Avoidance Transactions Under IBC: Preferential, Undervalued, Fraudulent and Extortionate

One of the most powerful tools available to Resolution Professionals and liquidators under the IBC 2016 is the ability to challenge and reverse transactions that occurred before the corporate insolvency process began. Sections 43-51 of IBC provide the framework for "avoidance transactions" — transactions that unfairly benefited insiders or prejudiced creditors.

Overview of Avoidance Provisions

Preferential Transactions (Section 43)

What Makes a Transaction Preferential?

A transaction is preferential when:

1. It was made during the look-back period
2. It was for the benefit of a creditor, surety, or guarantor
3. The transaction has the effect of putting the creditor in a better position in a notional liquidation than they would otherwise have been

Key Tests

• Was the transaction at fair value? (If yes, not preferential)
• Was it in the ordinary course of business? (Ordinary course is a defense)
• Was it to a related party (higher scrutiny — 2-year look-back)

Example

A company pays off a bank loan of Rs.10 crore 6 months before CIRP is initiated. This was done knowing the company was insolvent. If the bank is an unrelated party — preferential (within 1 year). The RP can apply to NCLT to have the payment reversed and Rs.10 crore restored to the estate.

Undervalued Transactions (Section 45)

• Corporate debtor transferred assets at significantly less than fair market value
• Recipient gave consideration less than the market value
• Classic examples: selling factory at 50% of value to a related party; making a gift of real estate
• Defense: Transaction was in good faith; company was not insolvent at the time; adequate consideration was given

Fraudulent Trading (Section 66)

The most powerful but most difficult to prove:

• Business carried on with intent to defraud creditors
• NCLT can impose personal liability on directors/officers to contribute to corporate assets
• No time limit
• Wrongful trading: Directors who knew (or ought to have known) that insolvency was inevitable but continued to incur debt — can be personally liable (borrowed from UK Insolvency Act).
• Key case: CIRP proceedings post-IL&FS collapse, NCLT examined transactions pre-collapse

Process for Challenging Avoidance Transactions

1. RP/Liquidator identifies suspicious transactions during CIRP/liquidation
2. RP files application with NCLT citing relevant section (43/45/50/66)
3. NCLT issues notice to the transaction counterparty
4. Counterparty responds; parties may submit evidence
5. NCLT passes order: set aside transaction, order restoration of assets, impose personal liability
6. Appeal: NCLAT → Supreme Court

Practical Impact

• Significant tool in large CIRP cases — Jet Airways, DHFL, Yes Bank (AT1 bonds controversy)
• Deterrent: Promoters cannot clean out company assets and then file insolvency
• Financial creditors (CoC) encourage RP to pursue avoidance applications to enhance estate value