NCLT Chennai(11.02.2022) in Mr. Ashish Rathi RP of SBQ Steels Ltd. Vs. Joseph Philip & Ors. ( MA/631/2018 in CP/665/IB/2017) held that;
For a transaction to qualify under sub - section (2) of Section 66 of IBC, 2016 the Resolution Professional has to substantiate before this Tribunal that the Director or the Partner of the Corporate Debtor is aware the company is insolvent and continues to trade and increases the debt of the Company.
Further, it is to be noted that on examining Section 66(2) of IBC, 2016 the element of 'Fraud', 'dishonest intention' and 'defrauding the creditor' is conspicuous by its absence, as compared to Section 66(1) of IBC, 2016.
As noticed, the question of intent is not involved in Section 43 and by virtue of legal fiction, upon existence of the given ingredients, a transaction is deemed to be of giving preference at a relevant time.
However, whether a transaction is undervalued requires a different enquiry as per Sections 45 and 46 of the Code and significantly, such application can also be made by the creditor under Section 47 of the Code.
The consequences of under valuation are contained in Sections 48 and 49. Per Section 49, if the undervalued transaction is referable to sub-section (2) of Section 45, the Adjudicating Authority may look at the intent to examine if such undervaluation was to defraud the creditors.
On the other hand, the provisions of Section 66 related to fraudulent trading and wrongful trading entail the liabilities on the persons responsible therefor.
To find if the transaction is undervalued or is intended to defraud the creditors or had been of wrongful/fraudulent trading are entirely different.
Specific material facts are required to be pleaded if a transaction is sought to be brought under the mischief sought to be remedied by Sections 45/46/47 or Section 66 of the Code.
Excerpts of the order;
MA/631/2018 is an Application filed by the RP in respect of the Corporate Debtor viz. SBQ Steels Limited under Section 66 of IBC, 2016, seeking relief as follows;
(i) Declare that the impugned transactions entered into by the Corporate Debtor are fraudulent and wrongful transactions in terms of Section 66 of the Code;
(ii)Direct Respondent Nos. 1 to 3 to make good of impartments amount to Rs.365.66 Crores (Rupees Three Hundred Sixty Five Crores and Sixty Six lakhs) caused on account of the transactions described in paragraphs 12 to paragraphs 17, which were undertaken without necessary management approvals and independent assessment;
(iii) Direct Respondent Nos. 1,2,3 and 4 to 8 being related parties and, to make good the losses amount to Rs.4.93 Crore (Rupees Four Crore and Ninety Three Lakh) incurred on account of questionable and fraudulent transactions / wrongful trading with the Corporate Debtor described in paragraphs 18 to paragraphs 21;
(iv) Direct Respondent Nos. 1 to 3 to make good of Rs.24.82 Crore (Rupees Twenty Four Crore and Eighty Two Lakhs), being the amounts owned by them on account of unadjusted receivable balance in the respective accounts described in paragraph 22 and paragraph 23 due to lack of adequate documentation and rationale to support such transactions;
Any such other direction / instructions / order in terms of Section 66 and Section 67 of the Code, which the Hon'ble Tribunal may find fit in the facts and circumstances of the present case; and
(vi) To award the costs of these proceedings;
(vii) Any such other/ further order which the Hon'ble Tribunal may find fit in the facts and circumstances of the present case.
# 2. The Learned Counsel for the Applicant submitted that vide order dated 29.12.2017 CIRP in respect of the Corporate Debtor was initiated by this Tribunal and one Mr. Vasudevan was appointed as the IRP and thereafter, the Applicant herein was appointed as the Resolution Professional in respect of the Corporate Debtor by order of this Tribunal dated 03.04.2018. Subsequent thereto, it was submitted that the RP has appointed an Auditor to conduct a review of business operations and activities carried out by the Corporate Debtor for the period from 29.12.2015 to 31.03.2018. It was submitted that the Auditor has accordingly reviewed the business operations and performance of the Corporate Debtor during the Review period.
# 3. It was submitted that the said Auditor has submitted a First Audit Report on 11.09.2018 and the Revised Audit Report on 05.11.2018 to the RP. As per the revised Audit Report, it was submitted that the Auditor has noted that high value assets and capital work in progress impairments were accounted in the FY 2015 - 2016 and FY 2016 - 2017 to an extent of Rs.365.66 Crore. On observing such high value, the Auditor requested the management of the Corporate Debtor to provide basis of assessment and necessary approvals, if any, for such impairments, however there was no reply.
