Contesting Section 44 (IBC) Application

Contesting Section 44 (IBC) Application

 

1. Section 43 of the Code reads as under;

•  # Section 43.  Preferential transactions and relevant time. -

(1) Where the liquidator or the resolution professional, as the case may be, is of the opinion that the corporate debtor has at a relevant time given a preference in such transactions and in such manner as laid down in sub-section (2) to any persons as referred to in sub-section (4), he shall apply to the Adjudicating Authority for avoidance of preferential transactions and for, one or more of the orders referred to in section 44.

(2) A corporate debtor shall be deemed to have given a preference, if– (a) there is a transfer of property or an interest thereof of the corporate debtor for the benefit of a creditor or a surety or a guarantor for or on account of an antecedent financial debt or operational debt or other liabilities owed by the corporate debtor; and (b) the transfer under clause (a) has the effect of putting such creditor or a surety or a guarantor in a beneficial position than it would have been in the event of a distribution of assets being made in accordance with section 53.

(3) For the purposes of sub-section (2), a preference shall not include the following transfers–

-   (a) transfer made in the ordinary course of the business or financial affairs of the corporate debtor or the transferee;

-   (b) any transfer creating a security interest in property acquired by the corporate debtor to the extent that –

-    (i) such security interest secures new value and was given at the time of or after the signing of a security agreement that contains a description of such property as security interest, and was used by corporate debtor to acquire such property; and

-    (ii) such transfer was registered with an information utility on or before thirty days after the corporate debtor receives possession of such property:

-        Provided that any transfer made in pursuance of the order of a court shall not, preclude such transfer to be deemed as giving of preference by the corporate debtor.

-        Explanation. – For the purpose of sub-section (3) of this section, “new value” means money or its worth in goods, services, or new credit, or release by the transferee of property previously transferred to such transferee in a transaction that is neither void nor voidable by the liquidator or the resolution professional under this Code, including proceeds of such property, but does not include a financial debt or operational debt substituted for existing financial debt or operational debt.

(4) A preference shall be deemed to be given at a relevant time, if –

-    (a) It is given to a related party (other than by reason only of being an employee), during the period of two years preceding the insolvency commencement date; or

-    (b) a preference is given to a person other than a related party during the period of one year preceding the insolvency commencement date.

 

1.1. Following are the attributes/caveats of Section 43;

1. There is a transfer of property or an interest thereof.

2. Transfer is for the benefit of a creditor or a surety or a guarantor.

3. Transfer is on account of an antecedent financial debt or operational debt or other liabilities owed by the corporate debtor;

4. A preference shall be deemed to be given at a relevant time, if –

- It is given to a related party (other than by reason only of being an employee), during the period of two years preceding the insolvency commencement date;

- a preference is given to a person other than a related party during the period of one year preceding the insolvency commencement date.

5. Preference is precluded if transfer is made in the ordinary course of the business or financial affairs of the corporate debtor or the transferee;

 

1.2. Thus an application under 44 r/w section 43 to succeed, applicant (RP/Liquidator) has to satisfy all the attributes/caveats under section 43.

1. That there is transfer of property or an interest thereof.

2. That the transfer is for the benefit of a creditor or a surety or a guarantor.

3. That the Transfer is on account of an antecedent financial debt or operational debt or other liabilities owed by the corporate debtor;

4. That the transfer is within the relevant time (Look back period).

5. That the transfer has not been made in the ordinary course of the business or financial affairs of the corporate debtor or the transferee;

 

1.3. Hon’ble Supreme Court of India (26.02.2020) in Anuj Jain IRP for Jaypee Infratech Limited Vs Axis Bank Limited Etc. (Civil Appeal Nos. 8512-8527 of 2019 and other petitions), speaking on the role of RP/Liquidator for identifying Preferential Transactions held that;

#  20. The analysis foregoing leads to the position that in order to find as to whether a transaction, of transfer of property or an interest thereof of the corporate debtor, falls squarely within the ambit of Section 43 of the Code, ordinarily, the following questions shall have to be examined in a given case:

(i). As to whether such transfer is for the benefit of a creditor or a surety or a guarantor?

(ii). As to whether such transfer is for or on account of an antecedent financial debt or operational debt or other liabilities owed by the corporate debtor?

(iii). As to whether such transfer has the effect of putting such creditor or surety or guarantor in a beneficial position than it would have been in the event of distribution of assets being made in accordance with Section 53?

