State Bank Of India vs Paresh Kantilal Patel & Anr.

Somnath Textile Private Limited (hereinafter referred to as the “Corporate Debtor”) was admitted into the Corporate Insolvency Resolution Process (CIRP) vide order dated 28.07.2017. Upon expiry of the CIRP period under Section 12 of the Insolvency and Bankruptcy Code, 2016 (“IBC”), the Corporate Debtor was ordered to be liquidated vide order dated 05.02.2018 passed by this Adjudicating Authority in I.A. No. 37 of 2018.

The Corporate Debtor had defaulted in payment of its creditors, with claims amounting to Rs. 47,95,18,747/-. Accordingly, in compliance with Regulation 12 of the IBBI (Liquidation Process) Regulations, 2016, a public announcement in Form B was made on 09.02.2018 in The Times of India and Divya Bhaskar (Gujarati).

The Liquidator filed I.A. No. 262 of 2020 in CP (IB) No. 49 (AHM) of 2017, seeking an extension of the liquidation period. This Adjudicating Authority, vide order dated 15.06.2020, granted an extension of six months from the date of the order.

The Liquidator made several attempts to realise the assets of the Corporate Debtor and successfully sold its plant and machinery. However, the land and building remained unsold, necessitating a further application for extension. Accordingly, vide order dated 05.01.2021 passed in I.A. No. 934 of 2020, this Adjudicating Authority granted a further extension of six months from 15.12.2020, i.e., up to 14.06.2021.

The Liquidator engaged HSVJ & Co., Chartered Accountants, on 05.11.2020 to conduct a transaction audit of the Corporate Debtor. The Transaction Audit Report (“TAR”) was submitted on 19.03.2021, covering the period from 27.07.2015 to 27.07.2017, to examine transactions potentially falling within the ambit of preferential, undervalued, transactions defrauding creditors, extortionate credit transactions, and fraudulent or wrongful trading under the relevant provisions of the IBC.

The Transaction Audit Report examined transactions with reference to Sections 43, 45, 49, 50 and 66 of the IBC. The present order shall determine only those statutory claims and reliefs that were actually pleaded, pressed and require adjudication.

With respect to potential preferential transactions under Section 43, the TAR, particularly Point No. 8, noted that payments had been made to certain creditors while amounts due to other creditors remained outstanding. However, owing to the non-availability of ageing reports, the auditor was unable to conclusively determine whether such payments were made in the ordinary course of business or constituted preferential transactions.

The report accordingly identified certain transactions warranting further examination under Section 43 of the IBC.

The Transaction Audit Report further identified the following transactions warranting examination:

Cash payments to creditors: During the financial year 2015–16, cash payments amounting to ₹81.21 lakh were made to creditors out of total payments of ₹396.44 lakh.

Loans and advances to related parties: During the financial year 2015–16, a loan of ₹2.60 lakh was advanced to Vaman Textile Private Limited, in which both directors of the Corporate Debtor had an interest.

Undervalued transactions and transactions defrauding creditors: With reference to Sections 45 and 49 of the IBC, the auditor observed that, during the financial year 2015–16, inventories comprising raw materials, work-in-progress (WIP) and finished goods, aggregating to ₹295 lakh, were adjusted/consumed despite there being no sales during the said financial year. The auditor noted that no reasonable justification for such adjustments could be ascertained from the available records or the independent auditor’s report.

Discrepancies in sales returns and inventory adjustments: The auditor further noted that sales returns were recorded at ₹94.95 lakh in the Annual Financial Statements (AFS) and ₹154.95 lakh in the books of accounts of the Corporate Debtor. However, no corresponding adjustments were made to the inventories in respect of such sales returns.

The allegations of fraudulent or wrongful trading under Section 66 of the IBC are considered separately in I.A. No. 986 of 2023, in accordance with the order dated 22.03.2023, subject to verification of the application number and the directions contained therein.

The Liquidator submitted that explanations were sought from the Respondents in respect of the transactions identified in the Transaction Audit Report. However, no response had been received from them. The Liquidator further stated that the findings of the Transaction Audit Report were communicated to the Respondents vide letter dated 12.03.2021, along with the report, and email dated 30.03.2021. Copies of the said letter, proof of postal service and email, along with the Transaction Audit Report, were annexed to the application as Annexure–VI.

In view of the aforesaid circumstances, the Applicant/Liquidator has filed the present application seeking appropriate directions from this Adjudicating Authority to declare the aforesaid transactions void and to grant appropriate reliefs for avoidance of such transactions in accordance with the applicable provisions of the IBC.

