While setting aside the judgment dated 1st August, 2019 of the NCLAT on avoidance of certain transactions under section 43, 45 and 66 of the Code whereby CD had mortgaged its properties for the financial assistance to JAL (holding company), the Hon’ble Supreme Court made important rulings on the following issues;
1. Analysis of sections 43 and 44.
2. Whether impugned transactions are preferential, falling within section 43(2)
3. Look back period in terms of section 43(4)
4. Ordinary Course of Business or financial affairs
5. Duties and responsibilities of RP in CIRP as per section 25 w.r.t. section 43
6. Undervalued and fraudulent transactions
7. Whether lenders of JAL could be categorised as FCs of JIL
Excerpts of the orders;
1. Analysis of sections 43 and 44.
# 18. ……. Looking to the contents, context and consequences, we are at one with the contentions urged on behalf of the respondents with reference to the decisions in Devinder Singh (supra) and other cited cases, that these provisions (section 43 & 44) need to be strictly construed. However, even if we proceed on strict construction of Section 43 of the Code, the underlying principles and the object cannot be lost sight of. In other words, the construction has to be such that leads towards achieving the object of these provisions.
# 18.2. However, merely giving of the preference and putting the beneficiary in a better position is not enough. For a preference to become an offending one for the purpose of Section 43 of the Code, another essential and rather prime requirement is to be satisfied that such event, of giving preference, ought to have happened within and during the specified time, referred to as “relevant time”. The relevant time is reckoned, as per sub-section (4) of Section 43 of the Code,.............
# 19. In order to understand and imbibe the provisions concerning preference at a relevant time, it is necessary to notice that as per the charging parts of Section 43 of the Code i.e., sub-sections (4) and (2) thereof, a corporate debtor shall be deemed to have given preference at a relevant time if the twin requirements of clauses (a) and (b) of sub-section (2) coupled with the applicable requirements of either clause (a) or clause (b) of sub-section (4), as the case may be, are satisfied.
# 19.3. On a conspectus of the principles so enunciated, it is clear that although the word ‘deemed’ is employed for different purposes in different contexts but one of its principal purpose, in essence, is to deem what may or may not be in reality, thereby requiring the subject-matter to be treated as if real. Applying the principles to the provision at hand i.e., Section 43 of the Code, it could reasonably be concluded that any transaction that answers to the descriptions contained in sub-sections (4) and (2) is presumed to be a preferential transaction at a relevant time, even though it may not be so in reality. In other words, since sub-sections (4) and (2) are deeming provisions, upon existence of the ingredients stated therein, the legal fiction would come into play; and such transaction entered into by a corporate debtor would be regarded as preferential transaction with the attendant consequences as per Section 44 of the Code, irrespective whether the transaction was in fact intended or even anticipated to be so.
# 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?
2. Whether impugned transactions are preferential, falling within section 43(2)
# 22.2.1. As noticed, 09.08.2017 is the insolvency commencement date in this case. The transactions in question, even if of putting the concerned properties under mortgage with the lenders, carry the ultimate effect of working towards the benefit and advantage of the borrower i.e., JAL who obtained loans and finances by virtue of such transactions. It is true that there had not been any creditor-debtor relationship between the lender banks and corporate debtor JIL but that will not be decisive of the question of the ultimate beneficiary of these transactions. The mortgage deeds in question, entered by the corporate debtor JIL to secure the debts of JAL, obviously, amount to creation of security interest to the benefit of JAL.
# 22.2.2. Now, the capacity of JAL is admittedly that of the holding company of JIL as its largest equity shareholder ( with approximately 71.64 % shareholding). Moreover, JAL had admittedly been the operational creditor of JIL, for an amount of approximately Rs. 261.77 crores. JAL itself maintains that it had been providing financial, technical and strategic support to JIL in various ways. It is the assertion that apart from making investment in terms of equity shareholding to the tune of Rs. 995 crores, JAL had pledged its 70,83,56,087 equity shares held in JIL in favour of the lenders of JIL; had also entered into Promoter Support Agreement to the lenders of JIL to meet the DSRA obligation of JIL towards its lenders; and had further extended Bank Guarantees of Rs. 212 crores to meet the DSRA obligation of JIL. These assertions, in our view, put JAL in such capacity that it is a related party to JIL and is a creditor as also surety of JIL. In other words, the corporate debtor JIL owed antecedent financial debts as also operational debts and other liabilities towards JAL.
