Failure To Assess Vulnerability Of Transactions To Clawback - The PUFE Risk

This is the No.1 diligence failure in lending, M&A, and resolution. You do transaction with company - loan repayment, asset sale, security release - and 6 months later company goes into IBC. Resolution Professional files avoidance application under Sections 43-50, 66 and transaction is clawed back. You have to return money / asset with interest.

Failure to assess vulnerability at time of transaction = You lose both money and security, and may face fraudulent transaction prosecution under Section 66.

1. The Legal Framework - PUFE Transactions

IBC Chapter III - Sections 43 to 51, and Chapter VI - Section 66 - provides 4 types of avoidable transactions - PUFE:

Section 43 Ingredients - Supreme Court in Anuj Jain case laid down:

1. Transfer of property or interest
2. To or for benefit of creditor / surety / guarantor
3. For antecedent financial / operational debt
4. Such transfer puts creditor in beneficial position than in Section 53 liquidation waterfall
5. Transfer was within look-back period and company was in financial stress

If all 5 satisfied, NCLT must avoid it and order return.

2. How Failure To Assess Happens

Scenario 1: Bank takes additional security 3 months before CIRP
Company already defaulted, paying others late. Bank insists on additional mortgage for its existing loan. Other creditors file CIRP 6 months later. RP files Sec 43 application - This is preferential because bank got security for past debt, putting it in better position than other unsecured creditors.

Scenario 2: Asset sale at 40% discount to sister concern 1 year before CIRP
Company sells factory worth Rs.20 crores to related party for Rs.8 crores to generate cash. This is undervalued under Sec 45 and also fraudulent under Sec 49 if intent to defraud.

Scenario 3: Repayment to promoter 2 months before CIRP
Company repays unsecured promoter loan of Rs.5 crores while not paying bank interest. This is preferential to related party.

Failure: At time of transaction, lawyer / credit officer did not check:

• Is company balance sheet insolvent? (liabilities > assets)
• Is there default to other creditors?
• Is transaction within 1-2 year vulnerable window?
• Is counterparty related party?
• Is consideration at fair market value with valuation report?

3. Landmark Case Laws - Must Know

Case 1: Anuj Jain, IRP for Jaypee Infratech Ltd vs Axis Bank Ltd & Others - Supreme Court, 2020 (2020) 8 SCC 401 - Foundation of PUFE Law

Facts: Jaypee Infratech gave mortgage of 858 acres of land worth Rs.5,000+ crores to Axis Bank to secure debt of its holding company Jaiprakash Associates Ltd (JAL). Transaction done when Jaypee Infratech itself was in financial stress.

IRP filed Sec 43 application for preferential transaction.

Supreme Court held:

1. Mortgage for debt of related party is preferential if it is for benefit of related party and puts bank in better position than other creditors
2. Look-back period 2 years for related party - Transaction was within period
3. Once preferential, NCLT must avoid and release security
4. Clarified essential ingredients of Sec 43 as above

Ratio for your failure: If you take security from subsidiary for parent's debt without assessing group insolvency, your security will be clawed back. This is most cited case - Axis Bank lost security of 858 acres.

Case 2: Piramal Capital and Housing Finance Ltd vs 63 Moons Technologies Ltd - Supreme Court, 01.04.2025 - CIVIL APPEAL NOS. 1632-1634 OF 2022 - 2025 INSC 421 - Latest 3-Fold Clarity

This is most recent landmark distinguishing avoidance vs fraudulent trading.

Supreme Court clarified:

1. Applications under Sections 43,45,50 are "Avoidance Applications" - for setting aside specific transactions - preferential, undervalued, extortionate. Recoveries go to CoC / creditors.
2. Applications under Section 66 for Fraudulent and Wrongful Trading are NOT avoidance applications. They deal with overall conduct of business with intent to defraud creditors. Cannot be termed avoidance.
3. NCLT has power to pass orders under Sec 44,48,49,50 and Sec 66 separately. Recoveries under Sec 43,45,50 go to CoC, while recoveries under Sec 66 can be appropriated as per commercial wisdom of CoC approved in resolution plan.
4. NCLAT ought not to have tinkered with clause in Piramal's resolution plan retaining recoveries from fraudulent transactions.

Impact on vulnerability assessment: If your transaction is fraudulent trading (e.g., you knowingly helped promoter siphon money), RP will file Sec 66, not Sec 43. Sec 66 has no look-back limit and can have personal liability of directors plus exemplary damages.