Vide order dated 22.03.2023, this Adjudicating Authority directed the Applicant to file separate applications for the reliefs sought under the relevant provisions of the IBC, having regard to the judgment in Anuj Jain, IRP for Jaypee Infratech Limited v. Axis Bank Limited, (2020) 8 SCC 401. The Applicant thereafter pursued the separate proceedings.

In compliance with the aforesaid order, the Applicant filed a separate application under Section 66 of the IBC.

The Applicant/Liquidator submitted that the liquidation process was stayed for a period of 460 days pursuant to the order dated 21.03.2018 passed by this Adjudicating Authority in I.A. No. 99 of 2018 in I.A. No. 37 of 2018 in CP (IB) No. 49 of 2018. The said application was subsequently dismissed vide order dated 22.01.2020. A copy of the order dated 22.01.2020 was annexed as Annexure–III.

The Applicant further submitted that, after making several attempts to realise the assets of the Corporate Debtor, the remaining properties were successfully sold through an e-auction conducted on 05.06.2021. Accordingly, the Applicant sought a further extension of the liquidation period to complete the liquidation process, which was granted by this Adjudicating Authority vide order dated 06.07.2021 passed in I.A. No. 430 of 2021, extending the period up to 14.12.2021. A copy of the said order was annexed as Annexure–IV.

The Applicant submitted that HSVJ & Co., Chartered Accountants, was engaged on 05.11.2020 to conduct a transaction audit of the Corporate Debtor. The audit covered the period from 27.07.2015 to 27.07.2017 to identify transactions potentially falling within the ambit of preferential, undervalued, extortionate credit, transactions defrauding creditors, and fraudulent or wrongful trading under the IBC. The Transaction Audit Report (“TAR”) was submitted on 19.03.2021, and a copy thereof was annexed as Annexure–V.

The Applicant further submitted that the transaction audit examined transactions with reference to Sections 43, 45, 49, 50 and 66 of the IBC. With respect to fraudulent or wrongful trading under Section 66 of the IBC, the TAR, particularly Point No. 8.3, identified discrepancies between the payments reflected in the bank statements and the corresponding entries in the books of accounts of the Corporate Debtor. It was observed that, in certain instances, payments were made to creditors while the ledger accounts of different creditors were debited in the books of the Corporate Debtor. The report identified certain parties in respect of whom such discrepancies were observed.

The Applicant submitted that explanations were sought from the Respondents regarding the transactions identified in the Transaction Audit Report (“TAR”); however, no response was received. The findings of the TAR were communicated to the Respondents vide letter dated 12.03.2021 and email dated 30.03.2021. Copies of the said communications, along with proof of postal service and the TAR, were annexed as Annexure–VI.

The Applicant/Liquidator accordingly filed the present application seeking a declaration that the aforesaid transactions were void and appropriate reliefs for avoidance of such transactions in accordance with the provisions of the Insolvency and Bankruptcy Code, 2016 (“IBC”).

The Applicant submitted that I.A. No. 661 of 2021 was filed on or about 22.09.2021 under Sections 43, 45, 49 and 66 of the IBC. Subsequently, vide order dated 22.03.2023, this Adjudicating Authority, taking into consideration the judgment of the Hon’ble Supreme Court in Anuj Jain, IRP for Jaypee Infratech Limited v. Axis Bank Limited & Ors., directed the Applicant to file separate applications in respect of the reliefs sought under the aforesaid provisions. A copy of the order dated 22.03.2023 was annexed as Annexure–VII.

As per Note 4 of the financial statements for FY 2016– 17, the inventory comprising work-in-progress, finished goods and stock-in-trade, including textile materials such as yarn and silk fabrics, decreased from ₹2,54,58,996/- to ₹25,00,000/- during FY 2015–16, reflecting a difference of ₹2,29,58,996/-.

The Applicant further submitted that, as per Note 3.7 of the financial statements, no corresponding increase in revenue from operations was reflected. On the contrary, the negative figure of revenue from operations indicated sales returns, which ordinarily ought to have resulted in an increase in inventory.

The Applicant submitted that no satisfactory explanation was available for the aforesaid discrepancy and alleged that the transactions warranted examination under Sections 43, 45 and 49 of the IBC. A copy of the balance sheet of the Corporate Debtor as at 31.03.2017 was annexed as Annexure–A.

Vide order dated 28.07.2025, this Adjudicating Authority directed the Applicant to obtain necessary instructions from the Financial Creditor, namely, State Bank of India (“SBI”), regarding the present whereabouts of the ex parte Respondents, the assets held by them, and their business activities.

