Ritesh R. Mahajan vs Shivkumar Malaghan & Ors.

Per: Manoj Kumar Dubey, Member (Technical)

This application filed by Mr. Ritesh Mahajan, the Resolution Professional of Corporate Debtor i.e., M/s Sovereign Industries Limited on 17.11.2023 against the Respondents under Section 66 of the Insolvency & Bankruptcy Code, 2016, praying for the following reliefs:

The facts and circumstances leading to the present application are stated briefly as follows:

Signatory Details of Sovereign Industries Limited:

Signatory Details of Lokapur Cements Limited:

Signatory Details of SLV Cements Limited:

Respondent No. 1 Mr. Shivakumar Malaghan, Respondent No. 2 Mr. Guruappa Reddy and Respondent No. 3 Basavaraj Ningappa Arakeri have filed Objections vide Diary No.5719 and 5716 dated 07.10.2024, whereby, the Respondent have submitted the Applicant is in violation of the CIRP Regulation 35-A which mandates the RP to form an opinion within 75 days from the commencement of the CIRP on whether the Corporate Debtor has been subjected to any transaction covered under Sections 43, 45, 50 or 66 of the Code. The RP is required to make a determination within 115 days and file an application before the Adjudicating Authority within 135 days. However, the Applicant has filed the captioned Application as a mere formality without first obtaining TAR from the Auditor. The application was filed without any report or input from the Auditor and with a preconceived notion that the Respondent has committed the alleged fraud. In-fact subsequent filing of the TAR in April 2024 after six months from the captioned application exemplifies the misuse of the provisions of the Code.

The second objection taken by the Respondent is that the TAR submitted by M/s. Shambhu Gupta & Co., Chartered Accountants, lacks credibility and conclusiveness due to significant disclaimers, limitations and caveats which evince that the said report and its findings cannot be relied upon by this Tribunal or the RP. The following are some of the Clauses from the TAR that the Respondents mentioned for substantiating their contentions:

It was contended that these clauses from the TAR establish that such an inconclusive report holds no value in the eyes of the law for establishing any transactions under the Code. The disclaimers and limitations admitted by the Transaction Auditor indicate that the findings are based on incomplete, inaccurate information and judgemental sampling. Consequently, the report’s conclusions cannot be deemed definitive or reliable for legal scrutiny or the determination of preferential transactions.

It was further averred by the Respondent that the TAR’s conclusion regarding fraudulent transaction is baseless and erroneous as the Transaction Auditor himself has admitted to significant shortcomings. The Transaction Auditors has himself stated that he cannot vouch for his conclusions as the analysis may not represent all possibilities. Thus, the conclusions in TAR at best can be described as “suspicion” that fails to be conclusive.

Therefore, the Respondent states that analyses in TAR is based on incomplete information and cannot be relied upon as the Transaction Auditor has not received all relevant documents such as necessary financial documents, Tally Data, Bank Statements, Secretarial Records and ledgers.

Heard the learned Counsel for the Applicant and learned Counsel for the Respondents and perused the documents placed on record. The Counsel for the Applicant has also submitted the Transaction Audit Report dated 06.12.2023 with Additional Affidavit vide Diary No.2151 on 04.04.2024. The extracts from the TAR related to transactions under Section 66 of the Code are reproduced hereunder [Page 28 of TAR]:

