This article has been authored by Indranil Chakravorty who is a fourth-year law student studying at the National University of Study and Research in Law, Ranchi.
Preferential transaction can be defined as the transaction which is associated with the transfer of the property or interest from the corporate debtor for the benefit of a creditor or when the transaction results in providing a beneficial position to the creditor/guarantor than it would be in case of liquidation as per Section 53 of The Insolvency & Bankruptcy Code 2016 (hereinafter referred to as “IBC 2016”).
Transactions which are under the ambit of ordinary course of the business and financial affairs of the corporate debtor are exempted even if they fall in look back periods. In the matter of Anuj Jain Interim Resolution Professional for Jaypee Infratech Limited v. Axis Bank Limited and others (hereinafter referred as "Jaypee Infratech"), the Supreme Court of India has elaborated and highlighted certain key aspects in respect of preferential transactions under Section 43 of the IBC with a key emphasis on the role of financial creditors as per Section 5(7) of IBC 2016.
Factual Matrix & Summation of Issues
In the present matter, the key issue before the Supreme Court was whether certain mortgages created by Jaypee Infratech Limited (hereinafter referred to as "JIL") that is the company under insolvency for loans availed by its parent company Jaiprakash Associates Limited (hereinafter referred to as "JAL") amounted to preferential transactions avoidable under Sections 43 of the IBC. Besides, whether the transactions in question deserve to be avoided as being preferential, in terms of Sections 43, of the Code; and second, as to whether the lenders in this case could be categorised as financial creditors or not.
The Issue of Preferential Transaction
i. The transfer of property/interest thereof was for the benefit of a creditor.
One of the prominent points which need to be noted are that JAL, the operational creditor, was not the first one in line the other creditors of JIL as per Section 53. Hence the Supreme Court looked upon the issue whether JAL had been handed over an advantageous position as the concerned transaction reduced the operational creditors’ liability.
One of the key observations is that the lenders of the debtors did not provide any direct financial assistance. The point which needs to be focused is if the ultimate beneficiary of transactions was a creditor of the corporate debtor. Purposive approach vis-à-vis interpretation of statutes which is a form of interpretation for enactment in light of the primary purpose for which it was enacted. It seems that the Supreme Court has clearly given a purposive construction to the provisions governing preferential transactions under the Code, (primarily Section 43) by placing the debtor in the net of Section 43. Hence, it is quite clear that there is not strict requirement of creditor/debtor relationship and what needs to be examined is the ultimate benefit of the creditor.
ii. Ordinary course of business/financial affairs
The Supreme Court held that a transaction could be classified as ordinary course of business only if it was part of an undistinguished common flow of business done and did not arise out of any special or particular situation. Ordinary course of business shall not be construed in a rigid manner and it should not be confined to the primary business of the Corporate Debtor. The courts have often reiterated as per this exception of Section 43 that if the impugned transaction could be categorized as falling within the ordinary business of the debtor then it can be exempted from being preferential transaction.
In the present matter, it was quite clear that the corporate debtor’s primary business was development of land, execution of housing projects, etc. Consequently, mortgaging assets to secure debts of its holding company could in no way be a part of its ordinary course of business.
The Supreme Court has again emphasized on the prime purpose of the Section 43 that is to secure the wealth of the Corporate Debtor from transactions that might undermine the interest of stakeholders or other creditors for that matter. However, it is pertinent that the Courts have deviated from the literal rule of interpretation in this scenario. With a view of Section 43(3)(a), if literal interpretation is undertaken then every form of mortgage sent to the transferees might get exempted ignoring the transaction’s preferential nature. The term ‘or’ appearing in this clause was construed as ‘and’ to cover those transfers made in the ordinary business of the debtor. This has substantively widened the ambit of ordinary course of business for the future relatable disputes in India. The role of principle of Noscitur a sociis which means deriving meaning from the nearby associated words can be clearly seen in the Supreme Court’s approach.
Position of Lenders (Financial Creditors)
The Court has also held that the lenders herein cannot be considered financial creditors of JIL, however they could be considered secured creditors, on the strength of the mortgage created vide the impugned transactions. The primary ground for arriving at such conclusion was that the lenders in the present case cannot be categorized as ‘financial creditors’ in their capacity of mortgagee. It can also be observed that the Court as per Section 5(8), ‘financial debt’ does not inculcate ‘mortgage’. Hence, as per the Apex Court, third party security is not a financial debt.
The point which needs attention here is that the Court is following a very narrow interpretation of financial debt as set out in Section 5(8) of the IBC 2016. The prime criteria the Supreme Court seems to keep in check is that there should be disbursement of certain amounts to the corporate debtor (with a view of reciprocation) and it should fall within one of the requirements of financial debt. The narrow interpretation of the term ‘financial creditor’ qualifies the debt to be mortgage debt but not financial debt.
The principle of equitable treatment to creditors may be jeopardized by this interpretation as it gives an apprehension that third party security are not treated equally with other ‘secured’ financial creditors of the corporate debtor. The Supreme Court has not explained whether such mortgage was also avoidable under Section 44 of the IBC and has kept those questions of law unanswered. In addition to this, there is ambiguity on how these secured lenders or creditors would recover their loans and also whether such contracts are legally binding in the first place.
Undoubtedly, the judgement of the Hon’ble Supreme Court in this matter is likely to have significant and far reaching implications. However, the above-mentioned ambiguities as per the preferential transactions and categorization of financial creditors in such matters need to be resolved. This would come as breath of fresh air in the context of ongoing and future insolvency proceedings vis-à-vis creditor community.