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Exordinate Credit Transactions Under Ibc, 2016: Analysis

Acting as a key figure in the liquidation process, liquidators ensure that the equitable distribution of resources take place from the insolvent company and no injustice is caused to any of the creditors. Out of the various duties to be performed, one of the key roles of the liquidator is to find out the transactions occurred before the commencement of the liquidation process, if any, which can be challenged, with the sole aim to augment the estate of the company so that the general body of creditors are paid a larger dividend.

Appointing a competent Insolvency Professional is a must as he is the one who safeguards the assets of the 'Corporate Debtor', by facilitating interim finance and cooperating in the detection of avoidance transactions and performing other important tasks.

Almost all jurisdictions across the world have come up with provisions to set aside the antecedent transactions commonly referred to as 'Avoidance provisions' to ascertain the proper distribution of assets and prevent companies from favoring a few creditors, in turn, afflicting injury to the general body of creditors. There are provisions in Companies Act which provide for avoidance of certain transactions are undertaken before or after the winding-up proceedings.

Section 328 to Section 331 of Companies Act, 2013 talk about situations when the Tribunal declares the fraudulently preferred transactions as invalid and elaborates on the rights and liabilities of persons fraudulently preferred.

The recently introduced Insolvency and Bankruptcy Code, 2016 has also introduced provisions which devolve powers on the Adjudicating Authority to nullify the effect of certain transactions. Sections 43-51 of the Code specifically deal with avoidance of certain transactions. These transactions are divided into three categories: preferential transactions, undervalued transactions and extortionate credit transaction.

In the case of IDBI Bank Ltd. v. Jaypee Infratech Ltd, the NCLT held that the mortgages created by Jaypee Infratech Ltd. (JIL) in favour of the lenders of its holding company Jaiprakash Associates Ltd. (JAL) amounted to preferential, undervalued and fraudulent transactions.

The NCLT ordered the release of the encumbered lands from JAL's lenders, and directed that they be vested back in JIL, when found that the transactions were fraudulent, undervalued and preferential. Transactions which can be avoided need to be undertaken during the "relevant period", as specified. Section 25(2)(j) of the Code lays down that in order to protect the assets of the corporate debtor, it is the duty of the Resolution Professional to file an application for avoidance of transactions, if there is any. The application is to be filed in accordance with Chapter III of the Code.

Extortionate Credit Transactions: Meaning And Scope

The transactions which can be subject to challenge as in these transactions, credit is provided at exorbitant or extremely unfair terms in comparison to the risks accepted by the creditor are known as extortionate credit transactions.

As per the Insolvency and Bankruptcy Board of India (Liquidation Process) Regulations, 2016, a transaction can be called extortionate under Section 50(2) of the IBC Code, wherein the debtor had to make exorbitant payments w.r.t the credit or the terms were unconscionable under the principles of law relating to contracts. However, a debt which is in compliance with any law for the time being in force in relation to such debt shall in no event be considered as an extortionate credit transaction.

In cases where it is decided that the penal interest would not be included in quantifying the claims of the creditors against the Corporate Debtor, then in such situations it is not necessary to invoke such a provision of law.

Section 50 of the IBC Code, 2016 gives the power to the liquidator or the Resolution Professional to file an application before the Adjudicating Authority for avoidance of transactions where the corporate debtor has been subjected to an extortionate credit transaction, involving either financial or operational debt.

After the Adjudicating Authority is satisfied, it can either restore the position which existed prior to the transaction, or set aside the debt created on account of the extortionate credit transaction, or modify the terms of the transaction, or make any person(a party to the transaction) to repay any amount received by such person; or require any security interest that was created as part of the extortionate credit transaction to be relinquished in favour of the liquidator or the resolution professional, as the case may be.

Other Jurisdictions:
U.K. - The provisions related to undervalued and fraudulent transaction present in the Insolvency and Bankruptcy Code 2016 is a unique incorporation in the Code, adopted from the UK Insolvency Act, 1986. Under Section 244 of the Insolvency Act, 1986, the court may make an order related to extortionate credit transactions within a period of three years before the liquidation process of the company started. The term "extortionate" under S. 244 deals with circumstances where the individual is obliged to make exorbitant payments or there occurs extreme contravention of the principles of fair dealing.

This provision is UK was modelled on sections 138(1), 139(1) and 171(7) of the Consumer Credit Act 1974 (UK). According to these provisions, for the loan to be extortionate, it should also be oppressive apart from being unfair, where one of the party took advantage of the other.

This legislation applies in case of personal and corporate insolvency. Under S. 244, it is presumed that the transaction was extortion and the burden is on the defendant to rebut the presumption. This means that the English liquidators can wait and watch arguments the lender will come up with and what evidence will adduce.

North Ireland- Similar provisions are found in the insolvency code of North Ireland to ensure the principle of equity among the creditors. Article 206 introduces a new provision which permits the liquidator to revisit a credit bargain made with the company on the grounds that it was extortionate. Like U.K., here also, there is a presumption that the transaction was extortionate unless the contrary is proved.

Australia- In Australia, similar provision is found in S. 588FD of the Corporations Law which defines an unfair loan as a loan in which the either the interest or the charges related to the loan are extortionate. The aim of this provision is not to attack the loans which turn out to be a case of bad bargain but allows for impugnation of those loans which look really unfair, means those which any company wouldn't have entered into except when they had the intention to bestow some undue benefit on the lender.

However the term extortionate is not defined. Examination of certain factors is required to figure out if the interest or charges are extortionate, like the risk taken by the company in lending, value of the security, term of the loan, schedule for payment of interests or charges etc. In Australia, liquidators have the onus of establishing that a loan is extortionate, thereby requiring them to take the initiative and at times leading to difficulty in satisfying a court that interest or charges were grossly exorbitant.

Also no time zone is specified by Section 588FD, unlike the other jurisdictions. Unlike the English Courts which have unfettered powers, Section 588F provides powers to the Australian courts to make one or the other orders as enumerated. The Courts don't have much flexibility to do justice when compared to the English Courts.

Thus, the provisions for avoidance of transactions in various jurisdictions are introduced to do away with the situations which ensure the unfair enrichment of certain creditors or obstruct the process of insolvency. However, these principles should be exercised cautiously so that valid transactions undertaken in the normal course of business are not reversed and the whole purpose of introducing the concept of avoidance provisions is not lost.

Written By:
  1. Aditi Jaiswal from RMLNLU Lucknow and
  2. Anubhav Das from NUALS Kochi.

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