Jaiprakash Associates Limited (JAL) is a Public Listed Company and Jaypee Infratech Limited (JIL) is its subsidiary. Jaiprakash Associates Limited (JAL) obtained finance from a consortium of financial institutions and banks, ICICI Bank Limited, Standard Chartered Bank Limited and State Bank of India (JAL Lenders), the security of which inter alia comprised of mortgage created by Jaypee Infratech Limited (JIL) of certain lands held by it.

IDBI Bank Limited, a creditor of Jaypee Infratech Limited (JIL), instituted a petition under Section 7 of the Insolvency and Bankruptcy Code, 2016 before the National Company Law Tribunal (NCLT), Allahabad Bench for seeking initiation of CIRP against Jaypee Infratech Limited (JIL) while alleging that Jaypee Infratech Limited (JIL) had committed a default in repayment of its dues to the tune of 526.11 crores. National Company Law Tribunal (NCLT) initiated CIRP against Jaypee Infratech Limited (JIL) on 9th August 2017.

The National Company Law Tribunal (NCLT) on 9th May 2018 and 15th May 2018 approved the decision of the IRP of Jaypee Infratech Limited (JIL) rejecting the claims of the Jaiprakash Associates Limited (JAL) Lenders to be recognized as financial creditors of the Corporate Debtor Jaypee Infratech Limited (JIL) on the strength of the mortgages created by Corporate Debtor Jaypee Infratech Limited (JIL) as collateral security of the debt of its holding company Jaiprakash Associates Limited (JAL).

Further, the National Company Law Tribunal (NCLT)on 16th May 2018 held some particular transactions by which the Corporate Debtor Jaypee Infratech Limited (JIL) had mortgaged its properties as collateral securities for advances and loans made by the Jaiprakash Associates Limited (JAL) Lenders, as being preferential, fraudulent and undervalued under Section 43, 45 and 66 of the Code.

The National Company Law Appellate Tribunal, New Delhi ("NCLAT") on 1st August 2019 by a common order set aside the National Company Law Tribunal (NCLT) order dated 16th May 2018 and also permitted the appeals by the Lenders of Jaiprakash Associates Limited (JAL) to be financial creditors of Corporate Debtor Jaypee Infratech Limited (JIL). However, the entire National Company Law Appellate Tribunal (NCLAT) judgment had only been in regard to the order dated 16th May 2018 passed by National Company Law Tribunal (NCLT) on the application for avoidance filed by the IRP and no reasons were given for reversing the National Company Law Tribunal (NCLT) judgments of 9th May 2018 and 15th May 2018. The appeals from the National Company Law Appellate Tribunal (NCLAT) judgment dated 1st August 2019 are addressed by the present Apex Court judgment.

Issues

The major issues involved in the present case are as under :

1. Whether the mortgage transactions in question deserve to be avoided as being preferential, undervalued, and fraudulent under Section 43, 45, and 66 of the Code?
2. Could the Jaiprakash Associates Limited (JAL) Lenders be recognized as financial creditors of the Corporate Debtor Jaypee Infratech Limited (JIL) on the strength of the mortgage created by the Corporate Debtor, as collateral security of the debt of its holding company Jaiprakash Associates Limited (JAL)?

Judgment

The Apex Court has carefully analyzed each provision of Section 43 to see whether the mortgage transactions by Jaypee Infratech Limited (JIL) in favor of the Jaiprakash Associates Limited (JAL) Lenders are preferential and has identified five key requirements that need to be satisfied for a transaction to fall within its ambit.

In the present case, the Apex Court held that the creditor-debtor relationship between the banks and the corporate debtor (i.e. the parties to the transaction in question) will not be decisive of the question of ultimate beneficiary. The Court further held that as Jaypee Infratech Limited (JIL) owed operational debts towards Jaiprakash Associates Limited (JAL), JAL was an operational creditor of Jaypee Infratech Limited (JIL). It was further held that the nature of mortgage created by Jaypee Infratech Limited (JIL) in favor of the Jaiprakash Associates Limited (JAL) Lenders, made Jaiprakash Associates Limited (JAL) the ultimate beneficiary as it was able to raise finance based on such mortgage. Thus, the transactions in issue were made for the advantage of a creditor as the creditor was the ultimate beneficiary despite not being a party to the transaction sought to be set aside.

