The National Company Law Appellate Tribunal, New Delhi (“NCLAT”) has, in its judgement dated March 29, 2023 (“Judgement”), in the matter of Shri Baiju Trading and Investment Private Limited v. Mr. Arihant Nenawati and Others [Company Appeal (AT)(Ins.) No. 699 of 2021], held that ‘fraud’ for the purpose of Section 66 (Fraudulent trading or wrongful trading) of the Insolvency and Bankruptcy Code, 2016 (“IBC”) would include debts which the debtor has no intention to repay or does not expect to be able to pay.

Facts

Royal Refinery Private Limited (“Corporate Debtor”) was engaged in the business of trading in bullions, that is, import and export of gold and selling/ purchasing of gold in local markets. Raksha Bullion, a company that was doing business with the Corporate Debtor filed an application under Section 9 (Application for initiation of corporate insolvency resolution process by operational creditor) of the IBC owing to the Corporate Debtor’s default in payment of INR 4,90,01,183/- to Raksha Bullion. The National Company Law Tribunal, Mumbai (“NCLT”) by way of its order dated November 13, 2019, initiated corporate insolvency resolution process (“CIRP”) against the Corporate Debtor.

Shri Baiju Trading and Investment Private Limited (“Appellant”) engaged in the business of non-banking financial services, had taken financial assistance of INR 41.03 Crores from the Corporate Debtor to overcome financial distress. The amount owed by the Appellant to the Corporate Debtor remained unpaid for over a year prior to commencement of CIRP against the Corporate Debtor and was subsequently written off from the books of accounts of the Corporate Debtor by the erstwhile directors of the Corporate Debtor; namely Mr. Vishal Choudhary (“Respondent No. 2”) and Mr. Gaurav D. Panwar (“Respondent No. 3”).

Mr. Nandkishor Vishnupant Deshpande, the resolution professional of the Corporate Debtor (“RP”), filed an application before the NCLT under Section 66 of the IBC read with Section 26 (Application for avoidance of transactions not to affect proceedings) of the IBC, alleging a fraudulent transaction between the Appellant and the Corporate Debtor involving the said amount of INR 41.03 Crores (“Application”). In this Application, the RP, amongst other things, pleaded the NCLT to direct the Appellant, Respondent No. 2 and Respondent No. 3 to make contributions to the assets of the Corporate Debtor. The NCLT by way of its order dated January 29, 2021 (“Impugned Order”) allowed this Application and observed that the Appellant was the sole beneficiary of the fraudulent transaction.

Aggrieved by the Impugned Order, the Appellant filed the present appeal under Section 61 (Appeals and Appellate Authority) of the IBC (“Appeal”).

The NCLT had also passed an order dated April 16, 2021, for liquidation of the Corporate Debtor, wherein Mr. Arihant Nenawati was appointed as the liquidator of the Corporate Debtor. In light of the said liquidation order passed by the NCLT, the RP of the Corporate Debtor had become ‘functus officio’, that is, his agency to serve as the RP of the Corporate Debtor had expired. Therefore, the NCLT by way of an order dated September 8, 2021, held that the appointed liquidator of the Corporate Debtor namely Mr. Arihant Nenawati (“Respondent No. 1”) be substituted and impleaded in the Appeal, as ‘Respondent No. 1’, in place of the RP.

Issue

Whether ‘fraud’ for the purpose of Section 66 of the IBC would consist of debts which the debtor has no intention to repay or does not expect to be able to pay.

Arguments

Contentions of the Appellant:

The Appellant contended that the Application was without any substance and that the NCLT had placed the Appellant in jeopardy by allowing such Application. The Appellant submitted that the Respondent No. 1 had failed to submit any supporting documentary evidence before the NCLT, which would establish that the transaction between the Appellant and the Corporate Debtor was fraudulent in nature. The Respondent No. 1 did not even support his claims by way of any additional evidence or investigation report like a forensic audit.