In compliance with the aforesaid directions, the Applicant approached SBI and sought the requisite information. SBI thereafter engaged SAFAL Professional & Recovery Services Pvt. Ltd. (hereinafter referred to as the “Agency”) to conduct an investigation and procure relevant documentary evidence concerning the Corporate Debtor, M/s. Somnath Textile Private Limited, and its Directors/Guarantors.

The Agency submitted its first Investigation Report dated 26.09.2025, covering the individuals and entities connected with the Corporate Debtor, namely, Mr. Paresh Kantilal Patel, Mrs. Parulben Paresh Patel, Mrs. Geetaben B. Patel, Mr. Girish Kantilal Patel, Mr. Kantilal Ramdas Patel, Mr. Jignesh Pravinbhai Patel, M/s. Vaman Textiles Pvt. Ltd., M/s. Vaman Fabrics Pvt. Ltd., and M/s. Somnath Textile Pvt. Ltd.

The Applicant submitted that the Investigation Report identifies the assets held by the Respondents, their locations, and certain assets stated to be available for attachment. The report also contains a detailed table setting out the property owners and the status of the properties identified during the investigation, which is reproduced herein below for the consideration of this Adjudicating Authority

The Applicant submitted that the first Investigation Report dated 26.09.2025, prepared by SAFAL Professional & Recovery Services Pvt. Ltd., was annexed to the application and marked as Annexure–A1.

The Applicant further submitted that the Agency conducted a subsequent investigation and submitted its second Investigation Report dated 17.11.2025. As per the said report, the whereabouts and residential addresses of the individuals/borrowers could not be ascertained. Consequently, their present business activities also remained unverified.

A copy of the second Investigation Report dated 17.11.2025 was annexed to the application and marked as Annexure–A2.

In compliance with the aforesaid directions, the Applicant submitted that, on 08.01.2026, he, along with the authorised officer of the State Bank of India, visited the residential address of the Respondents, namely, A/504, Vinayak Residency, Parvat Patiya, Magob, Surat – 395010.

The Applicant further submitted that photographs of the visit, bearing GPS tracking details, were taken and annexed to the compliance affidavit as Mark–1.

The Applicant also referred to his affidavit dated 09.01.2026, wherein the visit to the aforesaid residential address, along with the bank officer, had been reported.

The Applicant affirmed that the address furnished by the Respondents was true and correct and that the Respondents were residing at the said address along with their family.

The Respondents, in their reply, challenged the maintainability of the present application filed under Sections 43, 45 and 49 of the Insolvency and Bankruptcy Code, 2016 (“IBC”), contending that the transactions referred to in the Transaction Audit Report dated 19.03.2021 did not attract the ingredients of the aforesaid provisions and were undertaken in the ordinary course of business.

With respect to the payments made to 14 creditors, as referred to in Clause 8.1.1 of the Transaction Audit Report, the Respondents contended that the allegations were false, malicious and misconceived. They submitted that the said creditors were engaged in the textile business and had regular business dealings with the Corporate Debtor. Accordingly, the payments were made in the ordinary course of business. The Respondents further relied upon Section 43(3) of the IBC and submitted that the auditor had expressed an inability to determine whether the payments were made in the ordinary course of business or constituted preferential transactions.

Regarding the loan of ₹2.60 lakh advanced to Vaman Textiles Private Limited during FY 2015–16, as referred to in Clause 8.1.2 of the Transaction Audit Report, the Respondents submitted that the machinery installed for yarn production at the Corporate Debtor's premises was temporarily non-functional. Consequently, yarn was procured from Vaman Textiles Private Limited, and the payment in question was made towards such supplies. Accordingly, the Respondents contended that the transaction did not constitute a preferential transaction.

With respect to the reduction in inventory without a corresponding increase in revenue, the Respondents contended that inventory reduction in the textile industry does not necessarily correspond to sales, as it may arise from production-related wastage, shrinkage, process losses, deterioration in quality, changing market trends and inventory write-offs or erosion in value. They further submitted that reduced market demand and operational constraints had resulted in lower revenue during the relevant period. Accordingly, the allegation of diversion or unaccounted transactions was stated to be based on assumptions and unsupported by any substantive material on record.

In view of the aforesaid submissions, the Respondents contended that the Applicant had failed to establish any case attracting Sections 43, 45 and 49 of the IBC and prayed for dismissal of the present application with exemplary costs.

The Applicant contended that the Respondents' assertion that the transactions identified in the Transaction Audit Report dated 19.03.2021 were undertaken in the ordinary course of business was vague and unsupported by documentary evidence. It was submitted that the report, particularly paragraphs 8.1.1, 8.1.2 and 8.2.1 at pages 50–51 of the application, identified payments to certain creditors, loans and advances to related parties, and adjustments in inventory during FY 2015–16, warranting examination under Sections 43, 45 and 49 of the IBC.

