Undervalued, extortionate, preferential and fraudulent transactions

The resolution professional files during the corporate insolvency resolution process, and the liquidator files during liquidation, each before the Tribunal that has the company. Section 26 provides that filing an avoidance application under section 25(2)(j) does not affect the proceedings of the resolution process, so the plan can be voted on and approved while the application is pending.

Where an undervalued transaction has taken place and the professional has not reported it, section 47 lets a creditor, member or partner of the company apply. If the Tribunal finds that the transaction was undervalued and that the professional had sufficient information or opportunity to find it and did not report it, section 47(2) requires it to reverse the transaction and to direct the Board to start disciplinary proceedings against the professional.

In a pre-packaged process, section 54C(3)(c) requires the company to declare at the time of filing whether any of its transactions may fall within the avoidance provisions of Chapter III or the fraudulent trading provisions of Chapter VI, and section 54N lets the Tribunal provide for those proceedings to continue if the pre-pack ends.

Section 43(2) deems a preference where the company transfers property or an interest in it for the benefit of a creditor, a surety or a guarantor on account of an antecedent financial debt, operational debt or other liability, and the transfer puts that person in a better position than it would have had in a distribution under section 53. The comparison is with what the transferee would have received in the liquidation waterfall.

Section 43(3) excludes a transfer made in the ordinary course of the business or financial affairs of the company or the transferee, and a security interest securing new value used to acquire the property, if registered with an information utility within thirty days after the company receives possession. A transfer under a court order can still be a preference.

Under section 43(4) a preference is given at a relevant time if it is given to a related party, other than only by reason of being an employee, in the two years before the insolvency commencement date, or to anyone else in the one year before it. Section 44 lists the orders the Tribunal may make: vesting the property back in the company, releasing a security interest, ordering payment for benefits received, and reviving a guarantor's liability. Its proviso protects an interest acquired from a person other than the company in good faith and for value.

Section 45(2) treats a transaction as undervalued where the company makes a gift, or transfers assets for consideration significantly less than the value of the consideration the company provides, and the transaction was not in the ordinary course of its business. Section 46 requires the professional to show that it was made with any person within one year before the insolvency commencement date, or with a related party within two years, and lets the Tribunal call for an independent expert to assess value.

Section 48 lets the Tribunal vest the property back in the company, release a security interest, require payment for benefits received, or require payment of the consideration an independent expert determines. The professional's application should therefore carry a valuation of what passed and what came back, with the date of each step.

Section 49 applies where the company entered into an undervalued transaction deliberately, either to keep its assets beyond the reach of a person entitled to claim against it or to adversely affect that person's claim. The Tribunal then restores the position as if the transaction had not been entered into and protects the victims.

Section 49 sets no relevant period, so the one and two year limits in section 46 do not confine it. The proviso protects a person who acquired an interest from someone other than the company in good faith, for value and without notice of the relevant circumstances, and spares a person who received a benefit in good faith, for value and without notice from paying anything unless that person was a party to the transaction. Intent is the element to prove, so the application has to plead the facts from which it is inferred, such as when each transfer was made and what the company owed at that time.

Section 50(1) lets the professional apply where the company was party to an extortionate credit transaction involving the receipt of financial or operational debt in the two years before the insolvency commencement date, and the terms required exorbitant payments. The Board may specify the circumstances covered. The Explanation to section 50 says that a debt extended by a person providing financial services in compliance with the law that applies to it shall in no event be treated as extortionate.

If the Tribunal is satisfied, section 51 lets it restore the earlier position, set aside the debt in whole or in part, modify the terms, order repayment of amounts received, or require a security interest created under the transaction to be relinquished to the professional.

Section 66(1) lets the Tribunal, on the resolution professional's application, order any persons who were knowingly parties to carrying on the company's business with intent to defraud creditors, or for any fraudulent purpose, to contribute to its assets. Section 66(2) adds wrongful trading: a director or partner who knew or ought to have known before the insolvency commencement date that there was no reasonable prospect of avoiding the process, and did not exercise due diligence to minimise the loss to creditors, can be ordered to contribute.

Section 67 lets the Tribunal make the liability a charge on any debt the company owes the person, and where that person is a creditor, rank its debt after all other debts in the order of priority under section 53.

In Piramal Capital and Housing Finance Ltd. v. 63 Moons Technologies Ltd. the Supreme Court held that applications for fraudulent or wrongful trading under section 66 are not avoidance applications. Under Chapter III the Tribunal sets aside identified transactions; under section 66 it fixes a contribution from the persons responsible. Where the professional files a common application, the Tribunal has to decide which provision governs which part of it.

The longer two year period applies only where the counterparty is a related party, so the professional's first task is to map the group. In Anuj Jain, Interim Resolution Professional for Jaypee Infratech Ltd. v. Axis Bank Ltd. the Supreme Court held that mortgages created by the company over its land to secure loans taken by its holding company were preferential transactions under section 43, and that the holding company's lenders who held those mortgages were not financial creditors of the company.

In Phoenix Arc Pvt. Ltd. v. Spade Financial Services Ltd. the Court held that two entities whose transactions with the company were collusive were related parties, were not financial creditors, and had to be excluded from the committee of creditors. A professional who finds collusive lending can therefore challenge the claim at the verification stage as well as by an avoidance application.

In liquidation, section 36(3)(f) places in the liquidation estate any assets or their value recovered through proceedings for avoidance of transactions, so the recoveries go down the waterfall in section 53. During the resolution process the resolution plan can deal with them. In Piramal Capital the Supreme Court set aside the Appellate Tribunal's order that had sent the plan back to the committee of creditors over its treatment of section 66 recoveries, and restored the Tribunal's approval of the plan.

A professional preparing these applications should work from the company's bank statements, the records with an information utility and the register of charges, and should plead for each transaction the date, the counterparty, its relationship to the company, the value given and received, and the relevant period it falls within. A good-value defence is answered by the valuation evidence section 46(2) contemplates.