The RP has based its opinion of fraudulent transactions prima facie by perusing the documents of the CD. The RP in its observation has identified an amount of Rs.29,48,05,000/- which falls under the ambit of “fraudulent transaction” as per the definition given u/s 66 of the Code. The RP has based its deduction while relying on the very limited quantity of records and documents which notes that the money received by the CD from a third party Ugar Sugar Works Ltd. amounting to Rs.24 crores which was immediately siphoned off to the related parties of the CD, namely, SLV Cements Ltd. and Lokapur Cements Ltd., merely 23 days prior to the initiation of CIRP and after the application for commencement of CIRP was filed on 07.11.2022. The RP has also based the opinion by obtaining a Transaction Audit Report which states that such financial advances were duly reflected in the Balance Sheets of the related parties. It is also contended that as per the MCA records, the last filed balance sheet for these companies pertain only to FY 2021-22, rendering the verification impossible for the impugned period. It is averred that by the Transaction Auditor that the tally records don’t have the details relating to advances such as PAN No., GST No., contact details and other necessary information. This absence of these pivotal records not only made the findings difficult for the Auditor, but raised questions on the genuineness of the parties; with which the CD has entered into transactions. However, the RP has communicated to the auditor that the records were not made available by the CD explaining that the same were damaged during the floods at the factory, as was communicated to the RP by Mr. Shishir Malagan, the General Manager of the Corporate Debtor. When the RP visited the site of the Corporate Debtor to take possession of the records, documents etc. this person explained that due to flooding in the factory area, the documents have been misplaced. However, it is pertinent to mention here that no evidence has been furnished for the same, and in case of important documents of the Company or factory being destroyed due to floods, the secondary evidences like F.I.R./Insurance claim etc., as may be required by the relevant Regulations was a necessity. Another such limitation pointed out in the audit report is regarding the details of the parties which could not be verified from the Bank Statements and books of accounts of the CD; as the CD is booking purchases as a generic descriptions like “Cane Supplier 17-18” and “Cane Supplier 18-19”; without giving the name and address etc.

With regards to the transactions in question, the Auditor’s Report state that the transaction which transpired subsequent to the filing of the application for initiation of CIRP were completed prior to the initiation of CIRP and each of these transactions were executed within a timeframe of 23 days preceding the initiation of the CIRP. The Auditor’s Report has stated that “the circumstances surrounding these financial maneuvers strongly suggest a premediated scheme or an afterthought by the CD, reflective of a deliberate and calculated effort to divert funds from the corporate entity in question.” The Report conclusively state that “considering the available documents, lack of evidence & explanation from CD and circumstances under which these transactions with related party occurred paint a picture of fraudulent transaction u/s 66 of IBC.”

The primary objection of the Respondent is that the RP has not filed this application u/s 66 of the Code within a period of 135 days as prescribed under Regulation 35-A of the IBBI (CIRP) Regulations, 2016. In this connection, reliance is placed on the Judgments of the Hon’ble NCLAT in the case of Aditya Kumar Tibrewal RP v. Om Prakash Pandey reported at (2022) ibclaw.in 278 NCLAT in Order dated 06.04.2022, according to which the Regulation 35-A is not mandatory and is only directory in nature. Subsequently, a similar decision was rendered in the Prasant Chandra Rath (Suspended Director of Corporate Debtor) v. Surya Kanta Satapathy (RP) and Ors. reported at (2022) ibclaw.in 789 NCLAT in Order dated 30.09.2022, in which, the reliance was placed on this earlier order in the case of Aditya Kumar (supra) and the same Judgment was delivered. It is also important to note here that in the latter Judgment, it was elaborately discussed and underlined that the delay in completing the report on the part of the RP for the purposes of Section 66 of the Code was caused primarily due to non-cooperation on the part of suspended Directors, as documents and registers was not handed over in time in that case. It was further noted that there was a delay on the part of suspended Directors to furnish documents, registers to the Transaction Auditor to complete the Transaction Audit for the purposes of Section 66. Therefore, these facts are identical to the case herein; here also there was absolute non-cooperation by the suspended Directors in handing over the documents and registers on the pretext that the same had been destroyed on account of floods, for which there is no evidence whatsoever. Hence, relying on the above mentioned Judgments of the Hon’ble NCLAT, the objection regarding non-submission of the RP’s report for the fraudulent transaction u/s 66 within the time is rejected as the timeline given under Regulation 35-A has been held to be directory and not mandatory.