In light of the facts of the matter, the Court held that corporate debtor Jaypee Infratech Limited (JIL) owed antecedent financial debts as also operational debts and other liabilities towards Jaiprakash Associates Limited (JAL).

The Court held that Jaiprakash Associates Limited (JAL) was obviously put in a benefit position vis-à-vis other creditors because of the receipt of the huge amount of loans by way of facilities and by way of the abovementioned transaction Jaiprakash Associates Limited (JAL) liability towards its creditors has been reduced in so far as the mortgaged properties are concerned. In light of these facts, Jaiprakash Associates Limited (JAL) stands clearly benefited by way of the distribution of assets being made according to manner other than laid down in Section 53, at the cost of exclusion of other creditors and stakeholders of corporate debtor Jaypee Infratech Limited (JIL).

The Supreme Court agreed that the financial affairs or ordinary course of business of the corporate debtor Jaypee Infratech Limited (JIL) cannot be that of providing mortgages to secure loans and facilities obtained by its holding company, that too at the cost of its own financial health and thus the transactions were neither in the financial affairs or ordinary course of business of corporate debtor Jaypee Infratech Limited (JIL) nor did they secure new value in the property acquired by corporate debtor Jaypee Infratech Limited (JIL) and hence are not excluded transactions under Section 43(3).

The Supreme Court thus noted that all the requirements of Section 43 were satisfied in the present case and the transactions were hit by Section 43 and the IRP was correct in issuing directions for release and discharge of the mortgages under Section 44.

The Supreme Court did not elaborate on whether the transactions were also undervalued and fraudulent as they had already been decided as preferential and their avoidance was approved. However, the Supreme Court noted that in the present case the NCLT recorded combined findings on the transactions being preferential, undervalued, and fraudulent without making requisite inquiries to find out whether the transactions were indeed undervalued or fraudulent. The Bench, therefore, remarked that in the future it would be appropriate to deal with each question and issue separately and distinctly as the scope of inquiry to determine whether a transaction is undervalued is entirely different from determining whether it is fraudulent and/or preferential.

The Bench has further laid down a checklist to be followed by a resolution professional in order to identify and avoid preferential transactions under Section 43 of the Code. Thus, a transaction involving security provided by a third party does not automatically fall under the category of "preferential transaction" and these steps are required to be performed by the resolution professional to determine whether such transaction falls within the ambit of Section 43:

1. Organizing all the transactions backward from the date of commencement of insolvency to the preceding two years and identify the person involved and categorize them as related parties and others;
2. Bifurcate the identified transactions into two sub-sets and the transactions involving non-related parties are to be further trimmed to include the transaction of the preceding one year from the date of commencement of insolvency;
3. Examine the sub-sets to find (i) as to whether the transaction is of transfer of property or an interest thereof of the corporate debtor, and (ii) whether the beneficiary involved in the transaction stands in the capacity of creditor or surety or guarantor qua the corporate debtor. This would lead to shortlisting that transaction which seems to be preferential;
4. Scrutinize the transaction to find if the transfer is made on account of an antecedent financial or operational debt or other liability owed by the corporate debtor;
5. Scrutinize whether the transfer in question has the effect of putting such creditor, guarantor or surety in a beneficial position than it would have been in the event of distribution of assets as per Section 53 of the Code; if affirmative the transaction is a preferential transaction entered into in relevant time;
6. The last filtration is to make the transaction pass through clauses (a) and (b) of Section 43(3);
7. After the analysis, the IRP is required to apply to the Adjudicating Authority for necessary transactions that had passed through all the positive tests of sub-section (2) and (4) and also the negative test under sub-section (3).