Transactions specifically related to Sections 43 to 46 and Section 66 of the Insolvency and Bankruptcy Code, 2016 are being looked at by the forensic experts. These sections deal with identifying preferential and undervalued transactions, and those deliberately entered into to defraud creditors. These sections also deal with identifying undisclosed relationship(s) between the entities of the company.
1.1. Preferential transactions and relevant time [Section 43]
(1) Where the liquidator or the resolution professional, as the case may be, is of the opinion that the corporate debtor has at a relevant time given a preference in such transactions and in such manner as laid down in sub-section (2) to any persons as referred to in sub-section (4), he shall apply to the Adjudicating Authority (i.e. National Company Law Tribunal or NCLT in short) for avoidance of preferential transactions and for, one or more of the orders referred to in section 44.
(2) A corporate debtor shall be deemed to have given a preference, if—
(a) there is a transfer of property or an interest thereof of the corporate debtor for the benefit of a creditor or a surety or a guarantor for or on account of an antecedent financial debt or operational debt or other liabilities owed by the corporate debtor; and
(b) the transfer under clause (a) has the effect of putting such creditor or a surety or a guarantor in a beneficial position than it would have been in the event of a distribution of assets being made in accordance with section 53.
(3) For the purposes of sub-section (2), a preference shall not include the following transfers—
(a) transfer made in the ordinary course of the business or financial affairs of the corporate debtor or the transferee;
(b) any transfer creating a security interest in property acquired by the corporate debtor to the extent that —
(i) 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 security interest, and was used by corporate debtor to acquire such property; and
(ii) such 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.
Explanation.—For the purpose of sub-section (3) of this section, “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.
The expression “transfer of property” connotes the passing of rights in property from one person to another. In one case, there may be a passing of the entire bundle of rights from the transferor to the transferee. In another case, the transfer may consist of one of the estates only out of all the estates comprising the totality of rights in the property. In a third case, there may be reduction of the exclusive interest in the totality of rights of the original owner into a joint or shared interest with other persons. An exclusive interest in property is a larger interest than a share in that interest. To the extent to which the exclusive interest is reduced to a shared interest, it would seem that there is a transfer of interest [Sunil Sidharthbhai v. CIT  156 ITR 509 (SC)]
“Transfer” is generally regarded as comprehending within its scope both voluntary and involuntary [Mangalore Electric Supply Co. Ltd. v. CIT  113 ITR 655 (SC)]
Interest in property means one or more of those rights which go to make up ownership. It includes, for example, mortgage, lease, charge, easement and the like (see Collector of Bomaby v. Nusservanji Rattanji Mistri AIR 1955 SC 298). Without any right, present or contingent, interest in property cannot exist. Right precedes interest. Such rights must have economic significance, have a value capable of yielding income or being transferred. Such rights are called proprietary rights and are manifested as estate, asset or property. Rights devoid of economic significance, incapable of being transferred for a consideration, lacking value or content, are rights of status which are in the nature of personal rights, for example, the right to reputation, right to personal liberty etc. The distinction between the property and the personal rights is that the property rights are susceptible to valuation while the personal rights are not. The right would be proprietary, if it has economic value [see Stock Exchange v. ACIT  94 Comp. Cas. 683 (Guj.)]
The word “ordinarily” means “normally” but there can be deviation of the rule if the circumstances so demand and it makes relaxation in compliance of the rule permissible (Krishan Gopal v. Prakashchandra AIR 1974 SC 209). Deviation is permissible if such deviation can be justified by reasons (Union of India v. Majji Jangammayya AIR 1977 SC 757, Union of India v. Vipinchandra Hiralal Shah  6 SCC 721). In Eicher Tractors Ltd. Haryana v. CC AIR 2001 SC 196, the Supreme Court held that word “ordinarily” necessarily implies the exclusion of “extraordinary” or words “special circumstances.”
Course ordinarily conveys the meaning of a continuous progress from one point to the next in the time or space and conveys the idea of a period of time, duration and not a fixed point of time [CIT v. East West Import and Export (P.) Ltd.  176 ITR 155 (SC)].
