66.

  Fraudulent / wrongful trading (mechanism for undervalued transactions)

(1) If the RP, during the CIRP, finds the business of corporate debtor has been
carried on to defraud creditors or for any other fraudulent purpose, the NCLT may on
the application by the RP pass an order that any persons (including the directors,
officers) who were knowingly parties to such business, shall be liable to make
contributions toward the assets of the corporate debtor as the NCLT directs. 

In IDBI Bank vs. Jaypee Infratech Ltd. (JIL) the corporate debtor had transferred
immovable property by the way of mortgage without any consideration; the court
held that the transaction was undervalued transaction – declared it as void, and
restored the original position, as summarized below:

Basically, JIL (the corporate debtor) had, under its real estate township project,
promised to deliver 32000 units, against which it had received part consideration
from homebuyers. It had also taken loans from a consortium of banks (inc. IDBI
Bank). However, the corporate debtor not only delivered only 12000 units, but as its
financial hardships mounted, it defaulted on its loans, was declared an 'NPA', and
dragged to NCLT under the IBC for CIRP by IDBI (acting as lead applicant). It was
found, during the insolvency proceedings, that it had, under a parallel arrangement,
and without seeking any prior requisite approval from the joint forum of bank lenders,
mortgaged off the project property and land in favour of lenders to Jaypee
Associates Ltd. (JAL) - the holding company as the holding company was to infuse
the loan amount in the corporate debtor to ease off the situation. In the meanwhile,
IBC was amended and homebuyers were now to be treated as Financial Creditors,
and the homebuyers of the current case were now a part of the CoC holding 60%
voting share. After much negotiation, submissions & rejection of resolution plans, the
authority finally concluded the following:

"It is true the collateral security is common practice in loan transactions. It is on

record that in this case, the Corporate Debtor was under liquidity crunch and its
accounts were declared NPA by LIC and other creditors. The Joint Lender Forum
was formed to deal with the situation. Hut the Corporate Debtor entered into the
transaction even without taking prior approval of Joint Lender Forum and mortgaged
its unencumbered land in favour of the lenders of the JAL.

The said mortgage of immovable properties, i.e. of the unencumbered land of the
corporate debtor has been made without any consideration to the corporate debtor.
Therefore the said transaction is covered under the umbrella of Sec. 45(1) of the
Code and will be treated as an undervalued transaction as defined under section 45
of the Code is also clear that these transactions are undertaken during the relevant
period of 2 years from the date of initiation of Corporate Insolvency Process as
provided under section 46(1)(ii) of the Code. Therefore, this issue is also decided
positively, in favour of applicant Resolution Professional and against the Corporate."

Avoidance proceedings are one of the crucial measures in saving the value of an insolvent
entity under liquidation. The UNCITRAL Legislative Guide on Law of Insolvency defines
avoidance proceedings as "provisions of the insolvency law that permit transactions for the
transfer of assets or the undertaking of obligations prior to insolvency proceedings to be
cancelled or otherwise rendered ineffective and any assets transferred, or their value, to he
recovered in the collective interest of creditors". The avoidance proceedings are intended to
targetand reverse the effect of so-called "vulnerable transactions". Preference transactions
are one such often-talked about vulnerable transactions, and may take different forms.