What Is Fraudulent Preference? Section 328

Fraudulent preference is what the Companies Act, 2013 calls a transaction that quietly moves one creditor to the front of the queue shortly before a company is wound up. Section 328 lets the Tribunal undo it. Three neighbouring sections extend the same idea to transfers that were not in good faith, to assignments for the benefit of creditors, and to floating charges. Each has its own look-back window, and the windows are not the same length.

What makes a transaction a fraudulent preference?

Three elements, all inside section 328(1). There must be a preference given to a person who is one of the creditors of the company or a surety or guarantor for any of the debts or other liabilities of the company. The company must do or allow something: the sub-section covers the case where the company does anything or suffers anything done. And the effect must be putting that person into a position which, in the event of the company going into liquidation, will be better than the position he would have been in if that thing had not been done prior to six months of making winding up application.

The remedy is then wide rather than mechanical. Where the Tribunal is satisfied that such transaction is a fraudulent preference, it may order as it may think fit for restoring the position to what it would have been if the company had not given that preference. The section quantifies nothing: it restores.

Two points on how sub-section (1) is printed. The six month reference sits at the end of the comparison clause, prior to six months of making winding up application, rather than at the top of the sub-section where a reader looks for a limitation period; sub-section (2) states the same window in plainer terms. And the Act prints a stray comma in if satisfied that, such transaction is a fraudulent preference.

Sub-section (2) is the one that names the acts. Where the Tribunal is satisfied that there is a preference transfer of property, movable or immovable, or any delivery of goods, payment, execution made, taken or done by or against a company within six months before making winding up application, it may order as it may think fit and may declare such transaction invalid and restore the position.

Note by or against a company. An execution taken against the company by a creditor is inside the sub-section, so a creditor who levied execution is not outside it merely because the company did not act voluntarily.

Which transfers are void, and from when?

Section 329 is stricter than section 328 because it does not ask the Tribunal to be satisfied of anything. It was substituted by Act 31 of 2016, section 255 and the Eleventh Schedule, with effect from 15 November 2016, and now provides that Any transfer of property, movable or immovable, or any delivery of goods, made by a company, not being a transfer or delivery made in the ordinary course of its business or in favour of a purchaser or encumbrancer in good faith and for valuable consideration, if made within a period of one year before the presentation of a petition for winding up by the Tribunal under this Act shall be void against the Company Liquidator.

Two exclusions save a transfer: the ordinary course of business, and a good faith purchaser or encumbrancer for valuable consideration. Everything else inside the year is void against the Company Liquidator, which is a defined consequence rather than a discretionary one.

Section 330 carries no window at all. It reads, in full: Any transfer or assignment by a company of all its properties or assets to trustees for the benefit of all its creditors shall be void. The target is a general assignment of everything to trustees, and the section voids it whenever it was made. Note the two "all"s: all its properties or assets, for the benefit of all its creditors.

How do the look-back windows compare?

They run from different events as well as for different lengths, which is the detail most easily mixed up.

Section 357 states that a winding up by the Tribunal shall be deemed to commence at the time of the presentation of the petition for the winding up, so the section 332 window and the section 329 window run from the same moment by different words. Neither is measured from the winding up order, which is one of the dates the effect of a winding up order turns on.

What happens to a floating charge?

Section 332 invalidates it, with one proof and one carve out. Where a company is being wound up, a floating charge on the undertaking or property of the company created within the twelve months immediately preceding the commencement of the winding up, shall, unless it is proved that the company immediately after the creation of the charge was solvent, be invalid.

The solvency proof is the escape, and the test date is precise: immediately after the creation of the charge, not at the time of the winding up. The carve out saves new money rather than old debt. The charge stays good except for the amount of any cash paid to the company at the time of, or subsequent to the creation of, and in consideration for, the charge, together with interest on that amount at the rate of five per cent. per annum or such other rate as may be notified by the Central Government in this behalf.

So a floating charge taken to secure an existing unsecured debt inside the twelve months has nothing to save it unless solvency is proved, while one taken for fresh cash advanced against it survives to the extent of that cash. Even a surviving floating charge does not outrank the preferential payments list, because section 327(3)(b) gives those debts priority over the claims of debenture holders under any floating charge, so far as the assets of the company available for payment to general creditors are insufficient to meet them.

What is the position of the person who was preferred?

Section 331 converts him into a surety. Where something done after the commencement of the Act is invalid under section 328 as a fraudulent preference of a person interested in property mortgaged or charged to secure the company's debt, that person shall be subject to the same liabilities, and shall have the same rights, as if he had undertaken to be personally liable as a surety for the debt, to the extent of the mortgage or charge on the property or the value of his interest, whichever is less.

Sub-section (2) fixes the valuation date and the assumption: the value of his interest is determined as at the date of the transaction constituting the fraudulent preference, and as if the interest were free of all encumbrances other than those to which the mortgage or charge for the debt of the company was then subject.

Sub-sections (3) and (4) handle procedure. On an application about a payment said to be a fraudulent preference of a surety or guarantor, the Tribunal has jurisdiction to determine questions between the payee and the surety or guarantor and to grant relief, notwithstanding that it is not necessary so to do for the purposes of the winding up, and may give leave to bring in the surety or guarantor as a third party as in the case of a suit for the recovery of the sum paid. Sub-section (4) then applies sub-section (3) mutatis mutandis in relation to transactions other than payment of money.

Who brings these applications, and what else can follow?

Section 328 names no applicant, and the Company Liquidator has the standing to be one. Clause (f) of section 290(1) is the power to institute or defend any suit, prosecution or other legal proceeding, civil or criminal, in the name and on behalf of the company, and clause (n) the power to apply to the Tribunal for orders necessary for the winding up, both covered with the powers of a Company Liquidator. Section 280 puts the resulting dispute before the Tribunal itself, since clause (d) of that section reaches any question of priorities or any other question whatsoever.

Setting a transaction aside is a civil consequence and does not by itself decide anything criminal. Where the conduct amounts to fraud as defined in section 447, that is a separate determination under a separate section. Section 328 asks whether the person's position was improved, whether the transaction is a fraudulent preference, and what order restores the position.

Reading a fraudulent preference question therefore starts with two dates and one test: when the winding up application was made or the petition presented, when the transaction happened, and whether the counterparty ended up better off than liquidation would have left him. The grounds the petition was brought on do not change any of it, but the date the petition was presented decides which of the three windows a transaction falls inside.

Flock reports the filings themselves, each stamped with its date and linked back to the exchange or regulator that published it. What any of it means for you is your call to make.