The word “business” in a generic sense means any purposeful activity, any activity directed towards some end, an activity engaged in as normal, logical or inevitable and usually extending over a period of time (see Bakhtawar Singh Balkrishan v. Union of India AIR 1983 Delhi 201). It encompasses almost anything which is an occupation, as distinct from a pleasure – anything which is an occupation or duty which requires attention is a business. The expression “business” is not confined to trade or manufacture. It includes within its scope professions, vocations, and callings for a fairly long time. The word “business” is one of wide import and it means an activity carried on continuously and systematically by a person by the application of his labour and skill. For the purposes of formation and incorporation, what is necessary is any legal or lawful activity and not necessarily the commercial activity for profit, as for example is trust company [see Ramchandra Adityan v. Educational Trustee Co.  113 Comp. Cas. 334 (Mad.)]
1.2. Order in case of preferential transactions [Section 44]
(1) The Adjudicating Authority, may, on an application made by the resolution professional or liquidator under sub-section (1) of section 43, by an order :
(a) require any property transferred in connection with the giving of the preference to be vested in the corporate debtor;
(b) require 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;
(c) release or discharge (in whole or in part) of any security interest created by the corporate debtor;
(d) 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;
(e) 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;
(f) direct 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
(g) 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—
(a) 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;
(b) 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.
Explanation I.—For the purpose of this section, it is clarified that where a person, who has acquired an interest in property from another person other than the corporate debtor, or who has received a benefit from the preference or such another person to whom the corporate debtor gave the preference, —
(i) had sufficient information of the initiation or commencement of insolvency resolution process of the corporate debtor;
(ii) is a related party,
it shall be presumed that the interest was acquired or the benefit was received otherwise than in good faith unless the contrary is shown.
Explanation II.—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.
The applicant, an educational society, had entered into a lease agreement with company-in-liquidation under which a land was leased to applicant on a monthly rent for a period of 28 years after which, applicant was to become an absolute owner – Liquidation proceedings in respect of company-in-liquidation had been commenced on 14-3-2000, which was followed by an order of winding up – Official Liquidator was appointed as liquidator of company-in-liquidation and he took possession of its properties – For financing its expansion programme, applicant approached a bank which in turn demanded security over leasehold land and sought specific orders from Court approving creation of charge on leasehold land in favour of bank, and for keeping said land outside purview of liquidation proceedings till time loan amount was repaid – Applicant, therefore, filed instant application under rules 6 and 9 seeking permission from Court to create charge over leasehold land in favour of bank – It was found that value of leasehold property of 6 acres was more than Rs. 1 crore per acre but same was leased out to applicant society for a meager amount of Rs. 2.84 lakhs for 28 years with absolute ownership thereafter. It was held that the property was transferred to applicant-society not for valuable consideration and thus the transaction entered into between company-in-liquidation and applicant-society was not in ordinary course of business and encumbrance was not in good faith – Kirloskar Institute of Advanced Management Studies v. Official Liquidator of Mysore Kirloskar Ltd. (In Liquidation) [ 108 SCL 720 (Karnataka)]
Entering into a lease agreement, with regard to a prime asset of company, providing for 30 years lease, within one year prior to presentation of winding up petition is held to have fallen within prohibition mentioned above – Sri Krishnasamy Reddiar Educational Trust vs. Official Liquidator  22 taxmann.com 293 (Madras)
1.3. Avoidance of undervalued transactions [Section 45]
(1) If the liquidator or the resolution professional, as the case may be, on an examination of the transactions of the corporate debtor referred to in sub-section (2) of section 43 determines that certain transactions were made during the relevant period under section 46, which were undervalued, he shall make an application to the Adjudicating Authority to declare such transactions as void and reverse the effect of such transaction in accordance with this Chapter.
(2) A transaction shall be considered undervalued where the corporate debtor —
(a) makes a gift to a person; or
(b) 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.
1.4. Relevant period for avoidable transactions [Section 46]
(1) In an application for avoiding a transaction at undervalue, the liquidator or the resolution professional, as the case may be, shall demonstrate that—
(i) such transaction was made with any person within the period of one year preceding the insolvency commencement date; or
(ii) such transaction was made with a related party within the period of two years preceding the insolvency commencement date.
(2) The Adjudicating Authority may require an independent expert to assess evidence relating to the value of the transactions mentioned in this section.
