Fraudulent Transaction Recoveries under Section 66 of the IBC
Table of Contents
Section 66 of the Insolvency and Bankruptcy Code, 2016 (IBC) empowers the Adjudicating Authority, the National Company Law Tribunal (NCLT) to hold individuals liable for contributions to a corporate debtor’s assets if they knowingly participated in fraudulent business activities during the corporate insolvency resolution process (CIRP) or liquidation. The increasing importance of Fraudulent Transaction Recoveries and wrongful trading recoveries stems from their role in maximizing the value of debtor’s assets for the benefit of all creditors, thereby strengthening the integrity of the insolvency framework and promoting responsible corporate governance. However, disputes often arise between stakeholders because recoveries under section 66 must benefit creditors collectively and not unjustly enrich the resolution professional (RP), leading to conflicts over the interpretation of intent, the scope of liability, and the fairness of contributions.
Understanding Section 66: Purpose and Scope
- Section 66(1) addresses Fraudulent Transaction Recoveries trading, which occurs when a corporate debtor’s business is carried on with the intent to defraud its creditors or for any fraudulent purpose. The burden of proof lies with the RP to establish such intent, and the application must identify knowingly involved parties and demonstrate undue benefit at the creditors’ expense.
- Section 66(2) imposes liability on directors or partners who knew or ought to have known there was no reasonable prospect of avoiding insolvency but failed to exercise due diligence in minimizing potential losses to creditors.
- Who Can Be Held Liable: Directors, promoters, and persons involved in management can be held liable for company offences if they personally participated in or were responsible for the misconduct, as liability is not automatic and requires specific statutory provisions. Courts use tests based on whether the individual had actual knowledge, exercised due diligence, or was personally involved in the act. They must establish a direct link between the individual’s conduct and the offence, rejecting mere association or supervisory roles.
Why the Tug-of-War Occurs
-
- Competing Stakeholder Interests: Creditors aim for maximum debt recovery, potentially by pursuing actions against past management. Suspended management seeks to avoid personal liability, while resolution applications try to distance themselves from legacy legal risks.
- Ambiguity in Standards of Proof: Establishing intention or negligence in financial matters is often a difficult legal challenge. This difficulty is compounded by conflicting interpretations and rulings from different tribunals.
- Timing of Applications: There is a strategic conflict regarding whether the RP or liquidator should file applications during insolvency or wait for liquidation. Investigations and forensic audits cause delays, which can impact the viability and timing of these applications.
Read more : Financial creditor can initiate CIRP against both Principal Borrower and Corporate Guarantor
Judicial Trends and Key Case Law
-
- Expanding Liability of Management: Courts holding directors accountable for diversion of funds, particularly when the intent to defraud creditors is evident. In certain instances, promoters have been directed to contribute massive amounts personally to cover the shortfall caused by preferential or Fraudulent Transaction Recoveries .
- Protection for Bona Fide Decisions: The judiciary offers protection for bona fide business decisions, recognising that actions taken in good faith and the interests of the company should not automatically trigger personal liability under section 66 of the IBC.
- Role of Forensic Reports: Forensic reports play a critical role as evidence in identifying suspicious transactions during insolvency proceedings, with courts frequently relying on these transactions audits to establish the flow of funds and intent. However, courts maintain a skeptical stance toward unsubstantiated findings, requiring the forensic auditor’s conclusions to be supported by concrete evidence and adhere to principles of natural justice.
Practical Challenges in Recovery
-
- Difficulties in Enforcing Orders: Enforcing orders involving the attachment of personal assets can be difficult because establishing the connection between the director’s actions and such actions involves complex legal hurdles and requires substantial evidence. These challenges along with the fact that directors may dissipate or obscure assets during the lengthy process, often result in a situation where recovery is minimal, even after a favorable ruling.
- Coordination with Other Laws: The overlap with other laws, such as the Prevention of Money Laundering Act and the Companies Act, creates significant confusion, particularly in jurisdictions and can lead to conflicting orders regarding the same assets. This jurisdictional overlap directly contributes to the core of determining the priority of claims, creating legal uncertainty, and further delaying the resolution process.
- Costs of Litigation: There are high expenses for critical actions like forensic audit and extensive legal processes often exceeding the potential amount of recovery, especially for small creditors. There are significant concerns about this burden on the insolvency process, as these expenses can quickly deplete the remaining value of the corporate debtor, ultimately leaving less for distribution among the stakeholders.
Evolving Role of RPs and Liquidators
The role of RPs and liquidators have evolved to investigate suspicious transactions, particularly those involving potential money laundering to safeguard the integrity of the insolvency framework. Further, they also have the duty to recognise early detection of suspicious activity, as it enables them to file the correct reports in a timely manner, which serve as vital tools for the appropriate authorities. Furthermore, they need to maintain detailed records and gather evidence essential for justifying actions taken, supporting investigations, and ensuring compliance with regulatory requirements.
Strategic Filing of Section 66 Applications
- Applications under section 66(2) requires careful timings, as such applications cannot be initiated for defaults occurring during the suspension period under section 10A, and the feasibility of recovery depends on identifying individuals who knowingly participated in fraudulent business or failed to maximise creditor losses.
- While the CoC pressures the RP to take actions, managing conflicts involves balancing the CoC’s commercial interest with the RP’s statutory duty to act impartially and in accordance with the IBC, ensuring that decisions are not influenced by undue CoC pressure and that the RP maintains independence in overseeing CIRP.
Impact on Resolution Plans
-
- Treatment of Fraudulent Transaction Recoveries Claims: There are ambiguities revolving around whether Section 66 recoveries belong to creditors, the corporate debtor, or the resolution applicant. The uncertainty surrounding the beneficiary of these recoveries increases risk for potential bidders and the lack of clarity can deter bidders or lead to significantly lower offers.
- Judicial Clarification Needed: Stakeholders are confused about who ultimately benefits from these recoveries, leading to disputes and litigation that prolong the insolvency process. There is a need for prompt and consistent judicial guidance from appellate bodies to clarify the legal standing of section 66 proceeds and ensure equitable distribution.
Policy and Reform Considerations
- To ensure clearer guidelines on burden of proof it is important to establish a standard for determining intent or negligence.
- To protect genuine businesses failures, authorities need to ensure Section 66 is not weaponized and implement balanced enforcement against fraudulent conduct.
- To improve inter-agency coordination, amendments are needed to clarify the role of authorities under the IBC and other recovery mechanisms.
Conclusion : Fraudulent Transaction Recoveries
Section 66 serves as a powerful recovery mechanism, yet its effectiveness is hindered by overlapping interests, inconsistent judicial interpretation, and practical implemental challenges. The lack of uniform standards in forensic processes contributes to judicial uncertainty and undermines case integrity, further complicating recovery efforts. Strengthening judicial clarity through specialised training and consistent application of legal principles can help resolve ambiguities in insolvency cases. Hence, enhanced forensic methodologies, transparent evidence handling, and balanced enforcement are essential to ensure section 66 fulfills its purpose in strengthening insolvency framework.
Recent Posts
