The Insolvency and Bankruptcy Code of 2016 ('IBC') marks a pivotal shift in
Introduction
The IBC hailed as landmark legislation, marks a significant departure from previous insolvency regimes by abolishing the concept of a defaulter's paradise and restoring the creditor's position in the economy. However, challenges have emerged from vulnerable transactions entered into by corporate debtors ('CDs') during the pre-insolvency twilight period also known as the 'look-back period.' These transactions are defined 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, are encapsulated under four types:
PUFE transactions, falling within the ambit of ss. 43 to 51, and s. 66 of the IBC. The resolution professional ('RP') or liquidator must identify such transactions and file an application before the
Related Party Transactions
The IBC lays out a detailed list of those who qualify as 'related parties.' These could be individuals like directors or key managerial personnel of the CD, or other entities such as associate companies, subsidiaries, or corporate holdings. In Phoenix Arc v.
Preferential Transactions
Preferential transactions, as defined under s. 43 of the IBC, carry significant implications for both CD and creditors involved in distressed situations. These transactions occur when a CD extends favouritism to specific creditors, sureties, or guarantors by transferring assets or benefits, thus elevating their position above others. Such transactions must occur within a defined 'relevant period' preceding the commencement of insolvency proceedings. The relevant period has been defined under section 43(4) of the IBC in two terms-
- Preference is given to a related party (other than by reason only of being an employee) during the period of two yearspreceding the insolvency commencement date; or
- a preference is given to a person other than a related party during the period of one yearpreceding the insolvency commencement date.
Notably, s. 44 empowers the NCLT to overturn such transactions and mandate the recovery of benefits accrued from them.
Key Provisions: The criteria for assessing preference include determining whether the transfer places the recipient in a more advantageous position compared to what they would have received under the standard asset distribution process outlined in s. 53 of the IBC. Exclusions apply to transfers made in the ordinary course of business or those creating security interests in property acquired by the CD.
Case Laws: Several case precedents offer insights into the application and interpretation of preferential transaction provisions under the IBC:
S.V. Ramkumar v.Orchid Pharma Ltd. 3: Payments made under the corporate debt restructuring mechanism ('CDR') were considered ordinary course transactions.Chitra Sharma v.Union of India 4: The mortgage of land in favour of lenders was considered preferential treatment, as it put certain creditors in a more beneficial position.- Mrs.
Dipti Mehta v.Shivani Amit Dahanukar 5: Transactions made in the ordinary course of business and outside the look-back period may not be considered preferential. Ram Ratan Kanoongo v.Sunil Kathuria 6: Directors were ordered to return sums received from the CD, highlighting the remedial actions available for preferential transactions.Adriatic Sea Foods (P.) Ltd. v.Suresh Kumar Jain 8: Transactions involving meagre payments for valuable assets may be deemed preferential and undervalued, warranting cancellation to uphold fair distribution principles.Rakesh Kumar Jain v.Jagdish Singh Nain 10: It was held that s. 14 is not a bar to pass appropriate order in pending proceedings against RP or suspended directors and related parties before NCLT during the CIRP or liquidation process. Thus, during the currency of moratorium under s. 14, the order passed by NCLT under s. 66 against RP who indulged in fraudulent trade or business to defeat the rights of creditors of CD was in accordance with law.- Jayesh Shanghrajka v. Divine Investments 11: This case clarified that the transfer of assets among group companies, without fraudulent intent, does not constitute fraudulent trading, offering insight into the nuances of related-party transactions.
Edelweiss Asset Reconstruction Company Ltd. v.Net 4 India Ltd 12: Here, undervalued, and fraudulent transactions aimed at keeping assets beyond the reach of creditors were declared null and void.Axis Bank Ltd. v.Anuj Jain 13: In this case, it was held that mortgages were made by CD (JIL) in favour of banks and financial institutions in respect of loans given by appellant banks and financial institutions to holding companies (JAL). were executed in the ordinary course of its business as a guarantor. These mortgages were not made to defraud creditors of CDs or for any fraudulent purpose. Therefore, mortgage deeds could not be said to be made by way of preferential transactions or undervalued transactions.- In
Shinhan Bank v.Sungil India (P.) Ltd 15., the NCLT ruled that charging unreasonably high rates of interest constitutes an extortionate credit transaction. This ruling underscores the imperative of identifying and addressing predatory lending practices, thereby highlighting the legal recourse available under s. 50 to rectify imbalances created by extortionate transactions.
