What Is the Role of Forensic Accounting in Insolvency Cases?

Forensic accounting plays a crucial role in insolvency cases by providing specialized financial investigations that help uncover fraud, financial mismanagement, and other issues that can impede the insolvency resolution process. Under the Insolvency and Bankruptcy Code (IBC), forensic accountants assist in investigating the financial health of companies, tracing hidden assets, and ensuring that the process is fair, transparent, and in compliance with the law.

Role of Forensic Accounting in Insolvency Cases:

Detection of Fraudulent Transactions:

Forensic accountants are often tasked with identifying and investigating fraudulent transactions that may have occurred before the company entered insolvency. This includes detecting any undisclosed liabilities, misappropriations of assets, or illicit transfers that could harm creditors' interests.

They help identify if there were fraudulent preferences, preferential payments, or undervaluation of assets made to related parties or other stakeholders before the insolvency filing.

Investigating Financial Mismanagement:

Forensic accountants examine the company’s financial statements and accounting records to assess whether there was any financial mismanagement or negligence by management that contributed to the company’s insolvency.

They identify if proper accounting principles were followed or if financial statements were manipulated to show a healthier financial position than existed, misleading stakeholders, including creditors and investors.

Asset Tracing:

In cases where assets might have been hidden, transferred, or disposed of inappropriately, forensic accountants trace these assets to ensure they are accounted for. This includes both physical assets and intangible assets like intellectual property, which might be critical in resolving the insolvency.

Forensic accountants also help identify and locate any offshore assets or assets that might have been transferred to other entities or individuals to avoid creditors.

Uncovering Concealed Liabilities:

Forensic accounting plays a vital role in uncovering concealed liabilities that the company might have failed to disclose. This ensures that the full extent of the company’s financial obligations is known and that all creditors are treated fairly during the insolvency process.

The forensic accountant helps reconcile discrepancies in the company’s balance sheet and identifies unreported liabilities, ensuring transparency and fairness in the process.

Supporting Insolvency Professionals:

During Corporate Insolvency Resolution Process (CIRP), insolvency professionals (IPs) often rely on forensic accountants to help with the financial analysis of the company’s records. The forensic accountant provides expert insights and helps in drafting a clear picture of the financial situation.

Forensic accountants assist the insolvency professionals in preparing accurate reports regarding the company’s financial health, which are essential for the Committee of Creditors (CoC) in making decisions on resolution plans.

Analyzing and Validating Claims:

Forensic accountants help in validating the claims made by creditors during the insolvency process. They assess the authenticity of claims, ensure that they are backed by proper documentation, and ensure that creditors are not over- or under-compensated.

They also investigate whether the claims of creditors are valid and whether any fraudulent or inflated claims have been submitted, protecting the integrity of the process.

Litigation Support:

In cases where fraudulent transactions or financial mismanagement need to be litigated, forensic accountants can provide expert testimony in court or tribunals. Their findings are crucial in resolving disputes between creditors, debtors, and other stakeholders.

They may also help prepare the case for potential legal action against directors or others responsible for misconduct that led to the company’s financial distress.

Providing Expert Reports and Evidence:

Forensic accountants provide expert reports to the National Company Law Tribunal (NCLT) and insolvency courts, offering evidence that may be crucial in deciding the outcome of insolvency cases.

These reports could include detailed findings on asset tracing, liabilities, fraudulent activities, and financial mismanagement, all of which are essential for resolving the insolvency proceedings in a fair and transparent manner.

Example:

Let’s assume ABC Ltd. is undergoing Corporate Insolvency Resolution Process (CIRP) under the IBC, and its creditors suspect that the company’s management has transferred assets to related parties before the insolvency filing.

Forensic Accounting Investigation:

The insolvency professional hires a forensic accountant to investigate the company’s financial transactions from the past few years. The forensic accountant finds that ABC Ltd. transferred significant assets to related entities at undervalued prices just before filing for insolvency.

Asset Tracing:

The forensic accountant traces the assets and finds that some of the assets were transferred abroad to a sister company. These findings are presented in the resolution process to the Committee of Creditors (CoC).

Litigation and Reversal of Transactions:

The insolvency professional, based on the forensic accountant’s findings, files an application with the NCLT to reverse the fraudulent transactions under the fraudulent preference provisions of the IBC.

Conclusion:

Forensic accounting is a critical element in ensuring the integrity and transparency of the insolvency proceedings under the Insolvency and Bankruptcy Code (IBC). From detecting fraudulent transactions and uncovering financial mismanagement to tracing hidden assets and validating creditor claims, forensic accountants provide invaluable assistance to insolvency professionals and courts. Their expertise ensures that all parties are treated fairly and that the resolution process is based on accurate, complete financial information.