Preferential Transactions under IBC

The Insolvency and Bankruptcy Code, 2016 (IBC) was enacted to consolidate and amend the laws relating to reorganisation and insolvency resolution of corporate persons, partnership firms, and individuals in a time-bound manner. One of its significant features is to ensure that during the insolvency process, all creditors are treated fairly and equitably. To achieve this objective, the Code identifies certain types of transactions as “avoidable transactions” that may be reversed if they are found to be detrimental to the interests of creditors as a whole.

Among these avoidable transactions are preferential transactions, which are covered under Sections 43 to 51 of the Code. The other two are undervalued transactions and extortionate credit transactions. The concept of preferential transactions prevents a corporate debtor from giving undue advantage to certain creditors at the cost of others.

Meaning and Objective of Preferential Transactions

A preferential transaction takes place when a corporate debtor, just before or during the insolvency process, transfers its property or any interest in it for the benefit of a creditor, surety, or guarantor in such a way that puts that party in a better position than other creditors during liquidation.

The idea behind this provision is to stop corporate debtors from making transactions that favour some creditors while harming the collective interests of others. It ensures that during financial distress, the assets of the company are preserved and distributed equitably among all stakeholders.

Statutory Provision: Section 43 of the IBC

Section 43 of the Insolvency and Bankruptcy Code deals with the concept of preferential transactions and specifies the conditions under which a transaction can be treated as a preference. The section empowers the Resolution Professional (RP) or Liquidator to approach the Adjudicating Authority (National Company Law Tribunal – NCLT) to reverse such transactions.

As per Section 43(2), a corporate debtor shall be deemed to have given a preference if:

1. There is a transfer of property or an interest in property of the corporate debtor for the benefit of a creditor, surety, or guarantor.
2. The transfer is made on account of an antecedent debt or liability, i.e., a debt that existed before the transaction took place.
3. The transfer has the effect of putting the creditor, surety, or guarantor in a beneficial position than they would have been if such transfer had not been made during the distribution of assets in liquidation.

For instance, if a corporate debtor repays a loan to one particular creditor while defaulting on others, such payment may be deemed preferential if it gives that creditor an advantage over the rest.

Objective and Rationale of Section 43 of the IBC

The rationale behind identifying and reversing preferential transactions is to preserve the equality of treatment among creditors. When a company nears insolvency, it may attempt to protect certain stakeholders—such as promoters, relatives, or friendly creditors—by transferring assets or repaying their dues selectively.

Such transactions reduce the pool of assets available for distribution to all creditors. Section 43 seeks to undo this imbalance by allowing the NCLT to set aside these transactions and restore the property or value to the corporate debtor’s estate.

Conditions for Identifying a Preferential Transaction

For a transaction to qualify as “preferential” under Section 43, the following conditions must be met:

1. Transfer of property or interest – The corporate debtor must have transferred some property or an interest in property.
2. Beneficiary relationship – The transfer must benefit a creditor, surety, or guarantor of the corporate debtor.
3. Antecedent debt or liability – The transfer must be related to an existing debt, not a new or contemporaneous transaction.
4. Favourable position – The transaction must put the recipient in a better position than others in case of liquidation.

These elements collectively determine whether a transaction is preferential in nature.

Exceptions to Preferential Transaction under Section 43(3)

Section 43(3) specifies certain exceptions where a transaction shall not be deemed preferential. These are as follows:

1. Ordinary Course of Business – Any transfer made in the ordinary course of the business or financial affairs of the corporate debtor or the transferee is not considered preferential. For example, regular payments to suppliers or employees for services rendered in the usual business operations are not covered.
2. Security for New Value – If a corporate debtor creates a security interest in property acquired for securing “new value” (such as new goods, services, or credit), it will not be treated as preferential. However, the security interest must:
   • Be given at the time of or after signing a security agreement that describes the property,
   • Be used by the corporate debtor to acquire the property, and
   • Be registered with an information utility within 30 days of the debtor receiving possession of the property.
3. Court-Ordered Transfers – The proviso to Section 43(3) clarifies that a transfer made under the order of a court may still be treated as preferential if it meets the conditions under sub-section (2). Thus, judicial direction does not automatically validate a transaction.

Definition of “New Value”

The explanation to Section 43(3) defines “new value” as money or its equivalent in goods, services, or new credit, or the release by the transferee of property previously transferred to them in a valid transaction. However, it does not include substitution of an existing financial or operational debt for another.

