Business booms for forensic auditors as firms head to bankruptcy court

Forensic departments of large audit firms and independent investigation agencies have been inundated with requests for forensic work following the push to clean up the bad debt mess under the Insolvency and Bankruptcy Code (IBC). 

According to some estimates, the forensic business linked to the IBC has more than doubled in the past few months, and experts believe it will only increase. The work primarily includes doing background checks on promoters, asset searches, verification of creditors, and forensic monitoring of cash flows. For big accounting firms, this is the icing on the cake as they are already working on bankruptcy cases as insolvency professionals. 

Checks on promoters

Background checks on promoters have surged after the recent amendment to the Insolvency and Bankruptcy Code (IBC). This stems from concerns that promoters or their allies might try to buy back the companies at a discounted value through proxy investors. This is especially true when the bidders are overseas entities or come from a seemingly unrelated industry.

“We are being asked to do checks on the background and linkages of bidders in the majority of cases,” said Reshmi Khurana, managing director and head of South Asia, Kroll. “A thorough assessment of the background of bidders, their intent, source of funds, and past track record has become critical for the banks while selecting the buyer.”

The connected parties’ definition under the amended IBC is quite exhaustive, and the onus is now on insolvency professionals and the committee of creditors to abide by the requirements and carry out the necessary diligence, experts say. 

“Several Indian companies work through a maze of subsidiaries and associate companies that have complex cross-holding structures and multiple directorships. Also, several companies often do not disclose who the related parties are, even in annual reports. This makes it difficult to ascertain who the related parties are,” said Vikram Babbar, partner, fraud investigation & dispute services, EY India. 

According to experts, there have been instances in the past when background checks have helped identify siphoning off large funds through dummy or shell companies and the infusion of promoters’ equity by round-tripping of borrowers’ or bankers’ funds.

Forensic experts have also identified fake customers and vendors who undertake financial transactions to inflate financial statements.

“Both bankers and IRPs (insolvency resolution professionals) want to understand transactions with related or connected entities that may be used for asset stripping, diversion or siphoning,” said Suveer Khanna, partner - special situations Group, KPMG India. Added Rajesh Jhunjhunwala, an ex-banker-turned-insolvency professional: “We are reaching out to tech companies that survey social media and firms that verify details such as address proof, pan card details and credit profile.” 

The process of conducting background checks on promoters can take three to six weeks depending on the depth of information required. Forensic experts typically approach insolvency professionals for information after first scouring through public data. This is followed up with field checks on specific entities involving site visits and interactions with key vendors and suppliers. Common directorships, past legal cases and beneficial owners also help in identifying linkages with promoters.

“We don’t need to find a direct link. Often, lack of sufficient information on the bidder’s background, source of funding, and track record is enough to deter banks from considering them,” said Kroll’s Khurana. 

Asset searches

In the event of default, it is not uncommon for promoters to claim bankruptcy when banks try to enforce the promoters’ personal guarantees. Undeclared assets can be attached by banks; even assets with an indirect link can be used to put pressure on companies to repay. So, it has become critical for banks to identify hidden unencumbered assets of distressed companies and their promoters.  

“The idea is to identify the potential application of funds which may have been diverted from any entity. Typically, a significant part of such funds will be invested in land, real estate or other physical assets,” said Samir Paranjpe, partner, Grant Thornton India.

Identifying hidden assets can be challenging as assets are often held through proxy owners, which cannot be linked back to the promoters. The proxies may include current and former employees, close confidants of the promoters and even their minor children or older parents. 

“The globalisation of business and the ever-expanding world of offshore finance means that it can be relatively easy to set up complex corporate structures to hide the true ownership of assets,” observed Khurana. According to Khanna, information sharing across countries can be a challenge, which is why forensic experts rely on global databases, to the extent information is publically available.

Sweetheart deals 

Transactions specifically related to the IBC sections 43, 44, 45, 46 and 66 are being looked at by forensic experts. These sections deal with identifying preferential and undervalued transactions, and those deliberately entered into to defraud creditors. These sections also deal with identifying undisclosed relationship/s between the entities and the company.  

For instance, preferential transactions as per section 43 of the code would cover transactions where there is a transfer of property or an interest in respect of an existing debt or liability. An undervalued transaction as per section 45(2) of the Code is one where a corporate debtor makes a gift or transfers one or more assets for insignificant consideration, provided that such a transaction has not taken place in the ordinary course of business of the corporate debtor.

Bankers, IRPs and potential buyers are also concerned about internal frauds perpetrated by employees, promoters and third parties such as vendors and customers.

New opportunities

• Audit firms, investigation agencies inundated with forensic work related to IBC
• Business linked to IBC has more than doubled in the past few months
• Double bonanza for big accounting firms as they also work as insolvency professionals
• Connected parties’ definition under the amended IBC put onus on IRPs, committee of creditors (CoC) to do due diligence
• Assets are often held through proxy owners and cannot be linked back to promoters
• Preferential and undervalued transactions under scanner