The second objection is that the Transaction Audit Report submitted by M/s. Shambhu Gupta & Co., Chartered Accountants, lacks credibility due to significant disclaimers and caveats which have been mentioned in Para 4 above. Therefore, the Respondents have observed in their objection that such an inconclusive report holds no value in the eyes of Law for establishing the fraudulent transactions. In this connection, it is pertinent to mention here that the RP had constantly pursued with the suspended management to provide the documents and cooperate for the conduct of the Transaction Audit and Due Diligence for determining whether the transactions attract the provisions of Section 66 of the Code. It is reiterated by the RP that considering that the CIRP commencement date of 28.03.2023, the transfer of funds to the related parties (M/s. SLV Cements Ltd. and M/s. Lokapur Cements Ltd.) was done in the month of March 2023 itself i.e. in the immediately preceding period, which amounts to fraudulent transaction, since the suspended Directors refused to explain the nature of these transactions and give any details whatsoever. There was no documentary evidence nor any outstanding dues payable to these parties, which would justify these payments to the tune of Rs.29.48 crores as mentioned above at Para 2(h). On 16.08.2023, the Applicant sent an e-mail to the suspended Directors of the Corporate Debtor requesting for a detailed explanation regarding the nature of these transactions, reasons and the supporting documentary evidence. The same was also asked in respect of the Lease deposit of Rs.4 crores, for which also no documents, date of transactions etc. was furnished. The details in respect of all these transactions have been mentioned above in the facts at Para 2(h); and the total amount is Rs.29.48 crores.

The RP had also issued separate notices dated 24.07.2023 and 25.07.2023 to the two related parties mentioned above for repayment of the outstanding dues with the Corporate Debtor, to which also they have not responded; without any explanation. Accordingly, we are of the opinion that with this conduct of the suspended management / Directors of Corporate Debtor, they cannot raise the objections and observations in respect of the disclaimers made by the Transaction Auditor in his report.

It is noticed from the TAR, that the Auditor has clearly placed on record the link of the Corporate Debtor receiving an amount of Rs.24 crores in March 2023 from Ugar Sugar Works Ltd; and immediately within a day or two, transferred the same to the related party. The Banking Transactions have established a direct nexus or link between the receipt from Ugar Sugar Works Ltd. and transfer to the related parties; as is shown below:

Therefore, considering the dates of these transactions when the money which has been received from M/s. Ugar Sugar Works Ltd. by the Corporate Debtor had been transferred immediately within a day or two as reflected above to the related parties, namely, M/s. SLV Cements Ltd. and M/s.Lokapur Cements Ltd., it was all the more necessary for the Corporate Debtor or suspended management to respond to the queries raised by the Auditor or the RP for explaining the nature and basis along with the documentary evidence of these transactions, which was not done in spite of repeated opportunities.

In such a case, the person responsible (the Respondents in this case) being part of the suspended management of the Corporate Debtor would be liable to make appropriate contribution to the assets of the Corporate Debtor. Sub-Section (2) of Section 66 of the IBC 2016 also specifies that such a Director or Partner of the Corporate Debtor is liable to make such contribution to the Corporate Debtor if they did not exercise the due diligence in minimising the potential loss to the Creditors of the Corporate Debtor.

In this case there is a clear cut pattern established which shows that instead of exercising due diligence in minimising the potential loss to the creditors, the Respondents herein were in fact actively involved in facilitating to carry out the above referred fraudulent transactions, and causing grave losses to the Creditors of the Corporate Debtor as well as to the Corporate Debtor itself.

Therefore, it was logical on the part of the Transaction Auditor to look into the nature and purpose of such huge transfer and withdrawal from the CD's account just before the commencement of CIRP. In fact, the suspended Directors of CD also failed to provide the requisite details along with documentary evidence to the Auditor and explain to the Auditor as to why the huge withdrawals / transfers immediately after receipt of the money were made. It was only made known by the study of banking transactions of the CD that the money was taken from a third party, and immediately transferred to the related parties. Therefore, such transaction would be squarely covered within the scope and meaning of the provisions of Section 66 of IBC and the Respondents would be liable to make contributions to the assets of the Corporate Debtor as provided in that Section. There is no doubt in this case that the Respondents were ‘knowingly parties” in carrying out such fraudulent transactions and instead of exercising due diligence as provided in sub-section (2) (b) of the said Section 66 in minimising the potential loss to the Creditors of the Corporate Debtor; they actually actively indulged in and contributed to causing such losses to the Creditors.

