PUFE Transaction Under IBC Vis-À-Vis Real Estate Sector

Since the implementation of the Insolvency and Bankruptcy Code, 2016, (“Code”), the Real Estate Sector has been in turmoil, with many transactions entered into by the Builder(s) undermining and jeopardising the legitimate interests of innocuous creditors. The Code encompasses a collection of transactions that the Interim Resolution Professional (“IRP”) and the liquidator appointed by the National Company Law Tribunal (“NCLT”) for companies in insolvency or liquidation should avoid, as stated below. Preference, Undervalued, Fraudulent, and Extortionate Transactions (“PUFE Transactions”) is how the group of transactions is known. Each of the aforementioned has been examined in relation to the Indian real estate sector in order to advance the conceptual nature.

Understanding PUFE Transactions

 

Preferential Transactions

The factors that may lead to transactions being classified as preferential in character are discussed in Section 43 of the Code. Thus, if specific criteria exist in a set of transactions conducted by the corporate debtor that may be preferential in character, they can only be avoided if the IRP or liquidator files an application with the NCLT.

When a court determines that a transaction was not carried out in the ordinary course of business to create a new value in the corporate debtor’s interest, but instead acted to give preferential advantage to a related party or other parties, the transaction is to be avoided under Section 44 of the Code. Its main goal was to reverse the consequences of preferential transactions by requiring the person who received the preference to refund any profit gained as a result of the preference.

 

Undervalued Transactions

An undervalued transaction occurs when a corporate debtor has the malafide intention of causing a wrongful gain to a linked party or selling assets for a cheap price in a short period of time to boost cash liquidity.

In addition, the time frame for challenging an undervalued transaction has been classified according to whether the party is linked or unrelated. As a result, an undervalued transaction with a ‘related party’ might be called into question two years prior to the start of insolvency proceedings, whilst an undervalued transaction with a ‘unrelated party’ could be called into question one year prior to the start of bankruptcy proceedings.

If the NCLT determines that the transaction was undervalued and that the Resolution Professional (“RP”) or liquidator failed to report it despite having sufficient information or opportunity, the NCLT can order the position to be restored to its pre-transaction state and order the insolvency board to initiate proceedings against the liquidator or RP.

 

Fraudulent Transactions

The Code’s scope and ambit for identifying fraudulent transactions are rather broad in order to protect creditors’ legitimate rights against the corporate debtor. The phrasing used in Section 66(1) of the Code, which deals with deceptive dealing, demonstrates the same. As a result, if the corporate debtor conducted business with the intent to defraud creditors or for any other fraudulent purpose, the NCLT can issue an order directing any individual who was knowingly a party to the corporate debtor’s business conduct to make such contributions to the corporate debtor’s assets as the NCLT deems appropriate during the insolvency process.

While Section 66(2) of the Code covers wrongful trading (i.e., conduct that is not fraudulent but falls short of the standards governing directors’ duty to behave correctly in the case of insolvency), the NLCT has the authority to impose a pecuniary penalty on the director or partner.

 

Extortionate Transactions

Extortionate transactions are covered under Section 50 of the Code, which requires the corporate debtor to make exorbitant payments to any of its creditors in the two years preceding the bankruptcy beginning date. An NCLT order may be used to prevent such transactions. If a person’s debt is in line with the law, this rule does not apply.

The two-year period before the start of bankruptcy is crucial for establishing whether a transaction is excessive.

As a result, before engaging in any transaction, contractual parties and creditors must confirm that they have evaluated the company’s most recent financial status, particularly those involving the transfer of assets or value from such a business, to identify any financial crisis indicators.

 

Analysis

Troubled businesses must be prohibited from engaging in activities that may block creditor recovery if insolvency proceedings were to be commenced. In India, where promoter groups typically control enterprises, such measures are essential. Through opaque arrangements, promoter groups may seek to move income from assets to other group companies for their own benefit. As a result, the NCLT has the jurisdiction under the Code to reverse any such transaction in order to safeguard creditors’ and other stakeholders’ interests.

The case of IDBI Bank Ltd. v. Jaypee Infratech Ltd[1]. (“IDBI”), which was confirmed by the Supreme Court in Jaypee Infratech Ltd. Interim Resolution Professional v. Axis Bank Ltd.[2], is an important precedent for PUFE Transactions.

M/s Jaiprakash Associates (“JAL”) established a special purpose firm, M/s Jaypee Infratech Ltd. (“JIL”), to manage the project design, engineering, development, and construction. JAL controlled 70 percent of JIL’s equity. Significantly, JIL encountered financial difficulties and failed to satisfy contractual deadlines for project completion and debt repayment. As a result, JIL’s account was designated non-performing by the Life Insurance Corporation (“LIC”). Since JIL’s account was deemed non-performing, its financial creditors, including IDBI, filed an application with the NCLT’s Allahabad Bench under Section 7 of the Code, which was granted, and the NCLT appointed an IRP. The IRP filed an application with the NCLT after reviewing the transactions, requesting that they be declared as PUFE Transactions.

According to the NCLT, JIL failed to strive diligently to decrease the creditors’ losses and mortgaged the land without JAL’s counter-guarantee since it completed the series of transactions while in financial distress. JIL had also failed to acquire the essential approvals for the challenged acquisition from the JLF lenders as well as the shareholders. As a result, the NCLT determined that the contested transactions occurred during the relevant period and that they were preferential transactions under Section 43 of the Code.

 

Conclusion

PUFE transactions in the real estate sector have become a threat, and the changes have proven unsuccessful in facilitating the filing of a lawsuit against infrastructure and real estate behemoths. The real estate industry in India is one of the few to have risen at an exponential rate during the previous two decades. It has drawn significant investments from many who have put their life savings into realising their ambitions of buying a home. The most sought-after investment channel, on the other hand, has lost favour owing to stagnation.

On the other hand, a careful examination of the modifications reveals that they are helpful to homebuyers. The amendment to the Code is favourable to buyers who are facing difficulties due to incomplete real estate developments. Homebuyers are affected by project delays since they invest a considerable portion of their cash in a down payment and an EMI on the loan while continuing to pay rent in their current location. This situation has now altered as a result of the recent Code modification.

References:

[1] Company Petition NO.(IB)77/ALD/2017

[2]  Civil Appeal NOS. 8512-8527 OF 2019

Photo by: Tierra Mallorca on Unsplash

PUFE transactions in the real estate sector have become a threat, and the changes have proven unsuccessful in facilitating the filing of a lawsuit against infrastructure and real estate behemoths. The real estate industry in India is one of the few to have risen at an exponential rate during the previous two decades. It has drawn significant investments from many who have put their life savings into realising their ambitions of buying a home. The most sought-after investment channel, on the other hand, has lost favour owing to stagnation.

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