The Insolvency and Bankruptcy Code, 2016, reckoned to be a landmark legislation is a significant departure from previous insolvency regimes with the loss of defaulter's paradise and resurrection of economy's rightful position. However, certain challenges have come to the fore in the wake of vulnerable transactions entered into by the corporate debtor (CD) during the timeline of the pre-insolvency twilight period. The UNICITRAL Legislative Guide defines such transactions as "provisions of the insolvency law that permit transactions for the transfer of assets or the undertaking of obligations prior to insolvency proceedings to be cancelled or otherwise rendered ineffective and any assets transferred, or their value, to be recovered in the collective interest of creditors." The Code, 2016 has encapsulated four types of transactions i.e. Preference, Undervalued, Fraudulent and Extortionate transactions as avoidable transactions under the ambit of Sections 43 to 51. It is often extremely important for the RP or the liquidator to identify such transactions and eventually file an application before the Adjudicating Authority so that the creditors can receive their claims. Regulation 35 A requires the resolution professional (RP) to form an opinion on transactions covered under the aforesaid sections by the 75th day, make a determination by 115th day and file the application within 135 days.
On Related Party Transactions
The Code, 2016 also offers a comprehensive yet exhaustive list identifying as to who all come under the definition of 'related parties. These persons/ entities inter-alia can include director or key managerial personnel of CD, a corporate holding a subsidiary or an associate company of CD and so on. The Apex Court in Phoenix Arc v. Spade Financial Services Limited has also interpreted its meaning u/s 5(24) of the Code, as a commutative relationship between CD and related party. Qua the lookback period, the UNICITRAL Guide time and again acknowledges the transactions entered into by a CD with its related parties with enhanced scrutiny and suggests a longer lookback period vis-à-vis pinning down and redressing avoidance transactions. The BLRC in its report dated 4 November, 2015 has also firmly observed that "There should be stricter scrutiny for transactions of fraudulent preference or transfer to related parties, for which the "look back period" should be specified in regulations to be longer".
At times, to the borrower's advantage, sale of assets by the CD can be made on grounds of previous financial obligations and such a transaction becomes preferential as it puts the borrower in the position of profit rather than allocating properties in compliance with the waterfall mechanism u/s 53 of Code, 2016. To put it simply, a transaction can be said to be preferential when it results in the creditor obtaining an advantage or irregular payment. It is defined u/s 43 wherein the use of term 'preference' has been interpreted as 'paying or securing to one or more of his creditors, by an insolvent debtor, the whole or part of their claims, to the exclusion of the rest'. For instance, in the case of Anuj Jain Interim Resolution Professional for Jaypee Infratech Limited v. Axis Bank Limited, the Apex Court stated that the impugned transactions had been of transfers for the benefit of JAL, who is a related party of the corporate debtor JIL and have the effect of putting JAL in a beneficial position than it would have been in the event of distribution of assets being made u/s 53 of the Code. Thus, the corporate debtor had given a preference in the manner laid down in sub-section (2) of Section 43 of the Code. Essentials as stated by the Court to constitute a preferential transaction include firstly, the transfer of property/interest of the CD for the benefit of either a creditor or surety or guarantor on account of an antecedent financial or operation debt or liability; secondly, that such transfer puts such creditor or surety or guarantor in a 'beneficial position' as opposed to the status quo being in the event of distribution of assets u/s 53 of Code; thirdly, that such transaction has been carried out during the lookback period of 1 year preceding the Insolvency Commencement date (ICD) for unrelated parties transactions and 2 years with regards to related party transactions. In simple parlance, the three fold test includes transactions that satisfy twin requirements u/s 43(4) and 43(2) and not fall under the exceptions enumerated u/s 43(3).
