In IDBI Limited v. Jaypee Infratech Limited (order dated May 16, 2018), the National Company Law Tribunal, Allahabad Bench (NCLT), dealt with a crucial aspect of insolvency proceedings, namely vulnerable transactions. The resolution professional (RP) of the corporate debtor, Jaypee Infratech, filed an application in relation to a mortgageof an immovable property belonging to the corporate debtorto securethe debt of a related party(that is, the holding company of the corporate debtor). The RP sought the several directions,inter alia, so as to declare the transaction as preferential, undervalued and “fraudulent and wrongful” under the Insolvency and Bankruptcy Code, 2016 (the Code).
Forms of Vulnerable Transactions
The Code refers to four forms of vulnerable transactions, three of them as relevant to the context, being – preferential transactions, undervalued transactions, and transactions defrauding creditors. Note that there might be overlaps between such transactions, i.e. a transaction can be preferential, undervalued, and fraudulent at the same time.
Here it is relevant to note that the words “transaction” and “transfer” are omnibus expressions. Elsewhere in Security Interests as Preferential Transactions, I discuss how and under what circumstances a security interest can or cannot be treated as a preferential transaction, some of which are reflected in the observations made in Jaypee Infratech.
Further, section 66 of the Code holds the promoters and directors personally liable for carrying out the business of the corporate debtor with an intent to defraud creditors of the corporate debtor or for any fraudulent purpose.
The Ruling in Jaypee Infratech
Looking to the facts of Jaypee Infratech,the holding company of the corporate debtor was also its principal contractor. The RP alleged that the directors of the corporate debtor mortgaged unencumbered land it owned to secure one of the debts of the holding company.
Questions which arose for consideration include:
(a) whether the impugned transactions were carried out with an intent to defraud creditors of the corporate debtor or for any fraudulent purpose [section 66];
(b) whether the impugned transactions are preferential transactions [section 43] or undervalued transactions [section 45]; and
(c) whether the look-back period ought to be one year or two years.
The issues may be discussed as follows (although not in the same order), along with the deliberations of the NCLT:
(a) Whether the transaction was a preferential transaction
It may be noted that in view of the conditions specified under section 43 (2) of the Code, the debt, the creditor, and the assets should all belong to the corporate debtor. In this case, the lender in favour of whom the mortgage was created was not the creditor of the corporate debtor, but it was the creditor of the holding company. Therefore, the provisions of section 43 are not directly attracted in this case.
However, the NCLT noted that the holding company is also one of the operational creditors of the corporate debtor. Section 43(2) requires that the transfer should be for the benefit of a creditor of the corporate debtor. Hence, this being a deeming provision, applies in case of impugned transaction. The holding company, which is a creditor of the corporate debtor, is put in a beneficial position, than it would have been in the event of distribution of assets made in accordance with section 53.
The stand taken by the NCLT implies that once the corporate debtor has granted security interest in favour of its holding company, it has the effect of reducing the direct liability of the holding company towards the transferee lender. Hence, the holding company which is also one creditor, is being an indirect beneficiary in such a case.
(b) Whether the relief of “ordinary course of business” available
The provisions of the Code carve out exceptions for transactions entered into ordinary course of business from being challenged as avoidable transactions. For example, section 43(3)(a) excludes “a transfer made in the ordinary course of the business or financial affairs of the corporate debtor or the transferee”.
The NCLT held that the transaction of creating a security interest by way of mortgage in favour of lenders of a third party, on the unencumbered land of the corporate debtor without any consideration or counter guarantee, cannot be treated as transfer in the ordinary course of business or financial affairs of the corporate debtor. The exclusion clause cannot be interpreted such that the ordinary course of business also includes transferee’s ordinary business. The impugned transfer did not benefit either the business or the finances of the corporate debtor in any way. Such transfer is for the benefit of the related party, and therefore cannot be excluded under section 43(3). The word “transfer made” itself indicates that it relates to the transferor and not the transferee. Therefore, the ordinary course of business of transferee will not exclude the transactions from the purview of preferential transactions in relation to the corporate debtor (here the transferor).
(c) Whether the transaction was an undervalued transaction
The alleged transaction has been made without receipt of any consideration by the corporate debtor. Therefore, the transaction was said to be covered under section 45(1) of the Code, and will be treated as undervalued. The arguments as to collateral security being common practice in the banking industry and reciprocity in the relationship the holding and the corporate debtor were rejected by the NCLT.
(d) Whether look-back period will be one year or two years
It was argued that the relevant sections of the Code [sections 43, 45, 60(5) and 66] came into effect on December 1, 2016. Therefore, the limitation period of one year or two years, as the case may be, will apply only to transactions made on or after such effective date and not prior to that date. NCLT rejected the contention stating that the retrospective effect of such provisions is imbibed in the legislation itself. The look-back period is to be determined with reference to the commencement date of the insolvency and not the date when the Code came into effect. Therefore, in this case, since the beneficiary is a related party, the look-back period would be two years from the date of commencement of the insolvency.
Here, the ruling of Levit v. Ingersoll Rand, 874 F.2d 1186 F.2d (7th Cir. 1989) might be relevant. The Court held that the look-back period shall be determined on the basis of the ultimate beneficiary of the transaction, that is, whether the beneficiary is an outside creditor or an inside creditor.
I would also like to reiterate that since the transaction has already been classified by the NCLT as one defrauding creditors (see below), there was no need to delve into the question of lookback period. The reason is that no look-back period has been specified for fraudulent transactions. Where a fraudulent transaction is also a preferential transaction, there is no need to place limits on “look-back period”.
(e) Whether the transaction was to defraud creditors
The NCLT noted that the corporate debtor was facing financial difficulties and its account was declared a non-performing asset. The Joint Lenders Forum (JLF) advised the corporate debtor to not to create any mortgage or charge on any asset or land parcel without approval from the lenders. However, NCLT noted that the impugned transactions were carried out not only without the consent of JLF but also contrary to the decision of JLF.
The Jaypee Infratech case (supra)sets a precedent as regards avoidance proceedings under the Code. It circumscribes the scope and the reach of the rule relating to preferential transactions. At the same time, the possibility of an appeal cannot be ruled out, and further pronouncements can very well be awaited on the issues discussed herein.
– Sikha Bansal