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of <h1>Criminal proceedings quashed: complaint fails to disclose Section 405 IPC; loan created debtor-creditor transfer of beneficial ownership</h1> <h3>SUNIL SHARMA Versus M/s HERO FINCORP LIMITED & ANOTHER</h3> SUNIL SHARMA Versus M/s HERO FINCORP LIMITED & ANOTHER - 2025 INSC 1001 1. ISSUES PRESENTED AND CONSIDERED 1. Whether the complaint under Section 156(3), Cr. PC, insofar as it alleges criminal breach of trust under Section 405, IPC, discloses the ingredients of that offence sufficient to justify direction for registration of an FIR under Section 154, Cr. PC. 2. Whether, having regard to the decision in Lalita Kumari, a preliminary inquiry into a commercial offence was permissible and, if conducted, whether the police/EOW report (finding no cognizable offence) could be disregarded by the High Court in directing registration of an FIR. 3. Whether facts showing creation of creditor-debtor relation by loan transactions, subsequent repayment of instalments, a fire destroying the subject machinery, assignment/settlement of debt and insolvency/forensic audit findings negate dishonest intention and therefore preclude criminal liability under Section 405/406, IPC (i.e., the civil-criminal divide and the relevance of surrounding commercial/insolvency developments). 4. Whether continuation of criminal proceedings in the circumstances would amount to an abuse of the process of law and justify exercise of the High Court's revisional/quashing powers under Section 482, Cr. PC to set aside its direction to register an FIR. 2. ISSUE-WISE DETAILED ANALYSIS Issue 1 - Whether the complaint discloses ingredients of Section 405, IPC so as to warrant FIR registration Legal framework: Section 405 defines 'criminal breach of trust' by reference to (i) entrustment with property or dominion over property, and (ii) dishonest misappropriation/ conversion or dishonest use in violation of law or a legal contract; Section 406 prescribes punishment. Registration of FIR under Section 154, Cr. PC follows if a cognizable offence is prima facie made out. Precedent treatment: The Court applied the established tests distinguishing ordinary loan transactions (creditor-debtor relationship) from entrustment giving rise to criminal breach of trust; it analysed Lalita Kumari only for the permissibility of preliminary inquiry (see Issue 2). Interpretation and reasoning: The Court emphasised that 'entrusted' is a crucial element governing both 'property' and 'dominion over property' and entails a trust/confidence such that the recipient does not become beneficial owner for unrestricted use. By contrast, ordinary loans create creditor-debtor relations where beneficial ownership of money typically passes to the borrower to be used as intended; breach of repayment terms ordinarily gives rise to civil liability, and criminal liability under Section 405 arises only when dishonest misappropriation/ conversion with requisite mens rea is made out. Ratio vs. Obiter: Ratio - the plain terms of Section 405 require entrustment and dishonest misappropriation; ordinary loan transactions, without evidence of dishonest intention or a contractual regime creating an entrustment relationship distinct from a loan, will not ordinarily attract Section 405. Obiter - illustrative comments on how 'entrusted' operates in other factual permutations. Conclusion: On the facts, the transaction was a loan creating creditor-debtor relation; beneficial ownership of the funds was intended to pass to the borrower and repayments were made until April/May 2018. No prima facie dishonest misappropriation or conversion by the accused was established to justify FIR registration under Section 154, Cr. PC. Issue 2 - Permissibility and effect of preliminary inquiry in commercial offences under Lalita Kumari Legal framework: Lalita Kumari recognises that certain categories of cases (including commercial offences) may warrant a preliminary inquiry before registration of an FIR; such inquiry must be free from infirmity and may lawfully lead to a finding of no cognizable offence. Precedent treatment: The Court relied on paragraph 120.6 of Lalita Kumari identifying commercial offences as a non-exhaustive category where preliminary enquiry is permissible; it followed that a valid inquiry report can negate requirement of FIR registration. Interpretation and reasoning: The police/EOW conducted a preliminary inquiry and submitted a detailed Status Report recommending closure on the ground that no cognizable offence was made out. The High Court did not examine that inquiry report for infirmity