Friday, May 5, 2017

Antecedent Transactions: An Anomaly in the Insolvency and Bankruptcy Code, 2016

[The following post is contributed by Rahul Sibal, 3rd Year, and Deep Shah, 2nd Year, students of NALSAR, Hyderabad.  They can be contacted at sibbalrahul@gmail.com and shahdeep998@gmail.com.

In this post, they analyze certain anomalies with respect to provisions concerning antecedent transactions under the recently enacted Insolvency and Bankruptcy Code, 2016.]

The Insolvency and Bankruptcy Code, 2016 (the ‘IBC’) has been enacted with the intent to streamline the insolvency process through the consolidation of fragmented (and outdated) legislation that previously governed insolvency proceedings in India. It has been partially brought into force through several notifications, as detailed here and here. Interestingly, the IBC has been significantly influenced by the Insolvency Act, 1986 (the ‘UK Act’). However, the correlation between the two statutes is not limited to mere conceptual influence. In fact, with respect to some provisions, the drafters of the IBC have employed a ‘drag and drop’ approach by adopting specific provisions of the UK Act without any substantive modifications. While there do exist minor alterations, such changes are predominantly syntactic. Even so, alterations in the language or syntax can unintentionally result in significant changes in the meaning of the provision that is sought to be adopted.  

Section 164(6)(b) of the IBC is illustrative of the proposition that slight changes or errors in syntax and structure at the time of incorporating foreign provisions into domestic statutes could result in significant deviations from the original legislative intent behind the provision. This statutory provision is concerned with the regulation of ‘undervalued transactions’ undertaken by individuals prior to the onset of bankruptcy.

As is evident from the interim report of the Bankruptcy Law Reform Committee (BLRC), the drafters of the IBC intended to regulate undervalued transactions on the lines of corresponding provisions of the UK Act.[1] Curiously enough, a minor alteration in structure has translated into a scenario where section 164(6)(b) suggests the very opposite of the corresponding provision in the UK Act. However, it is necessary to first understand the concept of ‘undervalued transactions’ before this error is expounded upon.

The division of assets in insolvency proceedings is governed by the principle of pari passu. Simply put, this principle requires that every creditor of the same class must inter se receive a proportionate share from the bankrupt’s property in return for the debt owed. However, before an individual is deemed to be bankrupt, he might enter into a transaction (‘the antecedent transaction’), in which the consideration received by the individual is ‘significantly’[2] lesser than the consideration the transaction commands. Given that such transactions could result in the preferential payment (or discharge) of debt in favour of the counterparty, in contrast to a pro rata satisfaction of claims, such arrangements would be in derogation of the pari passu principle.

The unfairness, inherent in such arrangements, creates the need to regulate and avoid such transactions. Proceeding on this understanding, the error in Section 164(6)(b) is apparent. The relevant sub-clauses of the UK Act and the IBC have been reproduced below:

Section 339 of the UK Act
Section 164 of the IBC
(3) For the purposes of this section and sections 341 and 342, an individual enters into a transaction with a person at an undervalue if-
…………………………………….
(c) he makes a gift to that person or he otherwise enters into a transaction with that person on terms that provide for him to receive no consideration,
(6) For the purposes of this section, a bankrupt enters into an undervalued transaction with any person if--
(a) he makes a gift to that person;
(b) no consideration has been received by that person from the bankrupt;

According to section 339 of the UK Act, should a bankrupt ‘X’ enter into a transaction with an individual ‘Y’, which involves the sale of property by X to Y without the receipt of any consideration by X in return, then X would be held to have entered into a  ‘transaction at undervalue.’ However, clause (b) of sub-section (6) of section 164 of the IBC states that a bankrupt would be deemed to have entered into an undervalued transaction with any person if ‘no consideration has been received by that person from the bankrupt.’

Therefore, in India, as per section 164(6)(b) of the IBC, an undervalued transaction would have been entered into if the above situation were reversed, that is, if there were a sale of property by Y to X without the payment of any consideration by X.  

An analysis of other clauses under section 164(6) reveals that such a result was not intended. For instance, sub-clause (a) holds that a bankrupt would have entered into an undervalued transaction with any person if ‘he makes a gift to that person.’ Admittedly, this clause suggests that a transaction is ‘undervalued’ if it involves a loss to the bankrupt, and not to the individual transacting with the bankrupt. Sub-clause (d) further reinforces this proposition since it defines an undervalued transaction as one in which the consideration for the bankrupt is of a value significantly lower than the value in money or money’s worth of the consideration provided by the bankrupt. Both these provisions indicate that the result under clause (b) is not reflective of the legislative intent, but is an outcome of an isolated error.

The error seems to have stemmed from the fact that clause (c) of Section 339(3) of the UK Act was incorporated by the drafters of the IBC in the form of two different clauses. It is at the time of splitting up the clause that this error arose. For instance, an individual is held to have entered into an undervalued transaction under clause (c) of Section 339 of the UK Act if:

“(c) he makes a gift to that person or he otherwise enters into a transaction with that person on terms that provide for him to receive no consideration,”

For reasons not known, the drafters split clause (c) into two distinct clauses that have been reproduced below:

“(a) he makes a gift to that person;

(b) no consideration has been received by that person from the bankrupt;”

Therefore, the reversal in the effect of the clause vis-à-vis the UK Act, as illustrated above, is a consequence of the change in the use of pronouns on account of the splitting of clause (c). Interestingly, this error can be located in the Draft Insolvency and Bankruptcy Bill, 2015 as well as in the Joint Committee Report on the Insolvency and Bankruptcy Code, 2015. It appears that the error was left unquestioned by the Joint Committee on account of the presumption of accuracy in favour of the UK Act.

Strikingly, the textual connotation would not only be divergent from the purpose of section 164, but antithetical to it, since the rationale behind the incorporation of provisions pertaining to antecedent transactions is to prevent the shrinking of the asset pool available for distribution, so as to enable all creditors to be paid back to the greatest extent possible. However, section 164(6)(b), as it exists now, disallows transactions which would have had the effect of enlarging the asset pool. 

Therefore, what has been observed is a case of a drafting error which has unintentionally altered and, in fact, reversed the ambit of the provision. This particular provision has not been brought into effect as yet, and there remains a possibility that the Government could attempt to rectify the error before this provision is brought into force.

- Rahul Sibal & Deep Shah




[1] While the interim report was limited to corporate insolvency, its recommendations are indicative of the intent to adopt the provisions of the UK Act into the Insolvency Code. See pp. 27, 98 and 99 of the Interim Report.

[2] There is no clear standard or test which emerges from the existing case law to determine what constitutes ‘significantly’ lesser value. See E Bailey and H Groves, Corporate Insolvency: Law and Practice (LexisNexis Butterworths 2007) 940–42.

2 comments:

Anonymous said...

Indeed an insightful article.

Rahul Sibal said...

Thank You.