Penal provisions in Winding up

36.1 Preferential payments

Often, when it is felt that winding up of company is imminent, payments are payment to certain
creditors or property is disposed off, so that other creditors do not get anything. This is termed as
'fraudulent preference'. If such transfer of property/payment is done within six months before
commencement of winding up, the transfer will be invalid.
36.1-1 Power of NCLT to declare transaction invalid in certain case
NCLT can declare a transaction invalid in following cases
Fraudulent preference to creditor, surety or guarantor - If a company has given preference to a
creditor of company, surety or guarantor for any of its debts or other liabilities of company prior to six
months, which puts such creditor, surety or guarantor in better position, NCLT can restore the position
to what it would have been if the company had not given that preference, if NCLT is satisfied that the
transaction is fraudulent preference - section 328(1) of Companies Act, 2013 - no parallel provision in
the 1956 Act.
Preference transfer of movable or immovable property - If NCLT is satisfied that there is a preference
transfer of movable or immovable property, or any delivery of goods, payment, execution made, taken
or done by or against company within six months before making winding up application, NCLT may
declare such transaction invalid and restore the position - section 328(2) of Companies Act, 2013
[section 531(1) of the 1956 Act stated that such preference will be 'deemed to be fraudulent preference.
Section 328(2) of Companies Act, 2013 does not have such deeming provision.].
Section 328(1) of Companies Act, 2013 applies when preference is given to creditor, surely or
guarantor even prior to six months of making winding up application, while section 328(2) of
Companies Act, 2013 applies if such preference is sale, transfer or payment is within six months of
making winding up application.
In Official Liquidator v. MD, State Financial Corporation (2000) 26 SCL 303 (AP HC), it was held
that burden is on petitioner to prove that there was fraudulent preference to concerned creditor. It was
held that mere preference is not sufficient to draw inference that the preference is fraudulent. If the
transaction is made in good faith for valuable consideration, it cannot be said that the transaction is
void.
In Victor Chit funds In re (1972) 42 Comp Cas 396 (Del), it was held that section 531 of the 1956 Act
[section 328 of Companies Act, 2013] imposes an unequivocal burden on the Official Liquidator or a
party seeking to impeach a transaction. Fraud and dishonesty is entering into such a transaction must be
clearly alleged, proved and established - quoted with approval in Morepen Finance Ltd. v. RBI (2005)
60 SCL 410 (Del HC).
In Official Liquidator v. Venkineni Rajagopala (1966) 36 Comp Cas 888 (AP HC), it was observed that
it is necessary to evaluate the dominant motive to that impels a debtor to make a transfer of property in
favour of one of creditors, to decide whether the transfer amounts to a fraudulent preference or not.
In Prudential Capital Markets Ltd. (In Liquidation) In re (2008) 84 SCL 239 (Cal HC), it was held that
before it is found that a transaction is hit by section 531 of the 1956 Act [section 328 of Companies
Act, 2013], it needs to be proved that transaction not only reflected a preference shown to particular
creditor but is was entered into with an object of giving such creditor a favoured treatment. However, if
transaction is fraudulent, it can be set aside by Court.
In Liquidator of West Mercia Safetywear Ltd. v. Dodd (1988) 4 BCC 30 (CA), director was held
personally liable when he transferred UK Pounds 4,000 to another company (which was for his own
benefit), in disregard to interests of other creditors of company under liquidation.
In National Institute of Technology Trust v. Koshika Telecom Ltd. (2012) 111 SCL 700 = 18
taxmann.com 77 (Del HC), it was held that the agreement entered after filing of winding up petition
can be invalidated even if the other party was ignorant of coming up of winding up petition.
In Macho Foods P Ltd. v. Modiluft Ltd. (2003) 45 SCL 159 (Del HC), the company paid huge security
deposit of Rs. 36 crores for taking a property on rent of Rs. 10,000 per month. The security deposit was
even more than value of property taken on rent. It was held that it is fraudulent preference against
creditor and the said property was to be attached.
In P G Vivekanandan v. RPS Benefit Funds (2004) 49 SCL 671 (Mad HC), book value of property was
Rs. 3.18 crores and market value assessed by registering authority for stamp duty purposes was Rs.
