Extinguishment Of Receivables Through Accounting Entries Can Amount To Preferential Transaction Under IBC: NCLAT

The National Company Law Appellate Tribunal (NCLAT) at Delhi on Wednesday held that extinguishment of receivables through accounting entries can amount to a transfer of property under the Insolvency and Bankruptcy Code (IBC), and where such adjustments benefit related parties and reduce the corporate debtor's asset pool, the transaction may be treated as preferential under Section 43 of the Code.

The bench of Judicial Member Justice N. Seshasayee and Technical Members Arun Baroka and Indevar Pandey said that a transfer under Section 43 is not confined to the physical movement of funds.

“A transfer under Section 43 is not confined to the physical movement of funds. The extinguishment, relinquishment, or reduction of an enforceable receivable through accounting entries itself amounts to a transfer of property or an interest therein within the meaning of Section 43(2)(a)."

The tribunal made the observation while dismissing an appeal filed by Atul Babulal Prajapati and Pinal Prajapati, promoters of WSH Pvt. Ltd., against an order of the Ahmedabad bench of the National Company Law Tribunal (NCLT) which had directed the appellants along with their firm to pay Rs 2,00,50,000 after holding that the offsetting transaction was preferential.

The resolution professional found that receivables due to the corporate debtor from Wholesale Hub LLP were squared off through accounting entries against amounts payable by the corporate debtor to the appellants' proprietary concern, without routing the funds through the company's bank account. The Adjudicating Authority held that the adjustment amounted to a preferential transaction.

Before the appellate tribunal, the appellants argued that the entry was only an accounting adjustment, that no property was transferred, and that the transaction was in the ordinary course of business.

Rejecting the contention, the NCLAT held that the transaction fell within the two-year look-back period applicable to related-party transactions and could not be treated as a routine business transaction.

"Such selective adjustment, undertaken in the backdrop of outstanding creditor claims, does not reflect a routine or ordinary business transaction and had the effect of placing the Appellant in a more beneficial position in comparison to other creditors, thereby attracting the provisions of Section 43 of the Code. Furthermore, the diversion was carried out without authority, purely for the Appellant's benefit and to the detriment of the creditors and stakeholders of the Corporate Debtor. Such conduct also attracts Sections 66(1) and 66(2) of the Code. The forensic audit conclusively establishes that the Appellant orchestrated and benefited from the diversion.”

The appellate tribunal found no infirmity in the NCLT order and dismissed the appeal.