Fraudulent trading under Section 66 IBC: ex-directors ordered to repay siphoned funds; no look-back shield

NCLAT upheld the NCLT's finding that the erstwhile directors of the corporate debtor engaged in fraudulent trading under section 66 of the IBC. The tribunal held that the MOU for sale of assets, under which 98.997% of consideration was paid with deliberate structuring of dates and payment terms, was designed to enable forfeiture and siphoning of funds from the corporate debtor, rendering the MOU fraudulent and void ab initio. NCLAT clarified that there is no statutory look-back period for fraudulent transactions and that once fraud is established, timing is irrelevant. Finding no merit in the directors' objections, NCLAT affirmed the direction requiring them to contribute Rs. 36.53 crore to the assets of the corporate debtor and dismissed the appeal.

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1. ISSUES PRESENTED AND CONSIDERED

(1) Whether Section 66(1) and Section 66(2) of the Insolvency and Bankruptcy Code operate independently, and what is the scope of jurisdiction of the Adjudicating Authority and the Appellate Tribunal under Section 66 in relation to fraudulent/wrongful trading.

(2) Whether, in proceedings under Section 66, the Adjudicating Authority/Tribunal can examine the validity of the Memorandum of Understanding relating to acquisition of the Mafatlal receivable, treat it as void ab initio/fraudulent, and ignore it without recourse to a civil court.

(3) Whether the transaction involving the Corporate Debtor's acquisition of the Mafatlal debt through the MOU, and the related payments to the assignee, constituted business carried on with "intent to defraud creditors or for any fraudulent purpose" within the meaning of Section 66(1).

(4) Whether the absence of a statutory look-back period, the long time gap between the impugned transaction (2011-2014) and commencement of CIRP (2019), and the fact that the Code was not then in force, precluded action under Section 66(1).

(5) Whether, on the facts proved, the direction to the erstwhile directors to contribute Rs. 36.53 crores to the assets of the Corporate Debtor under Section 66(1) was legally sustainable, or the dispute was merely a contractual/civil dispute outside insolvency jurisdiction.

2. ISSUE-WISE DETAILED ANALYSIS

Issue (1): Operation and scope of Section 66(1) and 66(2) IBC

Legal framework (as discussed)

(a) The Tribunal referred to its prior decisions clarifying that Section 66(1) and Section 66(2) are "self-contained provisions" and operate independently, each with its own ingredients and mechanism for invocation during CIRP.

(b) Section 66(1) is broad, enabling orders against "any person" knowingly party to carrying on the business of the Corporate Debtor with intent to defraud creditors or for any fraudulent purpose.

(c) Section 66(2) is narrower, dealing specifically with directors/partners where, before the insolvency commencement date, they knew or ought to have known that insolvency was unavoidable and failed to exercise due diligence to minimise loss to creditors.

(d) Prior appellate and other decisions were cited to emphasise: (i) the need to establish "dishonest intention" and fraudulent conduct by adequate material (preponderance of probability but with heavy onus on the applicant); and (ii) that not every loss-making commercial transaction is fraudulent.

Interpretation and reasoning

(e) The Tribunal adopted the view that Section 66(1) and 66(2) "operate in a different arena"; Section 66(1) does not depend on the pre-insolvency foreseeability test embedded in Section 66(2), and can be applied where the business of the Corporate Debtor has been carried on for a fraudulent purpose even if insolvency was not then in contemplation.

(f) Relying on earlier appellate precedents, the Tribunal held that the applicant under Section 66 bears a heavy evidentiary burden to establish fraud, but such proof can be drawn from circumstantial evidence and attending facts; once the applicant discharges the initial onus, the burden shifts to the opposing party.

(g) The Tribunal also relied on the Supreme Court's exposition that Section 66 does not itself confer power to "avoid or set aside" transactions, but empowers the Adjudicating Authority, upon finding fraudulent or wrongful trading, to direct persons involved to make contribution to the assets of the Corporate Debtor.

Conclusions

(h) Section 66(1) and Section 66(2) are independent; Section 66(1) is wide and applies to "any person" involved in fraudulent carrying on of business, whereas Section 66(2) specifically targets directors/partners in the twilight of insolvency.

(i) In the present case, action and contribution directions rest on Section 66(1), not on Section 66(2), and the standard of proof is preponderance of probability, subject to a heavy onus to establish fraudulent intent, which the Tribunal found to be satisfied.

Issue (2): Power under Section 66 to examine and ignore the MOU as void ab initio / fraudulent

Legal framework (as discussed)

(a) The Tribunal examined decisions holding that Section 66(1) confers no jurisdiction to "declare any transaction as void" but only to fix personal liability for fraudulent or wrongful business, and that ordinarily, questions of setting aside or declaring documents void fall within civil courts, unless otherwise provided.

(b) The Tribunal also considered Supreme Court and High Court authority distinguishing between: (i) a voidable document, which requires a decree for cancellation; and (ii) a document void ab initio, which is non est in law and can be treated as a nullity without a formal decree.