With respect to the payments made to 14 creditors, the Applicant submitted that the Transaction Audit Report identified preferential treatment of certain creditors while other creditors remained unpaid. The Respondents had failed to produce any documentary evidence, including ageing analysis, to establish that the payments were made in the ordinary course of business. The Applicant contended that mere denial of the allegations was insufficient to rebut the findings of the audit report.

The Applicant further submitted that the Transaction Auditor had examined the books of accounts, bank statements, ledger entries, financial statements and other relevant records of the Corporate Debtor before identifying the impugned transactions as potentially falling within the ambit of preferential transactions under Section 43 of the IBC. It was contended that the Respondents had failed to demonstrate how the transactions were consistent with the regular business practices of the Corporate Debtor.

Regarding the loan of ₹2.60 lakh advanced to Vaman Textiles Private Limited, the Applicant disputed the Respondents' explanation that the payment was made towards the supply of yarn. The Applicant submitted that the Respondents had failed to produce the relevant invoices and delivery receipts to substantiate the alleged supply. It was further contended that the liquidation order dated 10.03.2021 passed in I.A. No. 170 of 2021 in CP (IB) No. 309 of 2018 concerning Vaman Textiles Private Limited reflected the association of Paresh Patel and Parul Patel with the Corporate Debtor as suspended directors. According to the Applicant, the transaction involved a related party and remained unsupported by documentary evidence establishing its ordinary commercial purpose. A copy of the said liquidation order was annexed as Annexure– A1.

With respect to the reduction in inventory amounting to ₹2,29,58,996/-, the Applicant submitted that the Respondents' explanation based on reduced demand, deterioration in quality and changing market trends was an afterthought unsupported by the financial records of the Corporate Debtor. It was contended that the Respondents had failed to produce supporting documents, including stock registers, wastage or scrap registers, records of write-offs, insurance claims or internal communications, to substantiate the alleged inventory losses.

The Applicant further contended that the absence of any alleged fraudulent intent would not, by itself, exclude a transaction from being preferential under Section 43 of the IBC. In support of this contention, reliance was placed on GVR Consulting Services Limited v. Pooja Bahry [2023 SCC OnLine NCLAT 2201], which, according to the Applicant, clarified that proof of fraudulent intent is not a prerequisite for establishing a preferential transaction under Section 43.

The Applicant also submitted that the Transaction Audit Report had been forwarded to the Respondents by email dated 30.03.2021, inviting their comments and observations. However, no response was received from them.

Accordingly, the Applicant maintained that the application was maintainable and that the Respondents had failed to substantiate their defence through documentary evidence. The Applicant therefore prayed that appropriate orders be passed in accordance with the provisions of the IBC.

The Applicant/Liquidator contended that the Respondents’ objections regarding the maintainability of the application were vague and misconceived, as no documentary evidence or ageing analysis had been produced in support of their defence.

With respect to the allegations of fraudulent or wrongful trading under Section 66 of the IBC, the Applicant relied upon the Transaction Audit Report dated 19.03.2021, particularly Paragraph 8.3.1, which identified discrepancies between the payments reflected in the bank statements and the corresponding ledger entries of the Corporate Debtor. Three transactions amounting to ₹78,72,600/-, ₹20,98,066/- and ₹1,15,859/-, aggregating to ₹1,00,86,525/-, were identified. While the bank statements reflected payments benefiting Kay International and Shri Muniveer Spinning Mills, the books of accounts recorded corresponding entries in favour of Vimal Textile, Sunflower Enterprise and Sarthak Yarn. The Applicant contended that such discrepancies could not be dismissed as mere accounting errors.

The Applicant further submitted that the Transaction Auditor had examined the books of accounts, bank statements, ledger entries and other financial records before identifying the impugned transactions. It was contended that the Respondents had failed to produce any evidence to rebut the findings recorded in Paragraph 8.3.2 of the report. The Applicant also relied upon the recording of sales returns during FY 2015–16 despite there being no sales during the said year, contending that the same indicated serious accounting discrepancies requiring examination.

The Applicant alleged that the transactions were undertaken to prejudice the interests of creditors and siphon off the assets of the Corporate Debtor. It was submitted that mere denial of the allegations, without supporting documentary evidence, could not absolve the Respondents of their liability. Reliance was also placed on the order dated 20.04.2026 passed by this Adjudicating Authority in Bank of India v. Mayur Balubhai Shah and Ors., I.A. No. 1007 (AHM) of 2023 in C.P. (IB) No. 407 of 2020, reported as [(2026) ibclaw.in 1191 NCLT].

