2025 (11) TMI 1803 - AT - IBC

Section 66 IBC: Directors Cleared as Commercial Share Purchase Not Proven Fraudulent, Transaction Audit Not Conclusive

NCLAT set aside the NCLT order that had directed suspended directors of the CD to contribute to the liquidation estate on the ground of fraudulent ... Fraudulent transactions - appellant were directed to contribute to the liquidation estate of the CD - complete ignorance of fact that due diligence has been exercised by the appellants - NCLT failed to consider that the commercial decision taken by the appellants with regard to purchase of shares - HELD THAT:- It appears to be an admitted situation that the appellants who are suspended director of the CD were involved in the business of financial intermediation and it was their core business and the sole defence of the appellants is that the decision to purchase the shares of these two companies which were admittedly not being traded at that point of time was a commercial decision, taken for the reason that it was expected that in future the shares of these companies may be listed and may be transacted at the stock exchange and thereafter a high value may be fetched by selling them. When the total debt owed to unsecured financial creditors was to the tune of Rs. 41,00,000/- (approximately) it may not be presumed that in order to deceive the creditors of this small amount the impugned transactions might have been undertaken. It is also evident that the appellants have categorically stated that the shares purchased by them were fetching a value of Rs. 15,00,000/- during CIRP, even when the CD was in CIRP and this fact has not been denied by the Respondent. To attract Section 66 though the standard of proof would be of preponderance of probability but the same is subjected to the heavy proof to the applicant, as each and every commercial transaction which has resulted in ‘loss’ may not be labelled as fraudulent. That is why under Section 66 (2) it is provided that the directors of the CD or partner must know or ought to have known that there is no reasonable prospect of avoiding the commencement of corporate insolvency resolution process and simultaneously another condition is added by putting the word “and” that such director or partner did not exercise due diligence in minimizing the potential loss to the creditors - non-exercise of due diligence alone may perhaps be not sufficient to label a transaction as fraudulent in order to attract sub-section 2 of section 66 of the Code. The Tribunal has not correctly appreciated the facts of the instant case and only on the basis of the transactional audit report which may not be termed as a conclusive piece of evidence, has arrived at an erroneous conclusion that impugned transactions made by the appellant at the relevant point of time were fraudulent without adverting to see the impugned transactions in the broad spectrum of commercial wisdom. The impugned order passed by the tribunal is hereby set aside - Appeal allowed. 1. ISSUES PRESENTED AND CONSIDERED 1.1 Whether the impugned share purchase transactions constituted 'fraudulent trading' or 'wrongful trading' within the meaning of Section 66 of the Insolvency and Bankruptcy Code, 2016. 1.2 Whether the statutory ingredients of Section 66(2) - knowledge of inevitable insolvency and lack of due diligence in minimising potential loss to creditors - were established on the material relied upon, particularly the transaction audit report. 1.3 Whether a commercial investment decision by directors, which subsequently results in loss or reduced value, can by itself justify a direction to contribute to the assets of the corporate debtor under Section 66 of the Insolvency and Bankruptcy Code, 2016. 2. ISSUE-WISE DETAILED ANALYSIS Issue 1 - Characterisation of the impugned transactions under Section 66 of the Insolvency and Bankruptcy Code, 2016 Legal framework 2.1 The Court reproduced and analysed Section 66 of the Insolvency and Bankruptcy Code, 2016, emphasising: (a) Under Section 66(1), liability arises if the business of the corporate debtor is carried on 'with intent to defraud creditors' or 'for any fraudulent purpose'. (b) Under Section 66(2), a director is liable to contribute if, before the insolvency commencement date: (i) the director knew or ought to have known that there was no reasonable prospect of avoiding the commencement of corporate insolvency resolution process; and (ii) such director did not exercise due diligence in minimising potential loss to creditors. (c) The explanation deems due diligence to be exercised if such diligence was reasonably expected of a person carrying out the same functions. 