Undervalued Transactions
Undervalued transactions, as defined under s. 45 of the IBC, involve asset transfers at values significantly lower than their actual worth.
Key Provisions: A transaction is considered undervalued under s. 45(2) of the IBC if it involves a CD gifting or transferring assets for a consideration significantly less than the value of the consideration that the CD would have provided (i.e., the cost of acquisition of such assets), and provided that such transactions are not in the ordinary course of business. The relevant period for challenging such transactions as mentioned above varies based on whether the party involved is related or unrelated to the CD.
Case Laws: Several case precedents shed light on the implications of undervalued transactions in insolvency proceedings:
Fraudulent Transactions
Fraudulent transactions within insolvency proceedings, as provided for under s. 66(1) of the IBC, involves actions conducted with the intent to defraud creditors or for any fraudulent purpose. This provision casts a wide net, covering various deceptive practices aimed at undermining stakeholder interests without any specific look-back period. However, s. 66(2) of the IBC provides reasonable grounds for defense, emphasizing the importance of due diligence and rationality in assessing transactions.
Key Provisions: S. 66 of the IBC provides for fraudulent and wrongful trading under which if an application is filed by the RP during the CIRP or liquidation process to act against persons who knowingly engaged in business with the intent to defraud creditors or for any fraudulent purpose. It allows the NCLT to impose such liabilities, including making them personally liable without any limitation of liability, requiring them to contribute to the CD's assets, or restraining them from managing the CD's affairs.
It is notable that in case undervalued transactions are entered into with the intent to defraud creditors, s. 49 of the IBC comes into play. S. 49 of the IBC pertains to transactions defrauding creditors and applies once the CD has entered into a preferential and/or undervalued transaction '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 person apropos the claim. Herein, the unique aspect is that there is no look-back period as fraud acts as a nullity. Also, s. 69 of the IBC imposes stringent penalties, including imprisonment and fines, on officers found guilty of fraudulent conduct, underscoring the gravity of such offenses.
Case Laws: Several case precedents illuminate the implications of fraudulent transactions in insolvency proceedings:
Extortionate Transactions
Extortionate transactions, as outlined in s. 50 of the IBC, are characterized by scenarios where a CD receives financial or operational debt under terms that demand exorbitant payments. The relevant period for scrutinizing extortionate transactions is within two years preceding the insolvency commencement date. This timeframe facilitates a retrospective examination of transactions that may have contributed to the financial distress of the CD by way of excessive payments of interest or similar financial costs.
Case Laws:
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In the landmark case of M/s
Conclusion
The primary goal of transaction avoidance under the IBC is to restore the assets to the CD, making them available to creditors who have agreed to receive less than the full amount owed. Timely recovery is crucial for providing creditors with better returns and minimized losses. However, there is a substantial backlog of claims, totalling approximately
The Insolvency and Bankruptcy Board of
Additionally, focusing on the success rate of PUFE transaction applications is essential to prevent the process from being used to unjustly harass erstwhile management. Such transparency and accountability will promote effective actions and prevent abuse, thereby upholding the fairness and integrity of the insolvency resolution process.
Footnotes
1 Phoenix Arc v.
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11 Jayesh Shanghrajka v. Divine Investments 2021 127 taxmann.com 494 (NCLT- Mum.)
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16 IBBI Quarterly Newsletter, January-
17 ibid
18 ibid
19 https://ibbi.gov.in/uploads/whatsnew/3d9849d4c72be198d901ba78006005cf.pdf.
20 https://ibbi.gov.in//uploads/legalframwork/b9b7d1e976d46ff8a982b6178303a1ff.pdf
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
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