This ensures that the exemption applies only to genuine new contributions to the debtor’s estate, not to mere adjustments of old debts.

Relevant Time or Look-Back Period

Section 43(4) introduces the concept of relevant time, often called the “look-back period.” It determines the time frame within which a transaction can be examined for being preferential.

• If the preference is given to a related party (other than an employee), the relevant time is two years preceding the insolvency commencement date.
• If the preference is given to a non-related party, the relevant time is one year preceding the insolvency commencement date.

This provision prevents the corporate debtor from making last-minute transfers or arrangements favouring insiders or certain creditors before initiating insolvency proceedings.

Application to the Adjudicating Authority

Under Section 43(1), when the Resolution Professional or Liquidator forms an opinion that the corporate debtor has given a preference at a relevant time, they must apply to the Adjudicating Authority (NCLT) for appropriate relief. The NCLT can then examine the matter and pass suitable orders under Section 44 to reverse the effects of such transactions.

Orders by the Adjudicating Authority under Section 44

Section 44 empowers the NCLT to issue one or more of the following orders to nullify or correct the effects of preferential transactions:

1. Revesting Property – Require that any property transferred in connection with the preference be vested back in the corporate debtor.
2. Revesting of Proceeds – Direct that if the property has been sold, the proceeds or substituted assets be vested in the debtor.
3. Discharge of Security Interests – Release or discharge, in whole or in part, any security interest created by the debtor.
4. Recovery of Benefits – Require the beneficiary to pay back sums equivalent to the benefit received to the Liquidator or Resolution Professional.
5. Reinstating Guarantor Liabilities – Direct any guarantor, whose debts were released due to the preference, to revive such obligations.
6. Creating New Security – Order a new security or charge on property for discharging a debt as deemed appropriate.
7. Extent of Liabilities – Clarify the extent to which the person whose property is vested in the debtor will have their debts recognised in the liquidation or resolution process.

These powers allow the Tribunal to ensure fairness by restoring the debtor’s estate and preventing unjust enrichment of certain creditors.

Transactions in Good Faith and for Value

The law also recognises that not all transactions made during financial distress are fraudulent or unfair. Therefore, an order under Section 44 shall not:

• Affect any interest in property acquired from a person other than the corporate debtor in good faith and for value, or
• Require a person who received a benefit from such a transaction in good faith and for value to pay any sum to the Liquidator or Resolution Professional.

This ensures protection for genuine third-party transactions conducted honestly and without knowledge of the debtor’s insolvency.

Presumptions under Section 44

To determine whether a transaction was made in good faith, certain presumptions apply:

1. If a person acquiring an interest or benefit from the preference:
   • Had sufficient information about the commencement of insolvency proceedings, or
   • Is a related party,
     then it is presumed that the transaction was not made in good faith, unless proven otherwise.
2. A person is deemed to have sufficient information about insolvency if a public announcement has been made under Section 13 of the Code. This ensures that once insolvency is publicly notified, parties dealing with the corporate debtor are expected to act cautiously.

Judicial Interpretation of Preferential Transactions

The landmark case of Anuj Jain, Interim Resolution Professional for Jaypee Infratech Limited v. Axis Bank Limited (2020) played a crucial role in interpreting Section 43.

In this case, the Supreme Court explained that preferential transactions are meant to prevent the depletion of the debtor’s assets and safeguard the collective rights of creditors. The Court held that the mortgaging of properties by a subsidiary company to secure loans taken by its holding company constituted a preferential transaction. The judgment clarified that a holding company could be treated as an operational creditor and that any transfer giving it undue advantage can be avoided under the Code.

This decision strengthened the legal framework by clarifying the broad ambit of Section 43 and setting a precedent for determining preferential transactions.

Conclusion

Preferential transactions under the Insolvency and Bankruptcy Code, 2016 are designed to uphold the principle of equality among creditors and maintain the integrity of the insolvency process. By empowering the Resolution Professional or Liquidator to challenge and reverse such transactions, the Code ensures that no creditor, guarantor, or surety gains an unfair edge during financial distress.

Through detailed provisions in Sections 43 and 44, and judicial clarity from landmark judgments, the IBC reinforces the idea that insolvency is a collective proceeding — one that aims for fair treatment of all stakeholders rather than individual advantage.