On questioning about the documents, the Corporate Debtor has shrugged off the responsibility of providing the same by stating that the documents were missing due to the floods at the CD’s site. In light of this, it is necessary to peruse the decision of the Hon’ble NCLAT in Company Appeal (AT) (Insolvency) No.454 of 2022 in Mr. Nitin Bharal Ex-Director/Promoter and others v. Stockflow Express Private Limited through Liquidator Mr. Sanjay Gupta vide order dated 04.05.2022 reported in (2022) ibclaw.in 333 NCLAT, in which, it was held that that if the IRP/RP has prima facie suspicion of any fraudulent transactions, as defined under the Code, it has the recourse to approach the Adjudicating Authority for necessary action. Further, relying on Stockflow (supra), this Tribunal holds that in the event of non-cooperation in giving the information to the RP, the CD cannot question the completeness of the Transaction Audit Report.

In this case also, though the Transaction Audit was duly carried on, the final conclusion could not be arrived at as discussed above due to the lack of cooperation on the part of the suspended Board of Directors. Therefore, the Transaction Auditor was been just able to flag the huge encashment amounting to Rs. 24 crores and immediately after receipt of the money from a third party, M/s. Ugar Sugar Works Ltd.; thus a direct nexus has been established, by transferring it to the related parties in the immediately subsequent period, to the tune of Rs. 29,48,05,000/-. Thus, this is a fit case where there is a siphoning-off of funds by the Promoters/ Respondents and therefore, Section 66 of the IBC, 2016 is squarely applicable for “Fraudulent Transaction”. Relying upon the ratio in judgement of Hon’ble NCLAT (supra), the reports of the RP along with the CA are considered sufficient to establish that the provisions of Section 66 of the IBC, 2016 are clearly attracted in this case.

It is thus a case where the Respondents have raised objections regarding the RP having delayed in filing the IA for fraudulent transaction u/s 66 of the Code and also for the Transaction Auditor giving a qualified and report with some caveats, whereas, it is the suspended management itself that is fully responsible for the delaying tactics by not providing any information under the excuse of floods having destroyed the documents etc., in view of the Judgments noted above. Therefore, the objections of the Respondents are liable to be rejected in toto as they are held to be fully responsible for such delay and the qualified report on the part of the Auditor. However, as has been held in the above decisions rendered by the Hon’ble NCLAT, in such situations the Transaction Auditor as well as the RP is justified in preparing the report on the basis of the Bank Statements which clearly reflects the immediate withdrawal and transfer of funds to the related parties after receipt of the same from M/s. Ugar Sugar to the tune of Rs.24 crores during March, 2023. The Respondents cannot be allowed to have both, “to have the cake and eat it to”, as it is stated, and the General Manager of the Corporate Debtor Mr. Shishir Malagan who was on the site when the RP visited to take over the possession of the records and documents, giving the explanation of those having been destroyed by the flood, was also acting on the instructions of the suspended Directors.

In this regard it is relevant to note the provisions of Section 66 of the IBC, 2016 which provide that:

Sub-Section (1) of Section 66 of the Code provides the ‘Intent to Default creditors of the Corporate Debtor’ or for any ‘Fraudulent Purpose’, and in case the persons who are knowingly parties to carrying on of the business in such manner will be hit by the provisions of Section 66. In such cases, the person responsible (the Respondents in this case) being part of the suspended management of the Corporate Debtor would be liable to make appropriate contribution to the assets of the Corporate Debtor. Sub-Section (2) of Section 66 of the IBC, 2016 also specifies that such a Director or Partner of the Corporate Debtor is liable to make such contribution to the Corporate Debtor if they did not exercise the due diligence in minimising the potential loss to the creditors of the Corporate Debtor.

