2025 (8) TMI 1354 - AT - IBC

Appeal allowed: Section 65 allegations of fraud, related-party control require merits scrutiny despite Section 7 proceeding

NCLAT allowed the appeal, set aside the Adjudicating Authority's order rejecting an intervention petition in Section 7 proceedings, and disposed of the ... Rejection of intervention petition filed by the Appellant in Section 7 proceedings initiated by Respondent No.1 against Respondent No.2 - failure to consider the application filed by the Appellant under Section 65 - fraudulent and collusive initiation of CIRP - HELD THAT:- The present is not a case where the Appellant is relying only on fact of pendency of Section 66 application filed by the Administrator of SIFL questioning the transaction. Rather, the Appellant in their application has given other facts, pleading that Respondent No.1 has control on Respondent No.2 through its related entities and the transaction, which is basis of Section 7 application is a circular transaction. Respondent No.2 once has already undergone CIRP and was taken over by related party of Respondent No.1 and the application under Section 7 has been maliciously initiated. The Adjudicating Authority has not proceeded to consider Section 65 application, it has only observed that the Appellant has no locus, it being neither proper nor necessary party in Section 7 application. Insofar as, Section 7 proceedings are concerned, there can be no quarrel to the observation that an Intervenor, who may not be necessary party or proper party, cannot intervene, but in a case where prayer of the Applicant under Section 65 regarding pleading to initiation of CIRP with fraudulent and malicious intent, the Adjudicating Authority ought to have looked into the allegations carefully. The IBC clearly prohibits any malicious or fraudulent initiation of CIRP and when in an application, it has been brought into notice by the stakeholders, the said application deserves consideration on merits. Rejection of the application only on the ground that Applicant has no locus, is unsustainable. It is not a case that Adjudicating Authority has returned any finding that Intervention Application has been filed to derail the CIRP. It was open for the Adjudicating Authority to consider the application under Section 65 on merits even at the time of hearing of Section 7 application. The order impugned cannot be sustained. In result, the impugned order rejecting Intervention Petition is set aside - appeal disposed off. ISSUES PRESENTED AND CONSIDERED 1. Whether an application under Section 65 of the Insolvency and Bankruptcy Code (alleging fraudulent or malicious initiation of insolvency proceedings) is maintainable and must be considered by the Adjudicating Authority in the course of Section 7 proceedings. 2. Whether third parties or stakeholders (specifically workmen/employees of the corporate debtor) possess locus standi to file an intervention under Section 65 and to seek dismissal of a Section 7 petition prior to admission. 3. Whether pendency of an avoidance action under Section 66 by an administrator/other authority precludes or stays the adjudication of a Section 7 application based on the same transactions. 4. Whether the Adjudicating Authority commits legal error by rejecting an application alleging malicious/collusive initiation solely on the ground that the applicants are not proper or necessary parties to Section 7 proceedings, without adjudicating the Section 65 allegations on merits. ISSUE-WISE DETAILED ANALYSIS Issue 1 - Maintainability and duty to consider Section 65 allegations in Section 7 proceedings Legal framework: Section 65 penalises initiation of CIRP fraudulently or with malicious intent; the Adjudicating Authority has power to impose penalties and to refuse or dismiss proceedings where such mala fides are established. Section 7 governs initiation and admission by a financial creditor. Precedent Treatment: Prior authorities establish that allegations of collusion/fraud in initiation must be examinable by the Adjudicating Authority and, if properly pleaded, cannot be ignored; also, appellate courts have directed that such pleadings be considered at the Adjudicating Authority level rather than raised first on appeal. Interpretation and reasoning: The Court reasons that the statutory scheme prohibits malicious or fraudulent initiation and contemplates adjudication of such allegations. When stakeholders properly invoke Section 65 with pleaded facts alleging collusive or circular transactions forming the basis of the petition, the Adjudicating Authority is obliged to examine those allegations. A blanket rule limiting preliminary-stage hearing only to the financial creditor and corporate debtor cannot justify ignoring properly pleaded Section 65 allegations which attack the bona fides of the initiation itself. Ratio vs. Obiter: Ratio - The Adjudicating Authority must consider Section 65 allegations brought before it in the context of Section 7 proceedings and cannot refuse to examine such allegations as a matter of course. Conclusion: Section 65 applications challenging the bona fides of initiation are maintainable in the course of Section 7 proceedings and must be considered by the Adjudicating Authority on their merits (subject to usual requirements of pleadings and standing). Issue 2 - Locus of third parties/stakeholders (workmen) to intervene under Section 65 Legal framework: Intervention mechanism (including Rule 11/NCLT Rules) permits persons with real interest to seek relief; Section 65 itself contemplates that 'any