The Applicant further submitted that the Transaction Audit Report had been forwarded to the Respondents by email dated 30.03.2021, inviting their comments and observations; however, no response was received. Accordingly, the Applicant maintained that the application was maintainable and prayed that the same be allowed.

A. Issue No. 1: - Whether the payments made by the Corporate Debtor to the identified creditors during the relevant period constitute preferential transactions within the meaning of Section 43 of the Insolvency and Bankruptcy Code, 2016?

B. Issue No. 2: - Whether the advance of Rs.2.60 lakh made to M/s. Vaman Textile Private Limited and the inventory adjustments made during the financial year 2015–16 constitute undervalued transactions or transactions defrauding creditors within the meaning of Sections 45 and 49 of the Insolvency and Bankruptcy Code, 2016?

C. Issue No. 3: - Whether the reduction in inventory of Rs 2,95,16,958, sales return of Rs ₹154.95 lakh without increase in the inventory, and discrepancies between the payments reflected in the bank statements and the corresponding ledger entries of the Corporate Debtor, involving transactions aggregating to ₹1,00,86,525/-, establish fraudulent or wrongful trading within the meaning of Section 66 of the Insolvency and Bankruptcy Code, 2016?

The Corporate Debtor, M/s. Somnath Textile Private Limited, was admitted into the Corporate Insolvency Resolution Process (CIRP) vide order dated 28.07.2017 based on an application under section 10 of the Code filed by the Corporate Debtor. The Corporate Debtor was subsequently ordered to be liquidated vide order dated 05.02.2018.

The Corporate Debtor defaulted in making payments to creditors and claims of Rs 47,95,18,747 were received from the creditors. During the liquidation process, the Liquidator engaged HSVJ & Co., Chartered Accountants, on 05.11.2020 to conduct a transaction audit of the Corporate Debtor for the period from 27.07.2015 to 27.07.2017. The Transaction Audit Report dated 19.03.2021 identified certain transactions warranting examination under Sections 43, 45, 49, 50 and 66 of the Insolvency and Bankruptcy Code, 2016 (“IBC”).

The Transaction Audit Report (TAR) dated 19.03.2021 is available on pages 39 to 59 of the Annexure to the Application. Page 62 of the Annexure shows that the Liquidator forwarded the report to Suspended Director seeking comments/feedback on the observations in the Report.

The present proceedings arise from the allegations concerning payments made to certain creditors, advances to a related party, and adjustments in the inventory of the Corporate Debtor during the financial year 2015–16. The Applicant seeks appropriate reliefs in respect of the transactions alleged to be preferential, undervalued or undertaken with the intent to defraud creditors. The allegations pertaining to fraudulent or wrongful trading under Section 66 of the IBC are the subject matter of the separate application, being I.A. No. 986 of 2023, and considered in this order later.

This Adjudicating Authority has considered the averments made in the application, the Transaction Audit Report dated 19.03.2021, the reply filed on behalf of the Respondents, the submissions advanced by the Applicant, and the material available on record. The issue for consideration is whether the payments made to the identified creditors during the financial year 2015–16, while other creditors of the Corporate Debtor allegedly remained unpaid, constitute preferential transactions within the meaning of Section 43 of the Insolvency and Bankruptcy Code, 2016 (“IBC”).

Section 43 of the Code is reproduced below:-

It is noted that Clause 8.1.1 of the Transaction Audit Report identifies payments aggregating to ₹396.44 lakh made to 14 creditors during FY 2015–16, including payments of ₹81.21 lakh in cash. The identification of these transactions in the course of the transaction audit, particularly in the context of other outstanding creditor liabilities, warrants examination of the circumstances in which such payments were made and whether those resulted in the impugned beneficiaries being placed in a more advantageous position than they would have occupied in the distribution of assets under Section 53 of the IBC.

The Respondents have contended that the identified creditors were engaged in the textile business and were regular business counterparties of the Corporate Debtor, and that the payments were made in the ordinary course of business. However, the mere assertion that the parties were engaged in the same line of business or had regular commercial dealings does not, by itself, establish that the impugned payments were made in the ordinary course of business. The nature of the underlying transactions, the corresponding invoices, ledger accounts, payment records, outstanding liabilities and the established course of dealings between the parties are relevant considerations in determining the true character of the transactions. The Respondents’ explanation, therefore, requires scrutiny in the light of the contemporaneous documentary record.

