A director’s fiduciary duty is usually considered to be one of acting in good faith to promote the company’s objects and to advance its interests. This obligation, however, is displaced when insolvency proceedings begin. The interests of creditors then take precedence.
A failure to exercise commercial prudence when corporate insolvency looms may give rise to personal liability. This may happen when a director breaches section 66 of the Insolvency and Bankruptcy Code, 2016 (code). Such provision empowers the National Company Law Tribunal (NCLT), as the adjudicating authority, to fasten liability on directors for fraudulent or wrongful trading.
NCLT reinforces directors’ creditor-focused duties
The recent decision of the NCLT in Devendra Umrao Resolution Professional of Opulent Infradevelopers Private Limited v Amit Kumar Dubey and Anr underlines the requirement for directors to carry out this changed duty. In this case, the adjudicating authority allowed an application by the resolution professional under section 66 of the code. The tribunal found that suspended directors knowingly conducted the company’s business with the intent to defraud creditors. The adjudicating authority identified a series of transactions as fraudulent and, exercising its powers under sections 66(1) and 66(2) of the code, ordered the directors to personally contribute approximately INR105 million (USD1.66 million) to the corporate debtor’s assets within 15 days.
The adjudicating authority held that the company had made a series of doubtful financial decisions shortly before insolvency proceedings began. This painted a clear picture of financial mismanagement. The company had made significant donations to trusts, advanced interest-free loans, entered adjustment entries to set off receivables without supporting documents and booked unverified expenses without proper invoices.
IBC section 66 conflation limits liability
Although the imposition of liability on directors was commendable, the adjudicating authority missed an opportunity to fully exercise the wide discretion contained in section 66(1). This empowers it to direct “any person”, including third-party beneficiaries, to make contributions to the assets of the corporate debtor if the business of the corporate debtor is found to have been carried on with intent to defraud creditors. By contrast, section 66(2) applies only to the directors or partners when they knew or ought to have known that there was no reasonable prospect of avoiding insolvency and failed to exercise due diligence in minimising potential losses to creditors. In addition, the adjudicating authority held the directors liable for wrongful trading under section 66(2) for making interest-free advances, but the judgment failed to analyse how the two conditions set out in section 66(2) of the code were satisfied.
The National Company Law Appellate Tribunal in Swapan Kumar Saha v Ashok Kumar Agarwal held that sections 66(1) and 66(2) are self-contained provisions and operate independently. In Opulent Infradevelopers, however, the adjudicating authority appeared to have conflated the two provisions by confining liability to the directors. This resulted in the third parties that benefitted escaping liability. This was despite the statutory framework permitting such action against such third parties. Although the directors were held liable under section 66(1), the reasoning and relief granted aligned more closely with section 66(2), without any deliberation as to whether the two conditions set out in section 66(2) were satisfied.
Creditor duties and broader liability
Despite this lapse, Opulent Infradevelopers reinforces the view that a director’s duty towards creditors is an important facet of their fiduciary duty towards the company. When insolvency is inevitable, creditors’ interests outrank members’ interests, making this decision a welcome deterrent against director misconduct.
The message is unambiguous. In periods of financial distress, directors are required to reorder their priorities from maximising shareholder value to preserving the asset pool available to creditors. Although in Opulent Infradevelopers the adjudicating authority stopped short of fastening liability on the beneficiaries of such transactions, the code remains cast in broad terms and extends well beyond the boardroom. Anyone, including the beneficiaries of wrongful transactions, may be subject to personal liability for participating in fraudulent conduct.
NCLT’s judgment in Opulent Infradevelopers has been challenged and is currently pending before the National Company Law Appellate Tribunal.
