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How amendments in IBC could put Family Trusts in the dock

How amendments in IBC could put Family Trusts in the dock

04 Jul 2021

The recent Supreme Court ruling, confirming the amendment to Insolvency Bankruptcy Code allowing creditors to proceed against personal guarantors of defaulting companies to recover debt has not only opened up a new dimension in the corporate insolvency resolution, but also caused a furor among the promoter families.

In Lalit Kumar Jain vs Union of India, 2021, the Supreme Court upheld the Insolvency and Bankruptcy Rules, 2019 notified by the Indian Government on 15 November 2019 (effective from 1 December 2019) paving way for lenders to go ahead with proceedings for recovery initiated against personal guarantors to corporate debtors undergoing CIRP (corporate insolvency resolution process), in any Court or Tribunal.

While this latest decision of the apex court upheld the strengthening of the legal provisions under the Insolvency and Bankruptcy Code, 2016, it has also given rise to concerns among the business community, given most of the companies are run by business families. This decision by the country’s highest court has left the personal guarantors in a tight spot by consolidating the actions against them to NCLT and moving away from civil courts, presumably in an effort to achieve time bound recovery. What is especially worrisome is the quantum of assets that the Personal Guarantors can be left with after a successful action.

Having anticipated this, in recent years, promoters have been structuring Trusts to ring-fence their personal assets, and questions have been raised about the protection offered by these Trusts, commonly referred to as Asset Protection Trusts.

Does this mean the Asset Protection Trusts are out or, if already made, need to be dissolved? It is important to note that the Trusts are themselves not being questioned here, but the transfer of property to the Trust if done with an intention to defraud creditors.

Transfers which have been carried out validly of assets which did not form a part of the personal guarantee would not fall under the definition of voidable transfers, and thus would continue to be protected. If a trust comprises assets which are a mix of fraudulent transfers and rightful transfers, the Trust will continue to the extent of rightful transfers.

However, it is for the creditors to prove that transfer to the trust fund has been done with mala fide intentions. Such transactions are termed as PUFE (Preferential, Undervalued, Fraudulent and Extortionate) transactions. At this juncture it is pertinent to note that the Code provides a look-back period only for PUE transactions and not for fraudulent transactions. For this, we will need to refer to S17 of the Limitation Act.

Hence for assets settled in Asset Protection Trusts, the timing of setting up the Trusts or of settlement of such assets is of utmost importance.

In the case of B.K. Educational Services (P.) Ltd. v. Parag Gupta & Associates, it was held by the SC that the provisions of the Limitations Act, 1963 would apply to any claims filed by creditors under IBC from the date of promulgation of the Code. While this application of the Limitation Act has not been extended to Personal Guarantors per se, an inference can be drawn that it will be extended to personal guarantors as well since Section 238A of IBC doesn’t differentiate among types of debtors for the application of the Limitation Act, 1963. Under the Limitation Act, the time period prescribed for bringing an action against any such transfer is specified as three years. However, the time when such a limitation would begin will depend on Sections 17, 18 and 19 of the Limitation Act.

For the Settlors of asset protection trusts, Section 5 of the Notification read with Section 79(14) of the IBC provides guidance on the specific assets to be excluded. The list of these assets does not include assets held in Trusts. Further, Section 79(14)(d) provides that ‘any unencumbered life insurance policy or pension plan taken in the name of debtor or his immediate family” shall be considered an excluded asset for the purposes of invocation of Personal Guarantee.

Thus, properly drafted Trusts where assets have been settled with due care and well in time should continue to enjoy Asset Protection. It is highly recommended that families and Trustees examine the Trusts and each transfer carefully to maintain trust integrity.

However, it needs to be seen how the law is interpreted if the promoter happens to be a personal guarantor.

Authored by Ashvini Chopra, Executive Director-Family Office at Avendus Wealth and Sanjay Rego, a Chartered Accountant and a practicing attorney. The views are their own).