Imp. Rulings;- Fraudulent Transactions under Section 66 of IBC.
Index;
NCLAT (06.03.2024) in Md Sadique Islam & Ors. Vs. Niraj Kumar Agarwal & Ors. [Company Appeal (AT) (Ins.) No. 1081 of 2022 & I.A. No. 3178 of 2022] (Ingredients of each transaction to be examined)
Supreme Court (19.05.2023) In Gluckrich Capital Pvt. Ltd. Vs. The State Of West Bengal & Ors. [Miscellaneous Application No. 1302/2023 ] [Remedy against Third Party]
NCLAT (10.10.2022) in Mrs. Renuka Devi Rangaswamy, RP of M/s. Regen Infrastructure and Services Pvt. Ltd. Vs. M/s. Regen Powertech Pvt. Ltd. [Comp. (AT) (CH) (Ins) No. 357 / 2022 & IA/814/2022] [Fraudulent business]
NCLT Kolkata (30.05.2022) in Shri Kuldeep Verma, RP v. Induslnd Media and Communications Limited (IMCL) & Ors. [I.A. (IB) No. 841/KB/2020 And I.A. (IB) No. 1288/KB/2020 In C.P. (IB) No. 1510/KB/2018] [Satisfaction & Determination by RP]
NCLT Kolkata (19.04.2022) in Pinaki Sarkar, Liquidator of Bansal Refineries Private Limited Vs Amicus Oil & Chemicals Private Limited & Ors. [IA (IB) No.295/KB/2020 in CP (IB) No.11/KB/2019] [Onus of Proof lies with the Liquidator]
NCLAT (06.04.2022) in Aditya Kumar Tibrewal RP Vs. Om Prakash Pandey, Suspended Director [Company Appeal (AT) Insolvency No. 583 of 2021] [Timeline is not Mandatory]
NCLT New Delhi-V (21.02.2022) in Satya Prakash Resolution Professional Y M Foodways Private Limited Vs. Uttam Roy & Ors. [L.A. No. 5610 of 2020 in Company Petition (IB)No.421/ND/2019] [Absence of specific Averments]
Supreme Court of India (26.02.2020) in Anuj Jain IRP for Jaypee Infratech Limited Vs Axis Bank Limited Etc. (Civil Appeal Nos. 8512-8527 of 2019 and other petitions) [Attributes of Avoidance Application]
NCLT Chennai (06.02.2019) in The Resolution Professional for M/s. Orchid Pharma Limited Vs. M/s. Hospira Healthcare India Pvt. Ltd & Others [MA/87/IB/2018 in CP/540/IB/2017] [Attributes of Fraudulent Transactions]
NCLT Chennai (10.01.2019) in Mr. Ramkumar SV Vs. M/s. Serum Institute of India Limited [MA/92/ 1B/2018 in CP/540/IB/CB/2017] [Attributes of Fraudulent Transactions]
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Basic Ingredients of Fraudulent Transactions;
First, transaction shall be entered into with an object to defraud the creditors,
Second, such parties shall be in know of such intention, and to pass an order under this section, it has to be seen that director/partner of the corporate debtor is for sure aware of the fact that commencement of CIRP is inevitable and
Lastly, it has to be proved that such director or partner has not exercised due diligence in minimising the potential loss to the creditors of the Corporate debtor.
Payments made to the creditors cannot be brought under the caption of either fraudulent trading or wrongful trading,
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Interplay of Section 66(2)(b) with section 10 & section 43 of IBC
The fact that CD’s net worth has turned negative, should put directors or partners, as the case may be, on notice of the reasonable prospect of the incipient insolvency of the company. Thus the duty is imposed on the management of the CD under section 66(2)(b) to initiate insolvency proceedings under section 10 to minimize the losses to the creditors. Directors or partners, as the case may be, can be asked to contribute towards the assets of the CD, an amount equal to the losses of the CD after the net worth of the CD turned negative.
Whenever the net worth of the CD turns negative, directors or partners, as the case may be, should take a conscious decision, preferably through board resolution/AGM to either file for insolvency proceedings under section 10 or to continue to run the business of CD on profitable prospects.
In my view, it should be made incumbent on the management/auditors to file for insolvency within 60 days, when the net worth of the company turns negative in the audited financials, and the management has not taken any steps to infuse fresh capital. Management should not be allowed to run the company on funds of creditors.
