The Mumbai Bench of the National Company Law Tribunal (NCLT) has held that timelines under Regulation 35A of the CIRP Regulations are directory, and an avoidance application is not liable to fail merely on that procedural objection. Where the primary facts of payment are undisputed, and cash payments are made within the statutory look-back period to discharge antecedent debt in a manner indicating appropriation of cash immediately prior to CIRP, such payments can be held to be preferential under Section 43 if they do not fall within the ordinary course of business or the exception under Section 43(3) of IBC.
The NCLT ruled that a write-off of inventory may be held fraudulent under Section 66(1) where the surrounding facts show non-maintenance and withholding of stock records, inconsistency between inventory figures and operational trends, and use of the write-off to conceal non-existent inventory with intent to defeat creditors in contemplation of insolvency. Accordingly, the Tribunal directed the Respondent Nos. 4 and 5 to repay Rs. 4.97 lakhs to the Corporate Debtor, and Respondent Nos. 1 to 3 were directed to contribute Rs. 10.83 crores to the assets of the Corporate Debtor, both within 30 days, failing which interest at 12% p.a. would apply from the date of the order.
The Division Bench comprising Sushil Mahadeorao Kochey (Judicial Member) and Prabhat Kumar (Technical Member) observed that the timelines under Regulation 35A of the CIRP Regulations are directory in nature. It opined that the factual basis of the transactions was not disputed by the Respondents, though the conclusions drawn from those facts were challenged. It also noted from the audit report that the transaction auditor had relied on information provided by the RP, staff, and promoters, and that the suspended directors had knowledge of the information shared with the auditor. On that basis, the Tribunal rejected the challenge founded on absence of annexures or signatures on every page.
As far as Preferential Transaction under Section 43 is concerned, the Tribunal noted that the Applicant had shown primary facts establishing cash payments to Respondent Nos. 4 and 5 within one year of commencement of CIRP, and those facts were not disputed. The report recorded that cash in hand of Rs. 9.34 lakhs was reduced to Rs. 8/- handed over to the RP, and management had shared a list of creditors paid in cash. Although the Respondents contended that the payments were in the ordinary course of business and that some transactions were with long-standing business counterparties, the Tribunal held that there was an antecedent debt, the payment was made to discharge that antecedent debt, and the payment fell within the statutory look-back period under Section 43(4).
The Tribunal further observed that the dates of payment were not properly made available and that the conduct suggested the cash in hand was being appropriated prior to commencement of CIRP so as to avoid handing over such cash to the IRP. It therefore held that the payments were not made in the ordinary course of business, satisfied Section 43(1) and 43(2), did not fall within Section 43(3), and were preferential payments to Respondent Nos. 4 and 5. Accordingly, Respondent Nos. 4 and 5 were directed to repay the amounts within 30 days, failing which interest at 12% p.a. would apply from the date of the order.
As far as Fraudulent Transaction under Section 66 is concerned, the Tribunal recorded that the case of the Applicant was based on inability of Respondent Nos. 1 to 3 to provide relevant data and on non-maintenance of proper stock records, resulting in write-off of inventory of Rs. 10.83 crores in FY 2020–21. The Tribunal found that transaction auditor had recorded management’s explanation of fire incidents and possible pilferage, but stated that only oral explanations were received and details were awaited. The auditor also noted non-maintenance of stock records and lack of records after FY 2016–17 for comparison.
The Tribunal rejected the explanation linking the write-off to the 2016 fire because the financial statements for later years already reflected continuing inventory balances, including Rs. 11.59 crores. It also noted that the second fire occurred on 10.09.2019 and that the related insurance receipt was accounted as other income in FY 2020–21, while no corresponding loss from that fire was accounted in that year. The write-off, instead, was reflected through reduction of closing stock and increase in “change in inventories” in FY 2020–21.
The Tribunal found that the foundation of the fraud allegation was conscious withholding of quantitative inventory particulars from FY 2017–18 onward, including non-disclosure even in Form 3CD, despite substantial inventory figures in the books and declining operational revenue. It held that these trends demonstrated that the major part of the inventory written off was not in existence, and that the write-off was used to remove non-existent inventory from the books by relying on the alibi of fire and a small insurance claim.
The Tribunal therefore held that the write-off of inventory in FY 2020–21 was a fraudulent act to conceal non-existent inventory, which may already have been sold. Since the CIRP was initiated by a Section 10 application and the FY 2020–21 financial statements were signed, the Tribunal held that the act was carried out with intent to defraud creditors so that the Corporate Debtor would not be required to hand over the inventory shown in the books if insolvency commenced. It accordingly held that the transaction squarely fell within Section 66(1), and directed Respondent Nos. 1 to 3 to contribute Rs. 10.83 crores to the assets of the Corporate Debtor within 30 days, with interest at 12% p.a. thereafter.
Briefly, an application was filed by the Resolution Professional of Nagraj Alloys Private Limited under Sections 43 and 66 of the Insolvency and Bankruptcy Code, 2016, seeking avoidance of one alleged preferential transaction and one alleged fraudulent transaction. The reliefs sought included recovery of Rs. 4.97 lakhs from Respondent Nos. 4 and 5 and recovery of Rs. 10.83 crores from Respondent Nos. 1 to 3.
The Corporate Debtor was admitted into CIRP and the Applicant was appointed as Resolution Professional in place of the IRP. Respondent Nos. 1 and 2 were suspended directors, Respondent No. 3 was a past director/promoter, and Respondent Nos. 4 and 5 were stated to be related party debtors. The CoC approved appointment of a transaction auditor, M/s. Khanzode & Shenwai, Chartered Accountants. The transaction audit covered one year prior to insolvency commencement for unrelated party transactions, two years for related party transactions, and ten years for fraudulent transaction review.
The audit report was submitted and the transaction auditor identified: (i) cash payment of Rs. 4.97 lakhs to Respondent Nos. 4 and 5, alleged to be related parties, out of cash in hand, as a preferential transaction; and (ii) write-off of inventories amounting to Rs. 10.83 crores in FY 2020–21 as a fraudulent transaction.
Respondent Nos. 1 to 3 argued that Regulation 35A requires an independent determination by the RP and that the RP had merely reproduced the transaction audit report without independent application of mind. They also questioned the credibility of the report on the ground that all pages were not signed and the supporting documents were not annexed.
Appearances:
Yahya Batatawala a/w Adv. Khyati, for Applicant
Jatin Kumar, for Respondent
