Forensic Audit Report Alone Cannot Prove Fraudulent Trading Under IBC Section 66: NCLT Ahmedabad

The Ahmedabad National Company Law Tribunal (NCLT) on 13 July held that a forensic audit report cannot, by itself, establish fraudulent trading under Section 66 of the Insolvency and Bankruptcy Code, 2016 (IBC), unless the Resolution Professional independently examines the transactions and forms the statutory opinion required under Regulation 35A of the CIRP Regulations.

A Bench of Judicial Member Chitra Hankare and Technical Member Dr VG Venkata Chalapathy rejected the liquidator's application against former directors of Vijay Timber Industries Pvt Ltd, holding that the Resolution Professional had failed to independently determine whether the transactions amounted to fraudulent trading. It observed:

“…the forensic audit report can at best constitute an investigative aid for enabling the Resolution Professional to examine the affairs of the Corporate Debtor and form an independent opinion under Regulation 35A. The report, by itself, cannot substitute the statutory satisfaction required to be arrived at by the Resolution Professional nor can it be treated as conclusive proof of fraudulent trading under Section 66 of the Code.”

Ramchandra Dallaram Choudhary, the liquidator of Vijay Timber Industries Pvt Ltd, filed the application seeking directions against former directors Gulabchand Jain and Ashwin Jain to contribute Rs 959.26 lakh along with amounts relating to assets provided as collateral security to Punjab National Bank (PNB). He alleged that the directors had carried out fraudulent transactions under Section 66 of the IBC.

Vijay Timber Industries entered Corporate Insolvency Resolution Process (CIRP) on 13 February 2020 after PNB filed a Section 7 petition (application by a financial creditor to initiate insolvency proceedings). The NCLT ordered liquidation on 31 December 2020 and appointed Choudhary as liquidator.

Choudhary relied on a forensic audit report prepared by Pipara & Co. LLP covering the period from 2015 to 2020. The report flagged several transactions, including an alleged reduction of closing stock value by Rs 4.59 lakh through unexplained journal entries, write-off of sundry debtors worth Rs 7.09 crore and impairment of assets worth Rs 73,200 before CIRP admission.

He also alleged that Vijay Timber Industries had made a payment of Rs 1.11 crore to related party Nakoda Logistics Pvt Ltd without proper substantiation. He further submitted that the forensic audit report recorded discrepancies in the valuation of plant and machinery, and that these transactions had caused loss to creditors.

The former directors denied fraudulent intent and submitted that they had furnished all information and clarifications sought by the liquidator. They contended that the reduction in stock value reflected deterioration of old wood-based inventory, that sundry debtors were irrecoverable amounts over a decade old and had been written off with the bank's knowledge, and that asset impairment was carried out in accordance with accounting standards.

The Tribunal held that Section 66 requires proof of fraudulent intent and cannot be invoked merely on the basis of accounting irregularities. It noted that Regulation 35A of the IBBI (Insolvency Resolution Process for Corporate Persons) Regulations, 2016 requires the Resolution Professional to independently examine transactions under Sections 43, 45, 50 or 66 of the IBC and form an opinion before filing an application.

It noted that, in the present case, the Resolution Professional relied solely on the forensic audit report, which contained disclaimers regarding incomplete records and non-expert findings. It held that the report could only assist the Resolution Professional's inquiry and could not replace the independent statutory determination required under Regulation 35A. The Bench observed:

“This Tribunal is therefore of the considered view that the Resolution Professional/Liquidator has not complied with the mandatory procedure contemplated under Regulation 35A of the CIRP Regulations before invoking Section 66 of the IBC. The application proceeds solely on the basis of the forensic audit report stating it is not expert opinion thereby demonstrating that the Resolution Professional has failed to independently form the statutory opinion and determination as required under the Code.”

Accordingly, the NCLT rejected and disposed of the application.