Avoidable Transactions UNDER THE INSOLVENCY & BANKRUPTCY CODE, 2016
The UNCITRAL Legislative Guide on Law of Insolvency defines avoidance proceedings 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."
It is very important for the Resolution Professional (RP) or the liquidator to identify such transaction and file applications to avoid it so that creditors can collect their claims. The Insolvency and Bankruptcy Code, 2016 (IBC) contains four types of avoidable transactions- preferential, undervalued, defrauding creditors and extortionate transactions. Usually, the avoidable transactions should be made within the prescribed relevant time or look back period. Look back period is the relevant time up to which an RP or a liquidator can go back to scrutinize an expected avoidable transaction.1 Provisions of look back period do not apply to transactions defrauding creditors.
The look back period for avoidable transaction is longer if one of the parties involved in the transaction is a related party. This is because it is presumed that related parties have an idea that the corporate debtor might undergo insolvency proceedings. Therefore, it is essential to carefully define who will qualify as a related party.
Section 5(24) discusses which entities and person are related parties to a corporate debtor while Section 5(24A) discusses related party in connection to an individual. Although other provisions such as Companies Act and SEBI define related parties, IBC defines the term separately to ensure that those entities that are related to the Corporate Debtor can be identified clearly, since their presence can often negatively affect the insolvency process.
In Phoenix Arc v. Spade Financial Services Limited2, the contours of related party under the scheme of IBC were extensively discussed. In this case the appellants were excluded from Committee of Creditors as they were related party to the corporate debtor. The court held that the definition of the expression 'related party' in Section 5(24) is exhaustive, since the expression is defined to "mean" what is set out in Clauses (a) to (m). According to the court the definition describes a commutative relationship between corporate debtor and the related party. Chandrachud, J. explained it in the following words "X can be a related party of Y, if either X is related to Y, or Y is related to X. The definition of 'related party' under the IBC is significantly broad. The intention of the legislature in adopting such a broad definition was to capture all kinds of interrelationships between the financial creditor and the corporate debtor."
1. PREFRENTIAL TRANSACTIONS:
Under the Section 43 IBC, RP can apply for avoidance or recovery of sums earned or lost by preferential transactions. A transaction is considered preferential when:
a) the transaction relates to transfer of property or interest of the corporate debtor in favor of a creditor/surety/guarantor for or on account of an antecedent financial debt or operational debt or other liabilities owed by the corporate debtor and;
b) such transaction should have the effect of putting the creditor/surety/guarantor in a more beneficial position than it would have been in the event of a distribution of assets being made in accordance with Section 53.
Such transactions should be made in a relevant time period, which is: two years preceding the insolvency commencement date in case of related party transactions, and one-year preceding insolvency in all transactions which are not related party transactions.
Further, a transaction will not be preferential if a) it is made in ordinary course of business and b) if it creates new value for the corporate debtor.
In Anuj Jain Interim Resolution Professional for Jaypee Infratech Limited v. Axis Bank Limited3 the corporate debtor had mortgaged its property as collateral security for the debt of its holding company. It was held that the transaction can be avoided as it was for the benefit of a related party and that it was made within the look back period of two years. In the course of the judgement the court made the following observations:
- A transaction will qualify as preferential transaction if it satisfies the three-fold test. It first has to fulfill the twin requirements of Section 43(4) and 43(2), and then it should not fall under the exceptions mentioned in Section 43(3). The intention of the parties or whether or not they anticipated that the transaction is preferential in nature is immaterial.
- Look back period is to start from insolvency commencement date and not from the date on which Section 43 came into effect.
Section 43(3) provides that a transaction will not qualify as preferential transaction if it is done in in the ordinary course of the business or financial affairs of the 'corporate debtor or the transferee'. According to SC the phrase 'corporate debtor or the transferee' should be read as 'corporate debtor and the transferee'. This purposive interpretation is required to make sure that inquiry remains focused on the affairs of corporate debtor and does not shift its focus towards the affairs of transferee. In Venus Recruiter Private v. Union of India4 the question before the court was whether an application filed under Section 43 for avoidance of preferential transactions can survive beyond the conclusion of the resolution process and the role of the Resolution Professional in filing/pursuing such applications. It was held that RP cannot wear hat of 'Former RP' and pursue avoidance application in respect of preferential transactions after hat of Corporate Debtor has changed.
2. UNDERVALUED TRANSACTIONS:
Under section 45 the RP can approach the Adjudicating Authority for making an order to declare an undervalued transaction void or to reverse it. A transaction will be considered undervalued if the corporate debtor has made the transaction a) by way of a gift or b) by paying a consideration which is significantly less than what the corporate debtor had paid for the asset. If such transaction was made in ordinary course of business, section 45 will not apply. The look back period is two years preceding insolvency commencement date in case of related party transactions, and one-year preceding insolvency in all transactions which are not related party transactions. The look back period should commence from the insolvency commencement date and not from the date on which section 43 came into effect.5
In IDBI Bank vs. Jaypee Infratech Ltd6 the corporate debtor had transferred immovable property by way of mortgage without any consideration; the court held that the transaction was undervalued transaction.
3. DEFRAUDING CREDITORS:
Section 49 deals with transactions defrauding creditors. The section will come into play if a corporate debtor has deliberately made an undervalued transaction under Section 45 in order to a) keep assets of the corporate debtor beyond the reach of any person who is entitled to make a claim against the corporate debtor; or (b) in order to adversely affect the interests of such a person in relation to the claim.
The section does not have any look back period, as fraud operates as a nullity forever. However, proceedings under Section 49 cannot continue in absence of an ongoing insolvency resolution or liquidation process.7
Unlike other avoidable transactions, Section 49 requires intent on part of corporate debtor. In fact, it is the presence of intent that transforms an undervalued transaction into a fraudulent transaction for the above purposes.
If a transaction comes under purview of section 49, it can trigger penal provision of Section 69. Section 69 provides for punishment of corporate debtor or its officers for entering into fraudulent transactions.
4. EXTORTIONATE CREDIT TRANSACTIONS:
Section 50 allows RP to file an application for avoidance of extortionate credit transactions. Section 50 does not define the term extortionate transaction; instead it vests the power to do so in the IBBI. Under the Insolvency and Bankruptcy Board of India (Liquidation Process) Regulations, 2016 an extortionate transaction is one in which the debtor had to make exorbitant payments w.r.t the credit, or the terms were unconscionable under the principles of law relating to contracts. However, if the impugned debt is extended by any person providing financial services and is in compliance with the law in force, the debt will not qualify as extortionate transaction.
In Shinhan Bank v. Sugnil India Private Limited8, NCLT Delhi Bench held that an interest rate of 65% P.A. is extortionate and accordingly set aside the debt. The court held that since the interest rate was well-above the business standards as prevailing in the market it amounted to an extortionate transaction.
1 The report of the Bankruptcy Law Reforms Committee Volume I: Rationale and Design, 2015 (May 2020) 101. (https://ibbi.gov.in/BLRCReportVol1_04112015.pdf).
2 AIR 2021 SC 77.
3 (2020) 8 SCC 401.
4 2020 SCC OnLine Del 1479.
5 V. Nagarajan, Resolution Professional in respect of M/s. Cethar Limited V Asset Reconstruction Company (India) Ltd. 2018 SCC OnLine NCLT 2021.
6 CA No. 26/2018 in Company Petition No. (1B)77/ALD/2017IDBI Bank Limited v. Jaypee Infratech Limited
7 Shiv Kant v. Juggilal Jute Mills Company Ltd CP No. (IB)40/ALD/2018.
8  109 taxmann.com 170 (NCLT - New Delhi).
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