(c) The Tribunal relied on a Supreme Court decision affirming that company law/NCLT fora have wide jurisdiction to decide issues integral or incidental to allegations before them, including questions of validity of instruments that lie at the "core" of the dispute, subject to no express statutory bar.

Interpretation and reasoning

(d) The Tribunal accepted the proposition that Section 66(1) does not, by its text, authorise the NCLT to formally "declare" a transaction void; its remedial focus is on contribution to the corporate debtor's assets. However, it drew a crucial distinction: where a document is fraudulent and void ab initio, it is, in law, a nullity and need not be set aside by any court; it may simply be ignored.

(e) The Tribunal held that in this case the validity and nature of the MOU was itself central to the Section 66 inquiry-whether the business of the Corporate Debtor was carried on with fraudulent intent. Therefore, the NCLT was bound to examine the MOU, assess whether it was per se fraudulent, and treat it accordingly.

(f) Applying the doctrine of void versus voidable transactions, the Tribunal reasoned that once the MOU is found to be a fraudulent device, void ab initio, it is non-existent in the eyes of law and may justifiably be ignored by the NCLT in deciding liability under Section 66(1), without requiring recourse to a civil court.

Conclusions

(g) While Section 66(1) does not confer a general power to decree avoidance or cancellation of contracts, the Adjudicating Authority is competent, in a Section 66 proceeding, to examine the impugned MOU which is central to the fraud allegation.

(h) On the Tribunal's findings that the MOU was per se fraudulent and void ab initio, it was non est, and the NCLT rightly ignored it for the purpose of fixing contribution under Section 66(1); there was no jurisdictional error in not relegating the matter to a civil court for cancellation.

Issue (3): Whether the Mafatlal receivable acquisition transaction amounted to fraudulent trading under Section 66(1)

Interpretation and reasoning

(a) Undisputed facts were summarised:

* A receivable owed by Mafatlal Engineering (already under court liquidation) with principal Rs. 15.34 crores (with 12% interest) was assigned by the bank to the assignee on 29.11.2011.

* The Official Liquidator of Mafatlal admitted a claim of approximately Rs. 16.68 crores against Mafatlal in favour of the assignee.

* On 17.12.2011, the assignee entered into the MOU with the Corporate Debtor to assign the same receivable for a much higher consideration of Rs. 36.90 crores, with 99% to be paid by 28.11.2011 and the remaining 1% by 30.06.2013 (extendable to 30.06.2014).

* By 28.11.2011, i.e. before (i) execution of the MOU (17.12.2011) and (ii) completion of the bank's assignment to the assignee (29.11.2011), the Corporate Debtor had already paid Rs. 36.53 crores (98.997% of the agreed MOU consideration).

* After 28.11.2011, the Corporate Debtor continued to pay and, by 07.01.2014, had paid a total of Rs. 38.19 crores to the assignee, i.e. over and above the MOU consideration.

* The MOU contained a clause that in the event of default in making payment as per the schedule, the purchaser would get 10 days' grace; failing payment, the amounts already paid would stand forfeited and the MOU cancelled.

(b) The Tribunal identified several circumstances indicating fraudulent design rather than bona fide commercial misjudgment:

* Gross overvaluation and commercial inexplicability: The receivable admitted by the Official Liquidator at around Rs. 16.68 crores was being acquired by the Corporate Debtor at Rs. 36.90 crores-more than double-without any rational explanation, notwithstanding that Mafatlal was in liquidation and that the Corporate Debtor was a real estate company, not a financial asset investor. This was held to be "against all commercial wisdom and common sense".

* Pre-dated payment schedule and acquisition: The MOU (executed on 17.12.2011) stipulated that 99% of the consideration be paid by 28.11.2011, a date prior to the assignee's own acquisition (29.11.2011) and even prior to the MOU itself. The Corporate Debtor had in fact paid 98.997% by that date. The Tribunal found this deliberate structuring-requiring payment before the seller had title and before contract execution-highly suspicious.

* Engineered default and forfeiture: On the MOU's own terms, the Corporate Debtor was in "default" of the 99% requirement on the date of MOU execution because only 98.997% had been paid. The Tribunal reasoned that by fixing the threshold at 99% and ensuring payment fell marginally short, default and consequent forfeiture were intentionally built into the contract.

* Continuation of payments post-default: Despite the alleged default and forfeiture, the Corporate Debtor continued paying till 2014-ultimately more than the total MOU consideration-without ever securing execution of the actual assignment deed. The Tribunal considered this continued outflow, coupled with non-enforcement of rights, as inconsistent with bona fide conduct and indicative of a conscious design to move funds out of the Corporate Debtor.

* Unusual expense/consultancy set-offs: The assignee claimed large amounts towards handling, consultancy and other expenses, set off against the Corporate Debtor's payments, and appropriated sums received from the Mafatlal Official Liquidator, all without transparent commercial rationale. The Tribunal viewed the "expenses" and "no recourse & forfeiture" clauses as deliberately introduced to facilitate siphoning and protect the beneficiaries.