2.2 The Court referred to prior appellate decisions interpreting Section 66, noting in particular: (a) Fraudulent trading requires a 'very high degree of proof' tied to fraudulent intent, to be established on a preponderance of probability with compelling material. (b) Bona fide belief of directors that the company would recover from financial difficulty may negate fraudulent trading. (c) 'Dishonesty' is an essential ingredient of fraudulent trading and cannot be inferred lightly; the intent to defraud is to be judged by its effect. (d) For Section 66(2), there must be proof that directors continued business despite knowing likely insolvency, and that they failed to exercise due diligence to minimise loss to creditors. Interpretation and reasoning 2.3 The impugned transactions related to purchase of equity shares of two companies whose shares were not actively traded at the time of purchase, and which were acquired from one of the unsecured creditors. 2.4 The adjudicating authority had inferred fraud primarily because: (a) The shares were non-traded/unlisted when purchased; and (b) The application for commencement of CIRP was filed within seven months of these purchases; and (c) It concluded that investment in non-traded shares created illiquidity and indicated lack of due diligence. 2.5 The Court examined the financial position and creditor structure as reflected in the minutes of the stakeholders' consultation committee. The total admitted unsecured financial debt was approximately Rs. 41 lakhs, out of which Rs. 15,27,161/- stood in the name of the same entity from whom the shares were purchased. 2.6 The Court noted that the share purchase transactions were done with one of the unsecured creditors, and only part consideration of Rs. 15 lakhs out of Rs. 28.50 lakhs was paid. It held that such a structure, involving a creditor as seller and partial payment, 'excludes the possibility' of the transactions having been undertaken to the detriment of creditors as a class. 2.7 The Court further noted that the shares continued as assets of the corporate debtor, and that during CIRP/liquidation an offer of Rs. 15 lakhs was received for these shares. This indicated that: (a) The investment remained an asset and was not rendered worthless; and (b) At least the amount actually paid (Rs. 15 lakhs) could be substantially recovered, negating any clear loss to the corporate debtor on these transactions. 2.8 The Court emphasised that to brand the transactions as fraudulent under Section 66, it must be shown that: (a) The business of the corporate debtor was carried on with intent to defraud creditors or for a fraudulent purpose; and (b) Before the insolvency commencement date the directors knew or ought to have known that there was no reasonable prospect of avoiding CIRP; and (c) They did not exercise due diligence in minimising potential loss to creditors. 2.9 On the facts, the Court found no direct evidence that, at the time of purchasing the shares, the directors knew that the commencement of CIRP was inevitable or that the transactions were structured to defeat creditors' interests. The proximity of the purchase dates to the CIRP filing, by itself, was held insufficient to infer fraudulent intent or knowledge. Conclusions 2.10 The impugned share purchase transactions did not satisfy the legal requirements of 'fraudulent trading' under Section 66(1) or 'wrongful trading' under Section 66(2). The necessary elements of intent to defraud and knowledge of unavoidable insolvency, coupled with lack of due diligence, were not established. Issue 2 - Standard of proof, role of the transaction audit report, and satisfaction of Section 66(2) requirements Legal framework 2.11 Relying on prior appellate precedent, the Court reiterated: (a) Fraudulent trading under Section 66 requires a high standard of proof, though on a civil standard of preponderance of probabilities. (b) Material relied upon must be compelling enough to satisfy the adjudicatory conscience. (c) Section 66(1) and Section 66(2) operate in distinct fields, and the specific ingredients of each must independently be pleaded and proved. 2.12 Under Section 66(2), both conditions in clauses (a) and (b) are conjunctive and must co-exist: knowledge (or deemed knowledge) of no reasonable prospect of avoiding CIRP, and failure to exercise due diligence in minimising potential loss to creditors. Interpretation and reasoning 2.13 The adjudicating authority had principally relied upon the transaction audit report to infer absence of due diligence and to draw an adverse conclusion under Section 66. 2.14 The Court observed that the transaction audit report recorded, inter alia, that: (a) The shares purchased were not actively traded, with last trade dates several years prior to purchase. (b) No demat account was used, and no sale/purchase agreement or valuation report was furnished. (c) These two scrips constituted the only stock-in-trade investments of the corporate debtor. (d) No documented due diligence or valuation was carried out prior to investment. 