Fraud Cannot Be A Ground To Reject Corporate Insolvency Resolution Process: NCLAT [Read Judgment]

The National Company Law Appellate Tribunal (NCLAT) on August 6, 2019, in the case of Shobhnath & Ors. v. Prism Industrial Complex Ltd. has held that fraud cannot be a ground to reject the Corporate Insolvency Resolution Process (CIRP).

In this case, the appellant filed an application under Section 7 of the Insolvency and Bankruptcy Code, 2016, against the corporate debtor. The National Company Law Tribunal (NCLT) by a judgment dated July 5, 2018, rejected the application after finding that the petition was filed fraudulently for initiation of the corporate insolvency process.

“The benevolent scheme of IBC for a resolution of a company under distress is not meant for a case of a financial fraud or irregularity, where the directors/promoters have deliberately engaged in a scheme having striking similarity with the Infamous "chit funds" or Ponzi schemes…..It can be no one’s case that in such a murky scenario of corporate fraud, section 7, which is intended for a holistic collective healing process, could be rightly deployed,” NCLT said dismissing the petition.

While dismissing the petition, NCLT also directed for issuance of show-cause notice under Section 65 of the I&B Code against the Appellants/Financial Creditors’ for further decision.

When the matter was placed before the Appellant Tribunal, it, however, rejected the impugned judgment passed by NCLT. Reliance was placed on the Supreme Court judgment in Innoventive Industries Ltd. v. ICICI Bank and Anr (2018) 1 SCC 407 to hold that “the ‘debt’ means a liability of obligation in respect of a ‘claim’ and a ‘claim’ means a right to payment even if it is disputed. The Code gets triggered the moment default is of rupees one lakh or more.”

“It is a settled law that the Adjudicating Authority is only required to ensure whether there is a debt and default on the basis of record (Form 1). It cannot take into consideration any other facts which are irrelevant. The ‘Corporate Insolvency Resolution Process’ not being a litigation much less adversarial litigation or a recovery proceeding or a money suit, has been held by this Appellate Tribunal in Binani Industries Limited vs. Bank of Baroda & Anr.─ Company Appeal (AT) (Insolvency) No. 82 of 2018 etc. For the said reason, we hold that the Adjudicating Authority cannot notice to hold that owing to the financial fraud the amount was not paid by the ‘Corporate Debtor’, the Appellant Tribunal said.

Regarding issuance of show-cause notice under Section 65 of the I&B Code, the Appellant Tribunal has observed that “In the present case, the Adjudicating Authority has failed to show that the present proceeding under Section 7 was filed by the Appellant fraudulently or with malicious intention for initiation of the ‘Corporate Insolvency Resolution Process’ against the ‘Corporate Debtor’. Whatever the grounds shown for not entertaining the application are not related and beyond Form 1 and were not to be pleaded. In fact, nothing on the record to suggest that the Appellant filed application fraudulently with malicious intention for initiation of the ‘Corporate Insolvency Resolution Process’ against the ‘Corporate Debtor’.”

“Prima facie no case was made out before the Adjudicating Authority for passing any observation under Section 65 of the ‘I&B Code’ merely on the ground that the Directors and Promoters have engaged in Scheme having striking similarity with the infamous chit funds or Ponzi Schemes. The Promoters/ Directors may face serious criminal implication for breach of the orders of SEBI, but that cannot be ground to reject the application under Section 7 against the ‘Corporate Debtor’, or to initiate any proceeding under Section 65 against the Appellants, who have no connection with the Directors or Promoters of the ‘Corporate Debtor’,” the Appellant Tribunal said setting aside the impugned judgment.

[Read Judgment]