* Lack of effort to protect the Corporate Debtor's interest: The erstwhile directors never took steps to insist on execution of the assignment deed or contest the forfeiture or recovery of excess amounts, even over a prolonged period, which the Tribunal considered inconsistent with the fiduciary duty owed to creditors and supportive of fraudulent intent.

(c) On cumulative assessment of the above, the Tribunal held that:

* The transaction structure (overvaluation, back-dated payment schedule, forfeiture mechanism), timing (payments preceding seller's own acquisition), and conduct (continued payment, non-enforcement of rights, opaque expense claims) indicated that the business of the Corporate Debtor was being carried on not as a normal investment, but as a mechanism to divert and siphon funds.

* These facts, taken together, were more than sufficient circumstantial evidence that the appellants carried on the business of the Corporate Debtor with "intent to defraud creditors" and "for a fraudulent purpose" within Section 66(1).

Conclusions

(d) The transaction concerning the purported acquisition of the Mafatlal debt was held to be a fraudulent device, not an ordinary or bona fide commercial transaction.

(e) The business of the Corporate Debtor, in entering into and acting upon the MOU, was carried on by the erstwhile directors with the intent to defraud creditors, satisfying the ingredients of Section 66(1) IBC.

Issue (4): Effect of time gap, pre-IBC conduct, and absence of look-back period on Section 66(1) jurisdiction

Interpretation and reasoning

(a) It was argued that since the impugned transactions occurred in 2011-2014, long before CIRP in 2019 and before the Code commenced, the directors could not have contemplated insolvency, and Section 66(2)-type considerations should preclude liability.

(b) The Tribunal distinguished between Section 66(1) and Section 66(2): the former is not conditioned on the "twilight of insolvency" test or any fixed look-back period; it focuses on whether, in fact, the business was carried on with fraudulent intent.

(c) The Tribunal observed that the legislature, "consciously, has not provided any look back period for fraudulent transactions" under Section 66(1). To read in a temporal bar or implied limitation period would amount to judicially supplementing the statute, contrary to legislative intent.

(d) The mere lapse of time or the fact that the Corporate Debtor was then a going concern was held irrelevant where the transaction itself is found to be fraudulent. The Tribunal emphasised that once fraud is established within Section 66(1), "the time gap between the transaction and CIRP, in our understanding is meaningless".

Conclusions

(e) The absence of a statutory look-back period under Section 66(1) means that fraudulently carried on business can be examined irrespective of when, in relation to CIRP, the transaction occurred.

(f) The fact that the impugned MOU and payments pre-dated both CIRP and even the Code's enactment did not bar proceedings or relief under Section 66(1), once the transaction was found to be fraudulent.

Issue (5): Justification for directing contribution by erstwhile directors; characterization as insolvency vs. civil/contractual dispute

Interpretation and reasoning

(a) The appellants contended that the dispute was purely contractual-concerning performance, forfeiture, alleged excess payment, and specific performance/refund under the MOU-and thus belonged to civil courts; further, they asserted there was no material of fraudulent intent or mens rea; and some appellants claimed no involvement.

(b) The Tribunal, having already held the transaction to be per se fraudulent under Section 66(1), rejected the characterisation of the matter as a mere civil/contractual dispute. It held that insolvency fora are competent to address fraudulent trading and protect the estate, even if the same facts might also support civil remedies.

(c) The Tribunal underscored that:

* The directors were in office during the relevant period and responsible for the impugned decisions.

* They permitted large outflows (Rs. 38.19 crores) for acquisition of an asset worth only about Rs. 16.68 crores, in a business area outside the Corporate Debtor's ordinary course, under a contract deliberately structured to allow forfeiture.

* They made no real efforts for nearly a decade to enforce the supposed rights under the MOU (assignment deed, reversal of forfeiture, recovery of excess amounts), nor to challenge the assignee's stance.

* The directors' inaction in the face of obvious red flags, and their failure to safeguard the Corporate Debtor's and creditors' interests, supported an inference of participation in carrying on business for a fraudulent purpose.

(d) In light of the fraudulent nature of the transaction and the direct depletion of the Corporate Debtor's estate, the Tribunal considered that the requirement under Section 66(1)-that persons "knowingly" parties to the fraudulent carrying on of the business may be directed to contribute-was satisfied with respect to the erstwhile directors.

(e) The Tribunal also observed that where a transaction has been proved fraudulent, "it could not be exonerated on technical issues or minor irregularities committed by the adjudicating authority", given the impact of such fraud on the Corporate Debtor, stakeholders and the broader economy.

Conclusions

(f) The matter was not a mere contractual dispute but a case of fraudulent carrying on of business under Section 66(1); insolvency jurisdiction was properly invoked and exercised.

(g) On the established facts and circumstances, the direction to the erstwhile directors to contribute Rs. 36.53 crores to the assets of the Corporate Debtor under Section 66(1) was upheld as lawful and justified.

(h) The appeal was dismissed, and the Tribunal declined to interfere with the order of contribution passed by the Adjudicating Authority.

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