3.46 crores. The property was sold in great hurry at Rs. 1.63 crores, just three months before winding
up petition was filed against the company. The transaction was set aside by High Court.
In Shefali Doshi In re (2010) 100 SCL 84 (Guj HC) also, transaction was entered to give preference to
some debenture holders with intention to transfer property for extraneous consideration. It was held
that the transaction is hit by section 531 of the 1956 Act [section 328 of Companies Act, 2013]
In Sri Krishnasamy Reddiar Educational Trust v. Official Liquidator (2012) 114 SCL 577 = 22
taxmann.com 293 (Mad HC DB), a lease agreement was executed for 30 years with meager monthly
rent, within a period of one year prior to filing of ending up petition. It was held that the terms of lease
were not bona fide and hence lease agreement was set aside.
In Rohtas Industries v. Official Liquidator (2005) 63 SCL 590 (Pat HC), company made transfer in
favour of tenant by creating lease rights in company's property after filing of winding up petition. It
was held as fraudulent and not made in ordinary course of business of company. The transfer was held
void and not binding on Court or liquidator.
In Sarala Srinath v. M Muthusamy (2006) 66 SCL 107 (Mad HC DB), irrevocable power of attorney
for sale of properties of company was issued to one of the depositors (when there were many other
depositors). Sale was made after winding up petition was filed. It was held that sale is void in terms of
section 536(2) of the 1956 Act [section 334 of Companies Act, 2013].
In Kirloskar Institute of Advanced Management Studies v. Official Liquidator of Mysore Kirloskar
(2011) 108 SCL 720= 12 taxmann.com 407 (Karn HC), property worth more than ' six crores was
given on lease of Rs. 2.84 lakhs for 28 years with absolute ownership thereafter It was held that
transaction was not bona fide. It is contrary to section 531A of the 1956 Act [section 329 of Companies
Act, 2013]
In Manekchowk & Ahmedabad Mfg. Co. Ltd., In re (1970) 40 Comp Cas 819 (Guj HC), a mortgage
was executed in favour of Provident Fund authorities. It was held that it is not a fraudulent preference
as it was done when threat of prosecution was looming large and transfer under such circumstances
cannot be 'fraudulent preference' - same view in Monark Enterprises v. Kishan Tulpule (1992) 74
Comp Cas 89 (Bom HC).
In Farokh S Todywalla v. OL of Vitta Mazda Ltd. (2007) 78 SCL 105 (Guj HC), sale of land done
pending winding up petition was upheld as it was in course of business and no favourism was shown.
In V R Muzumdar v. Mysore Kirloskar Ltd (in liquidation) (2006) 66 SCL 170 (Karn HC), company
entered into agreements with employees for sale of quarters and sale of vacant lands. When the board
resolution to that effect was passed, the company was already sick and winding up petition was already
instituted in Court. It was held that sale of assets could not be said to be bona fide and agreement to
sale was not valid.
In O.L. of Piramal Financial Services v. RBI (2004) 51 SCL 691 (Guj), it was held that payment made
under threat (of prosecution etc.) is not 'fraudulent preference'. However, if payment is voluntarily
made it can be 'fraudulent preference'. In this case, flats were hurriedly sold and transferred in name of
depositors at lower prices, even when payments against the deposits were not due. It was held that it is
fraudulent preference and official Liquidator was ordered to take possession of the flats - similar view
in Official Liquidator of Piramal Financial Services v. Decimal Systems (2009) 91 SCL 31 (Guj HC).
In Motorola India v. DSS Mobile Ltd. (2004) 56 SCL 601 (Del HC) (also in 65 SCL 107), it was held
that payment made to creditors as settlement when winding up petition is pending is not 'fraudulent
preference' and is not required to be recovered from creditors. It was also observed that it is never
contemplated that all moneys paid after commencement of winding up proceedings should be remitted
back. Only those payments made by company, which amount to 'fraudulent preference' can be directed
to be given back to Official Liquidator.
Bond/Negotiable Instrument transferred before winding up - If a bond or negotiable instrument is
transferred before even application for winding up is made for valuable consideration, the transfer is
valid and binding on company, even if submitted for transfer later, when there is no allegation of
fraudulent preference - Morepen Finance Ltd. v. RBI (2005) 60 SCL 410 (Del HC).