Corollary of incipient insolvency
During the period of negative net worth of the CD, any payments/refund of deposits & loan etc. to directors or partners, as the case may be, and shareholders & related parties, within the lookback period, will be treated as preferential transactions.
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1). NCLAT (2024.03.06) in Md Sadique Islam & Ors. Vs. Niraj Kumar Agarwal & Ors. [Company Appeal (AT) (Ins.) No. 1081 of 2022 & I.A. No. 3178 of 2022] held that;
When we look into the aforesaid paras, it is clear that the Adjudicating Authority has recorded only its conclusions and that too without considering the preferential, undervalued and fraudulent, each transaction separately and there is general observation that the transactions are undervalued transactions as well as preferential and fraudulent transactions.
The ingredients of preferential, undervalued and fraudulent transaction are entirely different and there has to be application of mind to the ingredients of each transaction to come to conclusion that ingredients are satisfied and the transaction falls in the said category adverting to the given pleadings in the application.
The Adjudicating Authority ought to have adverted to the said pleadings and returned the finding regarding the fulfilment of ingredients of each provision.
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2). Supreme Court (19.05.2023) In Gluckrich Capital Pvt. Ltd. Vs. The State Of West Bengal & Ors. [Miscellaneous Application No. 1302/2023 ] held that;
Accordingly, an application under Section 66(1) by the resolution professional would not bar any civil action in accordance with law, either at the instance of resolution professional or liquidator or by the corporate debtor in its new avatar on a successful CIRP for recovery of any dues payable to the corporate debtor by such organization / legal entities.
The remedy against third party, however, is not available under Section 66 of IBC, and the civil remedies which may be available in law, are independent of the said Section.
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3). NCLAT (10.10.2022) in Mrs. Renuka Devi Rangaswamy, RP of M/s. Regen Infrastructure and Services Pvt. Ltd. Vs. M/s. Regen Powertech Pvt. Ltd. [Comp. (AT) (CH) (Ins) No. 357 / 2022 & IA/814/2022] held that;
In the present case, the reason given by the Respondent in respect to transfer of assets among its group companies appears to be plausible and cannot be brought under Section 66 (1) of IBC, 2016.
Fraud is a sensitive and serious allegation and the authority claiming such allegation is duty bound to provide the copies of the report concerning the allegations even before issuing the Show-cause notice.
Therefore, non-disclosure of the report of the transaction audit conducted by the RP of the Corporate Debtor is sufficient for this Tribunal to dismiss the present application since it amounts to gross violation of principles of natural justice.
It must be borne in mind that whenever a ‘Fraud’ on a ‘Corporate Debtor’ is committed, in the course of carrying ‘business’, it does not necessarily mean that the ‘business’ is being carried on with an intent to ‘defraud’ the ‘Creditors’.
In this connection, this ‘Tribunal’ pertinently, points out that if the ‘Directors’ of a ‘Company’ had acted on a bona-fide belief that the ‘Company’ will recover from its ‘Financial Set Back’ / ‘Difficulties’ / ‘Problems’, then, it will not be liable for the ‘Act’ / ‘Offence’ of ‘Fraudulent Trading’, in the considered opinion of this ‘Tribunal’.
The aspect of `Fraud’ is the cementing platform for a `Liability’. An element of Dishonesty’, is to be `Proved’ and the `Aspect of Dishonesty’, cannot be inferred, when the `Conduct of the concerned Individuals’ is `Receptive’ of more than one explanation,
A company may actually be insolvent at a given time; but its directors may bona fide hold a different view. Even in a case where they are aware of the true position, they may still think that all was not lost and that they would be able to stem the rot by further borrowings and improving the business.
Transfer of Asset’ among / within the ‘Group Companies’, will not partake the character of a ‘Fraudulent Trading’/`Wrongful Trading’, in the teeth of the ingredients of Section 66 (1) of the Insolvency & Bankruptcy Code, 2016.
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4). NCLT Kolkata (30.05.2022) in Shri Kuldeep Verma, RP v. Induslnd Media and Communications Limited (IMCL) & Ors. [I.A. (IB) No. 841/KB/2020 And I.A. (IB) No. 1288/KB/2020 In C.P. (IB) No. 1510/KB/2018 ] held that;
From the above, and the relief sought in prayer part, it is clear that the RP himself was not sure as to whether the transactions impugned are wrong as alleged. He himself is seeking a Forensic Audit, as is evident from one of his prayers in the application.
We are of the view that the RP can file an application under section 25(2) (j) only after being satisfied about the particular transactions being avoidable, fraudulent or undervalued.
