Avoidance Of Undervalued Transactions Under Section 45 Of The IBC, 2016

The transactions that can be avoided or those referred to as avoidable transactions are covered under Sections 43 to 51 of the Insolvency and Bankruptcy Code, 2016, respectively. There are three types of transactions that fall within this category, preferential (Section 43), undervalued (Section 45), and fraudulent (Section 66) transactions. In the landmark case of Anuj Jain Interim Resolution Professional for Jaypee Infratech Limited Vs. Axis Bank Limited etc, the Supreme Court discussed the merits of preferential transactions in detail. Though the court didn’t deal with the other arguments related to undervalued and fraudulent transactions in length, leaving the questions open to law and to be examined in appropriate cases. However, the court did comment on the composite application brought by the IRP under the relevant sections stating that the said transactions were preferential, undervalued, and fraudulent. The court was of the view that all these aspects are different and are given explicitly under relevant provisions. It was observed that Section 43 of the code doesn’t involve the question of intent and by virtue of the legal fiction, if given ingredients exist the said transaction would be deemed to be of giving preference at a relevant time as defined under section 46(3) of the code. However, whether a transaction is undervalued or not requires a different enquiry, and the adjudicating authority can look at whether the intent of such undervaluation was to defraud the creditors. On the other hand, Section 66 related to fraudulent and wrongful trading entail liabilities on the person responsible therefor. The court further stated that it is not necessary to elaborate on all these aspects as the transaction in question has already been declared preferential and hence the order of their avoidance is approved, but it appears expedient to make observations related to the arena and scope of the requisite enquiries and to find out whether such transactions were undervalued, intended to defraud or preferential as all these transactions are entirely different. In order to bring a transaction under the mischief that is intended to be resolved by Sections 45/46/47 or Section 66 of the Code, specific and material facts are necessary to be pleaded. Thus, any resolution professional would be expected to keep such requirements in view while making a motion to the adjudicating authority.

In the realm of insolvency law, undervalued transactions have been the subject of persistent scrutiny. They possess a significant impact on the financial equilibrium of an insolvent company and its stakeholders. India’s legislation (IBC) follows a similar notion of the UK for undervalued transactions. This article seeks to undertake a comparative analysis of the treatment of undervalued transactions under the UK Insolvency Act 1986 and the Insolvency and Bankruptcy Code of India (IBC) 2016.

Understanding Undervalued Transactions

Section 45 provides for,

(1) If the liquidator or the resolution professional, as the case may be, on an examination of the transactions of the corporate debtor referred to in sub-section (2) determines that certain transactions were made during the relevant period under section 46, which were undervalued, he shall make an application to the Adjudicating Authority to declare such transactions as void and reverse the effect of such transaction in accordance with this Chapter.

(2) A transaction shall be considered undervalued where the corporate debtor—

(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.

In essence, an undervalued transaction occurs when a debtor, in dire need of liquidity, expedites the sale of assets at a considerable markdown from the actual value, generally without any intention to defraud or delay creditors. Nonetheless, this action may result in a substantial reduction in assets available to creditors during insolvency. For this reason, various insolvency laws worldwide have developed mechanisms to review and potentially reverse such transactions. The IBC also vests in the Resolution Professional (RP) the responsibility to identify undervalued transactions during the insolvency process. If the RP ascertains that certain transactions were undervalued, he may appeal to the National Company Law Tribunal (NCLT) to declare such transactions void and reverse their effect.

The Code considers a transaction to be undervalued where the debtor receives no consideration or an amount significantly less than the value of the transaction. The debtor must be insolvent during or immediately following the transaction. A two-year look-back period applies for related parties and one year for unrelated parties. Section 5(24) discusses which entities and person are related parties to a corporate debtor while Section 5(24A) discusses related party in connection to an individual. The companies and SEBI Act defines a related party as well, but IBC defined them in order to make sure that the entities related to corporate debtor can be identified easily. The look back period is different to both, the related and the unrelated parties because it is usually presumed that the related party might have an idea that the corporate debtor might undergo insolvency proceedings. Thus, we can see it becomes crucial to carefully define who qualifies as a related party as their presence can negatively affect the insolvency proceedings.

