The insolvency of Jaypee Infratech Limited (JIL)and the fate of its various stakeholders, including distressed home buyers, has occupied space on our screens for years on end now, The JIL insolvency has required a careful unravelling of various entangled matters and has in this process, become a touchstone to test the resilience and sturdiness of the Insolvency and Bankruptcy Code introduced in 2016 (the “Code” or “IBC“). Umpteenth petitions, public interest litigations and corresponding orders have dotted the narrative of these insolvency proceedings. Recent events seem to however suggest that the matter, and various ancillary issues have morphed into their final shape before resolution.
The insolvency proceedings in the Allahabad bench of National Company Law Tribunal (“NCLT“) had been initiated by an IDBI-led consortium under Section 7 of the IBC, seeking the initiation of the Corporate Insolvency Resolution Process (“CIRP“) against JIL, alleging that JIL had defaulted in repayment of its dues amounting to INR 526.11 Crores. After initially filing objections to IDBI’s petition, JIL later on withdrew the petitions and furnished consent for the resolution plan under the IBC’s provisions. A moratorium was issued under Section 14 of the IBC, under which an Interim Resolution Professional (“IRP“) was appointed and institution of suits and continuation of pending proceedings, including execution proceedings, was prohibited. Several orders were passed in the ensuing batch of petitions to the effect that the IRP was permitted to take over the management of JIL and to ensure that the necessary interest of the home buyers’ interest was protected, and the home buyers were also awarded the status of financial creditors in a ruling by the Apex Court.
It was during the pendency of the above proceedings, that an application was filed on February 6, 2018 by the IRP against a series of transactions surrounding the security interest created by JIL on 858-acres of unencumbered land in the favour of lenders of JIL’s holding company, Jaiprakash Associates Limited (JAL), without any valuable consideration (“Impugned Transactions“). The IRP had argued that the Impugned Transactions and the underlying transfer of land amounted to asset stripping.The Impugned Transactions took place after the banks started classifying JIL as a Non Performing Asset (NPA) due to its loan defaults.The IRP further contended that the land could have been sold or mortgaged by JIL to raise funds and complete the construction of flats had the Impugned Transactions not taken place It is prudent to take note that the Supreme Court had in 2019, barred JAL from contesting for JIL’s assets[i].
Below, we take a brief look at the trajectory of the matter and the orders that have led to the appeal and the final decision rendered by the Supreme Court:
The NCLT held that the Impugned Transactions had indeed been entered into to defraud the creditors of JIL in utter disregard of its fiduciary duties and duty of care.The NCLT further observed that the directors of JIL as well as the related party, JAL were fully aware that JIL was in default, had been declared as NPA by several creditors and thus insolvency was imminent, and should therefore have exercised due diligence in minimising the potential loss to the creditors but instead they entered into such transactions which ex facie gave benefits to JAL. The NCLT decisively held that any transfer without any consideration or counter guarantee could not be treated as having occurred in the ordinary course of business and since the Impugned Transactions did not in any way benefit JIL, they did not fall under ‘financial affairs’. The NCLT also made an important clarification that the computation of the relevant time under Section 43(4)(a) of the Code is 2 (two) years preceding the insolvency commencement date (for related parties) and does not hinge on the date when the Code came into effect[ii]. Based on all the above, the NCLT termed the Impugned Transactions as being a preferential transaction under Section 43(2)(a) of the IBC. It further held that the mortgage of immovable properties without any consideration fell squarely within the ambit of Section 45(1) of the Code as an undervalued transaction.
The National Company Law Appellate Tribunal (NCLAT), in its turn, rejected the order passed by the NCLT and was of the view that the Impugned Transactions were executed in the ordinary course of business of JIL and held that none of the Impugned Transactions were undervalued or preferential, and were not made with the intent to defraud the creditors of JIL.
The Supreme Court Judgment
The Supreme Court rendered its judgment in the matter on February 26, 2020 and quashed the NCLAT order and has approved the findings of the original NCLT order. The SC dealt with two major questions, firstly whether the Impugned Transactions were preferential transactions, and secondly, whether the lenders of JAL could be termed as the financial creditors of JIL under the IBC.
- Preferential Transaction
The Bench commenced with exploring certain facets of the Code as well as the treatment meted out to preferential transactions under the corresponding codes and acts in different jurisdictions around the world. The Supreme Court, while examining Section 43 of the Code, clarified that merely giving a preference and putting the beneficiary in a better position was not enough. For a preference to become an offending one for the purpose of Section 43, another essential requirement was that such event of giving preference ought to have happened during the relevant time as specified in Section 43(4) of the Code. Furthermore, it has to be ensured that the offending transaction does not fall within the exceptions listed in Section 43(3) which deals with transactions made in the ordinary course of business or transfers creating security interest which secure new value for the corporate debtor. An important observation made by the court was that in the event the above ingredients were satisfied, the transaction would be preferential irrespective of whether the transaction was in fact intended or even anticipated to be so[iii].