Similarly, in terms of Section 25(2(d), it was incumbent upon the RP to seek assistance of the Forensic Audit if so required, to engage the services of accountants, legal or other professionals with a view to satisfy himself about the transactions being avoidable.
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”.
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
“It is settled law that shares are separate and distinct from the assets of the company, and transfer of shares cannot be construed as transfer of assets of the company.
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5). NCLT Kolkata (19.04.2022) in Pinaki Sarkar, Liquidator of Bansal Refineries Private Limited Vs Amicus Oil & Chemicals Private Limited & Ors. [IA (IB) No.295/KB/2020 in CP (IB) No.11/KB/2019] dismissed the avoidance application due to non-appearance & non prosecution by RP.
The Liquidator has stated in his application that the above transactions are undervalued and fraudulent in terms of sections 45 and 66 of the Code as the sale of inventory was entered into with the related parties at a price lower than the book value . . . . . . . However, these are allegations that cannot be made lightly, and the Liquidator has to prove the same before the Adjudicating Authority.
The Liquidator should not expect that applications filed by him will be given due consideration even if he, as applicant, does not choose to appear. We do not see any reason to treat the Liquidator differently from other applicants whose applications will meet the same fate if they choose not to appear on multiple occasions.
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6). NCLAT (06.04.2022) in Aditya Kumar Tibrewal RP Vs. Om Prakash Pandey, Suspended Director [Company Appeal (AT) Insolvency No. 583 of 2021] held that;
“The question as to whether a statute is mandatory or directory depends upon the intent of the legislature and not upon the language in which the intent is clothed.
The meaning and intention of the legislature must govern, and these are to be ascertained, not only from the phraseology of the provisions but also by considering its nature, its design, and the consequences which would follow from construing it the one way or the other….”
In event the actions taken by the Resolution Professional after the timeline prescribed in Regulation 35A of the CIRP Regulations are to be annulled, the undervalued and fraudulent transactions will go out of the reach of Resolution Process, reach of the Court and shall cause great inconvenience and injustice to Corporate Debtor.
Hence, we are of the view that timeline prescribed in Regulation 35A of the CIRP Regulations is only directory and any action taken by the Resolution Professional beyond the time prescribed under Regulation 35A of the CIRP Regulations cannot be held to be non-est or void only on the ground that it is beyond the period prescribed under Regulation 35A of the CIRP Regulations.
There may be genuine and valid reasons for Resolution Professional not to file application for avoiding the transactions within time prescribed which are question relating to each case and has to be examined on case-to-case basis and if there are reasons due to which Resolution Professional could not file the Application within time the same has to be examined on merit.
The Law laid down by the Hon’ble Supreme Court in the above judgment which deals with the interpretation of provisions of the Code itself are applicable to interpretation of Regulation 35A of CIRP Regulations and following the above judgment we hold that timeline prescribed in Regulation 35A of CIRP Regulations is directory and not mandatory.
We thus conclude that for transactions defrauding creditors and fraudulent trading or wrongful trading as under Section 66 the timeline prescribed under Section 46 is not applicable.
The expression “shall” in regulation 35A (1), 35A(2) and 35A(3) is not mandatory and requirement of “forming an opinion” under Section 35A(1) “make a determination” under Section 35A(2) and “shall apply to the Adjudicating Authority for appropriate relief on or before 135th day of the Insolvency Commencement Date” are only directory.
The timeline prescribed for transactions under Section 46 does not cover the transactions covered by Section 49 and 66 of the Code.
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7). NCLT New Delhi-V (21.02.2022) in Satya Prakash Resolution Professional Y M Foodways Private Limited Vs. Uttam Roy & Ors. [L.A. No. 5610 of 2020 in Company Petition (IB)No.421/ND/2019] held that;
# 20. As per the averments made in the application and the report of the transaction Audit Report, we observe that the period of transaction is from 20th November, 2017 to 21 November, 2019 and both the respondents were not the directors from 22nd November, 2017, rather Respondent No.- 1 was appointed on 07th September, 2018 and the Respondent No.- 2 was appointed on 20th February, 2018.
# 21. We further notice that the applicant has not bifurcated the amount which was defrauded during the tenure of Respondent No.-1 and Respondent No. - 2 respectively rather he simply reproduced the report of the Transit Audit Report without stating the liability of the individual directors. We further observe that nowhere in the application, the applicant has stated if these two respondents were not the directors of the Corporate Debtor, then who were the directors from 22nd November, 2017 till the date of appointment of Respondent No.- 2 Le. 20th February 2018, therefore, in our considered view, the averments made in the application is vague and not clear, under such circumstances, it is very difficult to establish the liability of the Respondents under Section 66 of the IBC.
