"Preferential Transaction" and "Relevant Time" under Section 43 of IBC

The present Appeal was filed challenging the Impugned Order dated 26.02.2021 passed by the Adjudicating Authority (National Company Law Tribunal, Division Bench-I, Chennai) in, whereby the Adjudicating Authority allowed the said Miscellaneous Application filed by the Resolution Professional. Aggrieved by the aforesaid order, the Respondent therein i.e., M/s. Hira Cotton Partnership Firm filed the Appeal. [REED 2021 NCLAT Chen 08581]

BACKGROUND OF THE CASE

Learned Counsel for the Appellant submitted that the Appellant is one of the ‘Operational Creditor’ and the ‘Corporate Debtor’ owed a sum of Rs. 5,95,05,918/- for the supply of cotton. While so, the Corporate Debtor i.e., M/s. Sholingur Textiles Limited was admitted by the Adjudicating Authority, National Company Law Tribunal on 04.02.2019 in an application filed under the Insolvency and Bankruptcy Code, 2016. The Respondent herein was appointed as Resolution Professional by the Learned ‘Adjudicating Authority’.

The Appellant and the Corporate Debtor entered into a sale agreement on 22.06.2018 for transferring the land belonging to the Corporate Debtor to the Appellant towards partial settlement of the debt owed to the Appellant. By the aforesaid sale agreement, the Corporate Debtor offered to settle the said debt partially. The value of the land which was mentioned in the sale agreement was fixed at Rs.88,54,790/. During CIRP which was commenced on 04.02.2019, the Appellant submitted a claim in Form (B) for an amount of Rs.5,06,51,128/- after adjusting for the consideration of the sale agreement.

While the above was pending, the Respondent filed an Application seeking to set aside the aforementioned sale agreement on the ground that the said sale agreement in favour of the Appellant being a preferential transaction within the meaning of Section 43 of the IBC 2016.

Section 43 of the IBC is with respect to Preferential transactions and relevant time.

The Hon’ble Adjudicating Authority allowed the said Application by passing the above Impugned Order and set aside the sale agreement.

Following this, the learned counsel submitted that the Adjudicating Authority failed to take note of the fact that the Appellant has been supplying cotton to the Corporate Debtor since 2012 and there were accumulated dues which were to be settled by the Corporate Debtor. The Corporate Debtor was undergoing liquidity crisis, it chose to partially settle the debt of the Appellant by transferring a piece of land, being a non-core asset belonging to the Company.

The Respondent failed to demonstrate in collusion between the Appellant and the Corporate Debtor or to demonstrate any attempt to defraud the creditors. the Counsel also, there was no dishonesty on the part of either of the parties and that the allegations put forth by the Respondent are devoid of any merit or evidence and further, the relationship between the Appellant and the Corporate Debtor is a legitimate business relationship.

The Appellant supplied cotton, the most essential raw material in the textile industry to the Corporate Debtor. There is no dispute with regard to the debt owed by the Corporate Debtor to the Appellant.

According to the learned counsel the Adjudicating Authority failed to observe that the property transferred by way of sale agreement to the Appellant was free from encumbrances and that the Corporate Debtor could have sold it to anyone and used the proceeds to pay the debt owed to the Appellant. Instead, the Corporate Debtor directly transferred the property to the Appellant.

He also contended that the Hon’ble Adjudicating Authority erroneously passed the Impugned Order, failing to appreciate that the Impugned Transaction falls within the ambit of exception provided by Clause (a) of Sub Section (3) of Section 43 of the Code, being a transfer made in the ordinary course of business. The Learned Counsel submitted that the expression “ordinary course of business” has not been defined in the IBC 2016 or under the Companies Act 2013.

In view of the grounds as mentioned above the Learned Counsel prayed the tribunal to set aside the Impugned Order passed by the Adjudicating Authority, National Company Law Tribunal, Chennai.

ANALYSIS

The only issue fell for consideration in this case was whether the Transaction i.e., the sale agreement entered between the Appellant and the Corporate Debtor is a transaction that are preferential in nature between the Appellant and the Corporate Debtor as under Section 43(1) of the I & B Code 2016.

The Ld. Adjudicating Authority after noting the facts in detail and relying upon the Judgment of the Hon’ble Supreme Court in the matter of Anuj Jain, Interim Resolution Professional for Jaypee Infratech Ltd. v. Axis Bank Ltd., REED 2020 SC 02502 allowed the Application filed by the Respondent and set aside the sale agreement holding that the transaction falls within the provisions of Section 43 of the IBC, 2016 and set aside the sale agreement by accepting the prayers as made by the Respondent.

The above case commonly referred to as the “Jaypee Case”, further outlined the powers of the Resolution Professional (“RP”) in terms of handling of various claims and transactions submitted by the Committee of Creditors. The judgement is coherently segmented into two parts – firstly, it discusses the contours of Section 43 IBC and its application it to the facts of the present case; and secondly, it distinguishes the application of Section 43 IBC from that of Sections 45, 49 and 66 IBC. The judgment also adjudicates upon the existence of a financial debt in cases wherein a mortgage is created by a corporate debtor in favour of a third party.