For arriving at the conclusion of the applicability of Section 66(2) of the Code in this case, specifically Section 66(2)(a), that before the insolvency commencement date, such Director or Partner knew or ought to have known that there was no reasonable prospect of avoiding the commencement of a CIRP in respect of such a Corporate Debtor, it is seen that the provision of Section 66(2) is clearly applicable in this case. The sequence of the events reveals that the application for admission u/s 7 of the Code was filed on 07.11.2022 and was reserved for orders on 06.02.2023. Subsequently, the admission order of Section 7 of the Code was passed by this Tribunal on 28.03.2023. It is further noticed that all the above transactions were carried out in March 2023 i.e. after this Petition u/s 7 of the Code was reserved for orders on 06.02.2023 itself. Not only that, another glaring fact is that, though the matter for admission u/s 7 of the Code was reserved for orders on 06.02.2023; during the course of the proceedings before this Adjudicating Authority, the Corporate Debtor itself vide Diary No.5214 dated 02.12.2022, has admitted the default as under:

Therefore, on 02.12.2022 itself the ex-management of the Corporate Debtor was conscious of the fact that the Corporate Debtor was going to be admitted under CIRP; since the Corporate Debtor had itself submitted a categorical admission of the debt and default and had conveyed the willingness for the admission of the Petition u/s 7 of the Code for the purposes of the CIRP. This was done by the above mentioned letter filed by Corporate Debtor vide Diary No.5214 dated 02.12.2022. Therefore, the provision of Section 66(2)(a), as mentioned above, will be clearly attracted in the case, since the suspended Directors were absolutely aware of the fact that the CIRP proceedings u/s 7 of the Code was going to be commenced against the Corporate Debtor since they had themselves expressed their willingness for the same. Accordingly, it is apparent that the whole sequence of the transactions mentioned above were carried out in a planned way to siphon off the assets / funds of the Corporate Debtor by the suspended Directors by transferring huge funds to the related parties, just prior to its admission of the CIRP u/s 7 of the Code. Instead of exercising due diligence as provided u/s 66(2)(b) of the Code for minimizing the potential loss to the Creditors of the Corporate Debtor, in fact they have actively colluded by siphoning off the funds immediately within a day or two of its receipt, and thereby adding to the loss to the Creditors of the Corporate Debtor. Thus, it is held that the provisions of Section 66(2)(a) and (b) are clearly attracted.

In this connection, considering the above sequence of events and the facts showing the conduct of the suspended Directors of the Corporate Debtor, who have constantly obstructed the CIRP processes under IBC, 2016, it would be relevant to point out the underlining principles and objectives behind the enactment of the Code which are explained by the Hon’ble Supreme Court in Swiss Ribbons Pvt. Ltd. and Anr. v. Union of India and Ors. reported at (2019) ibclaw.in 03 SC, Order dated 25.01.2019, wherein, it was held that:

(Emphasis supplied)

It is further pertinent to point out the order passed by this Tribunal in IA No.167 of 2024 in CP (IB) No.197/BB/2022, which was filed by one of the suspended Directors, and was dismissed by this Tribunal vide Order dated 22.10.2024. In this I.A. also the matter reflected the conduct of the suspended Director with a view to put obstacles in the smooth progress of the CIRP under the IBC, 2016 in the same matter. This Order dated 22.10.2024 passed by this Tribunal in above matter also has been upheld by the Hon’ble NCLAT at Chennai in Company Appeal (AT) (CH) (Ins.) No.394 of 2024 vide Judgment dated 21.11.2024.

Accordingly, in this case, we have seen that the conduct of the suspended Directors has been through out with a view to put obstacles in the CIRP process, along with non-cooperation with the RP and Transaction Auditor in handing over the documents and registers and at the same time objecting to the Application filed herein u/s 66 of the Code on various pretexts, with a view to somehow prolong the smooth progress of the CIRP process by filing repeated litigation and objections which cannot be permitted in view of the underlined principles as mentioned in the above Judgment of the Hon’ble Supreme Court.

Therefore, the prayers (a) and (b) sought by the Applicant in the Application at (a) and (b) of para 6 are hereby allowed with a direction to the Respondents to make payment of the entire amount of Rs. 29,48,05,000/-(Rupees Twenty-Nine Crores Forty-Eight Lakhs and Five Thousand only) to the Bank Account of the Corporate Debtor within a period of 30 days from the date of receipt of copy of this Order.

In the result, IA No.258 of 2024 in CP (IB) No.197/BB/2022 is disposed of on the above lines.