Decoding the Doctrine of Antecedent Debt : A Condition to Preference – Pathik Choudhury, Advocate

Decoding the Doctrine of Antecedent Debt : A Condition to Preference

Pathik Choudhury, Advocate

The term “Preferential Transaction” can be defined as an act of an insolvent debtor who, in distributing his property or in assigning it for the benefit of a creditor to the exclusion of rest of the creditors, pays or secures to pay such creditor the full amount of the claim or a larger amount than it would be entitled to receive on a pro rata distribution[1].

The Black’s Law Dictionary defines the term “Preference” as “the favouring of one person over one thing.” Therefore, in the literal sense, Preferential Transaction takes place where a debtor pays a creditor in preference of other creditors, just before going into insolvency.

Section 43 of the Insolvency and Bankruptcy Code, 2016 (IBC) defines a transaction as a “preferential transaction” if the transaction is in relation to transfer of the property or interest of the Corporate Debtor for the benefit of a creditor, surety or guarantor “in relation to an antecedent debt” and if the transaction has the effect of putting such creditor, surety or guarantor in a beneficial position in the distribution of assets as prescribed under Section 53 of the IBC. Further, the transaction ought to have taken place two years prior to the insolvency commencement date in the case of a related party, or one year otherwise. However, the IBC does not specify when a “debt” should be treated as an “antecedent” debt.

The term “antecedent” means “comes before” or “prior or preceding in point of time”. “Antecedent debt” means an obligation that comes before a transfer. The simplest example is when a payment is received against what is already owed at the time of the payment.

Antecedent debt as used in Hindu Law implies two things i.e., antecedent in time and in fact, that is to say, the debt must be truly independent of and not part of the transaction impeached.

The phrase “Antecedent debt” was used for the first time by the Privy Council in the case of Suraj Bunsi Koer v. Sheo Persad Singh and Ors.[2] In a later Privy Council’s judgment, Brijnarain v. Mangala Pd.[3], Lord Dunedin defined antecedent debt as “antecedent in fact as well as in time” which means that the two conditions which are necessary for a debt to qualify as an antecedent debt are that the debt must be prior in time as well as in fact.

While the framers of the IBC were significantly influenced by the Insolvency Act, 1986 of the United Kingdom (U.K. Insolvency Act), however the concept of avoidance of preferential transfer has been borrowed from the United States Bankruptcy Code (U.S. Bankruptcy Code). Section 239 of the U.K. Insolvency Act which deals with preferential transactions defines preference as a transaction made by the debtor within 2 years of the relevant insolvent date which appear to have put a creditor in a better position than which they ought to have been and which is influenced by an intent to prefer such creditor. However, the provision does not explicitly specify that the transfer or payment must have been made on account of an antecedent debt.

Whereas, as per the power conferred under Section 547 of the U.S. Bankruptcy Code, the Bankruptcy Courts can allow the debtor/trustee to bring back recent payments made by debtor, to or for the benefit of a creditor, “on account of an antecedent debt”, during the insolvency period preceding the bankruptcy filing. The recovered funds are then available to the creditors of the bankruptcy estate. The look back period is ninety days. However, if the preferential transfer is made to an insider, then the period is one year.

Antecedent debt is not defined under the U.S. Bankruptcy Code as well. Section 101(5) of the U.S. Bankruptcy Code defines “claim” as a right to payment, whether or not such right is reduced to judgment, liquidated, unliquidated, fixed, contingent, matured, unmatured, disputed, undisputed, legal, equitable, secured, or unsecured. Under Section 101(12) the U.S. Bankruptcy Code, a “debt” is a liability on a claim. In Pa. Dep’t of Pub. Welfare v. Davenport[4], the United States Supreme Court while interpreting the terms “debt” and “claim” observed that both the terms are coextensive in nature and while giving an expansive language to the definition of “claim”, stated that a claim is equally applicable to the term debt. Hence, on a conjoint reading of both the provisions, it can be construed that a debt is any obligation of the debtor giving rise to a creditor’s claim for payment.

