Navigating the complexity of Preferential Transactions: Lessons learned from recent Judicial Pronouncements – By Sukhmani Kaur

Navigating the complexity of Preferential Transactions: Lessons learned from recent Judicial Pronouncements

Sukhmani Kaur
(3^rd Year Student, Campus Law Centre, University of Delhi)

Section 43 of the Insolvency and Bankruptcy Code (IBC) deals with preferential transactions and their relevant time. This section addresses the concept of avoidable transactions, specifically focusing on preferential transactions. Preferential transactions refer to transactions where a corporate debtor grants preferential treatment to specific creditors, sureties, or guarantors, thereby giving them an advantageous position over other creditors during the distribution of assets under the IBC scheme.

Analysis of Sub-sections

Under subsection (1) of Section 43, if the liquidator or the resolution professional forms an opinion that the corporate debtor has granted a preference to any person as mentioned in subsection (4), during a relevant period and in the manner specified in subsection (2), they are required to apply to the Adjudicating Authority for the avoidance of preferential transactions and the issuance of relevant orders under Section 44. Only the resolution professional or the liquidator can initiate proceedings against avoidable transactions.

To qualify as a preferential transaction, the transfer of property or an interest thereof by the corporate debtor must meet the conditions outlined in subsection (2). Firstly, there must be a transfer made for the benefit of a creditor, surety, or guarantor in relation to an antecedent financial debt, operational debt, or other liabilities owed by the corporate debtor. Secondly, this transfer should place the creditor, surety, or guarantor in a more advantageous position than they would have been in the event of a distribution of assets under Section 53.

Subsection (3) provides exceptions to preferential transactions. It states that certain transfers should not be considered preferential transactions. These exceptions include transfers made in the ordinary course of the corporate debtor’s business or financial affairs, as well as transfers that create a security interest in property acquired by the corporate debtor. However, such security interests must secure new value and be granted under a documented security agreement. Additionally, these transfers must be registered with an information utility within thirty days of the corporate debtor taking possession of the property. It is important to note that transfers made pursuant to a court order do not fall within these exceptions and can still be considered preferential transactions.

Subsection (4) defines the relevant time for preferential transactions. A preference is deemed to be given at a relevant time if it is given to a related party (other than by reason only of being an employee) within the two years preceding the insolvency commencement date. If a preference is given to a person other than a related party, the relevant time is the one year preceding the insolvency commencement date.

Relevant Rules and Regulations to be read with Section 43

Regulation 35A and 39(2) of the Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations, 2016, complement Section 43 by outlining the responsibilities of the resolution professional in assessing and reporting on preferential and other transactions observed during the insolvency resolution process.

Regulation 35A of the Insolvency and Bankruptcy Board of India (IBBI) Regulations pertains to preferential and other transactions. According to this regulation, the resolution professional must form an opinion on whether the corporate debtor has been involved in transactions covered under sections 43, 45, 50, or 66 within the first seventy-five days of the insolvency commencement date. If such transactions are identified, the resolution professional is required to make a formal determination by the one hundred and fifteenth day and inform the Board. Subsequently, on or before the one hundred and thirty-fifth day, the resolution professional must apply to the Adjudicating Authority for appropriate relief.

Regulation 35-A requires a Resolution Professional to form an “opinion” if the corporate debtor has been subjected to an avoidance transaction. Such opinion is to be followed by a “determination” by the Resolution Professional qua such avoidance transaction. The idea behind the Resolution Professional to form an opinion and make a determination reflects that the Resolution Professional has to apply his mind to the suspicious avoidance transactions. [i]

Regulation 39 of the IBBI Regulations deals with the approval of the resolution plan. It stipulates that the resolution professional is responsible for submitting all resolution plans that comply with the requirements of the Insolvency and Bankruptcy Code and its regulations to the committee. These plans should include details of any observed, discovered, or determined transactions falling under the categories of preferential transactions (under section 43), undervalued transactions (under section 45), extortionate credit transactions (under section 50), and fraudulent transactions (under section 66). Additionally, any orders issued by the adjudicating authority regarding such transactions should be included in the submission.

Notable Case Laws

Several notable case laws provide insight into the interpretation and application of Section 43. For example, In the case of IDBI Bank Limited v. Jaypee Infratech Limited (2018) ibclaw.in 49 NCLT [1], the National Company Law Tribunal observed that Section 43 of IBC has retrospective applicability. The NCLT emphasized that Section 43(4)(a) explicitly grants retrospective effect, stating that the provision applies to related party transactions occurring within the two-year period preceding the initiation of insolvency. This provision signifies the inclusion of retrospective effect in the legislation, and thus, the review of transactions is determined based on the insolvency commencement date rather than the date of enactment of the Insolvency & Bankruptcy Code.