# 22.5. Therefore, in relation to the present case, the answers to questions (i), (ii) and (iii) as referred in paragraph 20 are that: the impugned transactions had been of transfers for the benefit of JAL, who is a related party of the corporate debtor JIL and is its creditor and surety by virtue of antecedent operational debts as also other facilities extended by it; and the impugned transactions have the effect of putting JAL in a beneficial position than it would have been in the event of distribution of assets being made in accordance with Section 53 of the Code. Thus, the corporate debtor JIL has given a preference in the manner laid down in sub-section (2) of Section 43 of the Code.
3. Look back period in terms of section 43(4)
# 23.1.2.We may also observe that if the contentions urged on behalf of the respondents were to be accepted, the result would be of postponing the effective date of operation of sub-section (4) of Section 43 by two years in the case of related party and to one year in the case of unrelated party, and thereby, effectively postponing the application of entire Section 43 for a period of two years! That cannot be and had never been the intention of the legislature. It is also noteworthy that by virtue of proviso to sub-section (3) of Section 1 of the Code, different dates can be provided for enforcement of different provisions of the Code; and in fact, different provisions have been brought into effect on different dates. However, after coming into force of the provisions, if a look-back period is provided for the purpose of any particular enquiry, it cannot be said that the operation of the provision itself would remain in hibernation until such look-back period from the date of commencement of the provision comes to an end. There is nothing in the Code to indicate that any provision in Chapter II or Chapter III be taken out and put in operation at a later date than the date notified. Such contentions being totally devoid of substance, deserve to be, and are, rejected.
# 24. We may now take up the question as to which of the transactions in question would entail in giving preference at a relevant time or otherwise. As noticed, the preference is given to JAL who is a related party of JIL. Hence, the look-back period is two years preceding insolvency commencement date i.e., 09.08.2017 per clause (a) of sub-section (4) of Section 43; and accordingly, the point of enquiry would be as to whether the preference had been given during the period of two years preceding 09.08.2017. Therefore, the transactions commencing from 10.08.2015 until the date of insolvency commencement shall fall under the scanner. As noticed, it has been one of the major contentions of the respondents that most of the impugned transactions were not of creation of any new encumbrance by JIL and in fact, most of the properties in question had already been under mortgage with the respective lenders much before the period under consideration i.e., much before 10.08.2015.
# 24.3.1. It has been one of the major contentions of the respondents that most of the impugned transactions were not of creation of any new encumbrance by JIL and in fact, most of the properties in question had already been under mortgage with the respective lenders. The submissions of respondents in relation to the aforesaid five transactions, that they had been of so-called remortgage/s, carry their own shortcomings and cannot be accepted. In the first place, we are clearly of the view that on release by the mortgagee, the mortgage ceases to exist and it is difficult to countenance the concept of a so called Re-mortgage. ……….. As regards Property No. 5, even if there had been certain previous mortgage transactions falling beyond the look-back period, the property got released on 04.11.2015; and thereafter, the fresh mortgage on 24.05.2016, with increased facility amount from Rs. 1470 crores to Rs. 1767 crores, suffers from the same vice, of being a deemed preference to a related party during the period of two years preceding the insolvency commencement date.
# 24.5. For what has been discussed hereinabove, the answer to question (iv) as referred in paragraph 20 is that the transactions in question had been of deemed preference to related party JAL by the corporate debtor JIL during the look-back period of two years and have rightly been held covered within the period envisaged by sub-section (4) of Section 43 of the Code.