In the case of Re Girard[5], the United States Bankruptcy Court while dealing with an issue of avoidable preferential transaction observed that “The term “antecedent debt” is not defined under the Bankruptcy Code. Thus, the Court will look to the plain meaning of these two words for the answer. The term “debt”, however, is defined under Section 101(12) as a “liability on a claim.” Black’s Law Dictionary (8th ed. 2004), defines “antecedent” as: “Earlier; pre-existing; previous.” Additionally, Black’s Law Dictionary defines the term “antecedent debt” in the bankruptcy context as: “A debtor’s prepetition obligation that existed before a debtor’s transfer of an interest in property.” 

Antecedent debt is a liability on a claim which existed before the date of the transfer. However, payment received in advance or on delivery during the relevant period shall not fall under the purview of preferential transaction as the payment was not received on account of an antecedent debt. In the case of Hechinger lnv. Co. of Del., Inc. v. Universal Forest Prods., Inc. (In re Hechinger lnv. Co. of Del., Inc.)[6], the United States Bankruptcy Court held that advance payments are prima facie not preferences because the transfer from the debtor to the creditor is not for or on account of an antecedent debt.

For instance, rent payments made in advance on a monthly basis are not payments with respect to an antecedent debt. In Husted v. Taggart[7], it was held that if a lease requires payments in advance for each month, then rent payments are not on account of an antecedent debt but late rent payments are on account of an antecedent debt. Further, the fact that the execution of a lease occurs before the dates on which payments are made is not sufficient to invoke preference liability.

Similarly, if a contract for the sale of goods requires a payment before or on delivery, then payments made under those contracts are not payments of “antecedent debts.” as held in the case of Pirinate Consulting Grp., LLC v. Kadant Sols. Div[8].

Section 43 of the IBC lays down twin ingredients which needs to be satisfied to qualify a transaction as a “Preferential Transaction”. For any such preferential transaction to be avoidable, the transaction must be in relation to an antecedent financial debt or operational debt or any other liabilities and the transaction has the effect of putting such creditor or a surety or a guarantor in a beneficial position than it would have been in the event of a distribution of assets as per the waterfall mechanism. The transactions which are excluded from being construed as preferential transaction are if the transfer was made in the ordinary course of business/financial affairs of the Corporate Debtor and the transferee; and if it creates new value for the Corporate Debtor.

The Hon’ble Supreme Court of India in the case of Anuj Jain Interim Resolution Professional for Jaypee Infratech Ltd. v. Axis Bank Ltd. [2020] ibclaw.in 06 SC [9], while discussing the intent and scheme of preferential transactions under the IBC, observed that Section 43 is a deeming fiction as the provision contains the phrases “deemed to have given a preference” and “deemed to be given at a relevant time” and it excludes the need of establishing intent. Hence, if the ingredients of a preferential transaction are fulfilled in a transaction, then the preference would be deemed to be given by the Corporate Debtor to the creditor. While relying on the interpretation given by the Hon’ble Supreme Court of India in Anuj Jain’s verdict, the National Company Law Appellate Tribunal, New Delhi, in the case of GVR Consulting Vs Pooja Bahry (Erstwhile Resolution Professional of NTL Electronics India Pvt. Ltd.) (2023) ibclaw.in 261 NCLAT [10] held that any transaction entered into by the Corporate Debtor would be regarded as preferential transaction if it fulfils the conditions as prescribed under the IBC irrespective of whether the transaction was in fact intended or anticipated to be so.

 

 Reference

[1] Pirie v. Chicago Title & Trust Co., 182 U. S. 438, 21 Sup. Ct 906, 45 L. Ed. 1171; Ashby v. Steere, 2 Fed. Cas. 15; Chadbourne v. Harding, 80 Me. 580, 10 Atl. 248; Chism v. Citizens’ Bank, 77 Miss. 599, 27 South. 637; In re Ratliff (D. C.) 107 Fed. 80; In re Stevens, 38 Minn. 432, 38 N. W. 111

[2] I.L.R. 5 Calc. 148

[3] AIR 1924 PC 50

[4] 495 U.S. 552, 558 (1990)

[5] Case No. 03-23711, Adv. Proc. No. 04-2053

[6] Adv. No. 01-3170 (PBL), 2004 WL 3113718

[7] Re ECS Ref., Inc., 625 B.R. 425, 458 (Bankr. E.D. CA 2020)

[8] No. 11- 12804 (KG), 2016 WL 5787237 (Bankr. D. Del. Sept. 30, 2016)

[9] [2020] ibclaw.in 06 SC

[10] (2023) ibclaw.in 261 NCLAT

 

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