Extortionate Credit Transactions under IBC

The Insolvency and Bankruptcy Code (IBC) 2016 has emerged as a comprehensive framework to address the insolvency and bankruptcy issues in India. Among its various provisions, the concept of extortionate credit transactions stands out as a critical safeguard to protect corporate debtors from being exploited through unfair and exorbitant credit arrangements. 

What are Extortionate Credit Transactions?

Extortionate credit transactions refer to credit arrangements in which a corporate debtor is required to make payments on terms that are excessively unfair or exorbitant in relation to the value of the credit provided. Such transactions are typically characterised by unusually high interest rates, unconscionable repayment terms and other exploitative conditions that do not reflect the actual risk undertaken by the creditor.

Under Insolvency and Bankruptcy Code, extortionate credit transactions are identified and addressed to protect the interests of the corporate debtor during the insolvency process. These transactions are subject to challenge and can be avoided or modified to ensure that the debtor is not unduly burdened by unfair debt obligations.

Laws Governing Extortionate Credit Transactions

The provisions relating to extortionate credit transactions are primarily found in Sections 50 and 51 of the IBC, 2016. Additionally, specific regulations such as the Insolvency and Bankruptcy Board of India (Liquidation Process) Regulations, 2016 and the Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations, 2016 (CIRP Regulations) provide further clarity on the scope and application of these provisions.

Section 50 of the IBC, 2016

Section 50 is the cornerstone provision that defines and regulates extortionate credit transactions. It empowers the Resolution Professional (RP) or the liquidator to seek the avoidance of transactions that involve the corporate debtor making exorbitant payments in respect of financial or operational debt received during a specified period.

Key Provisions of Section 50:

• Definition of Extortionate Credit Transactions: Section 50(1) defines extortionate credit transactions as those transactions in which the terms are grossly unfair to the debtor and require the debtor to make exorbitant payments.
• Look-back Period: Section 50(2) specifies that only transactions entered into within the two years preceding the insolvency commencement date can be challenged as extortionate. This two-year period is referred to as the “look-back period.”
• Application to Adjudicating Authority: The RP or liquidator can file an application before the Adjudicating Authority (National Company Law Tribunal or NCLT) to seek avoidance of such transactions.

Section 51 of the IBC, 2016

Section 51 complements Section 50 by detailing the actions that the Adjudicating Authority can take if it finds that a transaction qualifies as an extortionate credit transaction. The NCLT is empowered to:

• Restore the Position: Restore the position that existed before the transaction.
• Set Aside the Debt: Set aside the whole or part of the debt created by the extortionate credit transaction.
• Modify Terms: Modify the terms of the transaction to ensure fairness.
• Repayment: Require any party to the transaction to repay any amount received due to the extortionate transaction.
• Relinquishment of Security: Require any security interest created as part of the transaction to be relinquished in favor of the liquidator or RP.

Criteria for Identifying Extortionate Credit Transactions

The identification of extortionate credit transactions is based on the principles laid down in the IBC and the associated regulations. Regulation 5 of the CIRP Regulations outlines specific criteria to determine whether a transaction qualifies as extortionate. These include:

• Exorbitant Payments: The transaction involves the debtor making exorbitant payments in respect of the credit provided.
• Unconscionable Terms: The terms of the transaction are unconscionable under the principles of law relating to contracts.

The determination of what constitutes “exorbitant” or “unconscionable” is made on a case-by-case basis, considering the specific facts and circumstances of the transaction.

Exceptions to Extortionate Credit Transactions

It is important to note that not all transactions with high-interest rates or stringent terms are automatically considered extortionate. The explanation to Section 50 clarifies that any debt extended by a financial services provider under applicable law is not to be considered an extortionate credit transaction. This exception ensures that lawful transactions in compliance with regulatory standards are not unfairly penalised under the IBC.

Role of Adjudicating Authorities in Extortionate Credit Transactions

The NCLT plays a pivotal role in adjudicating disputes related to extortionate credit transactions. Upon receiving an application from the RP or liquidator, the NCLT examines the terms of the transaction to determine whether they are indeed exorbitant or unconscionable. If satisfied that the transaction qualifies as extortionate, the NCLT has the authority to take corrective action as outlined in Section 51.

The NCLT’s orders can have significant implications for both the debtor and the creditor. By setting aside or modifying the terms of the transaction, the NCLT can alleviate the financial burden on the debtor and ensure a more equitable outcome in the insolvency process.

Judicial Interpretations and Case Laws on Extortionate Credit Transactions

The interpretation and application of the provisions related to extortionate credit transactions have been the subject of various judicial decisions. One notable case is Shinhan Bank v. Sungil India Private Limited and Others, where the National Company Law Appellate Tribunal (NCLAT) examined the concept of extortionate credit transactions in the context of high-interest loans.

In this case, the corporate debtor had agreed to a loan with an interest rate of 65%. The NCLAT ruled that such an interest rate constituted an extortionate credit transaction under Section 50 of the IBC. The Tribunal further clarified that creditors charging exorbitant rates, especially when they are unsecured, do not fall under the category of financial creditors under the Code and must seek alternative remedies.

This ruling underscores the importance of balancing the rights and obligations of both debtors and creditors in the insolvency process. It also highlights the role of the NCLAT in interpreting the provisions of the IBC to ensure that the Code’s objectives are met.

Interest Rate Guidelines

The NCLAT’s decision in the Shinhan Bank case also provided guidance on what constitutes an “exorbitant” interest rate. The Tribunal observed that the maximum interest rate that may be charged by private individuals is 24%. Any transaction requiring payments above this threshold may be considered extortionate and subject to avoidance under Section 50.

Impact of Extortionate Credit Transactions on Corporate Insolvency Resolution Process

The provisions related to extortionate credit transactions have a significant impact on the Corporate Insolvency Resolution Process (CIRP). By allowing the avoidance of unfair credit arrangements, these provisions help ensure that the resolution process is conducted in a fair and equitable manner.

For corporate debtors, the ability to challenge extortionate credit transactions provides a critical avenue for relief. It enables debtors to avoid being saddled with unsustainable debt obligations, thereby improving their chances of successful resolution.

For creditors, these provisions serve as a reminder to ensure that the terms of credit transactions are fair and reasonable. Creditors who engage in extortionate practices risk having their claims set aside or modified by the NCLT, which can have significant financial implications.

Conclusion

The concept of extortionate credit transactions under the Insolvency and Bankruptcy Code, 2016, is a vital safeguard designed to protect corporate debtors from exploitative credit arrangements. By providing a mechanism to challenge and avoid such transactions, the IBC ensures that the insolvency process is conducted in a manner that is fair, equitable and in line with the principles of justice.

The legal framework governing extortionate credit transactions is well-defined, with Sections 50 and 51 of the IBC providing the necessary provisions for identifying and addressing such transactions. The role of the NCLT and NCLAT in adjudicating disputes related to extortionate credit transactions further strengthens the efficacy of these provisions.