Preferential Transactions

Introduction

The purpose of the Insolvency and Bankruptcy Code, 1960 as has been mentioned at the advent of the act to be “corporate persons, partnership firms and individuals in a time bound manner for maximization of value of assets of such persons, to promote entrepreneurship, availability of credit and balance the interests of all the stakeholders” with a special focus on balancing the interest of all the stakeholders involved in light of the subject in question.

Preferential transfers on the other hand are transfers made before the insolvency of the corporate debtor making the transactions thereby giving the corporate creditor more than its rightful appropriate share of the debtor’s assets. By the very definition of these transactions they stand in contravention of the very principle and essence of the IBC, 2016. Their working, technicalities and repercussions are made more relevant with the dawn of economic slowdown that the world is facing at a length. The intricacies of the same have been discussed below.

Statutory Summarisation

1.      What are the determinants of a preference given to a corporate debtor?

Preference would be said to have been rendered under sub section 2 of Section 43 of the Insolvency and Bankruptcy Code, 2016 if –

  • There is transfer of property or an interest should be such that causes or results in the benefit of the creditor or surety or guarantor for an antecedent  financial or operational debt or other liabilities owed by the corporate debtor.
  • The transfer has put the corporate debtor in a beneficial position, which it would not have enjoyed had the assets been distributed in accordance with Section 53 of the IBC 2016.

2.      What can Not be construed to be a preferential transfer?

Under Section 43(3) of the Insolvency and Bankruptcy Code, 2016 the following cannot be considered preferential transfers-

  • If the transfers have been made in the ordinary course of the business of the corporate debtor
  • If the transfer creates a security interest in property acquired by the corporate debtor and was given during or after the signing of a security agreement that contains a description of such property as security interest with the same which had been utilised by corporate debtor to acquire property. In addition to the same;
  • the security interest is required to acquire a new value[1]
  • the transfer is required to be registered with an information utility on or before thirty days after the corporate debtor receives possession of such property
  • it is not in contravention a court’s order stating such transfer to be giving of preference by the corporate debtor

3.      Is there a time limit one must keep in mind?

Accord to subsection 4 of Section 43 a  preference is said to be given  at a relevant time, if –

  • It is given to a related party during the period of two years preceding the insolvency commencement date
  • It is given to a person other than a related party during the period of one year preceding the insolvency commencement date.

4.      What happens if the transactions made are found to be preferential in nature?

If the liquidator or the resolution professional feels that a corporate debtor(referred to sub-section (4) ) in  has been a recipient of a transaction that is preferential in nature according to Section 2 of Section 43 by the concerned insolvent company, the liquidator can apply to the Adjudicating Authority for avoidance of preferential transactions.

In the case that duty bound Resolution Professional fails to appeal to the jurisdiction of the concerned adjudicating authority under Section 43 of IBC despite creditor placing relevant material[2] alleging preferential transactions before the Resolution Professional then the creditor would be entitled to approach the adjudicating authority. [3]

5.      What possible action can be taken after the application is made on the behalf of the resolution professional/liquidator?

After the application made by the resolution professional or liquidator, the adjudicating authority under Section 44 of IBC, 2016 can interalia order the following:

  • The preferential transaction of the property to be vested in the corporate debtor.
  • The release of the security interests interest created by the corporate debtor
  • Direct any guarantor, whose financial debts or operational debts owed to any person were released due to preferential transactions to be under new or revived financial debts.
  • Order the benefactor of the preferential transaction to pay a sum to the liquidator/resolution professional.
  • Direct for providing security or charge on any property for the discharge of any financial debt or operational debt under the order

Analysis

1.     General

To argue that the creditor’s state of mind is an important element of a preference and that creditors should not be required to disgorge what they took in supposed innocence is to ignore the strong bankruptcy policy of equality among creditors.”[4] The aforementioned statement clearly and simply lays down the intent behind the inclusion of preferential transactions as malicious actions on the behalf of the perpetrators. These transactions by the corporate debtors single handedly seek to disrupt the equitable treatment and equality amongst the various stakeholders involved in the now insolvent company. It also wrongs the other creditors by robbing them of their share and in the debtor’s assets which is often the last return of their contributions to the company.

The line of thought that Logically and theoretically, the recipient of the preference has nothing to do with equality of distribution or that equality is determined by the fact that all creditors are being treated reasonably alike are all feeble ploys to waver and feed the stakeholders half cooked contentions and excuses to hid their poorly hidden malicious intentions.

2.      Statutory

Taking on the statutory base of the preferential transactions and their application, the laws in relation to preferential transactions provided much levy and ambiguity to the perpetrators involved and much dismay to the concerned stakeholders for the aforementioned reason. A recent case of Anuj Jain Interim Resolution Professional Jaypee Infratech limited v. Axis Bank Limited [5] in an appeal filed by the IRP to the Supreme Court challenging the order of NCLAT, holding third-party mortgages created by Jaypee Infratech Limited (JIL) in favour of the lenders of Jaiprakash Associates Limited (JAL) as not preferential where the Court examined the intent and design of preferential transactions under the Code and provided clarity with regard to the exception clause of Section 43 stand as a guiding light to remove some ambiguity from these transactions.

The Apex Court, in doing the same also has laid down the following points which are required to be considered before classifying a transaction as preferential:

(i) As to whether such transfer is for the benefit of a creditor or a surety or a guarantor?

(ii) As to whether such transfer is for or on account of an antecedent financial debt or operational debt or other liabilities owed by the corporate debtor?

(iii) As to whether such transfer has the effect of putting such creditor or surety or guarantor in a beneficial position than it would have been in the event of distribution of assets being made in accordance with Section 53?

(iv) If such transfer had been for the benefit of a related party (other than an employee), as to whether the same was made during the period of two years preceding the insolvency commencement date; and if such transfer had been for the benefit of an unrelated party, as to whether the same was made during the period of one year preceding the insolvency commencement date?

(v) As to whether such transfer is not an excluded transaction in terms of sub-section (3) of Section 43?


Conclusion

To culminate the above, preferential transactions are transactions made with malafide intentions in favour of corporate creditors and thus should be prohibited from taking place as has been rightly done in the case of ou nation with section 43 and 44 of the Insolvency and Bankruptcy Code 2016, due credit should also be given to the various tribunals and the apex court in their endeavour to make the laws with respect to such acts more efficient and effective. Work still has to be done with respect to the law and the provisions with respect to the sections involved, but the apex court’s recent judgement proves to be a light of hope at the end of the tunnel.


[1]  “new value” means money or its worth in goods, services, or new credit, or release by the transferee of property previously transferred to such transferee in a transaction that is neither void nor voidable by the liquidator or the resolution professional under this Code, including proceeds of such property, but does not include a financial debt or operational debt substituted for existing financial debt or operational debt.

(4) A preference shall be deemed to be given at a relevant time, if –

(a) It is given to a related party (other than by reason only of being an employee), during the period of two years preceding the insolvency commencement date; or

(b) a preference is given to a person other than a related party during the period of one year preceding the insolvency commencement date.

[2] A person shall be deemed to have sufficient information or opportunity to avail such information if a public announcement regarding the corporate insolvency resolution process has been made under section 13.

[3] Vitol S.A. vs. Asian Natural Resources (India) Ltd. and Ors. Order dated 06.11.2017

[4] H.R. REP. NO. 95-595, at 178 (1977).

[5] Anuj Jain Interim Resolution Professional Jaypee Infratech limited v. Axis Bank Limited

 Ins. by Act No.26 of 2018, sec. 27 (w.e.f. 6-6-2018).id

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