Removal Of Hypothecated Machinery During Insolvency Can Amount To Fraudulent Trading: NCLAT

The National Company Law Appellate Tribunal (NCLAT) at Delhi has held that removing high-value secured (hypothecated) machinery during insolvency proceedings and replacing it with substantially lower-value machinery is not a mere technical irregularity.

It directly affects a company's asset base and the security and recovery prospects of its creditors.

The bench of Judicial Member Justice Sharad Kumar Sharma and Technical Members Arun Baroka and Indevar Pandey made the observation while upholding an order directing two suspended directors of Santoshi Barrier Film India Pvt. Ltd. to contribute ₹17.23 crore to the company's assets undergoing insolvency.

“The removal of high-value secured machinery and its replacement by substantially lower-value machinery, if established on the evidence, is not a mere technical irregularity. It directly affects the asset base of the Corporate Debtor and the security and recovery prospects of its creditors.”, the tribunal ruled.

The appeal was filed by Dinesh Keshawrao Atkare and Madan Keshawrao Atkare against an order of the Mumbai bench of the National Company Law Tribunal (NCLT), which directed them to contribute ₹17,23,05,603.50 under Section 66 of the Insolvency and Bankruptcy Code.

The company had obtained loans of ₹8 crore from Tata Capital Financial Services Ltd. and ₹4 crore from Hero Fincorp Ltd., now Phoenix ARC following the assignment of the loan, to purchase two six-colour C.I. Flexographic Press machines. The machinery was hypothecated in favour of the lenders.

During the insolvency process, the Resolution Professional found that the financed machines were not present at the premises. Instead, two valuers identified Rotogravure printing machines at the site, which were substantially lower in value. Their reports also recorded physical indications that machinery had previously been installed and subsequently removed.

The suspended directors argued that the machines found at the premises were alternative equipment with better specifications. They also questioned the valuers' reports and relied on an expert engaged by them.

The NCLAT rejected these arguments. It noted that there was no contemporaneous documentary evidence showing that the financial creditors had consented to substitution of the hypothecated machinery. It also found that the appellants' expert had not personally inspected the machinery and had based his opinion on photographs and comparative features.

Section 66 permits the adjudicating authority to direct persons who knowingly participated in carrying on a company's business with an intent to defraud creditors or for a fraudulent purpose, to contribute to the company's assets. The NCLAT held that the provision does not require a series of fraudulent transactions.

The bench considered the circumstances cumulatively, including the absence of the original machinery, the presence of substantially lower-value machines, the lack of documents supporting the alleged substitution and the absence of creditor consent. It found these circumstances constituted compelling circumstantial evidence that valuable assets had been kept beyond creditors' reach.

The NCLAT also rejected the directors' challenge to the ₹17.23 crore contribution, holding that they had not shown the amount to be arbitrary or unsupported by the record. Their plea regarding depreciation and the realisable value of the replacement machines did not dislodge the finding that the financed machinery had been removed.

It further observed that the suspended Board's delay in handing over possession during the insolvency process strengthened the inference drawn from the inspection and valuation material.

The appeal was dismissed and the NCLT's order confirmed. The NCLAT also imposed costs of ₹5 lakh each on the two appellants, directing that the amount be deposited in the Prime Minister's National Relief Fund.