Applying the above principles to the matter at hand, the Apex Court stated that the Impugned Transactions clearly had the ultimate effect of working towards the benefit and advantage of JAL. SC also laid emphasis on the fact that in the distribution waterfall envisaged under Section 53 of the Code, JAL, as an operational creditor of JIL stands much lower than in priority than the other creditors and stakeholders, which reinforces the beneficial position that JAL was placed in due to the Impugned Transactions, at the cost, and in exclusion, of the other creditors and stakeholders of JIL[iv].
Ordinary Course of Business:
The respondents had argued that the transferees in the Impugned Transactions were lenders of JAL, whose ordinary course of business was of providing financial support with loans and advances. SC reiterated NCLT’s position that the matter was to be examined with reference to the dealing and conduct of JIL for the purpose of Section 43[v]. Furthermore, if such security interest created secured value enhancement or resulted in strengthening of the position of JIL, it was not to be treated as a preference[vi]. Relying on purposive interpretation of the clause so as not to frustrate the intent behind the clause, the SC held that Section 43(3)(a) was to be read as follows:
43(3)(a) ” a preference shall not include the transfer made in the ordinary course of the business or financial affairs of the corporate debtor and the transferee”[vii].
Commenting on whether the Impugned Transactions were in the ordinary course of the business for JIL, the SC, relying on the judgment rendered in Downs Distributing Co Pty Ltd v. Associated Blue Star Stores Pty Ltd (in liq.)[viii], said that a transaction occurring in the ordinary course of business means that “the transaction must fall into place as part of the undistinguished common flow of business done, that it should form part of the ordinary course of business as carried on, calling for no remark and arising out of no special or particular situation”[ix].It expressed surprise that any interpretation could lend itself to the surmise that JIL, whose ordinary course of business was of ensuring execution of housing/building projects, had inflated itself to routinely mortgaging its assets and/or inventories to secure the debts of its holding company, and that too, at the cost of its own financial well being[x].
- Financial Creditors
Interpreting the definition of Section 5(8) of the Code, the Apex Court said that for a debt to become a ‘financial debt’ for the purposes of Part II of the Code, the basic elements are that it ought to be a disbursal against consideration for the time value of money[xi].Tying the same above with the eligibility to be a financial creditor, it has to be shown that the corporate debtor owes a financial debt to such a person. It instantly becomes clear that a third party to whom the corporate debtor does not owe a financial debt cannot become its financial creditor for the purpose of Part II of the Code[xii]. Reading the provisions of the IBC along with the judgment rendered in Swiss Ribbons Private Limited vs. Union of India and Ors[xiii], the Supreme Court said that it was evident that the scheme of the IBC intended for a ‘financial creditor’ to be a person who has direct engagement in the functioning of the corporate debtor and is involved right from the beginning while assessing the viability of the corporate debtor[xiv].
The Court then further contrasted this with a person who had a mere security interest over the assets of JIL as against a financial creditor of JIL, since the former would be interested only in realising the value of its own security while the latter would, apart from looking at safeguards of its own interests, would also and simultaneously be interested in rejuvenation, revival and growth of the corporate debtor[xv]. The Supreme Court, while cementing the above position, held that “a person having only a security interest over the assets of the corporate debtor, even if falling within the description of ‘secured creditor’ by virtue of collateral security extended by the corporate debtor, stands ousted from the definition of ‘financial creditor’, since if it was allowed to be included as a financial creditor and thereby allowed to have a say in the CIRP envisaged under the Code, the very revival of JIL would be at stake, therefore defeating the aim of the Code.
The SC has ruled that the security interests created by JIL over the properties in question stand discharged in entirety. The Supreme Court has therefore ordered JAL to return the 858-acre parcel to JIL. Furthermore, the NCLT has now approved the resolution plan submitted by NBCC to acquire JIL. At the first instance, the above ruling can be said to be a profound victory for the home buyers and various stakeholders embroiled the insolvency. The decision may however be regarded as a milestone judgment with regards to the IBC as it has comprehensively interpreted various key provisions of the Code.
[iii] Para 19.3, Page 72, ibid
[iv] Para 22.4, Page 79, ibid
[v] Para 25.2, Page 91, ibid
[vi] Para 25.2.1, Page 92, ibid
[vii] Para 25.5, Page 95, ibid
[viii] (1948) 76 CLR 463
[ix] Para 25.6.1, Page 96, ibid
[x] Para 25.6.2, Page 97, ibid
[xi] Para 43, Page 153, ibid
[xii] Para 45, Page 154, ibid
[xiii] (2019) 4 SCC 17
[xiv] Para 47, Page 156, ibid
[xv] Para 47.1, Page 157, ibid