NCLAT had said Sec 66 recoveries cannot be retained by successful resolution applicant, must go to creditors. Supreme Court reversed and said CoC commercial wisdom prevails - Piramal could retain recoveries if resolution plan says so.

Case 3: Phoenix Arc Pvt Ltd vs Spade Financial Services Ltd - Supreme Court - Justice D.Y. Chandrachud - Sham Transactions Not Financial Debt

Court held: Collusive or sham transactions with corporate debtor will not amount to "Financial Debt" under IBC. Such avoidable transactions include preferential under Sec 43, undervalued under Sec 45(2), transactions defrauding creditors under Sec 49, and extortionate under Sec 50.

Lesson: If you do sham transaction to show debt and later try to file IBC as financial creditor, NCLT will reject you as collusive.

Case 4: Tata Steel BSL Ltd vs Venus Recruiters Pvt Ltd - Delhi High Court - Survival of Avoidance Application After CIRP

Division Bench held: Adjudication of avoidance application under IBC can survive CIRP of corporate debtor. Even after resolution plan approved, RP/liquidator can continue pursue PUFE applications.

Failure implication: You think transaction is safe because CIRP ended and company resolved. Wrong. RP can still pursue clawback for 2 years after resolution.

Case 5: NCLT Delhi - Ritu Tandon vs Rain Automotive - 2024 - Third Party Cannot Pursue PUFE

NCLT New Delhi held NCLT has no jurisdiction to adjudicate avoidance application pursued by third party / assignee to whom debt assigned under Sec 43,45,50,66. Only IRP/RP/Liquidator can file.

Implication: If you buy debt from bank after PUFE transaction, you cannot file avoidance yourself. Must ensure RP has filed before assignment.

Case 6: NCLAT - 2024 ibclaw.in 775 - PUFE Must Be Pursued by IRP/RP

Confirmed: PUFE applications shall be pursued either by IRP or RP or Liquidator. If RP fails to file, CoC can direct him. Failure to file is failure of RP duty under Sec 25(2)(j).

4. How to Assess Vulnerability - Checklist Before Any Transaction

Before taking repayment / security / asset purchase from distressed company, do:

1. Insolvency Test: Check last 2 years balance sheet, CIBIL, default list. Is company paying others on time? If liabilities > assets or default > 30 days, you are in vulnerable zone.
2. Related Party Test: Is counterparty related under Sec 5(24) IBC? If yes, look-back 2 years, not 1 year.
3. Antecedent Debt Test: Are you receiving something for past debt, not fresh value? If yes, Sec 43 risk high. Take only for fresh disbursement with contemporaneous consideration.
4. Valuation Test: Get registered valuer report under Companies Act 2013. If purchase price < 80% of FMV, Sec 45 risk. Keep report on file.
5. Market Check: Search NCLT, NCLAT, MCA for other creditor suits. If multiple suits, company likely insolvent.
6. Documentation: Record commercial rationale - Why transaction at this price, why now, board resolution showing independent business purpose, not to prefer one creditor.

Red Flags = Do Not Transact Without Legal Opinion:

• Repayment of unsecured promoter loan while secured debt overdue
• Creation of exclusive security for one bank when consortium exists
• Sale of sole revenue-generating asset to sister concern at discount
• Interest rate > 36% p.a. - Sec 50 extortionate credit
• Round-tripping - Money goes out and comes back same day

5. Consequences & Defence

If RP files Sec 43 application against you:

• NCLT will order you to return security / money with interest
• You will be downgraded to unsecured creditor for that amount
• If Sec 66 fraud proven, directors personal liability, and may face SFIO prosecution
• Under Sec 44, NCLT can also require you to release any guarantee given for preferential transaction

Defence:

• Show transaction in ordinary course of business - Sec 43(3)(a) exception - E.g., payment of salary, utility bills, or inventory purchase at market price
• Show new value given - You gave fresh money at same time as security, not for past debt
• Show solvency - Company was solvent at time with solvency certificate
• For undervalued - Show valuation report proving price was FMV

Best Practice Clause in Loan Agreement:

"Borrower represents it is solvent, no default to any creditor exceeding Rs.1 crore, no winding-up petition pending, transaction is for fair market value and in ordinary course. Borrower shall indemnify lender if transaction later held as preferential/undervalued and lender has to return. Borrower to provide solvency certificate from statutory auditor dated within 15 days of transaction."