Forensic Audit: Preventing the Abuse of Insolvency Code

The significance of forensic audit has gained paramount importance as the corporate debtors are moving for restructuring and bidding themselves for stressed assets. The concern has gained momentum particularly after the Essar Steel & Bhushan Steel has undergone Insolvency process and news of their promoters bidding for stressed assets has been in media. The bankruptcy of the corporate debtors may be due to the genuine business losses suffered by the corporate debtor arising out of arising out of variety of adverse economic condition beyond the control of the corporate debtors. It may be due to the misappropriation or fraud played by the corporate, siphoning the public or bank’s money. In case of siphoning the funds, the act of the corporate debtors to exploit the Insolvency process and getting the haircut of the liabilities or bidding for the stressed assets is getting advantage out of it’s own wrong. 

The imperative need is felt to bridge this gap so that the dubious or fraudulent promoters may not exploit the gap playing further scam with various stake holders such as financial institution, revenue departments or public. Such an outcome would seriously hamper the effort of the government to revitalise the economy or improve the financial discipline in the country. The filling of such a lacuna requires the conducting of the forensic audit of the corporate debtor to rule out the possibility of any fraud perpetrated by the promoters in the corporate debtor themselves particularly when corporate debtors approaches for insolvency proceedings or bid for the stressed assets in the liquidation proceedings. In case of no fraud, the genuine promoters may be allowed to proceed for insolvency proceedings or bidding for stressed assets and in situation of fraud/siphoning, the promoters may be charged and misappropriated funds be recovered.

In fact, the Insolvency & Bankruptcy Code itself put the duty or obligation on the Insolvency Professional which requires the adoption of the forensic audit approach. The code also cast a duty on the Insolvency Professional to report the preferential, undervalued, overvalued, defrauding and extortionate transactions executed by the promoters to unjustly benefit themselves, their relatives or other persons and such transactions are to be reported to the Adjudicating Authority who has the power to reverse the transactions or direct the beneficiary to refund the undue benefit obtained by him. Even in case of fraudulent transaction, the adjudicating authority may direct the accused promoters to compensate the loss caused to the creditors of the corporate debtor and even order the stay on the asset of corporate debtor. However, identifying such transactions and collecting the admissible evidence is a tedious & complicated task which not only required specialized knowledge but also technical skill.

The verdict  of Raju Ramalinga case reveals that substantial evidence of siphoning of funds to various shell companies, had to be recovered forensically from the computer and prosecution  has to engage various financial or computer experts to prove the trail of evidence and most of challenges are to the admissibility of technical & financial evidence. As a result, the task of the Insolvency professional itself is of forensic auditor and given the role, an Insolvency Professional has to play and complete the proceedings within 180 days, he has no option but to engage to the forensic auditor to perform his obligation under the law. The code provide for grievance redressal, monitoring of insolvency professionals,  disciplinary proceedings  and serious action against insolvency professionals for lapse in performance of obligation under the code.

Section 18 of the Code cast a duty on IP to collect information relation to the assets, finance or operations of the corporate debtor for the last two years and then to determine the financial position of the corporate debtor. Insolvency Professional cannot comply with this obligation independently and objectively, and therefore, the code provide the power under section 20 to appoint accountants, legal or other professional to perform his obligations under the code. The code under section 17 & 19 also provide the power to control the books of accounts and to seek any information from the promoters as well as the government department .

The Creditor can also report such dubious transactions to the Insolvency Professional who is under obligation to act on them and to report to Adjudicating Authority for remedial measure failing with Insolvency Professional is liable for disciplinary action. In event of failure of Insolvency Professional to act on such dubious transactions, the creditor also can file the application with the Adjudicating Authority. Thus, Insolvency Professional can engage the forensic auditor on it’s own  to perform his duty under section 18 as well as to meet the obligation of reporting, collecting and reporting of dubious transactions to the Adjudicating Authority. The creditor as well as the partner of corporate debtor also can file the application for setting aside such dubious transactions and for establishing such claim, the services of the forensic auditor may be required. Rather, the appointment of the expert like forensic auditor may be in larger interest as proving such dubious transactions would require establishing the chain of custody with admissible evidence otherwise, the interest of the creditors & other stakeholder  may not be protected for failure to prove the dubious transactions.

The State Bank of India took proactive steps whereby it ordered for forensic audit of M/s Videocon Industries before the company could approach for restructuring under the code to rule out the possibility of mismanagement. The Reserve Bank of India had already instructed all the banks to conduct the forensic audit of the companies having huge NPA.  The forensic audit process is inherent part of the insolvency proceeding not only to meet the objective underlying the code  but also to prevent the misuse of the code by the dubious promoters.