NCLAT Says Transactional Audit Report Alone Can't Prove Fraudulent Trading

NCLAT Says Transactional Audit Report Alone Can't Prove Fraudulent Trading

Introduction

The National Company Law Appellate Tribunal (NCLAT) has held that a transactional audit report alone cannot be conclusive proof of fraudulent trading under Section 66 of the Insolvency and Bankruptcy Code (IBC), 2016. The tribunal observed that each and every commercial transaction resulting in loss may not be labelled as fraudulent.

Factual Background

The Corporate Insolvency Resolution Process (CIRP) of the corporate debtor was initiated, and subsequently, a liquidation order was passed. The suspended director of the corporate debtor had invested in shares of two companies whose shares were not actively traded. The auditor flagged these transactions as fraudulent.

Procedural Background

The adjudicating authority considered the audit report and declared the transactions to be fraudulent, directing the directors to deposit Rs. 28.5 lakhs in the liquidation estate of the corporate debtor, aggrieved by the order, the directors preferred an appeal before the NCLAT.

Issues

1. Transactional Audit Report as Proof of Fraud: Whether a transactional audit report alone can be conclusive proof of fraudulent trading under Section 66 of the IBC.

2. Due Diligence and Fraudulent Intent: Whether the failure to exercise due diligence is sufficient to label a transaction as fraudulent.

Contentions of the Parties

Appellant's Contention: The appellant argued that the decision to purchase shares was taken in the ordinary course of business for the benefit of the corporate debtor. Merely because the transaction resulted in a loss, it cannot be said that the transaction was fraudulent or that due diligence was not taken. The appellant also highlighted that the audit report was full of contradictions and could not be relied upon.

Respondent's Contention: The respondent submitted that the directors invested in shares of a non-performing company without opening a demat account, violating RBI and SEBI regulations. It also argued that no due diligence was exercised by the suspended directors.

Reasoning & Analysis

The bench comprising Justice Mohd. Faiz Alam Khan (Member-Judicial) and Arun Baroka (Member-Technical) observed that each and every commercial transaction resulting in loss may not be labelled as fraudulent. The bench noted that the failure to exercise due diligence may not be sufficient to label a transaction as fraudulent under Section 66 of the IBC. The tribunal held that the adjudicating authority erred in deciding the case solely on the basis of the transactional audit report, which may not be termed as conclusive proof of fraudulent trading.

Implications

The NCLAT's decision clarifies that a transactional audit report alone may not be sufficient to prove fraudulent trading under the IBC. The tribunal's ruling emphasizes the need for conclusive evidence to establish fraudulent intent.

Conclusion

The NCLAT's judgment in this case highlights the importance of considering all relevant evidence before labelling a transaction as fraudulent. The decision ensures that commercial transactions are not unfairly labelled as fraudulent without sufficient evidence.

In this case the appellant was represented by Mr. Adit S. Pujari, Mr. Avinash Bhati, and Mr. Vanya Chhabra, Advocates. Meanwhile the respondent was represented by Mr. Animesh Pandey, Advocate.