Sham financial debt under insolvency law: inconsistent fund transfers and round-tripping defeated a section 7 petition.

A sham or collusive transaction does not amount to a financial debt under the Insolvency and Bankruptcy Code, 2016. Although the claim was supported by loan agreements and bank entries, the record showed inconsistencies in disbursement, repayment and pleadings, while corroborative material indicated common directors, a common registered office and immediate round-tripping of funds. The assessment order and forensic audit report were not treated as conclusive, but they supported the view that the dealings were not ordinary lender-borrower arrangements involving borrowing against time value of money. No bona fide financial debt was proved, and the section 7 petition was held not maintainable.

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Issues: Whether a bona fide financial debt existed so as to sustain initiation of CIRP under section 7 of the Insolvency and Bankruptcy Code, 2016.

Analysis: The application was founded on alleged inter-corporate deposits supported by loan agreements and bank entries, but the record revealed serious inconsistencies in the alleged disbursements, repayments, and the manner in which the transactions were reflected across the pleadings and annexures. The assessment order under the Income-tax Act, 1961 and the forensic audit report were not treated as conclusive against the financial creditors, but they were relied upon as corroborative material showing common directors, common registered office, immediate round-tripping of funds, and other features indicating that the transactions were not ordinary lender-borrower arrangements. The Court applied the principle that a transaction which is sham or collusive does not constitute financial debt for the purposes of the Code and found that the surrounding facts did not establish a genuine debt owed in the ordinary course of borrowing against time value of money.

Conclusion: No bona fide financial debt was proved and the petition under section 7 of the Insolvency and Bankruptcy Code, 2016 was not maintainable.

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