[2021] 

126 taxmann.com 16 (Article)
Date of Publishing: April 2, 2021

Avoidable Transactions Under IBC

image
ADITI BHAWSAR
Insolvency and Bankruptcy Code, 2016 (IBC) was enacted with a view to maximize the value of assets
and balance the interests of several stakeholders. However, for any insolvency regime to be successful,
it is imperative that defaulted companies are prevented from taking measures that could interfere with
recovery to creditors in the insolvency proceedings. Whenever an entity becomes insolvent, certain
transactions that could maximize the assets of the corporate debtor are avoided to prevent
opportunistic and value-destroying actions indulged by the corporate debtor. These transactions are
called 'avoidable transactions'. As per section 25(2)(j) of IBC, it is a duty upon the Resolution
Professional to file an application for the avoidance of transactions in accordance with Chapter III of
Part II of the Code, if there is any. Similarly, section 35(1)(l) of the IBC casts a duty on the liquidator to
inquire about the financial affairs of the corporate debtor, to ascertain the existence of any undervalued
or preferential transactions. Apart from the above mentioned specific provisions of the IBC, section 43
to 51 deals with other avoidable transactions. These transactions are divided into the following four
categories i.e., preferential, undervalued, extortionate transactions, and lastly fraudulent. These
transactions are collectively referred to as PUFE transactions.

Preferential Transactions

Preferential transactions are dealt with under section 43 and 44 of the Insolvency and Bankruptcy
Code. A transaction is said to be preferential, when -

i.   it is not done in the ordinary course of business and

ii.   the liquidator or the resolution professional is of the opinion that the transfer of
property or an interest in respect of existing debt or liability on account of a debt
owed by the corporate debtor is for the benefit of a creditor, surety or guarantor in
the distribution of assets in case of liquidation as per section 53 of the IBC.
Furth   2 years preceding the insolvency commencement date, if made to a related party and
er,
for
any
prefe
rentia
l
trans
actio
n to
be
avoid
able,
it
shoul
d
 have
been
given
at the
relev
ant
time
i.e.,
look-
back
perio
d.
The
'relev
ant
time'
perio
d for
a
trans
actio
n
being
prefe
rentia
l is1i.

ii.   1 year if made to a person other than a related party.

Section 5(24) of the Code specifies a list of the people taken as related party. Raison d'être for avoiding
a preferential transaction is to prevent a creditor, surety, or a guarantor from taking undue advantage
over other creditors during the period when the corporate debtor is already facing financial stress or has
already become insolvent.

IDBI Bank Ltd. v. Jaypee Infratech Ltd. -

2
is an impeccable example of a Preferential transaction. NCLAT in this matter allowed the appeal and
set aside the impugned order and observed that ''all the transactions in question were entered into
within the relevant period and are preferential transactions under section 43 of the Code, as all the
transactions in question had taken place either on or after the Insolvency Commencement Date''.

Further, the NCLAT in Tirumala Balaji Alloys (P.) Ltd. v. Sumit Binani3 observed that:

...as it is not in dispute that the promoters of the 'Corporate Debtor' hold 99.4% shareholding in 'Excello
Fin Lea Limited' and 50% shareholding in 'Tirumala Balaji Alloys Pvt. Ltd.' and rest of the 50%
shareholding of the 'Tirumala Balaji Alloys Pvt. Ltd.' is with the relatives of the promoters of the
'Corporate Debtor' i.e. 'Rungta Family', we are of the view that all the transactions made during the
period of two years preceding the date of Insolvency Commencement Date i.e., 18th July 2017 come
within the meaning of 'preferential transactions'.

The NCLT has wide powers with respect to preferential transactions and could inter alia reverse the
transaction under section 44 of IBC. However, there are certain exceptions to preference i.e., if the
transfer is made in the ordinary course of the business, or the transfer produces security in property
possessed by the corporate debtor and such security interest secures new value and was registered with
an information utility on or before 30 days after the corporate debtor receives possession of such
property.The rationale for having an exception is to ensure that the routine and regular transactions
undertaken by the corporate debtor in the regular course of business in the relevant period remain
unaffected and the company continues to operate smoothly.

Undervalued Transactions

Unde   makes a gift; or

rvalu
ed
trans
actio
ns
are
dealt
with
under
sectio
n 45-
48i.

ii.   enters into a transaction not done in the ordinary course of business and transfers
one or more assets for a considerably lesser value of the consideration provided by
the corporate debtor.
The relevant time-period for avoiding an undervalue transaction made with a related party is 2 years
from the Insolvency Commencement Date party and one year in other cases.

As per section 47 of the IBC, apart from the liquidator or resolution professional, a partner in case of a
limited liability partnership (LLP), a creditor, or a member in case of a company of a corporate debtor
shall make an application to the Adjudicating Authority if the transaction comes out to be an
undervalued transaction. The NCLT can order for the restoration of the position as it was, prior to the
transaction and can initiate proceedings against the liquidator or the resolution professional if, the
NCLT finds that same transaction was not reported by the resolution professional or liquidator in spite
of having sufficient information or opportunity to avail information of the transaction.

