Fraudulent trading under section 542 requires proof of intent, knowing participation, and quantified liabilities before personal fastening.
Section 542 of the Companies Act, 1956 applies in winding up where business was carried on with intent to defraud creditors or for a fraudulent purpose, and pre-1956 conduct may be used as factual material without making the provision retrospective. Proof that directors knowingly participated in concealment of defalcations, falsification of accounts, misleading entries, ratified fictitious advances, and fraudulent preference can attract liability, but the court must still determine the company's total debts or liabilities before fastening personal liability. Death of a respondent after hearing and reservation of judgment did not abate the proceedings, as judgment could still be pronounced under Order 22 Rule 6 CPC. The adverse observations on account books were not interfered with.
Issues: (i) Whether the directors were liable under section 542 of the Companies Act, 1956 for carrying on the bank's business with intent to defraud creditors or for a fraudulent purpose and whether the earlier transactions could be relied on after the section came into force; (ii) whether the proceedings against a deceased respondent abated or the appeal could still be decided; (iii) whether the adverse observations made against the Sales Tax Officer in relation to the account books were justified.
Issue (i): Whether the directors were liable under section 542 of the Companies Act, 1956 for carrying on the bank's business with intent to defraud creditors or for a fraudulent purpose and whether the earlier transactions could be relied on after the section came into force.
Analysis: Section 542 was held to apply where, in the course of winding up, it appears that the business had been carried on with the requisite fraudulent intent or purpose. Reliance on pre-April 1956 conduct did not amount to giving the section retrospective operation because earlier acts were only the factual basis for a later winding-up proceeding. On the evidence, the directors were found to have knowledge of the defalcations and falsification of accounts at least by the last Friday of July 1955, to have participated in covering up the misappropriations, to have ratified fictitious advances without scrutiny, to have caused or approved misleading accounts and canvassing of deposits, and to have been parties to fraudulent preference in two items. However, the appellate court held that the evidence and pleadings were insufficient to quantify the entire debts or liabilities of the company for which liability should be fixed under the section.
Conclusion: The directors were held liable for fraudulent trading and for the specific heads of claim found proved, but the decree fixing the full liability was set aside and the matter was remitted for determination of the total debts or liabilities and the extent of liability to be fastened on the directors.
Issue (ii): Whether the proceedings against a deceased respondent abated or the appeal could still be decided.
Analysis: Proceedings under the relevant company law provisions may abate where death occurs before crystallisation into an order, but once an order or decree has been passed, the liability does not automatically stand vacated. Where death occurs after the hearing is concluded and judgment is reserved, Order 22, Rule 6 of the Code of Civil Procedure applies and judgment may be pronounced notwithstanding the death, with full effect as if pronounced earlier. That rule was held applicable to the company proceedings.
Conclusion: The proceedings did not abate on the respondent's death and the appeal was maintainable to that extent.
Issue (iii): Whether the adverse observations made against the Sales Tax Officer in relation to the account books were justified.
Analysis: The court examined the two account books and the placement of the seal, writing and signature, and found no reason to reject the trial judge's inference that the endorsement in one of the books was subsequently inserted and that the same seal and signature appeared in the other book. The officer had only been issued a show-cause notice and would have an opportunity to explain the matter before the Government.
Conclusion: The appeal by the Sales Tax Officer was dismissed.
Final Conclusion: The principal decree against the directors was not allowed to stand in its quantified form and was remitted for fresh determination of the extent of liability, while the respondent's death did not cause abatement and the separate appeal against the observations on the account books failed.
Ratio Decidendi: For section 542 liability, proof that the company's business was carried on with fraudulent intent or purpose and that the respondents knowingly participated in that course of conduct is sufficient, but the court must also determine with evidence the total debts or liabilities and the extent to which they are properly attributable to that fraudulent trading before fixing personal liability.
TaxTMI 
AI Drafter ✕
TaxTMI 
