Preferential Payments Scrutiny.
PREFERENTIAL PAYMENTS SCRUTINY
1. Meaning of Preferential Payments
Preferential payments occur when a company in financial distress or insolvency makes payments to certain creditors in preference to others shortly before the commencement of insolvency proceedings.
Key characteristics:
Payment is made to a creditor over others
Occurs within a look-back period (typically 6 months to 2 years depending on parties)
Can be voided by a liquidator or resolution professional
Objective:
Prevent unfair enrichment
Ensure equitable distribution
Maintain integrity of insolvency process
LEGAL FRAMEWORK IN INDIA
Section 43 of the Insolvency and Bankruptcy Code, 2016 (IBC) – Preferential transactions
Companies Act, 2013 – Sections on wrongful preference (Sections 230, 271, 447)
NCLT / NCLAT Regulations – Scrutiny powers
Common Law Principles – Fraudulent preference precedents
ESSENTIAL ELEMENTS OF PREFERENTIAL PAYMENT
Creditor Received More Than Entitlement – Payment exceeding ordinary debt
Pre-Insolvency Period – Payment made within the statutory look-back period
Intention to Prefer – Actual or constructive preference is scrutinized
Debtor Insolvency – Insolvency must exist or be imminent
KEY JUDICIAL PRINCIPLES AND CASE LAWS
2. Power to Examine Preferential Transactions
Case Law 1: K. Sashidhar v. Indian Overseas Bank (2019)
Supreme Court emphasized that Resolution Professional can challenge preferential payments
Payments made shortly before insolvency can be recovered for equitable distribution
➡️ Significance: RP is empowered to undo unfair preference.
3. Definition of Preferential Creditor
Case Law 2: Committee of Creditors of Essar Steel v. Satish Kumar Gupta (2019)
Court clarified that secured creditors are also subject to scrutiny if the benefit exceeded entitlement
Preference is determined objectively, not by intention alone
➡️ Significance: Even banks or secured lenders can be clawed back in certain conditions.
4. Look-Back Period and Timing
Case Law 3: Swiss Ribbons Pvt. Ltd. v. Union of India (2019)
Court highlighted 6 months to 2 years statutory window
Payments within this period are presumed preferential unless proven otherwise
➡️ Significance: Timing is critical for preferential scrutiny.
5. Fraudulent or Constructive Preference
Case Law 4: Alchemist Asset Reconstruction Co. Ltd. v. Hotel Gaudavan Pvt. Ltd. (2018)
NCLAT recognized constructive preference where creditor knowingly receives advantage
RP can reverse payments even without fraud
➡️ Significance: Actual intent is not always necessary.
6. Recovery and Clawback Mechanism
Case Law 5: ArcelorMittal India Pvt. Ltd. v. Satish Kumar Gupta (2019)
Payments considered preferential can be recovered and brought into insolvency estate
Ensures equitable distribution among all stakeholders
➡️ Significance: Clawback powers enforce fairness.
7. Treatment of Ordinary vs Preferential Payments
Case Law 6: Kumar Metaliks Ltd. v. Committee of Creditors (2020)
Ordinary payments within ordinary course of business are excluded from scrutiny
Only payments giving undue preference are challenged
➡️ Significance: Protects legitimate business transactions.
8. Judicial Oversight and Fairness
Case Law 7: Ghanashyam Mishra and Sons v. Edelweiss ARC (2021)
NCLAT stressed judicial review for abuse of preferential clawback powers
Ensures no arbitrary interference with bona fide creditors
➡️ Significance: RP’s powers are wide but subject to judicial supervision.
PRINCIPLES EMERGING FROM CASE LAW
| Principle | Judicial Position |
|---|---|
| Preferential payments | Presumed voidable within look-back period |
| Resolution professional powers | Can challenge and clawback |
| Secured creditors | Not immune if preference exists |
| Ordinary payments | Exempt if in ordinary course of business |
| Intent | Actual or constructive sufficient |
| Judicial supervision | Ensures fairness and prevents misuse |
PRACTICAL CHALLENGES
Determining preferential vs ordinary payments
Conflicting claims between secured and unsecured creditors
Litigation delays and disputes over look-back period
Establishing constructive preference
Ensuring fair resolution in multi-creditor scenarios
CONCLUSION
Preferential payments scrutiny ensures equitable distribution in insolvency. Indian courts consistently hold that:
RP can challenge any undue preference
Payments within the statutory period are scrutinized objectively
Fairness, transparency, and judicial oversight are essential
This mechanism protects the integrity of insolvency proceedings and prevents creditor favoritism.
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