person' initiating CIRP fraudulently may be penalised - which implies complaints may arise from interested stakeholders. Precedent Treatment: Some decisions have held that at the admission stage only the financial creditor and corporate debtor are required to be heard, and other creditors or intervenors ordinarily lack a right to be heard; other authorities, including higher courts, have recognized the need to consider fraud/malicious initiation allegations when properly raised, and have permitted intervention by stakeholders to prevent miscarriage of justice. Interpretation and reasoning: The Court observes that employees/workmen who are stakeholders in the corporate debtor have a tangible interest because CIRP affects livelihood and employment. If a group of employees authorises a representative and files an application with requisite pleadings and supporting documents alleging collusion and fraudulent transactions, such applicants cannot be dismissed summarily as strangers. While the general rule that admission-stage hearings focus on the financial creditor and corporate debtor is valid, it does not nullify the obligation to consider prima facie credible allegations of malicious initiation brought by interested stakeholders under Section 65. Ratio vs. Obiter: Ratio - Stakeholders (including workmen), properly authorised and with cogent pleadings, have locus to seek adjudication of Section 65 allegations and cannot be summarily excluded solely because they are third parties to a Section 7 petition. Conclusion: Applicants who are bona fide stakeholders and who properly authorise representation and plead relevant facts are entitled to have their Section 65 intervention considered; lack of formal parity with the financial creditor does not bar consideration of allegations of fraudulent initiation by such stakeholders. Issue 3 - Effect of pendency of Section 66/avoidance proceedings on Section 7 adjudication Legal framework: Section 66 empowers avoidance of fraudulent transactions; Section 7 admission focuses on existence of debt and default. Statutory scheme provides separate remedies for debt recovery and avoidance of transactions. Precedent Treatment: Authorities have held that pendency of avoidance/avoidance-type proceedings under Sections such as Section 66 does not ordinarily impede the progress or admission of a separate Section 7 petition; however, where Section 65/66 allegations form part of a larger plea of malicious initiation, such pleadings require consideration. Interpretation and reasoning: The Court notes that while pendency of a Section 66 application filed by an administrator does not automatically bar hearing of a Section 7 petition, the presence of an ongoing avoidance challenge is a relevant factual matrix that may bolster allegations of collusion or sham transactions. Where intervention under Section 65 relies solely on the pendency of Section 66, it may be less persuasive; but when Section 65 pleadings include additional specific factual allegations of circular transactions and control that, together with pending avoidance proceedings, raise a prima facie case of mala fides, the Adjudicating Authority should examine those pleadings rather than dismiss for want of locus. Ratio vs. Obiter: Obiter - Pendency of Section 66 alone does not preclude Section 7 adjudication; Ratio - Pendency is relevant context and does not negate the Adjudicating Authority's duty to consider credible Section 65 allegations. Conclusion: Pendency of a Section 66 proceeding does not by itself stay or preclude Section 7 proceedings, but it is a material circumstance that, when accompanied by cogent Section 65 pleadings, warrants careful adjudication of allegations of fraudulent initiation. Issue 4 - Whether rejection solely on ground of lack of locus without adjudicating Section 65 allegations is legally sustainable Legal framework: Principles of natural justice and statutory duty to guard against misuse of insolvency framework; Adjudicating Authority must assess prima facie sufficiency of pleadings alleging fraud/malice. Precedent Treatment: Higher authorities have directed that allegations of collusive or fraudulent initiation, if properly pleaded, be considered by the Adjudicating Authority and not deferred to appellate stages or ignored by reliance on narrow locus rules. Interpretation and reasoning: The Court finds that the Adjudicating Authority erred in rejecting the intervention solely on the ground that applicants lacked locus as 'neither proper nor necessary parties,' without engaging with the substance of Section 65 allegations. The tribunal's reliance on a precedent limiting who is heard at admission cannot be applied mechanically to defeat the statutory protection against malicious initiation. The Adjudicating Authority should have examined whether the pleadings made a prima facie case warranting further inquiry; summary dismissal on locus grounds where stakeholders properly authorised an applicant and pleaded specific facts of collusion was unsustainable. Ratio vs. Obiter: Ratio - Rejection of a Section 65 intervention solely on non-joinder/locus grounds, without considering the merits of pleaded allegations of fraudulent initiation, is unsustainable. Conclusion: The Adjudicating Authority's summary rejection for lack of locus was legally erroneous; the intervention must be revived and adjudicated on merits (and may be heard along with the Section 7 petition). The appellate Court remitted the matter for fresh consideration without expressing views on the merits of the Section 65 allegations.