The Respondents’ reliance on the ordinary-course carve out under Section 43(3) of the IBC requires to be considered in accordance with the principles laid down by the Hon’ble Supreme Court in Anuj Jain, Interim Resolution Professional for Jaypee Infratech Limited v. Axis Bank Limited, (2020) 8 SCC 401. The applicability of the exception cannot be determined merely on the basis of a general assertion that the parties were regular business counterparties. The nature and circumstances of the transaction, the commercial dealings between the parties and the requirements of Section 43(3) must be examined before the exclusion can be applied. Accordingly, the Respondents’ plea of ordinary-course transactions cannot be accepted solely on the basis of their assertion, without due consideration of the supporting material.

The fact that payments were made to certain creditors while other creditor liabilities allegedly remained outstanding is a relevant circumstance for examination The Applicant’s case must be assessed by determining whether the impugned transfers were made for the benefit of the identified creditors on account of antecedent debts or liabilities, whether they placed the beneficiaries in a more advantageous position than they would have occupied in the distribution under Section 53, whether the transactions fall within the applicable relevant time, and whether any exclusion under Section 43(3) applies. The burden of establishing the necessary foundational facts remains governed by the applicable law, and the Respondents’ explanation must be assessed against the material available on record.

In view of the foregoing discussion, this Adjudicating Authority holds that the Respondents’ contention that the impugned payments were made in the ordinary course of business cannot be accepted merely based on a general assertion, in the absence of sufficient supporting material substantiating such plea. The payments were made to creditors for antecedent operational debts. As noted above payments are also stated to have been made in cash.

In view of the foregoing discussion, this Adjudicating Authority holds that the Respondents’ contention that the impugned payments were made in the ordinary course of business is rejected. Accordingly, payments of Rs 396.44 lakhs made to identified creditors in preference to the other creditors including financial institution are held to be covered by provisions of section 43 of the Code. In view of the above and considering the provisions of section 44 (1)(a) of the Code, we direct that amounts of Rs 396.44 lakhs be vested in the corporate debtor and the Respondent Nos. 1 and 2 contribute the same to the corporate debtor.

With regard to the advance of ₹2.60 lakh, the Transaction Audit Report records that the amount was advanced to M/s. Vaman Textile Private Limited, in which the directors of the Corporate Debtor had an interest. The Applicant has contended that the transaction involved a related party and that the Respondents failed to substantiate the commercial purpose of the payment through relevant invoices and delivery receipts. The Applicant has further relied upon the order dated 10.03.2021 passed in I.A. No. 170 of 2021 in CP (IB) No. 309 of 2018 concerning M/s. Vaman Textile Private Limited, in support of its contention regarding the association of the Respondents with the said entity.

The Respondents, in their reply, have stated that the machinery installed in the Corporate Debtor for the production of yarn was not functioning for a certain period during FY 2015–16 and that yarn was consequently procured from M/s. Vaman Textile Private Limited, against which the payment of ₹2.60 lakh was made.

Nevertheless, the existence of a related-party relationship or the absence of supporting documents cannot, by itself, conclusively establish that the advance constituted an undervalued transaction under Section 45 or a transaction defrauding creditors under Section 49 of the IBC. The transaction must be examined to determine whether it involved a gift or transfer for consideration significantly less than the value of the consideration provided by the Corporate Debtor, as contemplated under Section 45, and whether the requirements of Section 49, including the requisite intent to defraud creditors, are established. The absence of supporting documents assumes significance in assessing the explanation offered by the Respondents, but the statutory ingredients must still be satisfied.

As regards the inventory adjustments, the Transaction Audit Report records that, during FY 2015–16, inventory comprising raw materials, work-in-progress and finished goods aggregating to ₹295 lakh was adjusted or consumed despite there being no sales during the relevant financial year. The auditor further noted that no reasonable justification for the adjustments could be ascertained from the available records or the independent auditor’s report. The report also identifies a discrepancy between sales returns of ₹94.95 lakh reflected in the annual financial statements and ₹154.95 lakh recorded in the books of account, without corresponding inventory adjustments in respect of such sales returns. These discrepancies raise material questions concerning the manner in which the Corporate Debtor’s inventory was accounted for and the ultimate disposition of the relevant goods.

The Applicant, by its additional affidavit dated 14.09.2024, has further pointed out that, as reflected in Note 4 of the financial statements, the inventory comprising work-in-progress, finished goods and stock-in-trade decreased from Rs. 2,54,58,996/- to Rs. 25,00,000/-, reflecting a difference of Rs. 2,29,58,996/-. The Applicant has also relied upon Note 3.7 of the financial statements and contended that the reduction in inventory was not accompanied by a corresponding increase in revenue from operations. According to the Applicant, the discrepancies assume further significance in view of the sales-return figures and the absence of a satisfactory explanation for the reduction in inventory.