Any transaction as defined u/s 45 of the Code is said to be undervalued if the CD makes a gift to a person and enters into a transaction involving transfer of one or more assets by the CD in respect of a consideration whose value is significantly lesser than the value of consideration provided by the CD. Also, such a transaction must not take place in the 'ordinary course of business'. In the dicta of IDBI Bank v. Jaypee Infratech Ltd, certain immovable property by the CD was transferred by way of mortgage sans any consideration and the court held that such transactions were undervalued transactions. In terms of section 45, an RP can approach the Adjudicating Authority to either declare such an undervalued transaction as void or to reverse it. The lookback period in this case is 2 years preceding ICD qua related party transactions and 1 year in case of unrelated party transactions.
Transactions Defrauding Creditors
Section 49 refers to transactions defrauding creditors and it is applicable once a CD has entered into an undervalued transaction as referred to in sub-section (2) of Section 45 'deliberately' on the pretext of (a) keeping the assets of CD beyond the reach of any person entitled to make a claim against the CD or (b) to adversely affect the interests of such a person apropos the claim. Herein, the unique aspect is that there is no look out period as fraud acts as a nullity. However, as held by Hon'ble NCLT, Allahabad Bench in Shiv Kant v. Juggilal Jute Mills Company Ltd, proceedings under this section cannot continue sans an ongoing insolvency or liquidation process. Moreover, intent of the CD plays an integral role and often forms the basis of transforming an undervalued transaction into a fraudulent transaction. For instance, the undervalued transactions carried under section 49 mostly have a malafide or unlawful purpose. Further, penal provisions u/s 69 stipulating punishment to CD or its officers in case they enter into fraudulent transactions can be set off by the transactions falling under this section.
Extortionate Credit Transactions
At times, a corporation obtains credit which is at unreasonably high interest rates and such transactions which require the Corporate Debtor to make exorbitant payments qua the credit provided or are unconscionable under the principles of contract law, qualify as extortionate credit transactions. For instance, NCLT Delhi Bench in Shinhan Bank v. Sugnil India Private Limited, held that an interest rate of 65 % per annum was extortionate as it was well- above the business standards prevailing in the market and consequent thereto, it set aside the debt. Such transactions are addressed in Section 50 which allows the RP to file an application for avoiding such transactions. Moreover, unlike preferential or undervalued transactions, the lookback period in such a case is 2 years irrespective of whether the counter- party is related or unrelated to the CD.
In addition to the aforementioned vulnerable transactions, the directors of a company must also be extremely careful regarding fraudulent trading and wrongful trading as defined under Section 66(1) and 66(2) respectively. Since the main purpose to file applications for avoidance of preferential transactions is to restore the properties to the CD and to resurrect it back on its wheels via the Resolution Applicant, timely identification and reversal of such transactions is the essence to achieve a better recovery. However, at present, claims of over 2lakh crore filed as 'avoidance transactions' are still pending adjudication with various company law tribunals across the country and as of March 31, 2022, NCLT's have given their verdict only in 71 cases involving claims of 15,106 crore. Such a heavy pile-up of cases leads to adverse repercussions with cumbersome delays as even the process to provide avoidance transactions, according to experts, needs concrete proof and strong evidence. Moreover, The threat of related parties weakening the value of CD either during the lookback period of 2 years preceding the ICD or during the timeline of CIRP or gaining benefits under a resolution plan looms large and to mitigate the same, the Code has rendered a host of safeguards. The Insolvency and Bankruptcy Board of India vide its communication dated 8th May, 2020 offered some guidance for RP/liquidator to understand and identify certain red flags indicating the need to review avoidance transactions and file resultant applications to the Adjudicating Authority. Such initiatives offer a robust framework for identification of avoidance transactions and setting up of benches to hear matters on a summary trial basis in a timely manner with disbursal of recovered claims to creditors after adjusting the incurred costs incentivises stakeholders resulting in achieving the goals of IBC i.e., the timely resolution of insolvency aimed at ensuring maximisation of value, preservation of CD's assets and subsequent protection of stakeholder's interest.
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