# 4. It was further submitted that the Corporate Debtor was in default since 21.04.2014 and keeping the creditors interest in mind, prior to impairment of high value assets, the Corporate Debtor ought to have conducted an independent (third party) assessment of the rationale and value of impairment, however the same was not undertaken by the management of the Corporate Debtor and the same would point out the lack of due diligence on the part of the management of the Corporate Debtor. In response to the same, the management of the Corporate Debtor has stated that the accounting standard 28 does not warrant a third party evaluation of impairment.
# 5. It was further submitted that the Auditor has noted that the assets impaired were not insured and no physical verification of assets was conducted during the Review period by the Corporate Debtor. In response to the said observation, the management of the Corporate Debtor respondent that insurance premium was returned by the insurance company without assigning any reason, however the management of the Corporate Debtor has not given any specific reason why it did not opt for another insurance provider to get its assets insured. Further, it was submitted that as observed by the Auditors in the Revised Audit Report the management of the Corporate Debtor has not provided any clarity, documentation, approval or assessment on how the impairment value was arrived at before writing off such high value assets. Therefore, it appears that the existence of such assets is in question and such a significant write-off on the high value assets of the Corporate Debtor is without adequate documentation and approvals.
# 6. It was submitted that the Auditor has identified the following transactions which are questionable in nature and the same appears to be fraudulent and wrongful in nature. . . . . . .
10. FINDINGS OF THIS TRIBUNAL
10.1. Heard the submissions made by the Learned Counsel for both the parties and perused the records including the pleading placed on record. As already alluded supra, the Applicant has filed the present Application under Section 66 of IBC, 2016. In this context it is relevant to extract Section 66 of IBC, 2016, which is as follows;
66. Fraudulent trading or wrongful trading. -
(1) If during the corporate insolvency resolution process or a liquidation process, it is found that any business of the corporate debtor has been carried on with intent to defraud creditors of the corporate debtor or for any fraudulent purpose, the Adjudicating Authority may on the application of the resolution professional pass an order that any persons who were knowingly parties to the carrying on of the business in such manner shall be liable to make such contributions to the assets of the corporate debtor as it may deem fit.
(2) On an application made by a resolution professional during the corporate insolvency resolution process, the Adjudicating Authority may by an order direct that a director or partner of the corporate debtor, as the case may be, shall be liable to make such contribution to the assets of the corporate debtor as it may deem fit, if
(a) before the insolvency commencement date, such director or partner knew or ought to have known that the there was no reasonable prospect of avoiding the commencement of a corporate insolvency resolution process in respect of such corporate debtor; and
(b) such director or partner did not exercise due diligence in minimising the potential loss to the creditors of the corporate debtor.
(3) Notwithstanding anything contained in this section, no application shall be filed by a resolution professional under sub section (2), in respect of such default against which initiation of corporate insolvency resolution process is suspended as per section 10A.
10.2. A careful perusal of Section 66 of IBC, 2016 would manifest the fact that it deals with two transactions; Section 66(1) of IBC, 2016 deals with 'Fraudulent Trading' and Section 66(2) of IBC, 2016 deals with 'Wrongful Trading'. Section 66(1) of IBC, 2016 imposes liability on 'any person' who were knowingly parties to the carrying on the business with a dishonest intention to defraud the creditors, to make contribution to the assets of the Corporate Debtor. Thus, essentially for a transaction to qualify under Section 66(1) of IBC, 2016, the following conditions should be satisfied;
(a) Liability can be fixed upon 'any person';
(b) The said person should knowingly carry on the business with the Corporate Debtor;
(c) The said person should have a dishonest intention to defraud the creditors;
10.3. It can be seen that Section 66(1) of IBC, 2016 is pari materia to the provisions of Section 213 of UK Insolvency Act, 1986, which is extracted hereunder;
213 Fraudulent trading.
(1) If in the course of the winding up of a company it appears that any business of the company has been carried on with intent to defraud creditors of the company or creditors of any other person, or for any fraudulent purpose, the following has effect.
(2) The court, on the application of the liquidator may declare that any persons who were knowingly parties to the carrying on of the business in the manner above-mentioned are to be liable to make such contributions (if any) to the company's assets as the court thinks proper.
10.4. On analysing Section 66(2) of IBC, 2016 it is to be seen that it deals with 'Wrongful Trading' and for a transaction to qualify under Section 66(2) the following conditions must be satisfied;
(a) Liability can be fixed upon only 'Director' or 'Partner';
(b) They knew, or ought to have concluded that there was no reasonable prospect of avoiding insolvency proceedings;
(c) They did not take due diligence with a view to minimising the potential loss to the company's creditors;
10.5. It can be seen that Section 66(1) of IBC, 2016 is akin to the provisions of Section 214 of UK Insolvency Act, 1986, which is extracted hereunder;
214 Wrongful trading.
(1) Subject to subsection (3) below, if in the course of the winding up of a company it appears that subsection (2) of this section applies in relation to a person who is or has been a director of the company, the court, on the application of the liquidator, may declare that that person is to be liable to make such contribution (if any) to the company's assets as the court thinks proper.