The Respondents have sought to explain the inventory reduction by contending that inventory in a textile business may be consumed during production and may also be affected by wastage, shrinkage, process loss, deterioration in quality, reduced demand, operational constraints and write-offs. While such circumstances may, depending upon the supporting records, explain a reduction in inventory, the Respondents have not, on the material identified in the present record, substantiated their explanation through stock registers, production and consumption records, wastage or scrap registers, write-off records, sales-return documentation or other contemporaneous material correlating the inventory reduction with the alleged operational circumstances. A general explanation concerning the nature of the textile business is insufficient, by itself, to reconcile the substantial inventory reduction and the discrepancies identified in the Transaction Audit Report.

This Adjudicating Authority is of the view that the transaction of Rs 2.60 lakhs with Vaman Textiles Private Limited is not properly explained by the Respondents, particularly considering that there was no production and no documents to support receipt of corresponding benefits is submitted. Considering the provisions of section 49(1)(b), this Authority restores the transaction of payment of Rs 2.60 lakh to the Corporate Debtor as if the transaction had not been entered into. The Respondent Nos. 1 and 2 shall contribute this sum to the corporate debtor.

We are of the view that provisions of section 45 do not apply to reduction of inventory and the applicability of section 66 of the Code is considered later in this order.

As noted above there has been reduction/adjustment in inventory of raw material of Rs 65,57,962, work in progress of Rs 1,59,97,621, and finished goods of Rs 69,61,375 totalling to Rs 2,95,16,958. There has been no sale or production during the year and the Respondents have failed to provide a satisfactory explanation for the reduction of inventory and corresponding sales.

Further, a sales return of Rs ₹154.95 lakh has been accounted without increase in the corresponding inventory of finished goods.

Section 66 of the Code dealing with fraudulent or wrongful trading and the section reads as below:

Section 66(1) of the Code deals with fraudulent trading where, during CIRP or liquidation, the business of the Corporate Debtor is carried on with intent to defraud creditors or for any fraudulent purpose. Section 66(2) deals separately with wrongful trading and contains distinct statutory requirements which must independently be satisfied.

Thus, in cases of wrongful trading, liability may be fastened where it is established that:

The directors knew or ought to have known that there was no reasonable prospect of avoiding insolvency; and

They failed to exercise due diligence in minimizing potential losses to creditors.

From the records, it is evident that the Respondents were erstwhile directors/promoters of the Corporate Debtor during the relevant period when the impugned transactions of depletion of stock took and sales return took place. We note that the application under section 10 was filed by the Corporate Debtor and therefore the suspended directors knew or ought to have known that there was no reasonable prospect of avoiding the commencement of a corporate insolvency resolution process in case of the corporate debtor.

The material on record demonstrates that: -

The Respondents were in control of the affairs and management of the Corporate Debtor;

The transactions held as fraudulent transactions or wrongful trading were executed during their tenure;

No evidence has been produced to show that such transactions were undertaken without their knowledge or authority.

This Authority finds that the impugned transactions of depletion of stock (reduction of inventory) of the corporate debtor and sales return without addition to inventory took place after the corporate debtor was experiencing financial distress. The unaccounted disappearance of stock resulted into a loss to the corporate debtor and effectively to the creditors. The question whether such diminution was caused by fraudulent conduct attributable to the Respondents must, however, be determined independently on the evidence. Similarly, sales return results into corresponding less receivables/assets but there was no corresponding increase in the stock.

The Respondents have not produced satisfactory contemporaneous records explaining the reasons for depletion of inventory and non-recording of stock increase due to sales return. In the present case, the conduct of the Respondents demonstrates:

Failure to act in the best interest of the Corporate Debtor;

Active depletion of the asset base of the company.

Such actions amount to a clear breach of fiduciary duties. It is a settled principle that directors cannot take shelter of unsupported claims, particularly when they have failed to exercise due diligence expected of them. Creditors were prejudiced as the asset pool in the form of stock of goods available for resolution/liquidation was significantly reduced.

The material facts and chronology of events noted in this order demonstrate that the transactions identified in this Application as fraudulent trading or wrongful trading took place just before the corporate debtor filed application under section 10 seeking initiation of CIRP.

There exists a direct nexus between the conduct of the Respondents and the losses suffered by the Corporate Debtor. The depletion of stock/ assets and sales return without corresponding stock increase cannot be attributed to market forces or business exigencies, but to deliberate acts of mismanagement and diversion/sale of stock of the corporate debtor that was not accounted in the regular books of account and the proceeds did not come to the corporate debtor.