4. Ordinary Course of Business or financial affairs
# 25.5. Looking to the scheme and intent of the provisions in question and applying the principles aforesaid, we have no hesitation in accepting the submissions made on behalf of the appellants that the said contents of clause (a) of sub-section (3) of Section 43 call for purposive interpretation so as to ensure that the provision operates in sync with the intention of legislature and achieves the avowed objectives. Therefore, the expression “or”, appearing as disjunctive between the expressions “corporate debtor” and “transferee”, ought to be read as “and”; so as to be conjunctive of the two expressions i.e., “corporate debtor” and “transferee”. Thus read, clause (a) of sub-section (3) of Section 43 shall mean that, for the purposes of sub-section (2), a preference shall not include the transfer made in the ordinary course of the business or financial affairs of the corporate debtor and the transferee. Only by way of such reading of “or” as “and”, it could be ensured that the principal focus of the enquiry on dealings and affairs of the corporate debtor is not distracted and remains on its trajectory, so as to reach to the final answer of the core question as to whether corporate debtor has done anything which falls foul of its corporate responsibilities.
# 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.
25.6.2. Taking up the transactions in question, we are clearly of the view that even when furnishing a security may be one of normal business practices, it would become a part of ‘ordinary course of business’ of a particular corporate entity only if it falls in place as part of ‘the undistinguished common flow of business done’; and is not arising out of ‘any special or particular situation’, …….. In other words, we are clearly of the view that the ordinary course of business or financial affairs of the corporate debtor JIL cannot be taken to be that of providing mortgages to secure the loans and facilities obtained by its holding company; and that too at the cost of its own financial health. As noticed, JIL was already reeling under debts with its accounts with some of the lenders having been declared NPA; and it was also under heavy pressure to honour its commitment to the home buyers. In the given circumstances, we have no hesitation in concluding that the transfers in questions were not made in the ordinary course of business or financial affairs of the corporate debtor JIL.
# 27. For what has been discussed hereinabove, we are clearly of the view that the transactions in question are hit by Section 43 of the Code and the Adjudicating Authority, having rightly held so, had been justified in issuing necessary directions in terms of Section 44 of the Code in relation to the transactions concerning Property Nos. 1 to 6. NCLAT, in our view, had not been right in interfering with the well-considered and justified order passed by NCLT in this regard.
5. Duties and responsibilities of RP in CIRP as per section 25 w.r.t. section 43
# 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.
6. Undervalued and fraudulent transactions
# 29. Having found that the transactions in question cannot be countenanced, for being of preference during a relevant time to a related party; and having approved the order passed by NCLT in that regard, we do not consider it necessary to deal with the other length of arguments advanced by the learned counsel for parties on the questions as to whether the transactions are undervalued and/or fraudulent too. In the totality of circumstances, we would prefer leaving the said questions at that only, while also leaving all the related questions of law open; to be examined in an appropriate case.
# 29.1. However, we are impelled to make one comment as regards the application made by IRP. It is noticed that in the present case, the IRP moved one composite application purportedly under Sections 43, 45 and 66 of the Code while alleging that the transactions in question were preferential as also undervalued and fraudulent. In our view, in the scheme of the Code, the parameters and the requisite enquiries as also the consequences in relation to these aspects are different and such difference is explicit in the related provisions.
As noticed, the question of intent is not involved in Section 43 and by virtue of legal fiction, upon existence of the given ingredients, a transaction is deemed to be of giving preference at a relevant time.
However, whether a transaction is undervalued requires a different enquiry as per Sections 45 and 46 of the Code and significantly, such application can also be made by the creditor under Section 47 of the Code. The consequences of undervaluation are contained in Sections 48 and 49. Per Section 49, if the undervalued transaction is referable to sub-section (2) of Section 45, the Adjudicating Authority may look at the intent to examine if such undervaluation was to defraud the creditors.
On the other hand, the provisions of Section 66 related to fraudulent trading and wrongful trading entail the liabilities on the persons responsible therefore. We are not elaborating on all these aspects for being not necessary as the transactions in question are already held preferential and hence, the order for their avoidance is required to be approved; but it appears expedient to observe that the arena and scope of the requisite enquiries, to find if the transaction is undervalued or is intended to defraud the creditors or had been of wrongful/ fraudulent trading are entirely different. Specific material facts are required to be pleaded if a transaction is sought to be brought under the mischief sought to be remedied by Sections 45/46/47 or Section 66 of the Code.
As noticed, the scope of enquiry in relation to the questions as to whether a transaction is of giving preference at a relevant time, is entirely different. Hence, it would be expected of any resolution professional to keep such requirements in view while making a motion to the Adjudicating Authority.
