to understand the shift in the liability and also the economic nature of the transactions involved makes it more subjective and circumstances based.
(This article is authored by Shivam Singhal, a registered Advocate in India. The author can be contacted at: shivamsinghal020@gmail.com)
[1] Anuj Jain Interim Resolution Professional vs Axis Bank Limited & Ors,2020 SCC Online SC 237
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