IBC | Difference Between 'Avoidance Transactions' & 'Fraudulent Or Wrongful Trading' : Supreme Court Explains
The Supreme Court, in its recent decision in Piramal Capital and Housing Finance Ltd v. 63 Moons Technology explained the key difference between how the Insolvency and Bankruptcy Code 2016 deals with avoidance transactions and transactions relating to fraudulent or wrongful trading. Notably, under the IBC 2016, 'avoidance transactions' are specific transactions conducted by a corporate...
The Supreme Court, in its recent decision in Piramal Capital and Housing Finance Ltd v. 63 Moons Technology explained the key difference between how the Insolvency and Bankruptcy Code 2016 deals with avoidance transactions and transactions relating to fraudulent or wrongful trading.
Notably, under the IBC 2016, 'avoidance transactions' are specific transactions conducted by a corporate debtor prior to insolvency proceedings that are deemed detrimental to the interests of creditors. These include (1) Preferential transactions, (2) Undervalued transactions, (3) Extortionate Credit transactions; (4) Fraudulent transactions.
The bench of Justice Bela Trivedi and Justice SC Sharma noted that there was a fundamental distinction between Avoidance Applications under Chapter III and the Applications in respect of Fraudulent Trading or Wrongful Trading under Chapter VI.
Firstly, the ambit of avoidance applications comes under the duties of the resolution professional (RP) under S.25(j) of IBC. The RP can file an application for avoidance of transactions in accordance with Chapter III as part of his/her larger duty to 'preserve and protect the assets of the corporate debtor, including the continued business operations'.
Under S.26 of the IBC, filling of an Avoidance Application under Clause (j) of sub section (2) of Section 25 by the RP will not affect the insolvency proceedings.
Secondly, the aspect of 'Fraudulent trading or wrongful trading' within the corporate debtor entity has been separately dealt with under S. 66 under Chapter 4.
As per S.66(1) the Adjudicating Authority can order individuals who knowingly engaged in fraudulent business activities during the CIRP or Liquidation process to contribute to the assets of the Corporate Debtor (CD), based on an application from the Resolution Professional.
The Court observed that "the legislature has consciously kept the Applications in respect of Fraudulent trading or Wrongful trading falling in Chapter VI, outside the purview of Section 25(2), which requires the Resolution Professional to undertake the actions and file applications for the avoidance of transactions in accordance with Chapter III."
It was held that avoidance transactions under the IBC in a general sense were dealt with under S.25(j), but it excluded one specific kind of avoidance transaction- fraudulent and wrongful trading.
"Both, the Avoidance Applications under Chapter III and the Applications in respect of Fraudulent trading or Wrongful trading under Chapter VI, operate in different situations. The powers of the Adjudicating Authority in respect of the Avoidance Applications filed under Chapter III and the powers of the Adjudicating Authority in respect of the Applications pertaining to the Fraudulent and Wrongful trading filed under Chapter VI, have also been separately circumscribed."
How Does The IBC Deal With Different Transactions?
The Court explained the various transactions that come under the ambit of 'Avoidance Applications' as follows-
(1) Preferential Transactions - Under S.43 , the RP can file an application if he opined that at a relevant time, the CD had given preference in such transactions in the manner detailed under S.43(2).
Notably, the two types of scenarios of preference that CD may give are 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.
S.44 then empowers the Adjudicating Authority to pass orders upon the applications made under S.43.
(2) Avoidance/ Undervalued Transactions - Under S.45 the Resolution Professional may file an Avoidance Application if he determines that certain transactions were made during the relevant period prescribed under Section 46 which were undervalued. In such applications, the Resolution Professional may pray to declare such transactions as void and to reverse the effect of such transactions in accordance with Chapter III.
Notably, an avoidance/undervalued transaction will be considered when the CD -
(a) makes a gift to a person; or
(b) enters into a transaction with a person which involves the transfer of one or more assets by the corporate debtor for a consideration the value of which is significantly less than the value of the consideration provided by the corporate debtor, and such transaction has not taken place in the ordinary course of business of the corporate debtor.
Here the adjudicating authority can pass orders in two instances, (1) Under S.48 , directions to -
(a) require any property transferred as part of the transaction, to be vested in the corporate debtor;
(b) release or discharge (in whole or in part) any security interest granted by the corporate debtor;
(c) require any person to pay such sums, in respect of benefits received by such person, to the liquidator or the resolution professional as the case may be, as the Adjudicating Authority may direct; or
(d) require the payment of such consideration for the transaction as may be determined by an independent expert.
or (2) Under S.49, directions can be issued, where the Authority is satisfied that such undervalued transactions were deliberately entered into by such CD.