Undervalued Transactions in UK Insolvency Law and the Insolvency and Bankruptcy Code of India (IBC): Comparative Analysis

UK Perspective: The Insolvency Act 1986

According to the UK Insolvency Act 1986, a transaction is deemed undervalued if it involves no exchange of consideration (such as a gift), or if the value received by the company is significantly less than what was provided. This criterion applies when the company was insolvent at the time of the transaction or became insolvent as a result.

The Act presumes insolvency if the transaction is made with a connected person, unless proven otherwise. A defence can be presented if the respondents can convince the court that the company entered the transaction in good faith and for business continuity, with reasonable grounds to believe it would benefit the company.

The jurisprudence on this matter in the UK courts has evolved over time. In the landmark case of MC Bacon Ltd., re (1990 BCC 78), it was ruled that the mere creation of security over a company's assets doesn't constitute an undervalue transaction. However, in a subsequent case, Hill v. Spread Trustee Co. Ltd. (2007 1 WLR 2404), the granting of security was deemed as a potential undervalue transaction.

The Reid v Ramlort ([2004] EWCA Civ 800) case broadened the understanding of undervalued transactions in insolvency law, emphasizing the debtor's solvency status during the transaction and the complexity of valuing the transaction. It was established that a transaction could be overturned if the debtor was insolvent at the time, or became insolvent as a result, even if made in good faith. The ruling also highlighted the necessity of a nuanced valuation approach, especially for non-market or unique assets, stating that an asset's value doesn't automatically equate to its surrender value. This point was particularly relevant to insurance policies, where the surrender value – the amount the insurer is contractually obliged to pay upon the policy's surrender before the insured's death – might not truly reflect the asset's value. The court clarified that in the absence of an open market or direct evidence of a special purchaser, the policy's value on the transaction date should not be assumed to be its surrender value. The judgment underscored that a comprehensive and fair evaluation of transactions is crucial to protect all stakeholders' interests in insolvency proceedings.

Comparative Analysis

While the two jurisdictions share a common ground on the definition and intent behind undervalued transactions, the mechanisms to detect and reverse these transactions differ. In the UK, the action to challenge an undervalued transaction can only be initiated by a liquidator or an administrator, whereas, in India, the Resolution Professional (RP) carries this responsibility.

Furthermore, the look-back period varies in both jurisdictions, with the UK Insolvency Act prescribing a two-year period ending with the onset of insolvency, while the IBC 2016 in India applies a two-year period for related parties and a one-year period for unrelated parties.

Another difference lies in the defences available. In the UK, a transaction can escape being set aside if the court is satisfied that it was entered into in good faith for the purpose of carrying on the company's business, and there were reasonable grounds for believing that the transaction would benefit the company. On the other hand, the IBC 2016 does not explicitly provide such a defence.

The interpretation of undervalued transactions by the courts in both jurisdictions has also evolved. Notably, the UK courts, in the case of Reid v Ramlort, reinforced the importance of the financial status of the debtor at the time of the transaction. In contrast, Indian courts are yet to delve deeper into such intricacies, leaving some room for further clarity and development in this aspect of IBC 2016.

Conclusion

The Insolvency professional plays a major role in deciding whether the transaction is undervalued or not. On the satisfaction of the adjudicating authority such transactions can be declared void and be avoided as per the relevant provisions of the code. The laws governing undervalued transactions in both the UK and India aim to maintain a fair balance between the debtor's business continuity and the creditors' interests. While the UK Insolvency Act 1986 offers a more matured perspective, the Indian IBC 2016 is steadily shaping its jurisprudence. Given the similarities and differences, a comparative study of these two jurisdictions provides useful insights and paves the way for cross-jurisdictional learning and legal harmonization in insolvency law. The evolving nature of this subject further underscores the importance of continued research and legal scrutiny.

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