2026 (3) TMI 1538 - AT - IBC

Preferential transfer under insolvency law can arise from accounting adjustments, even without cash movement, when related parties are favoured.

An accounting adjustment that extinguishes a corporate debtor's receivable in favour of a related party can constitute a preferential transfer under ... Related party transaction - Preferential transaction - square-off and offsetting entries - violation of Section 43 of the Code - Look-back period - appointment of Transaction Auditor bad in law as it surpassed the look back period - 'Related party' under Section 5(24) - transaction bypassed banking channels, lacked corporate authorisation - absence of physical movement of funds - Ordinary course of business - proof beyond a reasonable doubt - director and key managerial personnel of the corporate debtor. Related party transaction - Look-back period - HELD THAT:- The Appellate Tribunal found that the first appellant was the director and key managerial person of the corporate debtor, exercised control over Wholesale Hub LLP, and was also the sole proprietor of the concern in whose favour the adjustment was made. On that basis, Wholesale Hub LLP and the appellant's proprietorship were treated as related parties. On the material in the ledger accounts, books of account and the forensic audit, the Tribunal found that the impugned offsetting entry was effected on 30.06.2019. Since the insolvency commencement date was 01.02.2021, the transaction fell within two years preceding that date and was therefore within the relevant period for related party preferences. The plea that the transaction was outside the permissible look-back period was accordingly rejected. [Paras 50, 55, 56, 57] The objection founded on limitation and the look-back period failed, and the transaction was treated as one with related parties within Section 43. Preferential transaction - Transfer of property through accounting entries - Beneficial position in liquidation - HELD THAT: - The Appellate Tribunal held that the receivable due to the corporate debtor from Wholesale Hub LLP was a valuable property interest. Its diversion and adjustment through book entries in favour of the appellant's proprietorship extinguished the corporate debtor's enforceable right to recover that amount. The Tribunal expressly held that a transfer under Section 43 is not confined to physical movement of funds; extinguishment, relinquishment or reduction of a receivable through accounting entries also constitutes transfer of property or an interest therein. It further found that the adjustment was in respect of antecedent liability and had the effect of satisfying the appellant's dues, reducing the corporate debtor's asset pool, and placing the appellant in a more beneficial position than other creditors in the event of distribution. On that reasoning, both limbs of Section 43(2) stood satisfied. [Paras 59, 60, 61, 62, 66] The square-off entry was rightly treated as a preferential transaction liable to be avoided. Ordinary course of business - Selective adjustment of receivables - HELD THAT: - The Appellate Tribunal rejected the appellants' reliance on ordinary course of business. It found that the transaction was between related parties under common control, bypassed the corporate debtor's banking channels, lacked corporate authorisation, and resulted in extinguishment of recoverable receivables. The record also showed that, while several creditors remained unpaid, the appellant's dues alone stood settled by the impugned set-off. Such selective adjustment, in the presence of outstanding creditor claims, was held not to be routine business dealing but a transaction conferring an undue advantage on the appellant. [Paras 63, 64, 65] The exclusion for transactions in the ordinary course of business was held inapplicable. Final Conclusion: The Appellate Tribunal upheld the finding that the impugned square-off of receivables in favour of the appellant was a related party preferential transaction within the statutory look-back period and not one in the ordinary course of business. Finding no infirmity in the impugned order on that issue, the appeal was dismissed. Issues: (i) Whether the impugned square-off and offsetting entries constituted a preferential transaction under Section 43 of the Insolvency and Bankruptcy Code, 2016. (ii) Whether the transaction was undertaken within the relevant look-back period and involved related parties. (iii) Whether the absence of physical movement of funds and the plea of ordinary course of business defeated the avoidance action.Issue (i): Whether the impugned square-off and offsetting entries constituted a preferential transaction under Section 43 of the Insolvency and Bankruptcy Code, 2016.Analysis: A transfer for the purposes of Section 43 is not confined to cash movement. Extinguishment or reduction of an enforceable receivable through accounting entries can amount to a transfer of property or an interest therein. The receivable of the corporate debtor was adjusted in a manner that satisfied the dues of the appellant or its controlled entity and diminished the asset pool available for distribution among creditors.Conclusion: The transaction amounted to a preferential transaction.Issue (ii): Whether the transaction was undertaken within the relevant look-back period and involved related parties.Analysis: The appellant was found to be the director and key managerial personnel of the corporate debtor, while also controlling the recipient entity and his proprietorship, bringing the entities within the related-party framework. The square-off entry was recorded on 30.06.2019, while insolvency commenced on 01.02.2021. The transaction thus fell within two years preceding the insolvency commencement date and within the relevant time for related-party transactions.Conclusion: The transaction was within the relevant period and involved related parties.Issue (iii): Whether the absence of physical movement of funds and the plea of ordinary course of business defeated the avoidance action.Analysis: The transaction bypassed banking channels, lacked corporate authorisation, and was made in favour of related parties under common control. Such selective adjustment, in the backdrop of other unpaid creditors, did not constitute a routine transaction in the ordinary course of business. The absence of physical transfer of funds did not alter the legal character of the transaction.Conclusion: The plea of ordinary course of business failed, and the absence of cash movement did not save the transaction.Final Conclusion: The avoidance order was sustained, and the appeal was rejected on merits with no interference in the finding that the impugned adjustment was a preferential transaction liable to be restored to the corporate debtor's estate.Ratio Decidendi: For the purpose of Section 43 of the Insolvency and Bankruptcy Code, 2016, an accounting adjustment that extinguishes a corporate debtor's receivable in favour of a related party within the relevant period can constitute a preferential transfer even without physical movement of funds, unless it is shown to be in the ordinary course of business.