[By Tushar Krishna]
The author is a student of West Bengal National University of Juridical Sciences.
Introduction
Section 45 of the Insolvency and Bankruptcy Code (‘IBC’) encompasses the expunction of transactions executed at undervalue, including acts of gifting or instances wherein the consideration obtained by the corporate debtor is significantly less than the value rendered by the corporate debtor. Similar provisions also resonate throughout the international landscape, exemplified by the presence of Section 238 in the United Kingdom (‘UK’)’s Insolvency Act of 1986, wherein the annulments of transactions conducted at undervalue are addressed. Likewise, the United States Bankruptcy Code’s Section 548 embraces the avoidance of transfers that may manifest as either overtly fraudulent or covertly deceptive in nature.[1] These provisions are instituted with the express purpose of thwarting the diversion of corporate assets by the corporate debtor’s management, who possess an intricate knowledge of the abysmal financial state of the said debtor and may purposefully engage in such transactions in close proximity to insolvency. In light of the same, Section 45 also provides the Adjudicating Authority, on the application of the liquidator or Resolution Professional, the prerogative to annul the consequences of such transactions, rendering them null and void, thereby depriving any party deriving benefit from the transaction of any associated rights.
Since the nascent nature of the IBC has a limited body of jurisprudence, the dearth of legal precedents pertaining to specific provisions, such as Section 45, is unsurprising. However, in the recent times, a discernible augmentation has been observed in the frequency of instances whereby Section 45 has been employed as a means to invalidate transactions deemed to be undervalued, bearing significant repercussions on the corporate assets.[2] Nevertheless, given that Section 45 is not a kind of provision invoked in every IBC matter, it becomes imperative to bestow due attention upon specific inquiries like the potential inclusion of interest-free loans within its purview. The complexity of this quandary transcends its superficial appearance, primarily owing to the fact that Section 45 predominantly employs a framework centered upon situations where the consideration involved is readily discernible. Consequently, comprehending its applicability vis-à-vis typical transactions like the granting of interest-free loans proves to be an intricate undertaking. In this regard, the present article has been meticulously organized as follows: Initially, it conducts an assessment of the potential classification of Interest-free loans as an undervalued transaction, a matter of utmost pertinence when examined within the purview of section 45. Subsequently, it engages in an intellectually stimulating exploration of the matter, delving into the profound ramifications stemming from the Oator Marketing Judgement. Finally, it culminates in a concise synthesis of the arguments, marked by a concluding remark.
Interest-free loans as undervalued transactions
The inquiry surrounding the inclusion of interest-free loans within the purview of Section 45 manifests as an examination into the potential categorisation of such loans as undervalued transactions. An undervalued transaction materializes when the corporate debtor transfers one or more assets at a significantly less value compared to the consideration disbursed. Precisely defining the phrase “significantly less” proves to be an elusive task, bereft of absolute precision. In the UK, one case elucidates that even a marginal 10% variance in price remains insignificant when grounded in the genuine divergence of opinion,[3] although in a different case, it may be deemed substantially dissimilar. Thus, even when drawing upon the position adopted by the UK, whose provision for the avoidance of undervalued transactions adheres to similar language as Section 45, a measure of ambiguity persists regarding the precise delineation of “significantly less.” However, it is discernible that a heightened threshold is necessitated. Notwithstanding, it is generally explicable that the consideration attached to a transaction assumes substantially less value if it notably falls below its fair value or the consideration furnished by the debtor itself. However, the comparison of values paid or received by the company may not be an easy task in every case, especially cases like interest-free loans, where transactional consideration does not overtly manifest.
In the case of an interest-free loan, the consideration tendered by the corporate debtor encompasses the opportunity cost. Even if the corporate debtor disburses funds at a markedly lower interest rate in relation to its capital’s comprehensive cost, encompassing the opportunity cost, the transaction in question may be appraised as an undervalued transaction. The opportunity cost associated with the interest accrued by the corporate debtor equates to the interest relinquished, thereby constituting the consideration offered by the company. Any detriment experienced by the corporate debtor assumes pivotal significance in the comparative evaluation of the consideration. In this milieu, one may argue that when it comes to interest-free loans, the threshold of “significantly less”, as required under section 45, may be more readily satisfied, as opposed to a scenario involving lending at a reduced rate, which presents a subjective and intricate predicament. This proposition gains particular credence in the context of the recent Insolvency and Bankruptcy Board of India (‘IBBI’) Guidance on avoidance transactions for resolution professionals, wherein it is asked to consider interest-free transactions by the corporate debtor as a “red flag”.[4] Furthermore, it is imperative to note that even if interest-free loans are deemed as undervalued transactions, as per Section 45, their avoidance can only be executed provided that the transaction was not conducted in good faith and did not adhere to the ordinary course of business. These factors can be assessed by observing the involved intention[5]to defraud the creditors using the specific material facts, as highlighted in Anuj Jain v. Axis Bank Limited and Ors.