# 22. In sequel to the above, in our considered view, in the absence of specific averments against the individual respondent, the applicant has failed to established that to what extent and from which period the Respondent No. 1 and 2 are liable under Section 66 of the IBC, 2016.
# 23. Under such circumstances, we have no option but to reject the prayer of the applicant, accordingly, the prayer (B) of the applicant is hereby rejected, and the application is hereby dismissed. However, the applicant is at liberty to file a fresh application after specifying the specific period and the amount for which the respondents are liable.
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8). Supreme Court of India (26.02.2020) in Anuj Jain IRP for Jaypee Infratech Limited Vs Axis Bank Limited Etc. (Civil Appeal Nos. 8512-8527 of 2019 and other petitions) held that;
# 29. Having found that the transactions in question cannot be countenanced, for being of preference during a relevant time to a related party; and having approved the order passed by NCLT in that regard, we do not consider it necessary to deal with the other length of arguments advanced by the learned counsel for parties on the questions as to whether the transactions are undervalued and/or fraudulent too. In the totality of circumstances, we would prefer leaving the said questions at that only, while also leaving all the related questions of law open; to be examined in an appropriate case.
# 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 undervaluation 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.
# 29.2. In the present case, it is noticed that NCLT in its detailed and considered order essentially dealt with the features of the transaction in question being preferential at a relevant time but recorded combined findings on all these three aspects that the impugned transactions were preferential, undervalued and fraudulent. Appropriate it would have been to deal with all these aspects separately and distinctively.
# 29.3. We are conscious of the fact that IBC is comparatively a new legislation and various aspects expected therein are in the progression of taking proper shape, particularly in the adjudicatory processes envisaged. Having said so, we would leave this aspect at that only, while expecting all the concerned to be more attentive to the scheme, object and requirements of the provisions contained in the Code.
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9). NCLT Chennai (06.02.2019) in The Resolution Professional for M/s. Orchid Pharma Limited Vs. M/s. Hospira Healthcare India Pvt. Ltd & Others [MA/87/IB/2018 in CP/540/IB/2017] held that;
The elementary difference between section 66 and other avoidance transactions is, fraudulent intention to defraud the creditors has to be proved by the person asserting such allegation. Intention is the element of difference in this section.
it is pertinent to note that the person filing this kind of application, with an imputation of fraud, has to give all the details disclosing how these Respondents Mhave committed fraud in respect to the transaction impugned before this Bench, not only that, the RP has to prove that these answering Respondents committed fraud as detailed in the application.
One more aspect that should not be ignored from reading of section 66 is, it is a qualified section with multiple caveats to invoke this subject matter jurisdiction, first, transaction shall be entered into with an object to defraud the creditors, second, such parties shall be in know of such intention, and to pass an order under this section, it has to be seen that director/partner of the corporate debtor is for sure aware of the fact that commencement of CIRP is inevitable and lastly, it has to be proved that such director or partner has not exercised due diligence in minimising the potential loss to the creditors of the Corporate debtor.
On the top of it, in explanation to section 66 of the Code, it has been laid down that presumption lies in favour of the director/partner that he has exercised due diligence as expected from a person carrying such function, to rebut this statutory presumption, sufficient material has to be placed.
One thing is evident from this section that burden is cast upon the RP to prove that fraud is committed by the director/partner, unless it is proved the presumption remains in force in favour of the director/partner.
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10). NCLT Chennai (10.01.2019) in Mr. Ramkumar SV Vs. M/s. Serum Institute of India Limited [MA/92/ 1B/2018 in CP/540/IB/CB/2017] Held that;
To say it is a preferential transaction, it has to be tested u/s.43 of the Code, to say it is fraudulent trading, it has to be tested u/s.66 of the Code.
As to Section 66 is concerned, here the case is that R1 is creditor to the Corporate Debtor company, therefore the Corporate Debtor was under obligation to make payment to R1 herein. If at all payment has been made other than in ordinary course of business, at the most it could be considered as a preferential transaction but not as a fraudulent transaction because payment was made towards the Creditor.
Payments made to the creditors and such payments cannot be brought under the caption of either fraudulent trading or wrongful trading, moreover legislature normally will not provide overlapping jurisdiction under two heads,
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