In IDBI Bank v. Jaypee Infratech Ltd. of the Insolvency and Bankruptcy Code, 2016. As per
section 45(2) of IBC, a transaction is said to be an undervalued transaction when the corporate debtor-
4
, it was observed by the NCLT, Allahabad Bench that, ''any transaction is said to be an undervalued
transaction, if the consideration for entering into the transaction is substantially of lesser value than
what it would have otherwise been if it had been entered at an arm's length basis''.
The aim of avoiding an undervalued transaction is to prevent inept reduction and diminution of the net
asset value of the corporate debtor during the twilight period. It is imperative that during the twilight
period, the net asset value of the corporate debtor is protected for the general benefit of the creditors.
The mere exception to an undervalued transaction is that the transaction took place in the ordinary
course of business of the corporate debtor. Further, the National Company Law Tribunal Mumbai
Bench observed in the matter of Mrs Dipti Mehta v. Shivani Amit Dahanukar5 that, ''since the
impugned transaction took place in the ordinary course of business of the corporate debtor. Hence, it
is exempted from being an undervalued transaction''.

The   require any property transferred as part of the transaction, to be vested in the
Adju corporate debtor;
dicati
ng
Auth
ority
may
decla
re an
under
value
d
trans
actio
n as
void
and
may
pass
the
follo
wing
natur
e of
order
s to
rever
se the
effect
of
such
trans
actio
n6i.

ii.   release or discharge (in whole or in part) any security interest granted by the
corporate debtor;
 iii.  
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
iv.   require the payment of such consideration for the transaction as may be determined
by an independent expert.
Extortionate Transactions

Section 50-51 of the IBC deals with extortionate transactions. Extortionate transactions are the credit
transactions which include the receipt of financial or operational debt and require exorbitant,excessive
or severe payments to be made by the corporate debtor. A transaction is said to be an extortionate
transactionif:
7
i.   the corporate debtor makes exorbitant payments in respect of the credit provided; or
ii.   the contracts made by the corporate debtor are unconscionable under the principles
of law relating to contracts.
The look back period for avoiding an extortionate credit transaction is 2 years preceding the date of
insolvency commencement date, regardless of whether the counterparty is a related party or unrelated
party. The only exception to an extortionate transaction is the presence of any debt extended by any
person providing financial services under any other law for the time being in force. Such transactions
will not be considered as extortionate credit transactions.

In Anamika Singh v. Shinhan Bank:

8
, the NCLT, New Delhi observed that, ''in the normal course of business, a company take loans from
banks at certain rate of interest, but in the present case,the appellant has charged the exorbitant rates
of interest within the relevant period of two years from the insolvency commencement date, and
therefore the said transactions are held to be unconscionable, or extortionate''.

The   Restore the position as it existed prior to such a transaction.

Adju
dicati
ng
Auth
ority
may
decla
re an
extort
ionat
e
trans
actio
ns as
void
and
may
pass
the
 follo
wing
natur
e of
order
s to
rever
se the
effect
of
such
trans
actio
n9i.

ii.   Set aside the whole or part of the debt created on account of the extortionate credit
transaction.
iii.   Modify the terms of the transaction.
iv.   Require any person who is, or was, a party to the transaction to repay any amount
received by such person.
v.   Require any security interest that was created as part of the extortionate credit
transaction to be relinquished in favor of the liquidator or the RP.
Fraudulent trading/transactions

Section 66(1) of IBC deals with fraudulent trading, or a fraudulent transaction. A transaction is said to
be a fraudulent transaction if, it is proven that during the corporate insolvency resolution process or a
liquidation process any business of the corporate debtor has been carried on with an intention to
defraud the creditors for any fraudulent purpose. This section is not only applicable to internal persons
like directors, partners, employees but, also outside persons.

If the Adjudicating Authority adjudges a transaction to be a fraudulent transaction, it may pass an order
against the person carrying on the business and direct him/her to make contribution to the assets of the
corporate debtor, if

i.   before the insolvency commencement date, such director or partner knew or ought
to have known that the there was no reasonable prospect of avoiding the
commencement of a corporate insolvency resolution process in respect of such
corporate debtor; and
ii.   such director or partner did not exercise due diligence in minimizing the potential
loss to the creditors of the corporate debtor.
In the case of fraudulent transactions, there is no look-back period. Hence directors under this section
cannot plead ignorance of knowledge and may be punished if they do not have an element of dishonest
intention but have acted negligently by exposing the company to loss.

Conclusion

One of the most important objective behind the robust framework for identifying avoidance
transactions entered into is to protect the interests of stakeholders of a corporate debtor. Hence, it is
imperative that the creditors or contracting parties make sure that they have access to the latest
financial position of a company before entering into any transaction, before involving in any transfer of
assets or value from such a company. Further, in the event of any signs of financial distress, the risk of
any such transaction being avoided should be appropriately considered and weighed.

■■

1. Section 43(4) of IBC, 2016.

2. IDBI Bank Ltd. v. Jaypee Infratech Ltd. [2018] 93 taxmann.com 308 (NCLT - All.)
3. Tirumala Balaji Alloys (P.) Ltd. v. Sumit Binani [2021] 123 taxmann.com 17 (NCL - AT)
4. Supra Note 1
5. Mrs Dipti Mehta v. Shivani Amit Dahanukar [2019] 104 taxmann.com 180/153 SCL 582
(NCLT - Mum.).
6. Section 48 of IBC, 2016.
7. Section 50(1) of IBC, 2016 r/w Regulation 5 of the CIRP Regulations.
8. Anamika Singh v. Shinhan Bank [Company Appeal (AT) (Insolvency) No. 912-913 of 2019,
dated 24-6-2020].
9. Section 51 of IBC, 2016.