NCLAT holds suspended directors liable after ₹17.23-crore hypothecated machinery was replaced with lower-value machines

The Corporate Debtor obtained loans of ₹8 crore from Tata Capital Financial Services Ltd. and ₹4 crore from Hero Fincorp Ltd. for purchasing two six-colour C.I. Flexographic Press Machines.

The machines were purchased under invoices dated 23 December 2016 and 14 March 2017 and were hypothecated in favour of the lenders.

During the CIRP, possession of the Corporate Debtor’s premises was eventually obtained on 5 July 2023 pursuant to orders of the Adjudicating Authority and police assistance.

Two valuers appointed during the insolvency process reported that the machines found at the premises were Rotogravure Printing Machines of substantially lower value, and not the financed C.I. Flexographic Press Machines.

The NCLT concluded that the financed machinery had been removed and replaced with lower-value machinery for the purpose of defrauding creditors and directed the appellants to contribute ₹17,23,05,603.50 to the assets of the Corporate Debtor.

Whether the Adjudicating Authority was justified in exercising jurisdiction under Section 66(1) of the IBC on the basis that the financed and hypothecated machinery had been removed and replaced with substantially lower-value machinery with intent to defraud creditors?

Whether fraudulent or wrongful trading under Section 66 requires proof of a series of transactions or may be established through the cumulative effect of one asset-removal transaction and surrounding circumstances?

Whether the valuation reports, inspection material, and circumstantial evidence sufficiently established the removal and substitution of the hypothecated machinery?

Whether the direction to contribute ₹17,23,05,603.50 was arbitrary or liable to be reduced on account of depreciation and the realizable value of the machinery found at the premises?

The Court applied Section 66(1) of the IBC, under which persons knowingly party to carrying on the business of a corporate debtor with intent to defraud creditors or for a fraudulent purpose may be directed to contribute to the corporate debtor’s assets.

Section 66 does not require fraudulent trading to be proved through a series of independent transactions; the decisive question is whether the business was carried on with fraudulent intent.

Fraudulent intent may be inferred from the cumulative effect of documentary, expert, physical-inspection, and circumstantial evidence, and direct proof of criminal intent is not indispensable.

The Court distinguished Renuka Devi v. Regen Powertech, where a mere isolated fraudulent act or bona fide conduct was held insufficient, because the present case involved multiple circumstances indicating intentional asset substitution.

It also relied on Piramal Capital and Housing Finance Ltd. v. 63 Moons Technologies Ltd. for the distinction between avoidance applications under Chapter III and fraudulent or wrongful trading proceedings under Section 66, while holding that the distinction did not assist the appellants where fraudulent purpose was established.

The applicable evidentiary assessment permitted an inference on the preponderance of probabilities from the totality of circumstances.

The NCLAT found that the original machinery was established by invoices, dispatch particulars, financing documents, and hypothecation agreements.

In contrast, the machinery found during the CIRP was identified by two independent valuers as Rotogravure machinery of substantially lower value; the premises also contained indications of earlier machinery foundations, while the nameplates and identification details were missing or inconsistent.

The appellants produced no contemporaneous purchase documents for the alleged substituted machinery and no documentary consent from the secured creditors authorising substitution.

The Court held that the earlier possession taken by a financial creditor under the SARFAESI Act did not create an estoppel or conclusively determine the identity of the machinery.

It further held that the appellants’ expert opinion, based substantially on photographs and not on a direct inspection, did not displace the reports of the valuers appointed during the insolvency process.

The delay and resistance in handing over possession, coupled with the removal indicators, lower-value replacement machinery, and absence of a satisfactory explanation, cumulatively supported the inference that valuable secured assets had been kept beyond the reach of creditors.

The Court also declined to interfere with the contribution amount, holding that the appellants had not shown it to be arbitrary or unsupported by the record.

It held that the removal of the hypothecated C.I. Flexographic Press Machines and their replacement with substantially lower-value Rotogravure Machines constituted fraudulent conduct within Section 66(1) of the IBC, notwithstanding that the case principally concerned one asset-substitution transaction.

The direction requiring the appellants to contribute ₹17,23,05,603.50 to the assets of the Corporate Debtor was upheld, and the Liquidator was permitted to continue the liquidation process and take consequential steps for preservation and realisation of assets.

Costs of ₹5,00,000 each were imposed on the two appellants, payable to the Prime Minister’s National Relief Fund.