Under the Insolvency and Bankruptcy code 2016, section 43 is dealt with Preferences if any given by the Corporate Debtor before and during the insolvency. This is a very important section and every Insolvency Professional should keep this in mind. Success of the insolvency depends upon timely completion of the process of insolvency and also ensures the corporate debtor should not alienate the property to others during twilight period. Twilight period means that time during which Directors have to come understand that they cannot avoid the commencement of insolvency and actual date of commencement of insolvency. During this period the Directors have to exercise extra caution to prevent the further loss to the creditors. Generally Directors will transfer certain properties to their nearby relatives. To avoid this, National Company Law Tribunal was given certain powers to undo these transactions and retransfer the properties to the control of insolvency Professional.

As a result of the preferences given by the corporate Debtor, there will be a disturbance in the distribution of assets in the liquidation of the corporate debtor under section 53 of the code .The section 43 will invalidate the entire transaction if it is done within the relevant time period for the benefit of creditor,guarantor,surety on account of antecedent debt or other liabilities which have the effect of putting such creditor, Guarantor or surety in a better position in the event of distribution made under section 53. Than if such transfer had not taken place. This transaction will be categorised under preferential transaction. The relevant period should be preference must have been given during the two years preceding the insolvency commencement date if it is given to the related party and one year preceding the insolvency commencement date if it is given to all other parties.

As per section 43(2) a corporate debtor shall be deemed to have given preference if the following conditions satisfied

1. There should be a transfer of property or interest thereof

2. The transfer shall be made for the benefit of creditor, surety or guarantor.

3. The transfer should be done on account of antecedent debt which may be financial or operational or other liabilities owed by the corporate debtor

4. As a result of this transfer, creditor, surety or guarantor position will change to a beneficial position in the distribution of assets being made in accordance with section 53 in the event of if the transfer has not been done.

5. This transfer should be done within the relevant period. The relevant period should be 2 years for related party and 1 year for other parties preceding the date of commencement  of insolvency of the corporate debtor

From the above it can be inferred that in order to consider a transaction as Preferential transaction, there should be a transfer of property or interest in property and this transfer should be done on account of antecedent debt. Antecedent debt means, earlier debt or prior debt. There will be a connection between transfer of property to the antecedent debt. Further as a result of this transfer of property or interest, the position of creditor, guarantor or surety will change to a Position which is better than that if the transfer would not take place. This transfer should take place within two years in case of related party and one year in case non related party preceding the commencement of insolvency resolution process.

But the following transfers made by the corporate debtor will not be considered as preferential transfer.

1. If the transfer of property or interest has been done in the ordinary course of the business or financial affairs of the corporate debtor or transferee

2. Any transfer creating a security interest in property acquired by the corporate debtor to the extent that

a) Such security interest creates a new value

b) It was given at the time of or after signing the security agreement that contains the description of such property as security interest

c) It was used by the corporate debtor to acquire such property

d) Such transfer was registered with an information Utility on or before thirty days after the corporate debtor receives such property

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 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.

IDBI Bank Ltd. v. Jaypee Infratech Ltd1  the Allahabad Bench of the National Company Law Tribunal (“NCLT”) has held that transactions amounted to preferential under the Insolvency and Bankruptcy code 2016.The case is good example for a transaction to be considered as Preferential transaction. The details of the case are

1. M/s JaiPrakash Associated (JAL) is holding company and M/s Jaypee Infratech ltd (JIL) is a subsidiary company.

2. JAL has promoted a special Purpose company JIL for undertaking certain design, engineering, development and construction of projects.

3. JAL is having 70% of the shares in JIL

4. Later JIL started facing financial difficulties and failed to honour its project completion details and loan repayment obligations.

5. As a result LIC has declared the account of JIL as NPA

6. Later other lenders have also classified the account of JIL as NPA

7. JIL is having 858 acres of land

8. JIL has offered this land as security for the loan availed by JAL from the creditors

9. Since the account of JIL was classified as NPA , their financial creditors (IDBI) have filed application in the NCLT under section 7 and Resolution Professional was appointed

10. RP has filed an application in the NCLT seeking the transaction as Preferential transaction under section 43 of IBC

11. NCLT has observed the following

a) Timing of entry of this transaction by JIL is questionable. JIL has entered into this transaction when it was facing severe financial difficulty. The beginning of the period from arising financial difficulty to the actual commencement of Corporate Insolvency resolution process is called Twilight zone period. During this period the Directors of the company have to exercise due dilegency and extra care and see that loss to the creditors due to their action during this period should not widen. But JIL has entered into this transaction when financial difficulty in the company commences.

b) The Tribunal has opined that JIL instead of mortgaging the land to financial institutions for securing the credit facility to JAL, had sold the said land and repaid the dues to the creditors are the best option.

c) JIL has not acted diligently for reducing the loss to the creditors

d) JIL has mortgaged the land without counter guarantee from JAL

e) Further JIL has not taken necessary approvals from the JLF lenders and also from the shareholders for the impugned transaction

f) Even if the JIL has sought approval from the members of JLF, it is quiet unlikely to get approval from JLF due to its financial position

g) NCLT has not accepted the contention of JAL that nominee director was present in the meeting in which the decision of mortgage of land was taken

h) The Tribunal further noticed that in the minutes of meeting of JLF members, it was decided that the entire land should be transferred to Trust where JIL lenders will be beneficiary’s for the Trust and later the land should be disposed and proceeds should be distributed to the lenders .But JIL has not acted as per the decision. But it acted in contravention of this decision

i) The Tribunal has also not accepted the contention of JAL that the transaction was done in the ordinary course of business.

j) It is observed that the impugned transactions were entered into within the relevant period

k) NCLT has not accepted the argument that to consider the transaction to be called a Preferential, the transfer of property should be made only to the Creditor, Guarantor or surety. It is stated that JAL has made finance to JIL hence JAL is an operational creditor

Finally the Tribunal has observed that creation of security interest through impugned transaction had the effect of putting JAL in a better position in the event of JIL assets are distributed as per waterfall mechanism as per section 53 of the IBC 2016. Hene the impugned transaction are considered as preferential transactions and accordingly order has been made to transfer the land from JAL lenders to JIL.

Disclaimer clause- The information shared above is true and correct to the best of our knowledge. All statements /recommendations are made without guarantee on the part of the author or publisher. The author or publisher will disclaim any liability in connection with the use of this information. The author shall not liable for any direct, indirect ,special or incidental damage resulting from arising out of or in connection with the use of the information  .The article is  for the purpose of education only.

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February 2024