In light of the above findings, this Authority is satisfied that, the Respondents were knowingly parties to the fraudulent conduct and they were knowing or ought to have known that there was no reasonable prospect of avoiding the commencement of a corporate insolvency resolution process in respect of the Corporate Debtor in this case and this finding by this Adjudicating Authority is reasonable because transactions were undertaken which defrauded creditors and the Respondents did not exercise due diligence in minimizing the potential loss to the creditors of the Corporate Debtor.

Accordingly, this Adjudicating Authority is satisfied that the ingredients of Section 66(2) of the Code stand established. Accordingly, the Respondents, being the persons found liable under Section 66 are liable to make contributions of Rs 2,95,16,958 on account of stock/inventory loss and Rs 154.95 lakhs for sales return without increase in the inventory, to the assets of the Corporate Debtor.

The object of Section 66 is compensatory and restorative rather than penal. The contribution directed herein is intended only to restore the value wrongfully depleted from the assets of the Corporate Debtor.

In view of the foregoing discussion and having regard to the totality of circumstances, the contentions raised by the Respondents are found insufficient to rebut the material placed by the Applicant. The present application therefore deserves to be allowed to the extent of the unexplained inventory loss/depletion of Rs 2,95,16,958 and Rs 154.95 lakhs for sales return.

Regarding the other transaction of Rs 1,00,86,525/-concerning mismatch of payments to parties different from those noted in the books of account. Accounts in the ledger were adjusted of parties other than to whom payments were made. The Applicant has relied upon Paragraph 8.3.1 of the Transaction Audit Report dated 19.03.2021, which identifies discrepancies between the payments reflected in the bank statements and the corresponding entries recorded in the books of account of the Corporate Debtor. The report identifies three transactions amounting to Rs. 78,72,600/-, Rs. 20,98,066/- and Rs. 1,15,859/-, aggregating to Rs. 1,00,86,525/-. As per the Applicant, while the bank statements reflected payments benefiting Kay International and Shri Muniveer Spinning Mills, the corresponding entries in the books of account were recorded in favour of Vimal Textile, Sunflower Enterprise and Sarthak Yarn. The Applicant has contended that these discrepancies cannot be dismissed as mere accounting errors, particularly in the absence of a satisfactory explanation reconciling the payments with the corresponding ledger entries.

The discrepancies identified in the Transaction Audit Report raise a material question regarding the actual beneficiaries of the payments made from the accounts of the Corporate Debtor and the purpose for which the funds were utilised. A mismatch between the beneficiary reflected in the bank statement and the entity in whose favour the corresponding ledger entry has been recorded is a circumstance requiring explanation through the underlying payment instructions, bank records, invoices, vouchers, ledger accounts and other supporting documents. In the absence of a satisfactory reconciliation, the discrepancies assume significance in determining whether the transactions were properly recorded and whether the funds of the Corporate Debtor were utilised for its legitimate business purposes or diverted for purposes prejudicial to the interests of its creditors.

The Applicant’s prayer for avoidance of payments made to 14 creditors under Section 43 of the Insolvency and Bankruptcy Code, 2016 (“Code”) for Rs 396.44 lakhs is allowed and the Respondents, as per provisions of section 44, are directed to contribute to the corporate debtor.

The transaction involving the advance of Rs. 2.60 lakh to M/s. Vaman Textile Private Limited is allowed as undervalued (sections 45 and 49 of the Code) and respondents are directed to contribute Rs 2.60 lakhs to the corporate debtor.

The inventory loss/depletion of Rs 2,95,16,958, sales return of Rs 154.95 lakhs, and mismatch in payments of Rs 1,00,86,525, all totalling to Rs 5,90,03,483 are considered fraudulent under section 66 of the Code.

The respondents are jointly and severally liable for making payments to the corporate debtor as determined above along with an interest at the rate of 12.00% per annum computed for the period starting from the date of the transactions to the date of realization.

The aforesaid amounts shall be deposited with the Applicant -SBI within a period of 30 days from the date of this Order.

Upon receipt of the aforesaid amounts, the Applicant -SBI shall deal with the same strictly in accordance with the provisions of the Insolvency and Bankruptcy Code, 2016 and the applicable Regulations, and shall distribute the amounts amongst the stakeholders in accordance with the provisions of Section 53 of the Code.

In the event of default in compliance with this order, the Applicant shall be at liberty to seek enforcement of this order by initiating appropriate execution proceedings in accordance with law before the competent forum.