(3) Extortionate Credit Transactions- Under S.50 , the RP may file Avoidance Application, where the CD had been a party to an Extortionate Credit transaction involving the receipt of financial or operational debt during the period within two years preceding the insolvency commencement date, and where the terms of such transactions required exorbitant payments to be made by the CD.
In case of such Extortionate Credit transactions, the Adjudicating Authority may pass any of the orders specified in Clause (a) to (e) of Section 51.
The court concluded that in all these 3 types of transactions falling under 'Avoidance applications' under Chapter 3, "the transactions in question, the properties involved and the persons with whom such transactions were made, could be ascertained by the Adjudicating Authority and therefore it is empowered to pass orders to avoid or set aside such transactions, under Sections 44, 48, 49 and 51, as the case may be."
In other words, the Authority has the power to examine the properties and persons involved in the transactions and pass orders accordingly.
How Are Fradulent Or Wrongful Transactions Different From Other Transactions Under IBC?
A key distinction that the Court observed was that unlike the above transactions, where the Adjudicating Authority could pass specific orders regarding the properties and persons involved in the said transactions, here the nature of 'fraudulent or wrongful' transactions would require a proper inquiry into the intention behind the business of the CD.
Since in considering the intent, it may not be possible to be certain about the properties and persons involved in this type of transaction. Thus, the Adjudicating Authority can only direct those persons who knowingly were party to such business of CD, to make contributions to the assets of CD.
The Authority here cannot avoid or set aside the alleged transactions.
"In respect of the business of the CD as contemplated in Section 66, the properties and the persons involved may or may not be ascertainable and therefore the Adjudicating Authority is not empowered to pass orders to avoid or set aside such transactions, but is empowered to pass orders to the effect that any persons, who were knowingly parties to the carrying on of business in such manner, shall be liable to make such contributions to the assets of the CD, as it may deem fit."
"The Adjudicating Authority in such applications may also direct that the Director of the CD shall be liable to make such contribution to the assets of the CD as it may deem fit, as contemplated in Section 66(2)"
"In case of Fraudulent trading or Wrongful trading, it would be a matter of inquiry to be made by the Adjudicating Authority as to whether the business of CD was carried on with intent to defraud creditors of the CD or was carried on for any fraudulent purpose."
The Court concluded that in instances where common applications are filed by RP both under 'Avoidance Transactions' (including the kinds under S.43,45 and 50) and under Fradulent Transaction under S.66, then it's upon the Adjudicating Authority to apply mind and decide which specific provision would apply in the facts of the case.
"There is clear demarcation of powers of the Adjudicating Authority to pass orders in the Avoidance Applications filed by the Resolution Professional under Section 43, 45 and 50 falling under Chapter III and the Applications filed by the Resolution Professional in respect of the Fraudulent and Wrongful trading of CD, under Section 66 falling under Chapter VI of the IBC. If the Resolution Professional has filed common applications under Sections 43, 45, 50 and also under Section 66, the Adjudicating Authority shall have to distinguish the same and decide as to which provision would be attracted to which of the Applications, and then shall exercise the powers and pass the orders in terms of the provisions of IBC."
In the present case, the Court approved the Resolution Plan proposed by Piramal Capita and Housing Finance for the erstwhile Dewan Housing Finance Corporation Ltd(DHFL).
The Court held that funds recovered from the fraudulent transactions at Dewan Housing Finance Corporation Ltd (DHFL) will go to Piramal Capital & Housing Finance Ltd.
The bench held that NCLT will freshly reconsider the applications relating to the allocation of proceeds from avoidance transactions worth Rs. 45,000 crore.
The key point of contention arose when the Piramal Group's resolution plan ascribed the value of Rs.1 only for the recoveries from the avoidance transactions of the corporate debtor.The bench upheld the resolution plan which was approved by the COC in 2021, as per which a national value of Rs.1 was assigned to potential recoveries of Rs.45,000 crores.
Case details : PIRAMAL CAPITAL AND HOUSING FINANCE LIMITED (FORMERLY KNOWN AS DEWAN HOUSING FINANCE CORPORATION LIMITED) v. 63 MOONS TECHNOLOGIES LIMITED & OTHERS | CIVIL APPEAL NOS. 1632-1634 OF 2022
Citation : 2025 LiveLaw (SC) 374
