Insolvency and related considerations for directors

Directors of a company in financial difficulty should be aware that their conduct may be subject to close scrutiny if the company falls into insolvency under the Insolvency and Bankruptcy Code, 2016, as amended. Courts have held that unless all measures have been taken to revive the company, the making of a winding-up order may not be in the best interests of creditors, and going concern values may result in higher repayments to the creditors. The directors should therefore take all steps to ensure that the company continues as a going concern. In this regard, directors should be able to defend their actions provided that they were made in good faith. However, when there is no reasonable prospect of the creditors ever recovering debts due to them from the company, courts may infer that any efforts to carry on the business were attempts to defraud creditors.

Section 166 of the Companies Act, 2013, as amended, which codifies the duties of directors, does not expressly recognize a duty in the event of potential or actual insolvency towards creditors as the company’s primary risk-bearers. Further, courts have held that the code is a beneficial legislation intended to put a corporate debtor back on its feet and not merely a statute for recovery by creditors. However, the code does contain protective provisions in relation to transactions that may be undervalued, preferential, extortionate, fraudulent or amount to wrongful trading. The conduct of directors who have authorized such transactions may be called into question and, in certain circumstances, such directors may incur personal liability. Following insolvency, such transactions may be declared void upon an application by the insolvency resolution professional or liquidator. Directors must therefore ensure that: (i) any transfer of property or assets transferred is valued appropriately and does not give preference to any creditor; (ii) the terms of any credit transaction do not involve exorbitant payments; and (iii) the company does not enter into any transactions that may be viewed as fraudulent or wrongful trading.

Shivaji Bhattacharya is a partner and Prateek Sharma is an associate at S&R Associates, a law firm with offices in New Delhi and Mumbai.

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Author email:
sbhattacharya@snrlaw.in | psharma@snrlaw.in