Companies Act Section 328

Companies Act, Section 328: Provisions Relating to Fraudulent Preference During Winding Up

Section 328 of the Companies Act, 2013 addresses the issue of fraudulent preference, which refers to unfair or biased transactions made by a company in favour of certain creditors or guarantors shortly before entering into liquidation. The intention behind this provision is to prevent companies from deliberately favouring certain creditors over others when insolvency is impending, thereby protecting the interests of the general body of creditors and ensuring equitable treatment during winding up proceedings.

This section empowers the National Company Law Tribunal (NCLT) to intervene when it identifies transactions that may have been carried out with the intent of giving an undue advantage to a particular party over others. It allows the Tribunal to reverse such transactions and restore the status quo, as if such preference had not been granted.

Key Provisions and Explanatory Notes:

1. Definition of Fraudulent Preference:
A fraudulent preference arises when a company, which is on the brink of being wound up, performs an act or allows an act to be performed which benefits one of its creditors (or a surety or guarantor for any of the company’s debts or liabilities).
This act must have the effect of placing that person in a better financial position than they would have otherwise been in the event of liquidation.
The act in question must occur within six months prior to the date of making the winding up application.
2. Examples of Fraudulent Preference:
Repaying the entire loan of one creditor when the company knows it is going to be wound up, while not paying other similarly situated creditors.
Providing security or collateral for a previously unsecured debt just before insolvency. Transferring company assets to a creditor to satisfy an existing debt, thereby reducing the pool of assets available to other creditors.
3. Role and Power of the Tribunal (NCLT):
Upon application or during winding-up proceedings, if the Tribunal is satisfied that the transaction or act was a fraudulent preference, it may issue an order to:
Declare the transaction as invalid. Restore the position of the parties involved to what it would have been if the preference had not been given.Issue any other direction it deems just and appropriate to ensure fairness and equity.
4. Scope of Tribunal’s Intervention:
The Tribunal’s power extends not only to direct preferences but also to:
Transfers of property (movable or immovable), Delivery of goods, Payments made, Executions taken or done by or against the company.
All such acts, if carried out within the six-month window prior to the filing of the winding up application and intended to give preference, can be set aside by the Tribunal.
5. Legal Consequences:
If a transaction is declared to be a fraudulent preference, the preferred party loses the advantage that was unlawfully or unfairly granted.
The affected creditor may be placed back in the position they would have occupied in the regular order of distribution during liquidation.
The act is treated as voidable, i.e., it can be rendered legally ineffective by the Tribunal to protect the interests of all creditors.
6. Objective of the Provision:
To discourage companies from engaging in manipulative or unfair practices just before insolvency.
To ensure equitable treatment among all creditors and prevent any attempt to defeat or undermine the liquidation process.
To protect the integrity of winding-up proceedings by maintaining fairness and transparency.