NCLT- "Preferential Transaction", "Financial Debt" & "Financial Creditor" defined by Supreme Court

In ANUJ JAIN INTERIM RESOLUTION PROFESSIONAL FOR JAYPEE INFRATECH LIMITED

Vs AXIS BANK LIMITED, CIVIL APPEAL Nos. 6777-6797 OF 2019, the issue was the Appellate Tribunal setting aside the order passed by the NCLT, on the application moved by the Interim Resolution Professional in the Corporate Insolvency Resolution Process concerning the Corporate Debtor Company viz., Jaypee Infratech Limited seeking avoidance of certain transactions, whereby the corporate debtor had mortgaged its properties as collateral securities for the loans and advances made by the lender banks and financial institutions to Jaiprakash Associates Limited, the holding company of JIL, as being preferential, undervalued and fraudulent, in terms of Sections 43, 45 and 66 of the Insolvency and Bankruptcy Code, 7 2016. The NCLT had also approved the IRB' s decision ejecting the claims of such lenders of JAL to be recognized as financial creditors of the corporate debtor JIL on the strength of the mortgage created by the corporate debtor, as collateral security of the debt of its holding company JAL.

When appeal against both decisions were allowed by NCLAT, the matter reached the Supreme Court.

The two major issues were, (1) whether the transactions in question deserve to be avoided as being preferential, undervalued and fraudulent, in terms of Sections 43, 45 and 66 of the Code; and (2) whether the respondents (lender of JAL) could be recognized as financial creditors of the corporate debtor JIL on the strength of the mortgage created by the corporate debtor, as collateral security of the debt of its holding company JAL.

On the issue of preferential transactions

Referring to various authorities, the Supreme Court looked into the theory relating to avoidance of certain transactions as being preferential. The court observed that the basic concept of ‘preference’ as per the law dictionaries and lexicons is the act of ‘paying or securing to one or more of his creditors, by an insolvent debtor, the whole or part of their claims, to the exclusion of the rest’. The time factor also plays a crucial role in such measures of avoidance. This ‘relevant time’ for the purpose of avoidance of preferential transactions is now commonly referred to as the ‘look-back’ period. Significantly, when the preferential transaction is with an unconnected party, the look-back period is comparatively lesser than that of the transaction with a connected party, who is referred to as ‘insider’ or ‘related party.

The Supreme Court held 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 were listed as relevant for such a determination :

1. As to whether such transfer is for the benefit of a creditor or a surety or a guarantor?
2. 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?
3. 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?
4. 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 insolvenc 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?
5. As to whether such transfer is not an excluded transaction in terms of sub-section (3) of Section 43?

On issue of whether the transactions having been made in the ordinary course of business, 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. Referring to the decision of the High Court of Australia in Downs Distributing Co, the court held that to be in ordinary course, 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.

Based on the said points, the Supreme Court held that the impugned transactions are preferential.

On the issue of whether lenders of JAL could be categorised as Financial Creditors of JIL, the Supreme Court looked into the definition of  Delhi Development Authority v. Bhola Nath Sharma (Dead) by LRs & Ors: (2011) 2 SCC 54 and Black Diamond Beverages & Anr. v. Commercial Tax Office, Central Section, Assessment Wing, Calcutta & Ors.: (1998) 1 SCC and applying the principles laid down in the said judgments to the definition occurring in Section 5(8) of the Code,  held that for a debt to become ‘financial debt’ for the purpose of Part II of the Code, the basic elements are that it ought to be a disbursal against the consideration for time value of money and the root requirement for a creditor to become financial creditor for the purpose of Part II of the Code, there must be a financial debt which is owed to that person.

The Supreme Court decided that in the scheme of the IBC, what is intended by the expression ‘financial creditor’ is a person who has direct engagement in the functioning of the corporate debtor; who is involved right from the beginning while assessing the viability of the corporate debtor; who would engage in restructuring of the loan as well as in reorganisation of the corporate debtor’s business when there is financial stress. Keeping the objectives of the Code in view, the position and role of a person having only security interest over the assets of the corporate debtor could easily be contrasted with the role of a financial creditor because the former shall have only the interest of realising the value of its security (there being no other stakes involved and least any stake in the corporate debtor’s growth or equitable liquidation) while the latter would, apart from looking at safeguards of its own interests, would also and simultaneously be interested in rejuvenation, revival and growth of the corporate debtor.

Agreeing with the decision of the IRP and the NCLT, the Supreme Court held that we have no hesitation in saying that a person having only security interest over the assets of corporate debtor (like the instant third party securities), even if falling within the description of ‘secured creditor’ by virtue of collateral security extended by the corporate debtor, would nevertheless stand outside the sect of ‘financial creditors’ as per the definitions contained in sub- sections (7) and (8) of Section 5 of the Code.