(iv). If such transfer had been for the benefit of a related party (other than an employee), as to whether the same was made during the period of two years preceding the insolvency commencement date; and if such transfer had been for the benefit of an unrelated party, as to whether the same was made during the period of one year preceding the insolvency commencement date?

(v) As to whether such transfer is not an excluded transaction in terms of sub-section (3) of Section 43?

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# 25.6.1. Thus, the enquiry now boils down to the question as to whether the impugned transfers were made in the ordinary course of business or financial affairs of the corporate debtor JIL. It remains trite that an activity could be regarded as ‘business’ if there is a course of dealings,which are either actually continued or contemplated to be continued with a profit motive. [State of Andhra Pradesh v. H. Abdul Bakshi and Bros.: 1964 STC 644 (at p. 647).] As regards the meaning and essence of the expression ‘ordinary course of business’, reference made by the appellants to the decision of the High Court of Australia in Downs Distributing Co (supra), could be usefully recounted as under:-

-  “As was pointed out in Burns v. McFarlane the issues in sub-s. 2(b) of s. 95 of the Bankruptcy Act 1924-1933 are “(1) good faith; (2) valuable consideration; and (3) ordinary course of business.” This last expression it was said “does not require an investigation of the course pursued in any particular trade or vocation and it does not refer to what is normal or usual in the business of the debtor or that of the creditor.” It is an additional requirement and is cumulative upon good faith and valuable consideration. It is, therefore, not so much a question of fairness and absence of symptoms of bankruptcy as of the everyday usual or normal character of the transaction. The provision does not require that the transaction shall be in the course of any particular trade, vocation or business. It speaks of the course of business in general. But it does suppose that according to the ordinary and common flow of transactions in affairs of business there is a  course, an ordinary course. 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.” 

1.4.  NCLAT (06.03.2024) in Md Sadique Islam & Ors. Vs. Niraj Kumar Agarwal & Ors. [Company Appeal (AT) (Ins.) No. 1081 of 2022 & I.A. No. 3178 of 2022] held that;

• When we look into the aforesaid paras, it is clear that the Adjudicating Authority has recorded only its conclusions and that too without considering the preferential, undervalued and fraudulent, each transaction separately and there is general observation that the transactions are undervalued transactions as well as preferential and fraudulent transactions. 

• The ingredients of preferential, undervalued and fraudulent transaction are entirely different and there has to be application of mind to the ingredients of each transaction to come to conclusion that ingredients are satisfied and the transaction falls in the said category adverting to the given pleadings in the application. 

• The Adjudicating Authority ought to have adverted to the said pleadings and returned the finding regarding the fulfilment of ingredients of each provision.

2.. Duty has been casted upon RP/Liquidator to investigate & file avoidance application under the Code. Hon’ble Supreme Court in its judgement (26.02.2020) in Anuj Jain IRP for Jaypee Infratech Limited Vs Axis Bank Limited Etc. (Civil Appeal Nos. 8512-8527 of 2019) had defined the role of RP in determining the avoidance transactions

• # 28.1. Looking to the legal fictions created by Section 43 and looking to the duties and responsibilities per Section 25, in our view, for the purpose of application of Section 43 of the Code in any insolvency resolution process, what a resolution professional is ordinarily required to do could be illustrated as follows:

1. In the first place, the resolution professional shall have to take two major but distinct steps. One shall be of sifting through the entire cargo of transactions relating to the property or an interest thereof of the corporate debtor backwards from the date of commencement of insolvency and up to the preceding two years. The other distinct step shall be of identifying the persons involved in such transactions and of putting them in two categories; one being of the persons who fall within the definition of ‘related party’ in terms of Section 5(24) of the Code and another of the remaining persons.

2. In the next step, the resolution professional ought to identify as to in which of the said transactions of preceding two years, the beneficiary is a related party of the corporate debtor and in which the beneficiary is not a related party. It would lead to bifurcation of the identified transactions into two subsets: One concerning related party/parties and other concerning unrelated party/parties with each subset requiring different analysis. The sub-set concerning unrelated party/parties shall further be trimmed to include only the transactions of preceding one year from the date of commencement of insolvency.

3. Having thus obtained two subsets of transactions to scan, the steps thereafter would be to examine every transaction in each of these subsets to find: (i) as to whether the transaction is of transfer of property or an interest thereof of the corporate debtor; and (ii) as to whether the beneficiary involved in the transaction stands in the capacity of creditor or surety or guarantor qua the corporate debtor. These steps shall lead to shortlisting of such transactions which carry the potential of being preferential.