The Appellant submitted that it had availed financial assistance from the Corporate Debtor to merely overcome financial distress and that no transaction had taken place between the Appellant and the Corporate Debtor after May 16, 2018. The outstanding dues towards the Corporate Debtor were pending for more than one year, owing to the Appellant’s financial problems being aggravated by the pandemic. It was also submitted that the Appellant and the Corporate Debtor were distinct corporate entities, carrying on different businesses and had no relationship with each other. The transaction was duly reflected in the books of accounts of both the parties as a borrowing transaction and should have been treated as a normal commercial transaction without any intent to defraud the creditors of the Corporate Debtor. The Appellant contended that no case of mala fide intention or willful misconduct including collusion with the Corporate Debtor had been established by the Respondent No. 1 and therefore, the NCLT had erred in allowing the Application.

The Appellant further contended that Section 66 of the IBC provides for three milestones which were required to be met before admission of an application. First, there should have been a clear ‘opinion’ followed by suitable ‘determination’ and finally there should have been a concrete ‘finding’. These milestones had not been met and the parameters stipulated under Section 66 of the IBC were not established in the Application. Moreover, Regulation 35A (Preferential and Other Transactions) of the Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations, 2016 (“CIRP Regulations”) had not been complied with and no ‘mens-rea’ was established. Therefore, the Impugned Order passed by the NCLT was illegal. In order to support its arguments, the Appellant relied on the judgements of Svenska Handels Bunken v. Indian Charge Chrome and Others [(1994) 1 SCC 504] and Anil Rishi v. Gurbaksh Singh [(2006) SCC 558] wherein the Hon’ble Supreme Court of India held that allegations of fraud are grave in nature and cannot be made on a mere suspicion and need to be pleaded with strong evidence.

The Appellant contended that Respondent No. 1 had classified the transaction between the Appellant and the Corporate Debtor as fraudulent purely on assumption basis. Further, mere write off by the Corporate Debtor of the debt of INR 41.03 Crores from its books of accounts would not harm the Corporate Debtor in any manner and that the Corporate Deb

Contentions of the Respondent No. 1:

The Respondent No. 1 vehemently opposed all the averments made by the Appellant as misleading, mischievous, devoid of any merit and pure abuse of the process of law and submitted that the Appeal filed should be dismissed.

The Respondent No. 1 submitted that the entire money owed by the Appellant to the Corporate Debtor was written off by Respondent No. 2 and Respondent No. 3 way of a simple journal entry ‘Sundry Balances W/off’, just one month prior to the Corporate Debtor being raided by the Department of Revenue Intelligence. Respondent No. 1 submitted that this transaction was fraudulent in nature and made in connivance between the Appellant, the Respondent No. 2 and the Respondent No. 3, by manipulating ledgers of the Appellant and the Corporate Debtor, in order to reap the illegal benefits arising from the write off of INR 41.03 Crores. In Respondent No. 1’s view, the transaction was carried out with clear knowledge of all concerned and with the intent to defraud the creditors of the Corporate Debtor. Further, the alleged loan of INR 41.03 Crores was given to the Appellant even though the Corporate Debtor was merely functioning as a gold bullion trader and was not in the business of lending money. Therefore, such a huge amount should not be written off without any reasons and cannot be treated anything less than a fraudulent and sham transaction.

The Respondent No. 1 also relied on the Impugned Order wherein the NCLT held that the IBC does not require pre-existence of ‘mens rea’ in order to establish a fraudulent transaction and also denied the contention of the Appellant that Regulation 35A of the CIRP Regulations were not complied with.

The Respondent No. 1 placed reliance on Ram Preeti Yadav v. U.P. Board of High School and Intermediate Education [(2003) 8 SCC 311] (“Ram Preeti Yadav Case”), wherein the Hon’ble Supreme Court of India held that a sole beneficiary of the fraud must be presumed to be a party to the fraud.

Lastly, the Respondent No. 1 contended that the Appellant was in no position to be aggrieved by the Impugned Order which effectively directed the Appellant to make contributions of the monies owed by it towards the assets of the Corporate Debtor which would assist in the process of liquidation by increasing the pool of assets available for liquidation thereby benefitting all stakeholders of the Corporate Debtor. Hence, the Respondent No. 1 sought for dismissal of the Appeal.