1.5. Transactions defrauding creditors [Section 49]
(1) Where the corporate debtor has entered into an undervalued transaction as referred to in sub-section
(2) of section 45 and the Adjudicating Authority is satisfied that such transaction was deliberately entered into by such corporate debtor—
(a) 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
(b) in order to adversely affect the interests of such a person in relation to the claim, the Adjudicating Authority shall make an order—
(i) restoring the position as it existed before such transaction as if the transaction had not been entered into; and
(ii) protecting the interests of persons who are victims of such transactions:
Provided that an order under this section—
(a) 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
(b) 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.
Fraudulent preference means giving an improper benefit to a few creditors leading to inequity between them and the generality of creditors. In order to establish that fraudulent preference was shown to a particular creditor it must also be shown that it was done with a view to giving him favoured treatment. The dominant motive attending the transaction has to be ascertained and if it is tainted with dishonesty, questions of fraud arise. A probe into the debtor’s mind and an assessment of the various motives that animate human conduct is thus involved. Since the inference relates to dishonesty or something approaching dishonesty, there must be solid ground for drawing it. If the circumstances proved are equally consistent with guilt or innocence, the benefit of doubt goes to the accused. Suspicion, however strong, will not be sufficient; if there is a room for more explanations than one for the debtor’s conduct, an intent for to prefer cannot be inferred in the absence of direct evidence. There is no fraudulent preference if the payment or transfer is not voluntary. The payment of debts by a company under threat of legal proceedings or under reasonable apprehension of such proceedings does not amount to showing of preference. However, a payment made or benefit given to a creditor is not considered to be involuntary merely because the company had previously promised to make or give it at a time when it was solvent [Official Liquidator v. Victory Hire Purchase Co. (P.) Ltd. 52 Comp. Cas. 88 (Ker.)]
1.6. Extortionate credit transactions [Section 50]
(1) Where the corporate debtor has been a party to an extortionate credit transaction involving the receipt of financial or operational debt during the period within two years preceding the insolvency commencement date, the liquidator or the resolution professional as the case may be, may make an application for avoidance of such transaction to the Adjudicating Authority if the terms of such transaction required exorbitant payments to be made by the corporate debtor.
(2) The Board may specify the circumstances in which a transactions which shall be covered under sub-section (1).
Explanation.—For the purpose of this section, it is clarified that any debt extended by any person providing financial services which is in compliance with any law for the time being in force in relation to such debt shall in no event be considered as an extortionate credit transaction.
1.6.1. Extortionate credit transactions – meaning: A transaction shall be considered an extortionate credit transaction under section 50(2) where the terms-
(1) require the corporate debtor to make exorbitant payments in respect of the credit provided; or
(2) are unconscionable under the principles of law relating to contracts – Regulation 11 of Insolvency and Bankruptcy Board Of India (Liquidation Process) Regulations, 2016.
1.7. Fraudulent trading or wrongful trading [Section 66]
(1) If during the corporate insolvency resolution process or a liquidation process, it is found that any business of the corporate debtor has been carried on with intent to defraud creditors of the corporate debtor or for any fraudulent purpose, the Adjudicating Authority may on the application of the resolution professional pass an order that any persons who were knowingly parties to the carrying on of the business in such manner shall be liable to make such contributions to the assets of the corporate debtor as it may deem fit.
(2) On an application made by a resolution professional during the corporate insolvency resolution process, the Adjudicating Authority may by an order direct that a director or partner of the corporate debtor, as the case may be, shall be liable to make such contribution to the assets of the corporate debtor as it may deem fit, if—
(a) before the insolvency commencement date, such director or partner knew or ought to have known that there was no reasonable prospect of avoiding the commencement of a corporate insolvency resolution process in respect of such corporate debtor; and
(b) such director or partner did not exercise due diligence in minimising the potential loss to the creditors of the corporate debtor.
Explanation.—For the purposes of this section a director or partner of the corporate debtor, as the case may be, shall be deemed to have exercised due diligence if such diligence was reasonably expected of a person carrying out the same functions as are carried out by such director or partner, as the case may be, in relation to the corporate debtor.
Compiled by: CA Kamal Garg [Insolvency Professional] and CA Himanshu Sarpal. The contributors can be reached at firstname.lastname@example.org