Now coming back to the current case, Following the Respondent filing an application in praying the Adjudicating Authority to set aside the sale agreement on the ground that the said transaction is a preferential transaction and therefore the same need to be set aside in the interest of the Corporate Debtor and after the Resolution Professional made a prayer for the relief sought, the Adjudicating Authority while allowing the Application observed the following

“We are of the view that taking into consideration the Sale Agreement and the recitals contained therein the transaction cannot be considered to be in the ordinary course of business or in relation to the financial affairs of the Corporate Debtor “

“In view of all the six steps as formulated by the Hon’ble Supreme Court of India in relation to consideration of the transaction as a preferential transaction have been satisfied from the facts and circumstances of the case, we are of the view that the transaction indeed falls within the provisions of Section 43 of the IBC, 2016 and the transaction cannot be considered to be excepted from the ambit of transactions as provided under the said Section itself”

“The 1st Respondent also not being the related party, it is also seen that the transaction under consideration in this Application has been carried as between the parties within one year period being the prescribed period for an unrelated party i.e., the 1st Respondent. “In the circumstances, this Application is required to be allowed as filed by the Resolution Professional by granting the reliefs as sought “

In the given situation, it is crucial to analyse Section 43 in light of the current issue.

Section 43 IBC is concerned with two things – preferential transaction and relevant time. To simplify, if the liquidator or RP is of the opinion that at a relevant time, a preference has been given by corporate debtor to a particular creditor in certain transactions, the liquidator or the RP shall be bound to make an application under Section 44 IBC for setting aside such a transaction.

After going through various interpretations of “preference”, the Court held “preferential transaction” as:

“being the transaction where an insolvent debtor makes transfer to or for the benefit of a creditor so that such beneficiary would receive more than what it would have otherwise received through the distribution of bankruptcy estate.”

In relation to “relevant time”, the Court observed that it is normal to have a longer look-back period in case of a related party, and a shorter one in case of an unconnected party. The Court further observed that a strict construction should be given to Section 43 but only after giving of apposite consideration to the underlying principles and objectives of IBC.

Thereafter, the Court devised a step-by-step process which must be applied by the RP (initially) and Tribunals (upon an application under Section 44 IBC) to see whether a transaction is hit by Section 43. These steps are as follows:

• Firstly, whether the transfer by way of transaction is for the benefit of the surety or guarantor in furtherance of an antecedent financial liability of corporate debtor [Section 43(2)(a) IBC];

• Secondly, whether such a transaction puts the surety or guarantor at a beneficial position than in case of a distribution of assets as per Section 53 IBC [Section 43(2)(b) IBC];

• Thirdly, whether the transaction was made two years prior in the case of a “related party” or one year otherwise [Section 43(4) IBC]; and

• Fourthly, whether such transaction is not and “excluded transaction” as per Section 43(3) IBC.

In its essence, the Court meant for a transaction to be a “preferential transaction” under IBC if the ingredients of clause 2 and 4 of Section 43 IBC are satisfied, and it is not protected by clause 3 of Section 43 IBC. The Court by formulating this test made it easier for the RPs and Tribunals to adjudicate upon the existence of a “preferential transaction”. Now, they need not interpret Section 43 in a broad manner but are only required to mechanically follow the stipulated steps. This brings in a greater degree of certainty in the CIRP.

In the given case, if if in compliance to Section 43, the Adjudicating Authority is of the opinion that the said transaction is preferential in nature and is within the period of one year preceding the Insolvency commencement date, the said transaction can be declared as void and reverse the effect of such transaction in accordance with Section 45 sub-section (1) of the I & B Code and in accordance with the Chapter III of the I & B Code, 2016.

In the given case, Adjudicating Authority relied upon the Judgment of the Hon’ble Supreme Court in the matter of Anuj Jain, the Hon’ble Supreme Court has given the ratio to be adopted in relation to the provisions of the Section 43 of the IBC, 2016. This judgement has been the first ruling by the Supreme Court in terms of laying down the principles of Section 43 of the IBC. The Court performed the task well and formulated the tests in a coherent manner for future Courts to follow. The Court’s distinction between Section 43 and Sections 45, 49 and 66 is also ingenious as this will now reduce confusion for the RP in bringing either a charge of “preferential transaction” or that of a “fraudulent” or “undervalued” transaction, both of which require the satisfaction of distinct ingredients.

From the ratio of the above Judgment of the Hon’ble Supreme Court in the Anuj Jain case, the issue to be determined and arrived at whether the said transaction is a preferential transaction or not? The resolution professional is needed to do the following,

• Whether the transaction is between the related party as defined in Section 5(24) of the Code and another is non-related party.

• If the party is non-related, the Resolution Professional has to see whether the transaction is preceding one year from the date of commencement of Insolvency

CONCLUSION

In the current case, from the documents it is crystal clear that the Appellant is not a related party and the transaction is preceding one year from the date of admission of the application by the Adjudicating Authority, the sale agreement and the Application, is well within one year preceding the admission of Application.

Therefore, the criteria as enunciated under the Code and the Law laid down by the Hon’ble Supreme Court, squarely applicable to the facts of the present case. In the present case, admittedly the property belongs to the Corporate Debtor as evident from the sale agreement and there is no dispute with regard to the same. Therefore, the criteria as prescribed by the Hon’ble Supreme Court in the above Judgment is fulfilled and the ‘Adjudicating Authority’ rightly allowed the Application of the Resolution Professional.

The vital question is whether the transaction is ‘preferential one’ and whether the said transaction is beneficial to such creditor (Appellant herein) by discriminating the distribution of assets as per Section 53 of the I & B Code in case of liquidation.

Ultimately, The Tribunal was of the view that the said transaction is a preferential transaction and not in the ordinary course of business. Further, the Tribunal is of the considered opinion that the said transaction entered between the Appellant and the Corporate Debtor by way of sale agreement certainly prejudice the interest of other Creditors who have precedence in relation to the claim being settled ahead of the Appellant or even in relation to other ‘Operational Creditors’ who are similarly placed like the ‘Appellant’.

Further, it stated that the Tribunal does not find any illegality in the Order impugned passed by the National Company Law Tribunal, Division Bench-I, Chennai and the Appeal is devoid of merits and liable to be dismissed.