A Hanging Sword of Damocles Over Preferential Transactions.

Abstract

Everyone is in a hurry, but no one is on time. In a complex and interconnected system with numerous variables, anticipating timely outcomes is akin to setting lofty expectations. This is particularly true in the context of the Corporate Insolvency Resolution Process (CIRP) under the Insolvency and Bankruptcy Code, 2016 (IBC). One of the critical challenges in ensuring an efficient CIRP is the handling of asset transfers and financial transactions during insolvency proceedings. The absence of strict time-bound enforcement mechanisms often creates loopholes that allow financially distressed entities to manipulate transactions before the resolution process concludes. Section 43(2) of the IBC defines a preferential transaction as one where an asset transfer benefits a creditor, surety, or guarantor, disadvantaging other creditors in the waterfall mechanism during asset distribution. If not identified and reversed promptly, such transactions can erode the corporate debtor’s financial health and disrupt the fair and equitable resolution process. To safeguard creditor interests and maintain fairness, an efficient CIRP requires the appointment of a Resolution Professional (RP) by the Committee of Creditors (CoC) under Section 21 of the IBC. A crucial responsibility of the RP is to audit transactions made by the corporate debtor during the “relevant time” or “lookback period” — which extends two years for related parties and one year for others under Section 43(4) of the IBC. Additionally, the RP must determine whether these transactions comply with Regulation 35A of the IBBI (Insolvency Resolution Process for Corporate Persons) Regulations, 2016 (CIRP Regulations). If transactions are found to be avoidable or preferential, the RP is obligated under Section 25(2)(j) of the IBC to report them to the Adjudicating Authority (AA) under Chapter III of the Code. This process ensures that no creditor, surety, or guarantor gains an unfair advantage during the period leading up to the Insolvency Commencement Date. The question of whether preferential transactions can be challenged even after the resolution process “concludes” remains a subject of debate. The key issue revolves around whether procedural requirements under the insolvency framework are mandatory or merely directory. Specifically, can the RP pursue avoidance of preferential, undervalued, or fraudulent transactions post-CIRP, even if the RP has already confirmed the ability to recover improperly transferred assets? The interpretation of the term “shall” within Regulation 35A of the CIRP regulations rests with the AA. Additionally, timelines: Do they enhance or hinder the overall effectiveness of the CIRP? Striking a balance between an expeditious resolution and a thorough examination remains crucial, as courts consider whether rigid adherence to timelines ensures fairness or compromises decision quality.