The Role of Forensic Auditors in PUFE Adjudications: Analysing the Increasing Reliance on Forensic Auditors’ Reports to Uncover PUFE Transactions

Himanshu Yadav*

Introduction

The title of this paper is self-explanatory, offering an insight into the issue under discussion. Although the National Company Law Tribunal (“NCLT”) relies on forensic auditors’ reports, there are currently no proper regulations available for forensic auditors. The significant sums of money involved in avoidance transactions undermine the principles of the Insolvency and Bankruptcy Code (“IBC”) and compromise the interests of creditors. Indian Institute of Insolvency Professionals of ICAI (“IIIPICAI”) has also mentioned in its study group report that “Forensic Accounting and Investigation Standards (“FAIS”) in the context of IBC, may be developed under the aegis of Insolvency Bankruptcy Board of India (“IBBI”). This would ensure uniformity and consistency in inputs, critical for better outcomes”.

Delay caused by Avoidance transactions

There are four main categories of avoidance transactions under the Code: preferential, undervalued, fraudulent, and extortionate credit transactions. These are commonly referred to as PUFE transactions covered under Sections 43, 45, 66, and 50 of the Code.

The Code requires the Resolution Professional (“RP”) and liquidator to assess whether the Corporate Debtor (“CD”) has previously engaged in avoidance transactions such as preferential, fraudulent, undervalued, or extortionate dealings. If any such transactions are identified, the Insolvency Professional (“IP”) is obligated to apply to the Adjudicating Authority (“AA”) for suitable orders.

The delay caused during the adjudication of the avoidance transaction creates significant distress to the creditors. The creditors are often found in a vulnerable state and with uncertainties. Firstly, the assets involved in suspicious transactions might have added value to the settlement process, which is the first loss to the debtor’s estate. The chances of a debtor’s settlement and creditors’ total recovery might be enhanced by the recovery of assets such as cash, key machinery, and even land. Secondly, adjudicating avoidance transactions is often a long and hefty process, leaving the assets in a deteriorated state, due to which the quality of assets degrades, thus leading to a reduction in the value of assets. As the finality of the conclusion remains distant and uncertain, this is likely to deter parties from investing significant effort in pursuing these proceedings. Creditors are now receiving, on average, just a small portion of their claims back through the liquidation and Corporate Insolvency Resolution Process (“CIRP”). If avoidance applications are dealt with expeditiously, they can be an important avenue to improve recoveries for creditors, especially where high-value assets are involved. A quick and effective mechanism to deal with avoidance applications is thus a critical missing piece in the current framework of the Code. To overcome this legal gap, appointing forensic Auditors to uncover such fraudulent transactions can be a go through. According to a study group report by the Indian Institute of Insolvency Professionals of ICAI (“IIIPI”), formulating Forensic Accounting and Investigation Standards (“FAIS”) specifically for the IBC, under the supervision of IBBI, would help establish consistency and standardisation in forensic inputs, which is essential for achieving more effective results.

Cracking Avoidance Transactions: Forensic Auditors to the Rescue

Currently, 1326 applications seeking avoidance of transactions have been filed with the AA till September 30, 2024, involving an amount of 3.76 lakh crore have been filed with the AA. Presented in Table 1.1.

Table 1.1

The avoidance transactions must not be left in the shadows, as forensic auditors play a crucial role in uncovering them. In various cases, the reports of forensic auditors have uncovered such transactions.

Forensic auditors are uniquely qualified to handle avoidance transactions due to their specialised skills in investigating complex financial records, tracing misappropriated funds, and identifying fraudulent patterns. They combine accounting expertise with legal understanding, enabling them to produce court-admissible evidence and assist in legal proceedings.  The report of a forensic audit is submitted as an ‘expert opinion’ and can also be presented in a court as evidence. Their work involves analysing internal controls, reconstructing transactions, and quantifying losses, tasks essential in proving fraudulent transfers or preferential transactions. Unlike regular auditors, forensic auditors go beyond routine checks and apply investigative techniques tailored to uncover hidden misconduct. Their expertise ensures that such transactions are thoroughly examined, appropriately challenged, and legally addressed.

Emphasis on the forensic auditor’s report

The forensic auditor’s role can play a highly impactful role while dealing with these avoidance transaction applications. These experts are skilled in the legal, accounting, auditing, and investigative methods associated with financial fraud, which can significantly aid the creditors to recover their money in a much more effective manner.

In India, auditors must report whether any fraud on or by the firm has been seen or reported throughout the year by the Companies (Auditors’ Report) Order, 2003. While forensic auditors go beyond the numbers, external auditors focus on the numbers.

The primary goal of an audit is to review the company’s financial records to ensure that the balance sheet and profit and loss statements are accurately prepared in line with legal requirements and that they genuinely reflect the company’s financial position. In contrast, the forensic auditing approach focuses on investigation. It goes beyond traditional auditing by thoroughly analysing, testing, and examining both civil and criminal issues, and ultimately providing an impartial and truthful report.