4. In the next step, the said shortlisted transactions would be scrutinised to find if the transfer in question is made for or on account of an antecedent financial debt or operational debt or other liability owed by the corporate debtor. The transactions which are so found would be answering to clause (a) of sub-section (2) of Section 43.

5. In yet further step, such of the scanned and scrutinised transactions that are found covered by clause (a) of sub-section (2) of Section 43 shall have to be examined on another touchstone as to whether the transfer in question has the effect of putting such creditor or surety or guarantor in a beneficial position than it would have been in the event of distribution of assets per Section 53 of the Code. If answer to this question is in the affirmative, the transaction under examination shall be deemed to be of preference within a relevant time, provided it does not fall within the exclusion provided by sub-section (3) of Section 43.

6. In the next and equally necessary step, the transaction which otherwise is to be of deemed preference, will have to pass through another filtration to find if it does not answer to either of the clauses (a) and (b) of sub-section (3) of Section 43.

7. After the resolution professional has carried out the aforesaid volumetric as also gravimetric analysis of the transactions on the defined coordinates, he shall be required to apply to the Adjudicating Authority for necessary order/s in relation to the transaction/s that had passed through all the positive tests of sub-section (4) and sub-section (2) as also negative test of sub-section (3).

# 28.2. On a motion made by the resolution professional after and in terms of the exercise aforesaid, the Adjudicating Authority, in its turn, shall have to examine if the referred transaction answers to all the descriptions noted above and shall then decide as to what order is required to be passed, for avoidance of the impugned transaction or otherwise.

2.1. Code & Regulations specifically provide that RP or Liquidator has to form an opinion & determine the Preferential Transactions under section 43, and then file suitable application under section 44. Following provisions of the Code & regulations are worth mentioning;

 

2.2. IBC, 2016.

# Section 25. Duties of resolution professional. -

(1) It shall be the duty of the resolution professional to preserve and protect the assets of the corporate debtor, including the continued business operations of the corporate debtor.

(2) For the purposes of sub-section (1), the resolution professional shall undertake the following actions, namely: -

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(d) appoint accountants, legal or other professionals in the manner as specified by Board;

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(j) file application for avoidance of transactions in accordance with Chapter III, if any; and

 

# Section 43. Preferential transactions and relevant time. -

(1) Where the liquidator or the resolution professional, as the case may be, is of the opinion that the corporate debtor has at a relevant time given a preference in such transactions and in such manner as laid down in sub-section (2) to any persons as referred to in sub-section (4), he shall apply to the Adjudicating Authority for avoidance of preferential transactions and for, one or more of the orders referred to in section 44.

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2.3. CIRP Regulations

# Regulation 35A. Preferential and other transactions.

(1) On or before the seventy-fifth day of the insolvency commencement date, the resolution professional shall form an opinion whether the corporate debtor has been subjected to any transaction covered under sections 43, 45, 50 or 66.

(2) Where the resolution professional is of the opinion that the corporate debtor has been subjected to any transactions covered under sections 43, 45, 50 or 66, he shall make a determination on or before the one hundred and fifteenth day of the insolvency commencement date .

(3) Where the resolution professional makes a determination under sub-regulation (2), he shall apply to the Adjudicating Authority for appropriate relief on or before the one hundred and thirtieth day of the insolvency commencement date.

(3A) The resolution professional shall forward a copy of the application to the prospective resolution applicant to enable him to consider the same while submitting the resolution plan within the time initially stipulated.

(4) The creditors shall provide to the resolution professional, relevant extract from the audits of the corporate debtor, conducted by the creditors such as stock audit, transaction audit, forensic audit, etc.

 

2.4. # Regulation 40B Filing of Forms.

(1B) The resolution professional shall file Form CIRP 8 intimating details of his opinion and determination under regulation 35A, on or before the one hundred and fortieth day of the insolvency commencement date:

 

2.5. Thus Avoidance Application U/s. 44 is not maintainable in absence of report of opinion & determination by either RP or Liquidator, prerequisite for filing avoidance application as per the Code &  regulations and law laid down by the Hon’ble Supreme court in Anuj Jain IRP for Jaypee Infratech Limited Vs Axis Bank Limited Etc.,  

2.6. Case Law;

1. NCLAT (25.01.2024) in Gloster Cables Ltd. Vs. Fort Gloster Industries Ltd. & Ors.. [Comp. App (AT) (Ins) No. 1343 of 2019]

