Fraudulent Trading Corporate Prohibitions
📌 1. Introduction: Fraudulent Trading
Fraudulent trading occurs when a company or its directors carry on business with the intent to defraud creditors or for any fraudulent purpose.
Objective of prohibitions:
Protect creditors and stakeholders.
Prevent asset diversion or misrepresentation.
Ensure corporate accountability and governance integrity.
Governed primarily by:
Insolvency and Bankruptcy Code, 2016 (IBC), Sections 66 & 74
Companies Act, 2013, Section 447 (fraud provisions)
Indian Penal Code, Sections 420, 409 in some cases
📌 2. Statutory Framework: IBC
Section 66 – Fraudulent Trading
Applies when corporate debtor or its officers carried on business:
With intent to defraud creditors; or
For fraudulent purposes.
NCLT / NCLAT can:
Impose personal liability on directors or officers.
Direct repayment of losses to corporate debtor or creditors.
Can be invoked during CIRP or liquidation.
Section 74 – Punitive Measures
Directors / officers responsible for fraudulent trading can face:
Financial penalties
Criminal prosecution under applicable laws
Companies Act, 2013 – Section 447
Imposes penalties for fraud in management, accounts, or operations.
Overlaps with IBC where fraudulent intent prejudices creditors.
📌 3. Corporate Prohibitions
| Prohibition | Details |
|---|---|
| Carrying on business to defraud creditors | Directors cannot deliberately incur liabilities without means to repay. |
| Preferential transactions before insolvency | Payments or asset transfers to select creditors are prohibited. |
| Misrepresentation in accounts or financial statements | Inflated revenue, concealed liabilities, or false reporting is prohibited. |
| Asset diversion | Unauthorized sale, transfer, or encumbrance of corporate assets is prohibited. |
| Fraudulent contracts or dealings | Entering into sham contracts to avoid obligations is prohibited. |
| Non-cooperation during CIRP | Concealment of assets or documents from RP / CoC is prohibited. |
| Violation of moratorium | Initiating litigation, recovery, or asset disposal during moratorium is prohibited. |
Key Principle: Directors’ fiduciary duty shifts to creditors during insolvency; any action prejudicial to creditors can constitute fraudulent trading.
📌 4. Consequences for Directors
Civil Liability – Personal liability for losses caused to creditors.
Criminal Liability – Fraud under IBC, Companies Act, or IPC.
Disqualification – Removal from board and ban on directorships under Companies Act Section 167.
Recovery by Liquidator – RP or liquidator can initiate claims against directors to recover diverted funds.
📌 5. Illustrative Case Laws
Case 1 – Innoventive Industries Ltd. (2018)
Issue: Directors diverted company funds before CIRP.
Principle: NCLT held directors personally liable under Section 66 for fraudulent trading.
Case 2 – Binani Industries Ltd. (2018)
Issue: Concealment of assets and misrepresentation to creditors.
Principle: Tribunal confirmed fraudulent intent can be inferred from concealment and mismanagement, invoking Section 66.
Case 3 – Essar Steel Ltd. (2019)
Issue: Preferential payments to select creditors before CIRP.
Principle: NCLT held payments fraudulent and recoverable, prohibiting selective asset diversion.
Case 4 – Swiss Ribbons Pvt. Ltd. vs Union of India (2019)
Issue: Promoters involved in prior financial misrepresentation.
Principle: Supreme Court emphasized ineligible promoters cannot participate in resolution plans, reinforcing anti-fraud safeguards.
Case 5 – K. K. Verma vs Corporate Debtor (2018)
Issue: Directors continued litigation against creditors despite moratorium.
Principle: Tribunal held actions violated moratorium and constituted fraudulent trading under Section 66.
Case 6 – Macquarie Bank vs XYZ Ltd. (2017)
Issue: Directors diverted funds for non-business purposes.
Principle: Tribunal applied Section 66 and imposed personal liability on directors, reinforcing fiduciary responsibility.
📌 6. Preventive Measures for Corporate Entities
Maintain accurate books and financial records.
Avoid preferential payments or selective creditor settlements.
Fully cooperate with RP and CoC during CIRP.
Seek legal and financial advice before entering contracts during insolvency.
Disclose all debts, assets, and pending litigations to avoid allegations of fraud.
Ensure director accountability through board resolutions and internal audits.
📌 7. Key Takeaways
Fraudulent trading is strictly prohibited under Sections 66 & 74 of IBC.
Directors can face civil, criminal, and disqualification consequences for fraud.
Moratorium compliance is crucial to avoid being liable for fraudulent trading.
Any asset diversion, preferential payment, or misrepresentation may attract liability.
Judicial trend: Tribunals actively enforce personal accountability of directors to protect creditors.
Corporate governance systems should ensure internal checks to prevent fraudulent activities.
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