When insolvency is imminent, it is not uncommon for companies to transfer its properties to known associates, create fraudulent encumbrances or devise transactions that would keep the asset base beyond the reach of its creditors. Traditionally[1], for such transactions to be struck down, it had to be established that they were made with an intent to defraud the creditors. Certain provisions of the Insolvency and Bankruptcy Code, 2016 (s. 43 and s.45 in particular) however do away with such requirements of having to establish ‘intent’. The Supreme Court was particularly concerned with s. 43 of the Code in Anuj Jain v Axis Bank Limited[2] decided on 26.2.2020.
The corporate debtor in this case was Jaypee Infratech Limited (JIL/corporate debtor), a subsidiary of Jaiprakash Associates Limited (JAL) which held 71.64% shares in the corporate debtor. Soon after the CIRP commenced, the IRP filed an application before the NCLT for setting aside of certain mortgage deeds by which nearly 858 acres of JIL’s properties were given as security to various banks and financial institutions for loans disbursed to its parent company, JAL.
While the NCLT allowed the application, the NCLAT set aside NCLT’s order and held the mortgages to be valid. Before the Supreme Court, the IRP, lenders of the corporate debtor and home buyers who had invested in projects of the corporate debtor made submissions supporting the NCLT’s order, while JAL and the lenders/bankers of JAL submitted that the NCLAT had rightly held the mortgage deeds to be valid.
S. 43 of the Code
43(1) lays down that a transaction can be struck down if it is found to be ‘preferential’ within the meaning of 43(2) and if it is entered into during the ‘relevant period’ as defined in 43(4). What will not constitute a preferential transaction is set out in 43(3) and the transactions therein constitute the exceptions.
43(4) defines ‘relevant period’ (popularly known as ‘look-back period’ or ‘suspect period’) to mean a period of one year preceding the commencement of CIRP if the transaction is with an unrelated party; and a period of two years preceding the commencement of CIRP if it is made with a related party. As to who is a ‘related party’ is defined in 5(24) of the Code. For the purpose of this case, suffice it to say that a related party includes the holding company of the corporate debtor.
43(2) creates a legal fiction by which certain transactions are deemed to be preferential. If it is a transfer (i) for the benefit of a creditor (ii) on account of an antecedent debt (iii) by way of which such creditor is put in a beneficial position than it otherwise would have been when assets of the corporate debtor are distributed under the Code, then such a transfer is deemed to be preferential. By way of an illustration, a transaction by which a new security is provided for an existing debt would be hit by 43(2).
43(3) lays down that a transaction would not be considered as preferential if it is made in the ordinary course of business or if it is a transfer creating a security interest for ‘new value’. Such new value would include a fresh loan/credit. In other words, it should not be an existing debt.
Reading these provisions together, if a transaction is deemed to be preferential as per 43(2) and is entered into during the relevant period as defined under 43(4), it is then liable to be struck down unless it falls within the exception mentioned in 43(3).
On whether the mortgages were during the look-back period
Some of the mortgage deeds in question were executed more than one year prior to the commencement of CIRP and the lenders of JAL therefore argued that they being an ‘unrelated party’, the said mortgage deeds would not attract s. 43 of the Code. The Supreme Court however held that the true beneficiary of the said mortgages was JAL, the parent company of the corporate debtor. The relevant look-back period was therefore held to be two years preceding the commencement of CIRP for the reason that JAL was a related party to the corporate debtor.
On whether the mortgages were preferential
The lenders of JAL argued that there was no antecedent debt or liability for which the corporate debtor created the mortgages. Rather, the securities were given in respect of loans and advances made to JAL. They submitted that the said mortgages were disclosed in the books of accounts/annual report of the corporate debtor. Further, s.43 being an expropriating provision that unsettles concluded transactions, they urged the Court to construe its ambit strictly.
The Supreme Court, while accepting that s. 43 would have to be strictly construed, held that the plain mandate of s. 43 cannot be ignored. It concluded that by way of s. 43, a legal fiction has been created whereby preferences are deemed to have been given. Even the question of ‘intent’ behind the transaction is irrelevant. Once the transaction falls within the ambit of s. 43(2) and is within the relevant period, it necessarily follows that it is a preferential transaction (unless an exception is made out under 43(3)). The Court further held that whether the transaction has been disclosed in the annual reports/books of accounts is irrelevant for the purpose of what constitutes a preferential transaction under s. 43.
As regards there being no antecedent debt for which the mortgages were executed, the Court held that even though there was no creditor-debtor relationship between the lenders of JAL and the corporate debtor, the mortgages were ultimately created to secure the debts of JAL. Taking note that JAL was an operational creditor in respect of the corporate debtor and had also regularly provided finances to the corporate debtor, the Court held that the mortgages were indeed created on account of antecedent debts owed by the corporate debtor to JAL.
Whether the mortgages were made during the ordinary course of business
The lenders of JAL argued that accepting securities from third parties is in ordinary course of their business and that the mortgages therefore fall within the exception provided in s.43(3). To this end, they pointed out that s. 43(3)(a), which exempts ‘transfer made in the ordinary course of the business or financial affairs of the corporate debtor or the transferee’, would apply even if it is not established that the transaction was made in the ordinary course of business of the corporate debtor.
The Supreme Court however held that the or in s. 43(3)(a) would have to be read as and in order to give effect to the true objectives of the Code. In view thereof, to avail the exception in s. 43(3)(a), it has to be established that the transaction was made in the ordinary course of business of the corporate debtor.
As to what would constitute ‘ordinary course of business’, the Supreme Court read out from the High Court of Australia’s judgment in Downs Distributing Co Pty Ltd v. Associated Blue Star Stores Pty Ltd (in liq)[3] that it ‘means that the transaction must fall into place as part of the undistinguished common flow of business done, that it should form part of the ordinary course of business as carried on, calling for no remark and arising out of no special or particular situation.’ Taking the said observations into account, the Supreme Court held that creating high valued securities cannot be said to be in the ordinary course of business of the corporate debtor.
In conclusion, the Supreme Court held that the mortgage deeds were void in view of the legal fiction created by s. 43 of the Code.
Parting remarks
I wonder what would happen if a large settlement is made in an insolvency petition and the matter is closed and within months thereafter in another petition, the insolvency is commenced. Would the settlement be set aside because it was in respect of an antecedent debt or would it be in the ordinary course to do so? To think there could be several such transactions that could be set aside if entered into in the twilight of insolvency can surely give the jitters to creditors. But while s. 43 can upset genuine transactions that were entered into in the months preceding the insolvency, it also has to be seen as a necessary evil to ensure all creditors get a fair chance at realizing their debts.
[1] The erstwhile Presidency – Towns Insolvency Act, 1909 and Provincial Insolvency Act, 1920,
Section 328, 329 of Companies Act, 2013, Transfer of Property Act
[2] Civil Appeal Nos. 8512-8527 Of 2019 With Civil Appeal Nos. 6777-6797 Of 2019
Civil Appeal Nos. 9357-77 Of 2019 (Arising Out Of Diary No. 32881 Of 2019)
[3] (1948) 76 CLR 463
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