PMLA v. IBC – Why should the Government have all the fun?

We have been working on a liquidation mandate wherein as soon as the liquidation process started, the Directorate of Enforcement (“ED”) and the Income Tax Department attached the properties of the Corporate Debtor.  The question whether ED could attach these properties has been sub judice for over a year now and it seems unlikely that the issue will be settled in the near future. Till the matter gets resolved, the value of the properties will keep diminishing and perhaps, the recoveries of the creditors will go down substantially. This led us to think whether there is a solution to the conflict between the creditors’ interest in the properties versus the State’s actions aimed towards preventing money laundering.

We are not going to get into the legality of ED attachments during the CIRP and the liquidation process. Enough has been said about it and the matter is before the Supreme Court at least for the CIRP process (See Committee of Creditors v. Directorate Of Enforcement & Ors., Special Leave to Appeal (C) Nos.29327-29328/2019). What we wish to examine is, can the law provide a win-win situation for all stakeholders, including the Government, in such cases? 

Here is what we know about the liquidation process under the IBC:

  1. The money realised from the sale of assets goes to the creditors (unless there is some money left for shareholders after the distribution of assets);
  2. In most cases, only the secured creditors get some recovery as the liquidation estate generally does not even cover the pay out to the secured creditors. In all likelihood, no payments will be made to the promoters of the Corporate Debtor as they as equity shareholders are placed at the bottom of the waterfall;
  3. This is an NCLT supervised process. Liquidator appointed by NCLT conducts the Liquidation Process. Promoters of the Corporate Debtor have no say in the liquidation process.

And here is what we know about ED attachments under PMLA:

  1. Attachments are ordered so that there is no transfer of the properties by the accused as these properties are believed to be a proceeds of crime;
  2. ED has to file a complaint stating the facts of such attachment before the PMLA Adjudicating Authority within 30 days of issuance of the provisional attachment order;
  3. PMLA Adjudicating Authority has 180 days from the date of provisional attachment to confirm the attachment; 
  4. If, on conclusion of a trial under the PMLA, the Special Court finds that the offence of money-laundering has been committed, it orders that such property involved in the money-laundering or which has been used for commission of the offence of money-laundering shall stand confiscated to the Central Government, thereby vesting absolutely in the Central Government, all the rights and title in such property, free from all encumbrances;
  5. These properties so confiscated may also be directed by the Central Government to be sold.

So after all the song and dance, the net result that the attachment achieves is the vesting of assets so attached in the Government of India and the money from sale of such confiscated assets going to the Government of India. So the entire issue boils down to who will have a better claim over a property which is or is deemed to be a proceed of crime, i.e., if PMLA is invoked then would the claim of the Central Government take precedence over the claim of the secured creditors?

IBC is very clear about the priority of claims and if the same priority is applied here too, then the dues payable to the Central Government would be ranked with the debts to the secured creditors remaining unpaid after enforcement of security interest. Based on this argument, the Central Government should have honoured the waterfall. And why not? It is giving up huge revenues on account of non-payment of Income Tax dues, GST dues and other dues in the CIRP resolutions too. What makes the money that comes in from the proceeds of crime more sacrosanct than the tax dues? Did we hear you say “… but it is a criminal proceeding”? Well, but what does the attachment of property have to do with the criminal proceedings? It doesn’t have any evidentiary value in the criminal proceedings. All the Central Government is going to do is confiscate the property and, in all likelihood, sell it.

However, such an ideal solution would be a win for the secured creditors and a loss for the Central Government. Remember what we set out to do? Yes, find a win-win situation. 

So hear us out. What we believe can be a win win solution is this:

  1. Let the provisional attachment order continue till filing of complaint by the ED with the PMLA adjudicating authority. In this complaint, ED may make the secured creditors as accused or may only complaint against the promoters. 
  2. If it does not consider the secured creditors as an accomplice in the crime, then let the liquidation process continue and distribute the assets in accordance with the waterfall provided in IBC. 
  3. If the secured creditors are also named accused in the complaint, then too proceed with the liquidation process. Sell the liquidation estate and keep the funds in an interest bearing account with a lien marked in favour of the Central Government. Should the Special Court find that the offence of money-laundering has been committed, the value of the proceeds of crime and the properties so involved in money-laundering goes to the Central Government. If not, distribute it amongst the creditors.

Why are we advocating this solution?

  1. IBC and PMLA cannot work in silos or at cross purposes. As long as the sale of assets by the Liquidator does not jeopardize the criminal proceedings, such sale should be allowed. What if the attachments are vacated by the PMLA Adjudicating Authority or Appellate Tribunal after months or even years of litigation? What if the properties on which the attachment is confirmed are released, as the Special Court finds that the offence of money-laundering has not taken place or the property is not involved in money-laundering  The only party that suffers the harm is the creditor of such company. To mitigate such risk, we need to find a solution which balances the interest of the creditors and the Central Government. The objective of PMLA was never to make money for the Central Government. An attachment helps in preventing a wrongful gain. However, it should not cause a wrongful loss to the party which is not accused of the crime. In an ideal world, the Central Government (through ED) would have taken a sensible approach and let IBC take precedence over recovery through PMLA.
  2. As the PMLA Appellate Tribunal has observed, depriving the secured creditors of quick recovery even though they did not participate in the crime and were bona fide parties to the mortgage/hypothecation transactions would be doing a disservice as it is the public money that is involved in these proceedings. (See Bank of India v. The Deputy Director Directorate of Enforcement, Mumbai, FPA-PMLA-2173/MUM/2018)
  3. IBC has no provision which takes into account an attachment on account of criminal proceedings. What about Section 32A, you say? Well, the less said about it the better. It reads “where such property is covered under … sale of liquidation assets under the provisions of Chapter III of Part II of this Code to a person, who was not – (i) a promoter or in the management or control of the corporate debtor or a related party of such a person; or (ii) a person with regard to whom the relevant investigating authority has, on the basis of material in its possession, reason to believe that he had abetted or conspired for the commission of the offence, and has submitted or filed a report or a complaint to the relevant statutory authority or Court.” So it only provides relief (if at all) to the person who bought the assets under the liquidation process. It still does not answer the question – how does a Liquidator liquidate the company if its assets are attached by the ED? Remember that there is a cost of maintaining the company alive – liquidator’s fee, fee of professionals, employees (if there are any), etc. It is the stakeholders (generally the secured creditors) who bear this cost. They lose their money with no prospects of recovery in the immediate future and are saddled with the burden of bearing these additional costs. No wonder, a number of insolvency professionals are finding it hard to make the secured creditors contribute funds to meet liquidation costs. 

To conclude, we believe that IBC and PMLA cannot work at cross purposes. Since public money is involved and genuine transactions are in any event given protection under PMLA, it makes sense for the Courts to ignore the attachment orders for purposes of liquidation of the Company and the sale of liquidation estate should not be affected by such attachment orders. Post sale, distribution of the liquidation proceeds can be done in accordance with IBC except only in those cases where the genuineness of security creation is also questioned by ED. In such cases, the funds may be kept in an escrow till the Special Court takes a decision and be distributed to the Central Government or the creditors, as the case may be, depending on the judgement of the Special Court. 

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