Contentions of Respondent No. 2 and Respondent No. 3:

Respondent No. 2 and Respondent No. 3 submitted that all transactions taking place between the Corporate Debtor and the Appellant were official transactions and had been confirmed by both the parties. Hence, the question of such transactions being classified as fraudulent did not arise. The Application was not supported by any verifiable evidence and was based on assumptions and presumptions. They further submitted that the Appellant had informed them about its inability to refund the balance amount as it was under financial stress. Consequently, the Corporate Debtor had written off the balance in its books of accounts believing that the amount, if received in the future, will be considered as profit of the Corporate Debtor. The transaction was entered into in good faith during the ordinary course of business as evidenced by the audited financial reports of the Corporate Debtor for the financial year 2017-2018. Therefore, the said transaction would not fall within the purview of Section 66 of the IBC.

Observations of the NCLAT

The NCLAT observed that the NCLT is empowered under Section 66 of the IBC to direct a person to make contributions to the corporate debtor’s assets, in case such person has carried on the business of the corporate debtor with intention to defraud its creditors. The NCLAT interpreted that ‘fraud’ can, inter alia, consist of such debts which the debtor has no intention of paying or does not expect to be able to pay or such fraud may also happen by way of a false representation to pay back when there is no intention to do so. Furthermore, the expression ‘any person’ would include a knowing party to the carrying out of the fraudulent transaction.

The NCLAT observed that Regulation 35A of the CIRP Regulations require the resolution professional to form an opinion on whether the corporate debtor has been subjected to any transaction covered under Sections 43 (Preferential transactions and relevant time), 45 (Avoidance of undervalued transactions), 50 (Extortionate credit transactions) and 66 of the IBC and where such opinion has been formed, the resolution professional can make a determination and is subsequently required to apply to the adjudicating authority for appropriate relief. The Corporate Debtor lending an amount of INR 41.03 Crores to the Appellant and the Appellant benefitting of this amount was unusual in the eyes of the NCLAT. Further, the Corporate Debtor was in no way connected with the business of financial services or lending money. The NCLAT observed that in the gold business, it’s a standard practice for transactions and dealings to occur on spot payment basis and there is hardly any scope for lending money in such businesses. In fact, the bullion business is conducted on thin margins and the cash flow of such business is required to be maintained in order for such businesses to sustain. Furthermore, there was no reason for the Corporate Debtor to give such loan without any substance and that too without suitable incentives or returns for time value of money.

The NCLAT observed that there was no explanation as to why such a write off was necessary and what circumstances led to it. Such transactions without any security interest or bank guarantee as collateral security in favour of the Corporate Debtor and the subsequent writing off of the same can only be termed as a fraudulent transaction done with the intent to defraud the creditors of the Corporate Debtor and evidently the Appellant was the principal beneficiary of such transaction.

Decision of the NCLAT

The NCLAT agreed with the observations made by the NCLT in the Impugned Order and held that the nature of the transaction in the instant case would squarely come within the ambit of Section 66 of the IBC. The NCLAT reiterated the settled principle of law laid down in the Ram Preeti Yadav Case that a beneficiary of fraud is presumed to be a party to the fraud. Further, the NCLAT observed that the Appellant had taken contrary stands before the NCLT while explaining the nature of the transaction and opined that such contradictory statements raised doubts in the mind of the NCLAT regarding the real nature of the transaction and relationship between the Appellant and the Corporate Debtor.

Therefore, the Appeal was dismissed by the NCLAT due to being devoid of any merit.

VA View:

It is the duty of a liquidator or the resolution professional to correct and reverse any fraudulent or wrongful transaction in case it is found that any person has carried on the business of the corporate debtor with the intent to defraud its creditors.

The NCLAT, while affirming the decision given by the NCLT, held that the Appellant was the principal beneficiary of fraudulent and wrongful trading and therefore, rightly classified the transaction to be fraudulent under Section 66 of the IBC. The NCLAT, through this Judgement, has thrown light on the fact that ‘fraud’ can, inter alia, consist of money lent by a corporate debtor which the corporate debtor has no intent of receiving back. Further, the NCLAT also reemphasized the position of law laid down in the Ram Preeti Yadav Case that the beneficiaries of fraud must be presumed to be a party to the fraud as well. Therefore, ‘fraud’ for the purpose of Section 66 of the IBC would consist of debts which the debtor has no intention to repay or does not expect to be able to pay.

For any query, please write to Mr. Bomi Daruwala at [email protected]

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