Critical analysis of different perspectives on a forensic auditor’s report

Appointing forensic auditors does not inherently guarantee the successful resolution of avoidance applications, as it is not a rule of thumb. A significant drawback that has been observed is that forensic auditors may sometimes overlook the fundamental essence of the IBC and the appropriate methodology for analysing avoidance transactions. Many forensic audit reports are either rejected or deemed insufficient by the AA, leading to stalled avoidance applications and unrealised recoveries.

In the case of Punjab National Bank v. Carnation Auto India (P.) Ltd., it was held that the liquidator’s application under Section 66, which was based on a forensic audit report, deserved to be dismissed because the report lacked substance and had not been conducted properly and thoroughly.

In contrast to the above, in the case of Bhupinder Singh V. Unitech Ltd., Unitech Ltd. was accused of large-scale misappropriation of funds by its promoters and directors. The company failed to deliver flats to nearly 29,800 homebuyers, despite collecting substantial advances. The Hon’ble Supreme Court ordered Grant Thornton to conduct a forensic audit for the accounts of Unitech Limited to ascertain any potential fraud on the part of the promoter or directors. The report of the forensic audit revealed that 29,800 home buyers have a sum totalling Rs. 14,270 crores, which failed to utilise approximately 40% of the funds for constructing or completing the project. Additionally, it also disclosed that Rs. 1,805.86 crores borrowed from financial institutions for development purposes failed to be used, 42% of it. Forensic auditors discovered evidence suggesting possible money laundering by the Unitech Group. Therefore, it was unequivocally declared that the aforementioned promoter directors had embezzled the money that homebuyers had paid them, moved it to tax havens, and engaged in business dealings with both revealed and undisclosed connected organisations.

Additionally, the Ahmedabad Bench of the NCLT ordered the promoters and suspended management of Sysco Industries Ltd. to deposit Rs. 7.78 crores back into the company. This decision was made following findings from a forensic audit report.

Recognising these concerns, the NCLT Mumbai in Mr. Girish Juneja v. Kailas Ramlal Pawar & Ors stated that:

“The IBBI may look into the qualitative aspect of Forensic and Transaction Auditor’s Report and may consider to hold one training session so as to equip them with the basic nuances of provisions relation to Avoidance Transactions contained in the Code and the expectation of the stake-holders from them in this regard.”

This recommendation stems from the fact that the RP and the forensic auditor have handled certain cases with a lack of diligence.

Way forward

The IBC does not specifically outline or mandate the involvement of forensic auditors in investigating avoidance transactions. However, the 185th Law Commission report, building on the 69th Report, suggested expanding the definition of “Expert Opinion”. The report fully supported these suggestions and emphasised the value of expertise, including in foreign law. It also recognised the relevance of knowledge in other fields like writing, trading, and inventory management. Under Indian Evidence law, the scope for accepting professional opinions from forensic auditors is quite broad, but there are no detailed rules that specifically address the role or profession of forensic auditors.

The expert’s view discussed does not include a test of partiality. This is mostly because of the legal uncertainty and vacuum surrounding the term “expert”. At the moment, the Indian framework only has clauses that urge financial auditors to expose fraud and inconsistencies. However, forensic auditors look for misstatements by looking beyond the data. The Evidence Act makes no mention of forensic auditors. Financial auditors only benefit from the whistleblower provision, which does not sufficiently incentivise them to start forensic auditing. The government must take the lead in hiring forensic specialists to look into financial crimes so that the scientific findings take precedence over inflated information.

Notably, Sections 25 and 29 of the code should be amended to formally empower the RP to appoint registered forensic auditors to identify PUFE Transactions only upon the approval of AA. This would expand the RP’s statutory duties by expressly including the power to appoint registered forensic auditors, but only with the AA’s approval. Certainly, inserting the definition of ‘forensic auditors’ under section 3 of the code. Moreover, an amendment to CIRP regulations to mandate the RP to conduct an independent forensic audit within a specified timeframe. Additionally, make forensic auditors report a mandatory attachment when applying Section. 43-51 of the code.

A formal system of registration and licensing should be formulated to qualify individuals as forensic auditors. More emphasis should be given by IBBI on issuing guidelines and regulations for the implementation of forensic accounting in avoidance transactions.

Conclusion

Fraud and forensic accounting seem to be the need of the hour, which helps in detecting corporate frauds, arresting business leakages, and checking compliance with the larger corporate governance norms. As in avoidance, transaction complexity and sophistication associated with the commission of white-collar crimes make it necessary that such matters be dealt with by professionals having the requisite training to detect such crimes. The detection of these crimes requires sharp observance. In simple language, it shall be necessary to have professionals with forensic skills. In India, no efforts are made to boost forensic science. A growing number of white-collar crimes has made it necessary for governments to launch formal training and skill-building exercises in forensic investigations. A forensic centre of excellence must be set up at the central and state levels. The forensic centre of excellence would create a central data repository that would collect data, including information regarding critical financial transactions.

*The author is a Third-year B.B.A., LL.B. (Hons.) student at Maharashtra National Law University, Chhatrapati Sambhajinagar.