Implications of Oator Marketing Judgement
In the context at hand, an intriguing avenue for analysis emerges by virtue of the recent pronouncement of the Supreme Court in Oator Marketing Pvt. Ltd. v. SamtexDesinz Pvt. Ltd. In this case, the Court expounded upon the contours of the term ‘Financial Debt’, and held that interest-free loans are unequivocally encompassed within the ambit of Financial Debt. Thus, it confers upon the creditor, who gave the interest-free loans, the capacity to initiate Corporate Insolvency Resolution Process (‘CIRP’) in the capacity of a financial creditor. Prima facie this decision is ostensibly disconnected from the focal point of Section 45; however, a meticulous examination reveals the potential ramifications. If the provision of interest-free loans were to preclude an entity from classifying its loan amount as a financial debt then such an outcome, beyond the mere opportunity cost entailed, would be of substantial disadvantage and would bolster the argument that interest-free loans may be deemed as transactions undervalued within the purview of Section 45. In essence, this scenario would entail the corporate debtor forfeiting the opportunity to secure recognition of the loan amount as a financial debt, thereby inflicting a severe toll upon the corporate debtor’s resources. Indeed, this was the position of law before the Oator Marketing judgment.
Prior to the seminal Orator Marketing ruling, the Tribunal’s stance in Dr. B.V.S. Lakshmi v. Geometrix Laser Solutions Private Limited was the governing law. It necessitated a financial creditor to substantiate the existence of a debt, coupled with any applicable interest, disbursed in consideration for the time value of money. This perspective was further affirmed in the case of Shreyans Realtors Private Limited &Anr. v. Saroj Realtors & Developers Private Limited. In this case, the NCLAT observed that when the corporate debtor explicitly disavowed any obligation towards interest and did not provide any undertaking to repay the loan with interest, the appellants could not lay claim to a ‘financial debt’ vis-à-vis the corporate debtor, thereby precluding their classification as ‘financial creditors’. Now, with the change in position of law with Oator Marketing judgment, a paramount inquiry arises, demanding contemplation on whether this change would impact the conclusion pertaining to the inclusion of interest-free loans within the scope of Section 45, as one may argue that interest-free loans now garner comparable recognition to that of non-interest free loans, in the realm of financial debt. However, the answer would be negative, as we have already discussed the undeniable fact that an interest-free loan, ultimately, poses a detriment to the corporate debtor, manifested in the forfeiture of opportunity cost and time value. Even if interest-free loans are now acknowledged as financial debt, this does not diminish the fact that they have the potential to impinge upon one of the cardinal objectives of the IBC, namely, the maximisation of asset value and safeguarding the interests of all the stakeholders, including the creditors. Even in the Orator Marketing case, the Court has underscored the significance of focusing on the overarching goals of the IBC itself. It again puts us with the same conclusion that interest-free loans may indeed fall within the purview of undervalued transactions as stipulated in Section 45, unless it can be substantiated that such transactions were executed in the ordinary course of business and in good faith.
Concluding Remark
From the above discourse, it becomes readily apparent that irrespective of the recent judicial acknowledgement of interest-free loans as a financial debt, interest-free loans, owing to their inherent detriments such as the forfeiture of opportunity cost and the erosion of temporal value, ought to incline towards the purview of Section 45. From a larger perspective, it is important to understand that interest-free loans may effectively serve as a conduit exploited by the management of the corporate debtor to divert the corporate assets prior to the commencement of insolvency proceedings, which hampers the interests of other stakeholders. Therefore, to safeguard the very essence of the IBC, which strives to ensure the protection of all stakeholders, it becomes imperative to adopt a liberal interpretation of Section 45 encompassing interest-free loans therein, while duly considering auxiliary factors such as the ordinary course of business and the underlying intent.
[1]See also, the Germany Insolvency Act, Section 134.
[2] See IDBI Bank v. Jaypee Infratech Ltd, CA No. 26/2018 in Company Petition No. (1B)77/ALD/2017; Phoenix Arc v. Spade Financial Services Limited, AIR 2021 SC 77; Jaypee Infratech Ltd. Interim Resolution Professional v. Axis Bank Ltd., (2020) 8 SCC 401; Jaypee Kensington Boulevard Apartments Welfare Assn. v. NBCC (India) Ltd., (2022) 1 SCC 401.
[3]SeeRe Martini Ltd. (2004) BCC 172.
[4] It becomes more important if we consider that it is RPs who file application under Section 45 for the avoidance of undervalued transactions.
[5] It may be noted that intent is not involved in section 43 preferential transactions.