NCLAT: Audit Report Alone Cannot Establish Fraudulent Trading Under Section 66(2) IBC
Pranav B Prem
The National Company Law Appellate Tribunal (NCLAT), Principal Bench, New Delhi, comprising Justice Mohd. Faiz Alam Khan (Judicial Member) and Arun Baroka (Technical Member), has held that a transactional audit report, by itself, cannot be considered conclusive proof to establish fraudulent trading under Section 66(2) of the Insolvency and Bankruptcy Code, 2016 (IBC).
Background
The appeal was filed by members of the suspended board of directors of Temple Leasing and Finance Ltd. against an order dated 09.05.2023 of the National Company Law Tribunal (NCLT), New Delhi Bench, which had declared certain share purchase transactions as fraudulent. The NCLT had directed the appellants to contribute ₹28.5 lakh to the liquidation estate of the corporate debtor on the basis of a transactional audit report.
During the liquidation proceedings, the liquidator appointed an auditor to examine the books of accounts. The audit flagged two transactions involving purchase of shares of Uno Industries Ltd. and Jayant Mercantile Company Ltd. The NCLT, relying primarily on the audit report, concluded that these purchases were fraudulent and in violation of Section 66 IBC.
Contentions
The appellants argued that the share purchases were taken in the ordinary course of business, with the expectation that the companies would become compliant and listed again in the future. They submitted that a commercial decision resulting in loss could not, by itself, be termed fraudulent. They also contended that there was no evidence of dishonest intent, apart from the audit report, which itself contained contradictions.
It was further submitted that the directors had exercised due diligence and that only partial payment of ₹15 lakh had been made for the shares, which continued to remain an asset of the corporate debtor. The appellants stressed that Section 66(2) requires proof that directors knew insolvency was unavoidable and failed to minimize losses—elements absent in this case.
The respondents, on the other hand, argued that the directors invested in non-traded shares without opening a demat account and without complying with SEBI and RBI guidelines. It was submitted that the audit report, based on the company’s financial records, demonstrated lack of diligence and wrongful use of corporate funds.
Tribunal’s Observations
The NCLAT noted that under Section 66(2) IBC, a transaction can only be held fraudulent if directors knew insolvency was imminent and failed to exercise due diligence in minimizing losses to creditors. It emphasized that not every commercial transaction resulting in a loss can be branded as fraudulent.
The bench observed that the appellants had paid only ₹15 lakh of the ₹28.5 lakh consideration and that the shares continued to remain with the corporate debtor, which even fetched offers during liquidation. The Tribunal found no direct evidence of fraudulent intent and held that reliance solely on the audit report, which cannot be treated as conclusive evidence, was erroneous. It further observed that vague allegations and post-facto inferences cannot substitute for proof of dishonesty or fraudulent intent required under Section 66.
Holding that the necessary ingredients of Section 66(2) IBC were not satisfied and that the audit report alone could not form the basis of liability, the NCLAT allowed the appeal and set aside the NCLT’s order directing contribution of ₹28.5 lakh to the liquidation estate.
Appearance
For Appellant: Mr. Adit S. Pujari, Mr. Avinash Bhati, and Mr. Vanya Chhabra, Advocates
For Respondent: Mr. Animesh Pandey, Advocate
Cause Title: Nalinesh Kumar Paurush v. Shree Vishvamurte Tradinvest Pvt. Ltd.
Case No: Company Appeal (AT) (Insolvency) No. 346 of 2024 & IA No. 6783 of 2024
Coram: Justice Mohd. Faiz Alam Khan (Member-Judicial), Arun Baroka (Member-Technical),
