2026 (1) TMI 1356 - AT - IBC

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 ... Fraudulent trading / Wrongful trading - Intent to defraud creditors - Write-off of inventory as extraordinary item and misstatement of closing stock - Transaction audit and unit visit/stock audit reports - Adjudicating Authority's power to order contribution to corporate debtor's assets - Resolution Professional's application under Chapter VI - National Company Law Appellate Tribunal (NCLAT) / National Company Law Tribunal (NCLT) - Whether the writing off of inventory in the books of the corporate debtor amounted to carrying on business with an intent to defraud creditors and justified an order under Section 66 directing the promoter-director to contribute to the corporate debtor's assets - HELD THAT:- To qualify under Section 66(1) of IBC, 2016, the transaction should be knowingly transacted with a dishonest intention to defraud the creditors of the CD, while under Section 66(2) of IBC, 2016, which deals with ‘Wrongful Trading’, Liability can only be fixed upon only ‘Director’ or ‘Partner’ and for a transaction to qualify under this Sub Section it must be shown that the parties to such transaction knew, or ought to have concluded that there was no reasonable prospect of avoiding insolvency proceedings and they did not take due diligence with a view to minimizing the potential loss to the creditors of the company. The facts alleged and evidence produced must satisfy the ingredients of this section and the facts from which the intention to defraud may be deduced must be proved to satisfy the conscience of the ‘Tribunal’ on the scale of ‘preponderance of probability’. However, it will depend on the facts and evidence of each case to asses as to whether the particular transaction may be treated as fraudulent or not. It is to be recalled that the CIRP of the CD was initiated vide order of Ld. Tribunal dated 10.06.2022. The transaction auditor has also noticed in its report that there was difference between sales reported in financial statement and sales reported in GST Returns and without approval of the board the appellant has paid the liabilities of the company and so far as the impugned transaction is concerned it was categorically reported by the transaction auditor that as per the audited financial statements for financial year 2019-2020 there was a reduction in stock in trade and there is no separate note regarding the reason for reduction of such stock in the financial statements and also that the same was not matching with the stock records maintained in tally. The defense which has been taken by the appellant is that to fulfill an export order, huge procurement of huge amount of cashew seed was done and as the funds were not given by the banks, the export assignment could not be fulfilled and also that the processed and non- processes cashew seeds were kept lying in the stock for a long time and keeping in view the low shelf life of these seeds and of no maintenance during the covid period and lockdown imposed, the seeds become useless and was written off. Keeping in view the documentary evidence available on record and lack of any acceptable explanation from the appellant with regard to the writing off of the inventory amount, we do not want to take any other view then taken by Ld. Adjudicating authority which appears to be legally and factually sound and it is established that the writing off of the inventory in the books of account of the CD was only for the purpose of cleaning of the books of accounts of the CD to wash a non-existent inventory meaning thereby no cashew seed or cashew was purchased and it was only a paper work which is also substantiated by the evidence mentioned by the transaction auditor to the effect that during the unit visit of the bank officials no such inventory was ever found at the plant of the CD. In view of above the appeal is devoid of merits and is dismissed as such there is no order with regard to the costs. 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.