2.15 The Court held that such observations, even if accepted, go only to the question of quality of commercial judgment or procedural diligence, but do not by themselves demonstrate: (a) Fraudulent intent to defraud creditors; or (b) Conscious knowledge that CIRP was unavoidable at the time of the transactions; or (c) Any concrete, quantified loss to the creditors resulting from the transactions, particularly when the investment remained an asset capable of realisation. 2.16 The Court expressly held that: (a) A transaction audit report is not a 'conclusive piece of evidence'; and (b) The adjudicating authority erred in treating the audit findings as sufficient, without examining the broader commercial context and without corroborative material establishing the core ingredients of Section 66. 2.17 The Court underscored that non-exercise or imperfect exercise of due diligence alone 'may perhaps be not sufficient' to label a transaction as fraudulent under Section 66(2). The statutory scheme requires both knowledge of inevitable CIRP and lack of due diligence in minimising loss; absence of either is fatal to the claim. 2.18 Examining the surrounding circumstances, including: (a) The limited overall unsecured debt (about Rs. 41 lakhs); (b) The fact that the seller of the shares was itself an unsecured creditor of the corporate debtor; (c) The partial payment of consideration (Rs. 15 lakhs paid out of Rs. 28.50 lakhs); (d) The continuing value of the shares and the offer of Rs. 15 lakhs received during CIRP/liquidation; the Court found that there was no demonstrable diversion or depletion of assets designed to prejudice creditors. Conclusions 2.19 The material placed on record, including the transaction audit report, did not meet the high standard required to prove fraudulent or wrongful trading under Section 66. 2.20 The essential conjunctive requirements under Section 66(2)(a) and (b) - knowledge of no reasonable prospect of avoiding CIRP and failure to exercise due diligence in minimising creditor loss - were not established against the directors. 2.21 The adjudicating authority erred in relying solely and conclusively on the transaction audit report, without proper examination of commercial context and without additional substantive evidence of fraudulent intent or wrongful trading. Issue 3 - Treatment of commercial decisions and business risk under Section 66 Interpretation and reasoning 2.22 The Court accepted that the corporate debtor was engaged in financial intermediation as its core business and that the impugned transactions were investment decisions taken in that context. 2.23 It noted the directors' explanation that the shares were purchased in the expectation that the companies would regularise compliances, be actively traded, and yield appreciation, and that there are instances of delisted companies being relisted and generating high returns. 2.24 The Court reiterated, in line with earlier appellate authority, that: (a) Not every commercial decision resulting in loss is fraudulent; (b) Business necessarily entails risk; and (c) Each commercial transaction that leads to loss cannot automatically be labelled as fraudulent or as undertaken to deceive creditors. 2.25 It found that in the instant matter, the investment in shares: (a) Remained on the balance sheet as the sole asset of the corporate debtor; (b) Attracted an offer of Rs. 15 lakhs during CIRP/liquidation; and (c) Therefore could not be said to have caused a loss to the corporate debtor or its creditors in the requisite sense under Section 66. 2.26 The Court considered the fact that had the directors' intent been to defraud, they might have structured the transaction differently (for example, by fully paying and siphoning out the full purchase value), whereas here only part payment was made and the asset remained with the corporate debtor. Conclusions 2.27 A bona fide commercial decision involving investment risk, even if it results in loss or reduced value, does not by itself attract Section 66 in the absence of demonstrated fraudulent intent, knowledge of unavoidable insolvency, and lack of due diligence aimed at minimising loss. 2.28 The impugned investments were commercial decisions which, viewed in the 'broad spectrum of commercial wisdom', could not be treated as fraudulent or wrongful trading so as to justify a contribution order under Section 66. 2.29 Consequently, the direction to contribute Rs. 28,50,000/- to the liquidation estate was unsustainable, and the impugned order was set aside.