2. NCLT Kolkata (06.05.2022) in Jitendra Lohia vs. Nikhil Chowdhury and others [I.A.(IB) No. 208/KB/2021INC.P (IB) No.204/KB/2019]

3. NCLAT (06.04.2022) in Aditya Kumar Tibrewal RP Vs. Om Prakash Pandey, Suspended Director [Company Appeal (AT) Insolvency No. 583 of 2021] 

4. NCLT Kolkata (30.06.2022) in Kshitiz Chhawchharia vs. Madhumalati Merchandise Private Limited & Ors [I.A. (IB) No. 346/KB/2019 In CP(IB) No. 349 /KB/2017

 

2.6.1. NCLAT (25.01.2024) in Gloster Cables Ltd. Vs. Fort Gloster Industries Ltd. & Ors.. [Comp. App (AT) (Ins) No. 1343 of 2019] held that;

• We have found that the legislature has used the different language in Section 43 and 45 of the Code because in Section 43, the RP or the liquidator has to form an opinion whereas in Section 45 the RP or the liquidator has to examine and then determine that the transaction in question were undervalued during the relevant period.

 

2.6.2. NCLT Kolkata (06.05.2022) in Jitendra Lohia vs. Nikhil Chowdhury and others [I.A.(IB) No. 208/KB/2021INC.P (IB) No.204/KB/2019] wherein it was held;

# 16. ``We have carefully seen the averments of the application and corresponding reply of the respondents. We have noticed that the allegations made in application do not constitute anything actionable against the respondents. It was the duty of the RP to come to conclusive determination before filing an application with the Adjudicating Authority. Simply by repeating the extracts or observations made in the forensic auditors report, the RP could not make an independent determination about the nature of transactions as required by Regulation 35A (2) of the CIRP Regulations.’’

2.6.3. NCLAT (06.04.2022) in Aditya Kumar Tibrewal RP Vs. Om Prakash Pandey, Suspended Director [Company Appeal (AT) Insolvency No. 583 of 2021] held that;

• “The question as to whether a statute is mandatory or directory depends upon the intent of the legislature and not upon the language in which the intent is clothed. 

• The meaning and intention of the legislature must govern, and these are to be ascertained, not only from the phraseology of the provisions but also by considering its nature, its design, and the consequences which would follow from construing it the one way or the other….”

• In event the actions taken by the Resolution Professional after the timeline prescribed in Regulation 35A of the CIRP Regulations are to be annulled, the undervalued and fraudulent transactions will go out of the reach of Resolution Process, reach of the Court and shall cause great inconvenience and injustice to Corporate Debtor. 

• Hence, we are of the view that timeline prescribed in Regulation 35A of the CIRP Regulations is only directory and any action taken by the Resolution Professional beyond the time prescribed under Regulation 35A of the CIRP Regulations cannot be held to be non-est or void only on the ground that it is beyond the period prescribed under Regulation 35A of the CIRP Regulations. 

• There may be genuine and valid reasons for Resolution Professional not to file application for avoiding the transactions within time prescribed which are question relating to each case and has to be examined on case-to-case basis and if there are reasons due to which Resolution Professional could not file the Application within time the same has to be examined on merit.

• The Law laid down by the Hon’ble Supreme Court in the above judgment which deals with the interpretation of provisions of the Code itself are applicable to interpretation of Regulation 35A of CIRP Regulations and following the above judgment we hold that timeline prescribed in Regulation 35A of CIRP Regulations is directory and not mandatory.

• We thus conclude that for transactions defrauding creditors and fraudulent trading or wrongful trading as under Section 66 the timeline prescribed under Section 46 is not applicable.

• The expression “shall” in regulation 35A (1), 35A(2) and 35A(3) is not mandatory and requirement of “forming an opinion” under Section 35A(1) “make a determination” under Section 35A(2) and “shall apply to the Adjudicating Authority for appropriate relief on or before 135th day of the Insolvency Commencement Date” are only directory.

• The timeline prescribed for transactions under Section 46 does not cover the transactions covered by Section 49 and 66 of the Code.

 

2.6.4. NCLT Kolkata (30.06.2022) in Kshitiz Chhawchharia vs. Madhumalati Merchandise Private Limited & Ors [I.A. (IB) No. 346/KB/2019 In CP(IB) No. 349 /KB/2017] held that;

6.7. ``According to regulation 35A(1) of the CIRP Regulations, the Resolution Professional shall form an opinion whether the corporate debtor has been subjected to any transaction covered under sections 43, 45, 50 or 66 on or before the seventy-fifth day of the insolvency commencement date. According to the regulation 35A(2), on or before the one hundred and fifteenth day of the insolvency commencement date, the Resolution Professional is also required to make a determination to that effect.

