Principles of Avoidable Preferential Transactions
Elements of Avoidable Preferential Specified Transactions under IBC 2016
As per the 2016 Insolvency and Bankruptcy Code, Section 43 to 51 deals with avoidable transactions. These transactions are also kept referring to as vulnerable transactions.
In case of code, there are three types of avoidable transactions. These are preferential transactions, undervalued transactions, and extortionate credit transactions that the corporate debtor must avoid during the relevant period.
Section 43: Preferential Transaction
To the advantage of the borrower, a sale of the assets or property of the corporate debtor shall be made on account of the previous financial obligation or other liabilities.
Such a move has the effect of placing the borrower in a place of profit rather than the allocation of the properties referred to in section 53
Not considered as preferential transactions
- Transfer made in the ordinary course of business of the corporate debtor or the transferee
- Any transfer creating a security interest in the property acquired by the corporate debtor to the extent that,
- Such security interest secures “new value” and was given at the time of or after the signing of a security agreement that contains a description of such property as a security interest and was used by corporate debtor to acquire such property
- Transfer was registered with an information utility on or before thirty days after the corporate debtor receives possession of such property
- Provided that any transfer made in pursuance of the order of a court shall not, preclude such transfer to be deemed as giving of preference by the corporate debtor
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.
Relevant Time: 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
A preference is given to a person other than a related party during the period of one year preceding the insolvency commencement date.
Section 44: Orders in case of Preferential Transactions
The Adjudicating Authority may on an application made by the resolution professional or liquidator, by an order
- Require any property transferred in connection with the giving of the preference to be vested in the corporate debtor
- Any property to be so vested if it represents the application either of the proceeds of sale of property so transferred or of money so transferred;
- release or discharge (in whole or in part) of any security interest created by the corporate debtor;
- require any person to pay such sums in respect of benefits received by him from the corporate debtor, such sums to the liquidator or the resolution professional, as the Adjudicating Authority may direct;
- Any guarantor, whose financial debts or operational debts owed to any person were released or discharged (in whole or in part) by the giving of the preference, to be under such new or revived financial debts or operational debts to that person as the Adjudicating Authority deems appropriate;
- For providing security or charge on any property for the discharge of any financial debt or operational debt under the order, and such security or charge to have the same priority as a security or charge released or discharged wholly or in part by the giving of the preference; and
- The direct for providing the extent to which any person whose property is so vested in the corporate debtor, or on whom financial debts or operational debts are imposed by the order, are to be proved in the liquidation or the corporate insolvency resolution process for financial debts or operational debts which arose from, or were released or discharged wholly or in part by the giving of the preference:
Provided that an order under this section shall not—
- affect any interest in property which was acquired from a person other than the corporate debtor or any interest derived from such interest and was acquired in good faith and for value;
- require a person, who received a benefit from the preferential transaction in good faith and for value to pay a sum to the liquidator or the resolution professional.
Section 45: Undervalued Transactions
If, as the case may be, the liquidator or the resolution professional finds, after reviewing the transactions of the corporate debtor, that such transactions have been made within the applicable time under section 46.
which have been undervalued, he shall make an appeal to the adjudicating authority to declare certain transactions null and void and to reverse the effect of such transactions in compliance with that clause.
A transaction shall be considered undervalued where the corporate debtor—
- makes a gift to a person; or
- enters into a transaction with a person which involves the transfer of one or more assets by the corporate debtor for a consideration the value of which is significantly less than the value of the consideration provided by the corporate debtor,
- and such transaction has not taken place in the ordinary course of business of the corporate debtor.
Section 46: Relevant period for avoidable transactions
In an application for avoiding a transaction at undervalue, the liquidator or the resolution professional, as the case may be, shall demonstrate that—
- such transaction was made with any person within the period of one year preceding the insolvency commencement date; or
- A transaction was made with a related party within the period of two years preceding the insolvency commencement date.
Section 47: Application by creditor in case of undervalued transactions
Where an undervalued transaction has taken place and the liquidator or resolution professional, as the case may be, has not informed the adjudicator, the borrower, the employee or the spouse of the corporate debtor, as the case may be, the appeal to the adjudicator to render those transactions null and void in compliance with this Clause.
Where the Adjudicating Authority, after examination of the application made under sub-section (1), is satisfied that—
- undervalued transactions had occurred; and
- the liquidator or the resolution professional, as the case may be, after having sufficient information or opportunity to avail information of such transactions did not report such transaction to the Adjudicating Authority,
It shall pass an order—
- restoring the position as it existed before such transactions and reversing the effects thereof in the manner as laid down in section 45 and section 48;
- requiring the Board to initiate disciplinary proceedings against the liquidator or the resolution professional as the case may be.
Section 48: Order in case of undervalued transactions
The order of the Adjudicating Authority under sub-section (1) of section 45 may provide for the following:
- Any property transferred as part of the transaction, to be vested in the corporate debtor;
- release or discharge (in whole or in part) any security interest granted by the corporate debtor;
- A require any person to pay such sums, in respect of benefits received by such person, to the liquidator or the resolution professional as the case may be, as the Adjudicating Authority may direct; or
- The payment required of such consideration for the transaction as may be determined by an independent expert.
Section 49: Transactions defrauding creditors
Where the corporate debtor has entered into an undervalued transaction and the Adjudicating Authority is satisfied that such transaction was deliberately entered into by such corporate debtor—
- for keeping assets of the corporate debtor beyond the reach of any person who is entitled to make a claim against the corporate debtor; or
- in order to adversely affect the interests of such a person in relation to the claim,
- the Adjudicating Authority shall make an order—
- restoring the position as it existed before such transaction as if the transaction had not been entered into; and
- protecting the interests of persons who are victims of such transactions:
Provided that an order under this section—
- shall not affect any interest in property which was acquired from a person other than the corporate debtor and was acquired in good faith, for value and without notice of the relevant circumstances, or affect any interest deriving from such an interest, and
- He shall not require a person who received a benefit from the transaction in good faith, for value and without notice of the relevant circumstances to pay any sum unless he was a party to the transaction.
Section 50: Extortionate credit transactions
Where a corporate debtor has been a party to an extortionate credit facility involving the acquisition of financial or operational liability for a period of two years before the date of commencement of insolvency, the liquidator or the resolution professional may, as the case may be, make an appeal to the Adjudicating Authority to prevent such an agreement if the terms of that transaction are met.
Section 51: Orders of Adjudicating Authority in respect of extortionate credit transactions
Where the Adjudicating Authority after examining the application made under sub-section (1) of section 50 is satisfied that the terms of a credit transaction required exorbitant payments to be made by the corporate debtor, it shall, by an order—
- restore the position as it existed prior to such transaction;
- set aside the whole or part of the debt created on account of the extortionate credit transaction;
- modify the terms of the transaction;
- require any person who is, or was, a party to the transaction to repay any amount received by such person; or
- He require any security interest that was created as part of the extortionate credit transaction to be relinquished in favor of the liquidator or the resolution professional, as the case may be.
Therefore, the rules for the prohibition of transactions ensure that transactions that have no other business intent and which have been conducted solely to the benefit of certain creditors or to obstruct the insolvency or liquidation process are put aside.
The laws aim to remedy the condition when a certain transfer of assets is made merely to hold the property away from the pool of assets to be shared by creditors.
However, the principles of deterrence must be strictly followed to ensure that legal activities conducted in the usual course of business are not overturned.