Imp. Rulings;- Wrongful Trading [Section 66(2)] of IBC.
Index;
NCLT Mumbai-V (2024.05.07) in Mr. Vijendra Kumar Jain Vs Mr. Nitin Ramchandra Jadhav and Ors... [(2024) ibclaw.in 515 NCLT, I.A. 677 of 2023 in CP (IB) No. 1023 of 2021] [ Attributes Wrongful Trading]
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] (Ingredients of each transaction to be examined)
NCLAT (2022.10.10) 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] [Wrongful Trading - Incipient Insolvency]
NCLT, Mumbai (2021.11.29) in Venkatesan Sankaranarayanan, the Resolution Professional for RTIL Limited v. Nitin Shambhukumar Kasliwal & Ors. (CP No. 382 / I & B / MB/2018)
NCLT Chennai (2019.01.10) in Mr. Ramkumar SV Vs. M/s. Serum Institute of India Limited [MA/92/ 1B/2018 in CP/540/IB/CB/2017] [Attributes of Wrongful Trading - Payment to Creditors]
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# Section 66. Fraudulent trading or wrongful trading. -
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(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.
Explanation. – For the purposes of this section a director or partner of the corporate debtor, as the case may be, shall be deemed to have exercised due diligence if such diligence was reasonably expected of a person carrying out the same functions as are carried out by such director or partner, as the case may be, in relation to the corporate debtor.
Attributes of Section 66(2)
Blogger’s Comments;
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 minimise 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). NCLT Mumbai-V (2024.05.07) in Mr. Vijendra Kumar Jain Vs Mr. Nitin Ramchandra Jadhav and Ors.. [(2024) ibclaw.in 515 NCLT, I.A. 677 of 2023 in CP (IB) No. 1023 of 2021] Held that;.
Thus, by taking a cue from the judgments rendered by the English Courts in this regard, the following acts have been held to constitute ‘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 while 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; and
(ix) Any transfer or sale of assets at anything less than a fair and reasonable commercial value.
[ Link Synopsis ]
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2). 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.
[ Link Synopsis ]
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3). NCLAT (2022.10.10) 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, Mumbai (2021.11.29) in Venkatesan Sankaranarayanan, the Resolution Professional for RTIL Limited v. Nitin Shambhukumar Kasliwal & Ors. (CP No. 382 / I & B / MB/2018) held that;
6. ``The Bench observes that it is a fact that management of company have taken certain decision which has not worked out as intended by the management and eventually loss occurred. However, such bad commercial business decision cannot be considered to be fraudulent or wrongful trading under provisions of Section 66 of the IBC.’’
[ Link Synopsis ]
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5). NCLT Chennai (2019.01.10) 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,
[ Link - Synopsis ]
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