before directing registration of the FIR. Where the preliminary inquiry is legitimate and its findings stand unchallenged for infirmity, the court should not direct registration of an FIR merely because a complaint has been filed. Ratio vs. Obiter: Ratio - a valid preliminary inquiry report in a commercial offence case that finds no cognizable offence precludes the necessity of directing FIR registration absent demonstrable infirmity in that inquiry. Obiter - contextual observations on the limited circumstances where a court may override such an inquiry. Conclusion: The EOW's inquiry report was not shown to suffer from infirmity; hence the High Court erred in directing FIR registration without properly considering the report and allowing the Magistrate's route under Section 202, Cr. PC to remain available to the complainant. Issue 3 - Effect of surrounding commercial/insolvency facts (fire, repayments, forensic audit, assignment/settlement) on mens rea and culpability under Section 405 Legal framework: Criminal liability under Section 405 requires dishonest intention; surrounding commercial developments (force majeure events, repayments, forensic audit, insolvency proceedings and subsequent assignment/settlement) are relevant to infer absence of mens rea and to distinguish civil defaults from criminal misappropriation. Precedent treatment: The Court applied standard principles distinguishing civil indebtedness from criminal breach where dishonest intention is absent; it considered insolvency proceedings, forensic audit findings and later assignment/settlement as material facts bearing on culpability. Interpretation and reasoning: The loan tranche disbursed shortly before a catastrophic fire that destroyed the machinery provided a reasonable causal explanation for non-purchase/use of funds for stated purpose. Instalments were paid regularly until 2018 and the forensic audit admitted the creditor's claim and found no diversion. Subsequent assignment and issuance of no objection certificate towards satisfaction of dues and withdrawal of NI Act complaints further support absence of dishonest misappropriation. The Court noted that the creditor did not raise objections immediately after disbursement and only became active after other creditors triggered insolvency processes. Ratio vs. Obiter: Ratio - factual matrix showing repayment history, force majeure event, forensic audit/insolvency findings and post-litigation assignments can negate inference of dishonest intention required for Section 405. Obiter - remarks on documentary support and timing of creditor's actions as indicia to be weighed by investigating agency/court. Conclusion: The totality of commercial and insolvency-related facts negates prima facie dishonest misappropriation; therefore criminal proceedings are not justified on the complaint as framed. Issue 4 - Abuse of process and exercise of inherent/quashing power under Section 482, Cr. PC Legal framework: High Courts' inherent power under Section 482, Cr. PC may be exercised to prevent abuse of process, to quash orders that lead to vexatious or frivolous criminal proceedings, and to protect against misuse of criminal law for adjudicating commercial disputes. Precedent treatment: The Court held that continuance of criminal proceedings in circumstances where no cognizable offence is prima facie made out and where criminal process would constitute abuse justifies intervention in exercise of Section 482 powers. Interpretation and reasoning: Given (i) absence of requisite entrustment/dishonest misappropriation on the available material, (ii) valid preliminary inquiry report finding no cognizable offence, and (iii) mitigating circumstances including repayment, forensic audit and settlement/assignment, continuation of criminal proceedings would be an abuse of process. The High Court's direction to register FIR thwarted the Magistrate's course under Section 202 and compelled criminal process contrary to those facts and inquiries. Ratio vs. Obiter: Ratio - High Court's direction to register an FIR in such circumstances was unsustainable and subject to being set aside under Section 482; quashing such direction is appropriate to prevent abuse. Obiter - guidance on weighing commercial realities and insolvency outcomes when considering quashing applications. Conclusion: Exercise of the High Court's inherent power was warranted to set aside the impugned direction; the order directing FIR registration was quashed as an abuse of process and the respondent's petition under Section 482 should not have been allowed.
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