When a corporate person is declared insolvent there certain transaction made before the insolvency commencement date which has a negative effect on the finances of the corporate debtor are overturned. Provisions to overturn such transaction is provided in Insolvency bankruptcy Act between section 43-51, two of such transactions are known as undervalued and preferential transactions. Further, there is a need to fix liability of the people due to whose negligent, fraudulent and wrongful act the corporate person has come at the verge of insolvency, this done by the application of section 66 of the Insolvency and Bankruptcy Code. This reason for doing both of these things is to achieve one of the main objectives of the code, i.e., maximizing the value of assets of the corporate debtor.
The responsibility of is provided to liquidator or resolution professional to find out undervalued, preferential transactions and fraudulent and wrongful trading done by the corporate debtor in period preceding and during the insolvency of the corporate debtor.
The scope of preferential, undervalued transactions and fraudulent and wrongful trading is held to be entirely different and independent from each other by Supreme Court in Anuj Jain Interim Resolution Professional for Jaypee Infratech Ltd. v Axis Bank Limited Etc. The Supreme Court further observed that violation all of these must be seen independently from each other and not jointly.
Section 43 of the code provide for the avoidance of preferential transaction by the resolution professional.
In Anuj Jain Interim Resolution Professional for Jaypee Infratech Ltd. v Axis Bank Limited Etc, the Supreme Court defined preferential transactions as “being the transaction where an insolvent debtor makes transfer to or for the benefit of a creditor so that such beneficiary would receive more than what it would have otherwise received through the distribution of bankruptcy estate”.
The reason for having such provision is to achieve the twin objective of the code, i.e., maximizing the value of assets of the corporate debtor and balancing the interest of all stakeholders. Because by virtue of such preferential transaction one of the creditors will go at a higher pedestal than that of other creditors which in turn will harm the interest of all other creditors.
For proving a transaction is fraudulent or not the Supreme Court in paragraph 20 of the judgment in Anuj Jain Interim Resolution Professional for Jaypee Infratech Ltd. v Axis Bank Limited Etc, provided step by step questions to determine whether a transaction is preferential or not. The questions are as follows:
“(i). Whether such transfer is for the benefit of a creditor or a surety or a guarantor?
(ii). Whether such transfer is for or on account of an antecedent financial debt or operational debt or other liabilities owed by the corporate debtor?
(iii). Whether such transfer has the effect of putting such creditor or surety or guarantor in a beneficial position than it would have been in the event of distribution of assets being made in accordance with Section 53?
(iv). If such transfer had been for the benefit of a related party (other than an employee), as to whether the same was made during the period 73 of two years preceding the insolvency commencement date; and if such transfer had been for the benefit of an unrelated party, as to whether the same was made during the period of one year preceding the insolvency commencement date?
(v) Whether such transfer is not an excluded transaction in terms of sub-section (3) of Section 43?”
In essence, if for a transaction answer of the questions from one to four is yes and it is not an excluded transaction as per sub-section 3 of section 43 than such transaction is a preferential transaction as per section 43 of the code.
Section 45 of insolvency and bankruptcy code provide for avoidance of undervalued transactions. As per section 45 and 46 undervalued transaction are those where corporate debtor gifts a person or transfers its one or more assets for consideration which significantly less than the value of the assets transferred which were done within preceding one year of insolvency commencement date or within preceding 2 years from the insolvency commencement date if done with the related party to the corporate debtor.
In case of the undervalued transaction other than liquidator or resolution professional the creditor can also forward an application to adjudicating authority against the validity of such transactions declaring them void.
It is imperative to know that the transaction took place in the ordinary course of business will not amount to be undervalued transaction. However, it depends on the facts whether a certain transaction which is alleged to be undervalued is done in the ordinary course of business or not.
This provision in our Insolvency and Bankruptcy Code is derived from the UK Insolvency Act of 1986. As per section 66 of the insolvency and bankruptcy code if it was found that the business of the corporate debtor is done with the intent to defraud the creditor of the corporate debtor or for any other fraudulent purpose than the adjudicating authority on the application of resolution professional pass an order against the person who is responsible for such trading to pay for the same to the assets of the corporate debtor.
Generally, the director or partner of the corporate debtor is ought to pay under this provision. However, the provision only applies when their intention is to carry out business in such a way is proven to be fraudulent.
Here, one more thing is important to take into account that the application under this section can only be forwarded by the resolution professional and not the liquidator because the very reason of this provision is to make people by way of their fraudulent conduct taken the company at the verge of insolvency.
By virtue of this provision, the director is obliged to take due diligence in an instant of financial distress of the company. Hence, they can be punished if they even do not have any dishonest or fraudulent intention but acted in a negligent and reckless manner in the times of financial distress of the company making it more prone to liquidation. However, much clarity on this point is still awaited from the judiciary.
As provided in the case of undervalued a preferential transaction there is no such limitation of look back period is given in section 66 of the code. Therefore resolution professional can look and collect all the frauds done by directors or partners of the company and correct them by making them liable to pay for such wrong.
 The Insolvency and Bankruptcy code 2016, S 35 (1) (l).  The Insolvency and Bankruptcy code 2016, S 25 (2) (j).  Civil Appeal Nos. 8512 – 2019. Anuj Jain Interim Resolution Professional for Jaypee Infratech Ltd. v Axis Bank Limited Etc , Civil Appeal Nos. 8512 - 2019  Ibid at para 17.2.  The insolvency and bankruptcy code 2016, S 47.  Mrs Dipti Mehta Resolution Professional, Prag Distillery Private Limited v Shivani Amit Dahanukar, CP (I&B) 1067/NCLT/MB/2017.