(2) This subsection applies in relation to a person if
(a) the company has gone into insolvent liquidation,
(b) at some time before the commencement of the winding up of the company, that person knew or ought to have concluded that there was no reasonable prospect that the company would avoid going into insolvent liquidation, and
(c) that person was a director of the company at that time; but the court shall not make a declaration under this section in any case where the time mentioned in paragraph (b) above was before 28th April 1986.
(3) The court shall not make a declaration under this section with respect to any person if it is satisfied that after the condition specified in subsection (2)(b) was first satisfied in relation to him that person took every step with a view to minimising the potential loss to the company's creditors as (on the assumption that he had knowledge of the matter mentioned in subsection (2)) he ought to have taken.
(4) For the purposes of subsections (2) and (3), the facts which a director of a company ought to know or ascertain, the conclusions which he ought to reach and the steps which he ought to take are those which would be known or ascertained, or reached or taken, by a reasonably diligent person having both
(a) the general knowledge, skill and experience that may reasonably be expected of a person carrying out the same functions as are carried out by that director in relation to the company, and
(b) the general knowledge, skill and experience that that director has.
(5) The reference in subsection (4) to the functions carried out in relation to a company by a director of the company includes any functions which he does not carry out but which have been entrusted to him.
(6) For the purposes of this section a company goes into insolvent liquidation if it goes into liquidation at a time when its assets are insufficient for the payment of its debts and other liabilities and the expenses of the winding up.
(6A) For the purposes of this section a company enters insolvent administration if it enters administration at a time when its assets are insufficient for the payment of its debts and other liabilities and the expenses of the administration.
(7) In this section "director" includes a shadow director. This section is without prejudice to section 213.
10.6. Thus, there seems to be a stark contrast in relation to Section 66(1) and 66(2) of IBC, 2016. It is needless to say that even the scope of sub – section (1) and (2) of Section 66 of IBC, 2016 are different. As to the present case, the Applicant sought the Respondents to make contribution to the Corporate Debtor, under Section 66(2) of IBC, 2016.
10.7. The essence of sub-section (2) of Section 66 of IBC, 2016 seems to be that the Directors and Partner should have acted reasonably and responsibly in the time preceding the company's insolvency to avoid wrongful trading proceedings. They must always have put creditors' interests first, and not work for their own benefit. In other words, the Creditor could recover the money from the Director or Partner, if they have traded irresponsibly and acted without care or consideration for the creditors and in doing so, increased the debts of the Company. In short, it is where directors continue trading despite being aware that the company is insolvent.
10.8. Further, sub-section (3) of Section 66 suspends the operation of sub-section (2) till such time the period as mentioned in Section 10A of IBC, 2016 is in force. Interestingly, the UK Insolvency Act, 1986 has also suspended Section 214 which deals with Wrongful Trading for the period from 01.03.2020 till 30.09.2020. The object behind inserting sub-section (3) in Section 66 of IBC, 2016 seems to be that the Directors and Partners of the Company may continue their business or trading during the Covid - 19 pandemic without having the risk of being prosecuted under wrongful trading. However, it may be noted that the same benefit of suspension is not granted to 'Fraudulent Trading' defined under Section 66(1) of IBC, 2016 and also under Section 213 of UK Insolvency Act, 1986.
10.9. For a transaction to qualify under sub - section (2) of Section 66 of IBC, 2016 the Resolution Professional has to substantiate before this Tribunal that the Director or the Partner of the Corporate Debtor is aware the company is insolvent and continues to trade and increases the debt of the Company. Further, it is to be noted that on examining Section 66(2) of IBC, 2016 the element of 'Fraud', 'dishonest intention' and 'defrauding the creditor' is conspicuous by its absence, as compared to Section 66(1) of IBC, 2016.
