August 19, 2022 / IBC

Preferential Transactions Principles under IBC -Insolvency

Table of Contents

Principles of Preferential Transactions & Speeding Up Insolvency Proceedings

When insolvency proceedings are initiated, it became important to stop all distressed companies from making any decisions that could hamper creditors (regarding their recovery). This is important in any context for the success of insolvency proceedings under any regime. For the Indian subcontinent, there is a need for specific provisions for the prevention of creditors and stakeholders.
Business valuation services used by creditors to carry out due diligence on borrower companies. Creditors will get a precise estimation of their businesses and tangible assets, with the help of the right valuation services.
Many Promoters of holding companies use biased structure to delegate the value of assets to other groups for making their own advantage. The NCLT has the power to undo such transactions so that the interests of the creditors can be protected, under IBC, 2016.
In one of the recent hearings, the incident between Anuj Jain, the interim resolution professional for Jaypee Infratech limited vs. Axis Bank limited and other organizations. The Supreme Court makes it clear that some crucial aspects of Section 43 of the Insolvency and bankruptcy code, in this case, SC applies the reference of the preferential transaction at the time of the hearing. ‘Preferential transactions’ are one of the four avoidable transactions that can be disregarded or annulled. Fraudulent, extortionate, & undervalued transactions are the rest three avoidable transactions.
Under this blog, we have a focus on these avoidable transactions as explained under the IBC act 2016, taking special note of the preferential transactions. We will also look to the Honorable Supreme Court’s analysis of some major aspects of the preferential transactions.

Preferential Transactions

Preferential transactions are explained in Sec-43 under Insolvency and Banking Code:

When a corporate debtor transfer interest and property to a guarantor, surety, or creditors in relation to the past liability.
When the surety, creditors or guarantor acquires a position a benefits by the distribution of assets in case of liquidation ( according to Section 53 of IBC 2016)

Preferential transaction to come under avoidable transactions

For a preferential transaction to come under avoidable transactions, it should have fall in the below circumstances –

When the transaction has occurred and the party is known covered under a timeline of a 2-year’ lookback’ period before the corporate debtor entered into insolvency under IBC 2016.
When the preferential transaction has occurred in other cases, & the case is covered within the period of one year’ lookback’ timeline period before the CD entered into insolvency under IBC 2016.

Undervalued Transactions

An Undervalued Transaction U/s 45(2) of the Insolvency and Bankruptcy Code, 2016 is defined in the below mention way:

In case, the corporate debtor gifts something to a person.
In case one or more of assets of corporate debtor is transferred to a person for consideration.

When compared to the value of the consideration offered by the corporate debtor, this consideration is very low. This transaction should not be carried out in the ordinary course of business by the corporate debtor.

Transactions Defrauding Creditors

Section 49 of the Insolvency and Bankruptcy Code, 2016 says that transactions defrauding creditors are the undervalued transactions in which the corporate debtor wants to enter in it-

By keeping the assets far away from everyone’s reach who is capable of claiming against them.
And by keeping the assets beyond their reach, which affects the interest of the person going to claim.

The difference between Undervalued transactions and transactions defrauding creditors is ‘Intent’.

Extortionate Transactions

Under Section 50 of the Insolvency and Bankruptcy Code, 2016, It involves the receipt of transactions of financial or operational debt within the time period of 2 years before the inception of insolvency. In case of avoidable transactions, deals with the transfer of assets, and the extortionate transactions cover the receipt of credit. Both transactions have the same result i.e. transfer of value outside the corporate debtors.

Supreme Court’s Analysis of Preferential Transactions

Jaiprakash Associates Ltd. is the parent company of Jaypee Infratech Ltd., Loans are taken by JAL, but JIL was created mortgage, which was under insolvency. The main question in the Jaypee Infratech case was whether these mortgages were avoidable preferential transactions under Sections 43 and 44 of the IBC. Another question was whether the JAL lenders should be considered JIL’s financial creditors because JAL’s loans were secured by mortgages on JIL’s properties.

Analysis

Supreme Court’s investigated and mentioned some basic principles of preferential transactions that ‘preference’ defined according to law it occurs when the insolvent debtor pays some part or whole of claims to creditors, mentioned in section 43 of the Insolvency and Bankruptcy Code 2016, the Supreme Court’s said that then the transaction would come under preferential:

1.If the assets were transferred by Corporate debtors it is advantageous for creditors in paying all financial debt owed to creditors

2.For the sake of creditors Benefit during any deal or transactions. This type of favorable position would not work during liquidation waterfall, Belongs to section 53(ii) of the Insolvency and Bankruptcy Code 2016.

These transactions took place –

Parties dealing under the timeline of two years’ lookback’ period prior to the corporate debtor entering into insolvency.

And there is one other case in which the timeline is a one-year’ lookback’ period prior to the corporate debtors entering into insolvency.

Scope of preferential transactions

The Following transactions would be excluded from the scope of preferential transactions on the below grounds:

When there are transfers or transactions done by the usual practice in business or financial affairs of the corporate debtor.
The transaction ensures the value of the corporate debtor to acquire property in conditions of services, goods, new credit, and services.

Judgment

Supreme Court of India agreed that the mortgage held by JIL includes all properties of a preferential transaction under the the Insolvency and Bankruptcy Code 2016. It is noticeable that:

If the transfer was made of interest/ property for creditors’ benefit.
Antecedent liability or debt owed by the debtor are reasons for the transfer.
Transfer made within a lookback period for the benefit of their allied party.
The transfer was not made in financial matters or in the usual practice of business.

Key Takeaways

It is essential for creditors to check the Updated latest current financial records of the company before contracting with them. While after going through the financial records of the company you can evaluate the risk of transactions or avoidable as per the condition.

In this regard, our business valuation services might be very beneficial to creditors. Our team of professionals is ready to help you with any valuation or business verification activities. Contact us today to learn more about our valuation services! We are here to assist you with all of your valuation needs.

Services in the field of Insolvency Laws

IFCCL is a well-known and renowned name in the fields of valuation consulting and allied services, insurance survey and loss assessment, and insurance advisory services, as well as corporate finance and deal advisory.

Drafting of Insolvency Petition Under IBC
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Appearances by the Advocates & pleadings for the same
Action for National Company Law Tribunal Final Order
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