Bombay HC Declines To Hold Morya Distillery’s Ex-Directors Personally Liable Under Section 542, Citing Rs 2.79 Lakh Scrap-Sale Revenue

Morya Grain Distilleries Pvt. Ltd. was wound up, and the Official Liquidator sought relief under Section 542 of the Companies Act, 1956 against its four former directors, alleging that they knowingly carried on the company’s business with intent to defraud creditors.

The Liquidator relied, among other things, on post-winding-up filings, board meetings, reported revenue from operations, and alleged omissions from the Statement of Affairs.

Union Bank of India was the only creditor to lodge a claim, for approximately Rs. 51.13 crore.

The former directors contended that the reported revenue arose from scrap sales, that the allegations did not establish fraud or identify each director’s role, and that no creditor had been defrauded.

The Court had directed the Liquidator to file evidence after finding a prima facie case; the directors later filed an affidavit in reply.

Section 542(1) of the Companies Act, 1956 permits a declaration of personal responsibility where, during winding up, the company’s business was carried on with intent to defraud creditors or for a fraudulent purpose, and the persons proceeded against were knowingly parties to that conduct.

The Court stated that the civil standard is preponderance of probabilities, while the serious nature of a Section 542 allegation calls for closer scrutiny and cogent material supporting a higher degree of probability.

The provision also requires a nexus between the business activity and the fraudulent intent.

Relying on Official Liquidator of John Galt Laboratories Ltd. v. R.B. Sangare, the Court noted that fraud must be specifically pleaded and proved, including the role of each person proceeded against; general allegations are insufficient.

The Court also cited K. Nagendra Prabhu v. Popular Bank Ltd. and Official Liquidator of Milan Chit Fund and Finance P. Ltd. v. Joginder Singh Kohli on the required connection between business conduct and fraudulent intent.

The annual report showed revenue from operations of approximately Rs. 2.79 lakh, while the income-tax return showed tax deducted at source of approximately Rs. 2,100.

The Court accepted as reasonable the directors’ explanation that the small revenue resulted from scrap sales and considered the figures insufficient to establish substantial business activity.

Although the report’s statement that no order had affected the company was inaccurate, the Court found no evidence that the misstatement facilitated business operations with intent to defraud, or that the limited activity caused loss to the company, a creditor, or another person.

The material therefore did not establish the necessary nexus between activity and fraudulent intent.

The Official Liquidator’s Report was finally disposed of without any directions.