10.10. The definition of Wrongful Trading as found in Section 66(2) of IBC, 2016 is somewhat seems to be exhaustive since it does not clearly delineate as to which act committed by a Director or a Partner of the Company would constitute 'Wrongful Trading'. It is to be noted here that there is no significant Judgement of the Appellate Tribunal and the Hon'ble Supreme Court in relation to the 'Wrongful Trading', in view of the fact that the concept of 'Wrongful Trading' is being imported from the UK Insolvency Act, 1986 into the IBC, 2016 which is still at a nascent stage in this country. Thus, it becomes imperative for this Tribunal to refer to the decision of the English Court. Thus, by taking a cue from the judgments rendered by the English Court in this regard, the following acts, but not limited to, would amount to 'Wrongful Trading';
(i) Repaying the director loan made to the company while other creditors were not paid;
(ii) Repayment of a loan to a family member;
(iii) A director paying his own salary whilst the salary for the employees was not paid;
(iv) Buying goods on credit when there is no means to pay for them;
(v) Using customer deposits for cash-flow purposes with no means of supplying goods;
(vi) Repaying bank personal guarantees over other creditors;
(vii) Not keeping proper accounting records;
(viii) Falsification of company records;
(ix) Any transfer or sale of assets at anything less than a fair and reasonable commercial value;
10.11. By keeping in mind the scope of sub - section (2) of Section 66 of IBC, 2016, this Tribunal is required to examine as to whether the transactions as alleged by the Applicant in the present Application against the Respondents would fall within the confine of 'Wrongful Trading' that is to say that whether the Directors of the Corporate Debtor knew, or ought to have known that there was no reasonable prospect of avoiding insolvency proceedings; and that they did not take due diligence with a view to minimising the potential loss to the Company's creditors. In this context, it is significant to refer to the decision of the Supreme Court in the matter of Anuj Jain IRP for Jaypee Inrfatech Limited - Vs- Axis Bank Limited Etc., in Civil Appeal No. 8512 - 8527 of 2019;
29.1. However, we are impelled to make one comment as regards the application made by IRP. It is noticed that in the present case, the IRP moved one composite application purportedly under Sections 43, 45 and 66 of the Code while alleging that the transactions in question were preferential as also undervalued and fraudulent. In our view, in the scheme of the Code, the parameters and the requisite enquiries as also the consequences in relation to these aspects are different and such difference is explicit in the related provisions. As noticed, the question of intent is not involved in Section 43 and by virtue of legal fiction, upon existence of the given ingredients, a transaction is deemed to be of giving preference at a relevant time. However, whether a transaction is undervalued requires a different enquiry as per Sections 45 and 46 of the Code and significantly, such application can also be made by the creditor under Section 47 of the Code. The consequences of under valuation are contained in Sections 48 and 49. Per Section 49, if the undervalued transaction is referable to sub-section (2) of Section 45, the Adjudicating Authority may look at the intent to examine if such undervaluation was to defraud the creditors. On the other hand, the provisions of Section 66 related to fraudulent trading and wrongful trading entail the liabilities on the persons responsible therefor. We are not elaborating on all these aspects for being not necessary as the transactions in question are already held preferential and hence, the order for their avoidance is required to be approved; but it appears expedient to observe that the arena and scope of the requisite enquiries, to find if the transaction is undervalued or is intended to defraud the creditors or had been of wrongful/fraudulent trading are entirely different. Specific material facts are required to be pleaded if a transaction is sought to be brought under the mischief sought to be remedied by Sections 45/46/47 or Section 66 of the Code. As noticed, the scope of enquiry in relation to the questions as to whether a transaction is of giving preference at a relevant time, is entirely different. Hence, it would be expected of any resolution professional to keep such requirements in view while making a motion to the Adjudicating Authority.
10.12. From the above judgement of the Hon'ble Apex Court, it is to be noted that specific material fact in relation to the transaction which is sought to be challenged by the Resolution Professional is required to be pleaded in the Application. As to the present case, the Applicant sought to reverse the transactions purported to be done by the Respondents under Section 66 of IBC, 2016. Also in the present case, the Applicant has not specifically pleaded as to which transactions he is sought to be reversed under Section 66(1) of IBC, 2016 and which transactions falls under Section 66(2) of IBC, 2016.
10.13. From the averments and in the submissions made by the Applicant, it is seen that the Applicant is trying to make a sweeping allegation by stating that there were impairments of assets just simply by relying upon the Report of the Auditor. However, the Learned Counsel for the Applicant has miserably failed to prove that the Respondents have paid the money with a dishonest intention and to defraud the creditors. Further, the Applicant nowhere in the Applicant has stated as to how the Respondents was in the knowledge that the Company is going to be insolvent and the Applicant has also miserably failed to substantiate that the Respondents have not taken diligent care to minimize the potential loss to the Creditors.
10.14. Further, the Hon'ble High Court of Himachal Pradesh in the matter of "Hypine Carbons Limited -VS- J.C. Bhatia and others", decided on 13.11.1998 has held that;
34. Mere failure on the part of the Respondents to initiate legal steps against the debtors would not bring the case within the ambit of Section 542 of the Act, unless it is shown that the respondents had failed to do so with fraudulent intentions to defraud the creditors, or any other person(s), or for any other fraudulent purpose.
10.15. Hence for the aforestated reasons, we find no merits in the present Application. Accordingly, MA/631/2018 stands dismissed. No costs.
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