IBBI comes up with 'red flags' for IPs to detect avoidance transactions

The document provides guidelines to insolvency professionals (IPs) for understanding certain warnings, or red flags, in this regard.

It noted that the IPs should gain a thorough understanding of the nature of business of the concerned entity or the corporate debtor. Certain categories of enterprises operating in domains such as trading infrastructure, construction, EPC contracts, real estate, power, steel among others may be more prone to avoidance transactions than others, it said.

"Any material changes to the business operations such as acquisition of a new division, sale of a division or a part of the undertaking, new investments in other entities, divestments, transfers of intangible assets of the CD (corporate debtor) such as brands, sale of large part of fixed assets or certain categories of fixed assets etc need to be specifically understood as these may be potential red flags," the IBBI document said.

The segment reporting in the annual financial statements of an entity would provide some insights on various business segments of the corporate debtor, it said.

Further, it said that entities marked by complex or unusual transaction structures such as sole selling arrangements, sole buying arrangements, pre-buy decisions, single sourcing strategies without competitive sourcing, high level of import-export and other related forex transactions etc may also be considered as an entity level red flag.

High level of trading transactions in case of non-trading entities is also a potential red flag, it said.

The document prepared for aiding IPs also said that IPs should review if the affairs of the company, financial as well as operations-related matters were handled by a competent team in place.

If such teams were inadequate or absent, the same may be a red flag with possibility of avoidance transactions having occurred due to lack of relevant checks and balances.

"The Directors being disqualified under Sec 164(2) of the Companies Act, 2013 for non-filing of Annual Financial Statements pertaining to the CD is a red flag," it said among other suggestions.

The Insolvency and Bankruptcy Code mandates the resolution professional and the liquidator to determine if the corporate debtor has been subject to avoidance transactions such as preferential transactions, fraudulent transactions, undervalued transactions, and extortionate transactions in the past.

In case there have been instances of avoidance transactions, the IBC casts an obligation on the insolvency professional to file an application to the adjudicating authority for appropriate directions.

The code enables the IP or liquidator to facilitate the claw-back or disgorgement of value, if any, lost through avoidance transactions and is aligned with the objective of maximisation of value of the assets of the corporate debtor for the relevant stakeholders.