NCLT Chandigarh Says Mere Directorship Insufficient For Fraud, Dismisses Plea Against 18 Directors

The Chandigarh Bench of the National Company Law Tribunal (NCLT) has held that mere designation as a director or participation in the management of a corporate debtor cannot, by itself, attract personal liability for fraudulent trading under the Insolvency and Bankruptcy Code (IBC).

A Bench comprising Technical Member Kaushalendra Kumar Singh and Judicial Member Khetrabasi Biswal dismissed an application filed by Resolution Professional (RP) Darshan Singh Anand in the insolvency proceedings of Vikas WSP Ltd. It observed:

“We are unable to accept such a broad proposition. Section 66 does not create vicarious liability merely because a person happened to be a Director.Liability under Section 66 is personal in nature and requires proof that the concerned person knowingly participated in carrying on the business of the Corporate Debtor with an intent to defraud creditors. Mere designation as a Director, Executive Director or Independent Director, without specific evidence of participation in the alleged fraudulent conduct, is insufficient.”

The Corporate Insolvency Resolution Process (CIRP) of Vikas WSP Ltd. commenced on 2 February 2022. Anand filed the application against 18 respondents, all of whom had served as directors at different points.

The RP alleged that freehold land worth over Rs. 423 crore reflected in earlier balance sheets had disappeared from the records. He also alleged that raw material consumption ratios were abnormally inflated, inventories worth Rs. 3,055.37 lakh were written off, advances of Rs. 6,455.66 lakh were made to related parties, and certain miscellaneous transactions, including a transfer of Rs. 17.24 lakh to a director and sale of a vehicle for Rs. 6 lakh, amounted to fraudulent acts intended to defraud creditors.

He also relied heavily on the Draft Transaction Audit Report prepared by Mukesh Raj & Co., which flagged the transactions as potentially fraudulent. However, the Final Transaction Audit Report exonerated the company and concluded that no fraudulent trading, undervalued transactions or acts intended to defraud creditors had been established. He also challenged the “clean chit”, arguing that the auditors had failed to justify their departure from the draft findings.

Respondent No. 1, Bimla Devi Jindal, argued that she was a nominal director with no role in the day-to-day affairs of the company, which were managed by her late husband, B.D. Aggarwal. She denied fraudulent intent and pointed out that the land acquisitions dated back to 2007–09, well before the present consortium of lenders began financing the company in 2012.

She also contended that the RP had selectively relied on extracts of the Draft Transaction Audit Report while disregarding the conclusions recorded in the Final Transaction Audit Report.

The other respondents also took a similar stand on their involvement in the alleged transactions. They further contended that merely because a respondent was a member or chairman could not, by itself, impose civil or criminal liability.

The RP countered that Respondent No. 1 had actively participated in management, signed financial statements and chaired annual general meetings. Similarly, Respondent No. 9 and others were said to have held positions in audit and risk committees, giving them access to financial records and responsibility for oversight.

He also pointed out that the management had repeatedly produced sale deeds and conveyance deeds relating to the company's freehold agricultural lands before successive statutory auditors. He argued that this made Respondent No. 1's claim that the title deeds of the three parcels of freehold agricultural land were “not traceable” unsustainable.

The Tribunal emphasised that Section 66(1) requires cogent evidence of fraudulent intent and that the burden of proof solely lies upon the applicant to establish such intent.

It noted that the RP relied on draft observations, whereas the Final Transaction Audit Report, prepared by the independent auditor after considering explanations, did not find fraud. It held that disagreement with the auditor's conclusions could not substitute for evidence. It observed:

“Once an independent expert has rendered his final opinion after considering the material available, the draft observations lose their independent evidentiary value unless the Applicant is able to establish, through independent evidence, that the final report is demonstrably incorrect or mala fide. No such material has been produced before this Tribunal.”

On the freehold land, the Bench noted that the acquisitions were made in 2007–09 and had been continuously reflected in the financials. It also noted that no evidence of transfer or encumbrance during the statutory look-back period had been produced.

It held that missing title deeds or lack of information about their whereabouts did not establish fraudulent diversion. It also noted that the Final Transaction Audit Report attributed the spike in raw material consumption to the write-off of obsolete stock. It found that the RP had failed to produce contrary forensic evidence proving misappropriation.

On the directors' liability, the Tribunal rejected the RP's broad proposition that mere designation as a director or committee membership was sufficient. It noted that liability under Section 66 is personal and requires proof of conscious participation in fraudulent trading.

It found that no specific act attributable to the respondents demonstrating fraudulent intent had been established and that mere participation in management was not enough. It added:

“It is well settled that proceedings under Section 66 are quasi-penal in nature and cannot be sustained on the basis of suspicion, conjectures or inferences arising merely from accounting discrepancies. Fraud must be specifically pleaded and proved through convincing evidence demonstrating dishonest intention..”

Accordingly, the NCLT dismissed and disposed of the application.