Avoidance applications: related-party preference, an out-of-window sale and unexplained consultancy payments
The RP of a textile corporate debtor, with an insolvency commencement date of 1 October 2024, finds three transactions. First, ₹9.2 crore was paid to a cotton supplier in which the corporate debtor's managing director and his wife hold 74%, 18 months before commencement, for supplies made four months earlier; the debtor's normal credit period is 90 days and other suppliers were unpaid for 120 days at the time, but this supplier was paid in six days. Second, a 22-acre plot was sold to an unrelated developer 26 months before commencement for ₹6 crore, when a valuation obtained a month before the sale put it at ₹11.5 crore; the sale proceeds were used to pay salaries and statutory dues. Third, ₹40 lakh was paid to the managing director's son as 'consultancy charges' 14 months before commencement, with no contract, invoice or deliverable on record. The CoC has asked the RP whether all three can be clawed back.
1. Analyse the ₹9.2 crore payment to the cotton supplier. Is it a preferential transaction, and what is the likely defence?
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Elements of Section 43. A preference requires a transfer by the corporate debtor for the benefit of a creditor or surety, on account of an antecedent debt, within the relevant time, at a point when the corporate debtor was unable to pay its debts. Supplies made four months earlier and already invoiced are an antecedent debt.
Relevant time and related-party status. Section 44 fixes the relevant time at two years before commencement for transactions with related parties, and one year for others. The supplier is a related party of a director (the MD and his wife hold 74%) and therefore a related party of the corporate debtor under Section 5(24). At 18 months, the transaction is inside the two-year window; had it been with an unrelated supplier, the one-year window would have excluded it.
The defence to defeat. Section 43(3)(a) protects transfers made in the ordinary course of business. The supplier will argue it was merely paid for goods. The counter is factual: a six-day payment against a 90-day credit norm, while other suppliers waited 120 days, is a departure from ordinary course that evidences a deliberate preference to an insider, and it occurred while bank dues were in default.
Outcome. The RP should apply to avoid the transaction and recover ₹9.2 crore for the estate. The supplier's claim revives as an unsecured claim ranking in the waterfall, which is precisely the loss the avoidance regime imposes.
2. Can the ₹6 crore sale of the plot to the developer be avoided? The undervaluation is nearly 48%.
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The transaction is substantively undervalued but procedurally outside the window. Section 45 permits avoidance of transactions for consideration significantly less than the value of the consideration, during the relevant time. The transaction is with an unrelated developer, so the relevant time is one year before commencement (two years only for related parties). The sale at 26 months is outside both measurements.
Why 'significant undervaluation' does not rescue it. The look-back is a jurisdictional condition, not a discretionary factor. A tribunal cannot extend it because the discount is large or the counterparty unattractive. The valuation report and the use of proceeds also point away from impropriety: the money went into salaries and statutory dues, which undermines any suggestion of diversion.
Could Section 66 help? Section 66 targets fraudulent trading and requires positive evidence of intent to defraud creditors, not merely a bad price. A single arm's-length sale at a discount, with a contemporaneous valuation and traceable proceeds, will usually fall short. If the RP finds that the developer was a front for the promoters, or the price was routed back, the analysis changes and the RP should plead Section 66 with evidence, not rely on valuation alone.
Instruction to the RP. Do not file on this transaction merely because the discount is dramatic; a failed application weakens the estate's other claims.
3. What is the position on the ₹40 lakh paid to the managing director's son, and what limits apply to the RP's power to file?
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Characterisation. There is no antecedent debt, so Section 43 preference does not apply. The payment is a transfer for no consideration or for consideration clearly less than its value, squarely within Section 45 as an undervalued transaction. The son is a relative of a director and therefore a related party, so the relevant time is two years; at 14 months the transaction is well inside.
Evidence to lead. Absence of a contract, invoice, scope of work or deliverable; no comparable payment to any other consultant; and the corporate debtor's financial distress at the time. These facts also support an alternative or additional plea under Section 66 if intent to defraud creditors can be shown.
Relief. An order that ₹40 lakh be returned to the estate, with the son's claim, if any, ranking in the waterfall. Because it is a related-party recovery, the RP should also examine whether the same director's other transactions are similarly structured - pattern evidence strengthens both the avoidance and the fraud case.
Limits on the RP's power. The application must be made by the RP; neither the CoC nor an individual creditor can file in their own name, although a creditor may approach the Authority if the RP refuses without reason. Under Section 238A, the limitation period is three years from when the cause of action arises - here well within time - but the RP should file during the CIRP, since the CoC's approval of a plan extinguishes the CoC itself and the applications must be pursued to conclusion.