6.8. Further, Regulation 35A(3) of the CIRP Regulations provides that upon making such determination under regulation 35A(2), the Resolution Professional shall apply to the Adjudicating Authority for the appropriate relief on or before the one hundred and thirty-fifth day of the insolvency commencement date. In this case, the one hundred and thirty fifth day is on 23 May 2018. The instant application being IA. (IBC) 346/KB/2019 has been filed on 20 March 2019, thus making it clear that the Applicant has not complied with the provisions of regulation 35A within the timeline provided therein.

6.9.  . ., we do not see any “determination” within the meaning of regulation 35A of the CIRP Regulations. Therefore, we will not act as court of first instance to determine the nature of the transactions mentioned hereinabove.

6.1 In light of the above facts and circumstances, the adjudicating Authority is satisfied that the instant application is not maintainable and the same is therefore rejected. “

3. Provisions of the Code & Regulations do not recognize  Transaction/ Forensic Audit Report to form the basis of avoidance application under section 43 & 44 of the Code, and in no case third party (Forensic/Transaction Auditor)  opinion, even if submitted, can substitute the mandatory report of opinion & determination by Resolution Professional/ Liquidator required under provisions of the Code & Regulations [Section 43 (1), Regulation 35A of CIRP Regulations and law laid down by Hon’ble Supreme Court in Anuj Jain IRP for Jaypee Infratech Limited Vs Axis Bank Limited Etc. (Civil Appeal Nos. 8512-8527 of 2019 and other petitions ].

 

3.1. Further, no report can ever form the only basis for convicting a person of an offence. The prosecution has to prove the offence, by adducing evidence. Reliance is being placed on the following;

a. High Court Madras (23.02.2021) in M.Suresh Khatri & Anr. Vs. Directorate of Enforcement Rep. by the Deputy Director GOI. [CRL.O.P.Nos.20127 & 25688 of 2018] held that;

• It is these words which amply suggest that an opinion is to be formed only after due application of mind that there is sufficient basis for proceeding against the said accused and formation of such an opinion is to be stated in the order itself. The order is liable to be set aside if no reason is given therein while coming to the conclusion that there is prima facie case against the accused, though the order need not contain detailed reasons. A fortiori, the order would be bad in law if the reason given turns out to be ex facie incorrect.

• No report can ever form the only basis for convicting a person of an offence. The prosecution has to prove the offence by adducing evidence and this opportunity has to be given to the prosecution in this case too.

4. Orders in case of preferential transactions. -

• #  Section 44. Orders in case of preferential transactions. -

• XXXXX

• (d) require any person to pay such sums in respect of benefits received by him from the corporate debtor, such sums to the liquidator or the resolution professional, as the Adjudicating Authority may direct;

• XXXXX

• Provided that an order under this section shall not -

• XXXXXX

• (b) require a person, who received a benefit from the preferential transaction in good faith and for value to pay a sum to the liquidator or the resolution professional.

• Explanation-I: For the purpose of this section, it is clarified that where a person, who has acquired an interest in property from another person other than the corporate debtor, or who has received a benefit from the preference or such another person to whom the corporate debtor gave the preference, -

• (a) had sufficient information of the initiation or commencement of insolvency resolution process of the corporate debtor;

• (b) is a related party,

• it shall be presumed that the interest was acquired, or the benefit was received otherwise than in good faith unless the contrary is shown.

• Explanation-II. – A person shall be deemed to have sufficient information or opportunity to avail such information if a public announcement regarding the corporate insolvency resolution process has been made under section 13.

4.1. Blogger’s comments; Section 44 does not contemplate any action against the promoters/directors of the CD. Actions contemplated in this section are all against the person receiving the benefit from the preferential transactions. Proviso to section 44 provides protection to a such person (non related party) receiving the benefit in good faith for value, prior to the date of commencement of the CIRP.

From the explanation I & II in the proviso of section 44, as above presumption of good faith will be in favour of the person who received a benefit from the preferential transaction, provided he is not a related party & the transaction was not done after the public announcement.

Disclaimer: The sole purpose of this blog is to create awareness on the subject and must not be used as a guide for taking or recommending any action or decision, commercial or otherwise. One must do his own research and seek professional advice if he intends to take any action or decision in the matters covered in this blog.

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