7. Whether lenders of JAL could be categorised as FCs of JIL
# 39.3. The enunciation aforementioned illuminates the reasons as to why at all a financial creditor is conferred with a major, rather pivotal, role in the processes contemplated by Part II of the Code. It is the financial creditor who lends finance on a term loan or for working capital that enables the corporate debtor to set up and/or operate its business; and who has specified repayment schedules with default consequences. The most important feature, as this Court has said, is that a financial creditor is, from the very beginning, involved in assessing the viability of the corporate debtor who can, and indeed, engage in restructuring of the loan as well as reorganisation of the corporate debtor’s business when there is financial stress. Hence, a financial creditor is not only about in terrorem clauses for repayment of dues; it has the unique parental and nursing roles too. In short, the financial creditor is the one whose stakes are intrinsically interwoven with the well-being of the corporate debtor.
# 42.1. As noticed, in the case of Pioneer Urban, a suggestion made on behalf of the respondents with reference to the decision in Krishi Utpadan Mandi Samiti, that when the words ‘means and includes’ are used in a definition, they are to be given a wider meaning and are not exhaustive or restricted to the items contained therein, was not accepted by this Court; and the statement of law in Krishi Utapadan Mandi Samiti was held to be not that of good law for it ignored the earlier precedents of larger and coordinate Benches and was also out of sync with the later decisions on the same point. However, the other extreme of interpretation, as canvassed by the petitioners, that a financial debt could only be a debt which is disbursed against the consideration for the time value of money, and such requirement pervades all sub-clauses (a) to (i), was also not accepted as a matter of statutory interpretation by this Court while observing that the expression ‘and includes’ speaks of subject matters which may not necessarily be reflected in the main part of the definition. Thus, it is evident that this Court did not accept either of the extremities suggested by the parties in Pioneer Urban for interpretation and implication of the expressions ‘means and includes’ in a definition clause of the statute. Significantly, in Pioneer Urban, none of the extremities had any bearing on the conclusion because, eventually, the amendment in question was held to be only clarificatory in nature; and this Court held that the Explanation added to Section 5(8)(f) of the Code by the Amendment Act did not enlarge the scope of the original Section.
# 43. …. The requirement of existence of a debt, which is disbursed against the consideration for the time value of money, in our view, remains an essential part even in respect of any of the transactions/dealings stated in sub-clauses (a) to (i) of Section 5(8), even if it is not necessarily stated therein. In any case, the definition, by its very frame, cannot be read so expensive, rather infinitely wide, that the root requirements of ‘disbursement’ against ‘the consideration for the time value of money’ could be forsaken in the manner that any transaction could stand alone to become a financial debt. In other words, any of the transactions stated in the said subclauses (a) to (i) of Section 5(8) would be falling within the ambit of ‘financial debt’ only if it carries the essential elements stated in the principal clause or at least has the features which could be traced to such essential elements in the principal clause. In yet other words, the essential element of disbursal, and that too against the consideration for time value of money, needs to be found in the genesis of any debt before it may be treated as ‘financial debt’ within the meaning of Section 5(8) of the Code.
# 47.2. Therefore, 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 subsections (7) and (8) of Section 5 of the Code. Differently put, if a corporate debtor has given its property in mortgage to secure the debts of a third party, it may lead to a mortgage debt and, therefore, it may fall within the definition of ‘debt’ under Section 3(10) of the Code. However, it would remain a debt alone and cannot partake in the character of a ‘financial debt’ within the meaning of Section 5(8) of the Code.
# 54. For what has been discussed hereinabove, on the issue as to whether lenders of JAL could be treated as financial creditors, we hold that such lenders of JAL, on the strength of the mortgages in question, may fall in the category of secured creditors, but such mortgages being neither towards any loan, facility or advance to the corporate debtor nor towards protecting any facility or security of the corporate debtor, it cannot be said that the corporate debtor owes them any ‘financial debt’ within the meaning of Section 5(8) of the Code; and hence, such lenders of JAL do not fall in the category of the ‘financial creditors’ of the corporate debtor JIL.
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