In the landmark judgment of Anuj Jain Interim Resolution Professional for Jaypee Infratech Limited Vs. Axis Bank Limited [2020] ibclaw.in 06 SC [2], the Supreme Court provided clarity on the duties and responsibilities of the Resolution Professional (RP) concerning avoidance transactions. The Court outlined a series of steps for the RP, which include reviewing all transactions related to the property or interest of the Corporate Debtor backward from the Insolvency Commencement Date (ICD) up to the preceding two years, categorizing persons involved as related parties or others, examining specific subsets of transactions involving unrelated parties occurring within one year preceding the ICD, scrutinizing the shortlisted transactions to ascertain their relation to antecedent financial debt, operational debt, or other liability of the Corporate Debtor, and analyzing the transactions to determine if they put the creditor, surety, or guarantor in a more advantageous position than the distribution of assets under Section 53. The RP is then required to apply to the Adjudicating Authority (AA) for necessary orders after conducting a comprehensive analysis of the transactions. The Supreme Court emphasized that different parameters and inquiries apply to various types of avoidance transactions, and once a transaction is deemed preferential, there is no need to examine whether it is undervalued or fraudulent. Intent is not a factor in preferential transactions, as they are deemed to give preference at a relevant time based on the given ingredients. Section 43 was held to be a deeming provision in this case.

In the case of Venus Recruiters (P) Ltd. v. Union of India (2020) ibclaw.in 41 HC[3], the issue at hand was whether an application filed under Section 43 of the Code for the avoidance of preferential transactions can survive beyond the conclusion of the resolution process and the role of the RP in filing and pursuing such applications. The jurisdiction of the National Company Law Tribunal (NCLT) to hear applications under Section 43 after the approval of the Resolution Plan was challenged. After a thorough discussion of Section 43, Section 44, Regulation 35A, and Regulation 39(2), it was observed that the assessment of objectionable transactions, including preferential transactions, by the RP cannot be an unending process. The examination must commence on the insolvency commencement date, and the RP must form an opinion by the 105th day (pre-amendment) or 75th day (post-amendment). If the RP concludes that the Corporate Debtor has been subjected to preferential transactions, the determination must be made by the 115th day. Furthermore, the RP must apply to the NCLT for appropriate relief on or before the 135th day. It was concluded that allowing avoidance applications relating to preferential and other transactions to survive beyond the conclusion of the Corporate Insolvency Resolution Process (CIRP) is contrary to the Scheme of the Code. Therefore, if an avoidance application for preferential transactions is permitted to be adjudicated after the approval of the Resolution Plan, it would effectively place the NCLT in the position of the new management to decide what is in the best interest of the company. Once the Plan is approved and the new management takes over, it is solely up to them to decide whether to continue a transaction or agreement. Thus, if the Committee of Creditors (CoC) or the RP deems any transactions objectionable, the relevant order must be passed prior to the approval of the Resolution Plan.

In the case of GVR Consulting Services Pvt. Ltd. v. Pooja Bahry (2023) ibclaw.in 261 NCLAT[4], the Corporate Insolvency Resolution Process (CIRP) was initiated against the Corporate Debtor, and the Respondent was appointed as the Resolution Professional (RP). The Adjudicating Authority determined that the transactions entered into by the Corporate Debtor with the appellants constituted preferential transactions under Section 43 of the Insolvency and Bankruptcy Code (IBC) and directed the appellants to refund the amount involved in those transactions. Additionally, the Adjudicating Authority rejected the prayers made by the RP in the application under Sections 45 and 66 of the IBC, seeking declarations of certain transactions as undervalued and fraudulent. The appellants filed three appeals against the impugned order. The central issue in question was whether the dominant motive of the Company in a transaction should be considered when determining whether it qualifies as a preferential transaction under Section 43 of the IBC. The Bench observed that even in mortgage transactions carried out by the Corporate Debtor for the benefit of related parties, such transactions can fall within the ambit of preferential transactions. The Bench further emphasized the need to consider the object and purpose of Section 43 and the overall legislative scheme while classifying a transaction as being in the ordinary course of business. Incorrect labelling of a transaction in this regard could lead to frustration of the provision itself. Relying on the precedent set in Anuj Jain (supra), the National Company Law Appellate Tribunal (NCLAT) held that the intent of the Corporate Debtor is not relevant in establishing whether a transaction is preferential or not. This is because Section 43 of the IBC envisions a statutory or deeming fiction, wherein certain transactions are deemed to be preferential regardless of the intention behind them.

Conclusion

Section 43 of the IBC plays a crucial role in addressing preferential transactions and ensuring fair distribution of assets during insolvency proceedings. It establishes the conditions for identifying preferential transactions, specifies exceptions to these transactions, defines the relevant time for assessing preferences, and outlines the responsibilities of the resolution professional. The interpretation and application of this section have been further clarified through various case laws, providing valuable guidance to stakeholders involved in the insolvency resolution process.

Reference:

[1] (2018) ibclaw.in 49 NCLT

[2] [2020] ibclaw.in 06 SC

[3] (2020) ibclaw.in 41 HC

[4] (2023) ibclaw.in 261 NCLAT

[i] Jagdish Kumar Parulkar RP Vs. Vinod Agarwal Ex-Director (2023) ibclaw.in 132 NCLAT

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