Inventory write-off in insolvency: fraudulent and wrongful trading standards require proof of dishonest intent before contribution ordered

Clarifies standards for treating inventory write-offs as fraudulent or wrongful trading: for liability under Section 66(1) the transaction must be knowingly executed with dishonest intent to defraud creditors, and for wrongful trading liability only directors/partners can be fixed if they knew or ought to have concluded there was no reasonable prospect of avoiding insolvency and failed to take due diligence to minimize creditor loss; such findings must be proved on a preponderance of probability based on transaction audit, stock records, and unit visit evidence, with paper write-offs unsupported by physical stock susceptible to being treated as conduit for contribution to corporate assets.

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Issues: Whether the appellant, as promoter/director of the corporate debtor, is liable under Section 66 of the Insolvency and Bankruptcy Code, 2016 to contribute Rs. 6,56,25,806/- to the assets of the corporate debtor for alleged writing off of inventory as a fraudulent transaction.

Analysis: The application before the Adjudicating Authority alleged that inventory amounting to Rs. 6,56,25,806/- was written off in the books of the corporate debtor without corresponding physical stock, that the write-off constituted an extraordinary item not properly disclosed, and that the amount represented an inflation/misreporting of closing stock benefiting related parties and management. Transaction auditor reports, unit visit reports and stock audit reports recorded discrepancies between book records and physical verification, absence of supporting stock documentation, and material reduction in reported stock without explanatory notes in the financial statements. Financial data showed large inventory carried forward despite classification as NPA and limited purchases, undermining the defence that stock perished due to inability to execute exports. The Adjudicating Authority applied Section 66 and concluded the business was carried on with intent to defraud creditors, directing contribution. The Tribunal reviewed statutory distinctions between Section 66(1) (fraudulent trading) and Section 66(2) (wrongful trading), considered precedents on elements required to establish fraudulent purpose, and evaluated the documentary evidence and absence of acceptable explanation from the appellant. On the record and on the balance of probabilities, the facts supported the inference that the write-off served to wash non-existent inventory and was undertaken with a fraudulent purpose.

Conclusion: The appellant is liable under Section 66 of the Insolvency and Bankruptcy Code, 2016 to contribute Rs. 6,56,25,806/- to the corporate debtor. The appeal is dismissed and the order of the Adjudicating Authority directing contribution is upheld.

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