Interplay of Section 66(2)(b) with section 10 & section 43
# Section 66. Fraudulent trading or wrongful trading. -
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(2) On an application made by a resolution professional during the corporate insolvency resolution process, the Adjudicating Authority may by an order direct that a director or partner of the corporate debtor, as the case may be, shall be liable to make such contribution to the assets of the corporate debtor as it may deem fit, if-
(a) before the insolvency commencement date, such director or partner knew or ought to have known that the there was no reasonable prospect of avoiding the commencement of a corporate insolvency resolution process in respect of such corporate debtor; and
(b) such director or partner did not exercise due diligence in minimising the potential loss to the creditors of the corporate debtor.
The fact that CD’s net worth has turned negative, should put directors or partners, as the case may be, on notice of the reasonable prospect of the incipient insolvency of the company. Thus the duty is imposed on the management of the CD under section 66(2)(b) to initiate insolvency proceedings under section 10 to minimize the losses to the creditors. Directors or partners, as the case may be, can be asked to contribute towards the assets of the CD, an amount equal to the losses of the CD after the net worth of the CD turned negative.
Whenever the net worth of the CD turns negative, directors or partners, as the case may be, should take a conscious decision, preferably through board resolution/AGM to either file for insolvency proceedings under section 10 or to continue to run the business of CD on profitable prospects.
In my view, it should be made incumbent on the management/auditors to file for insolvency resolution within 60 days, when the net worth of the company turns negative in the audited financials, and the management has not taken any steps to infuse fresh capital. Management should not be allowed to run the company on funds of creditors.
Corollary of incipient insolvency
During the period of negative net worth of the CD, any payments/refund of deposits & loan etc. to directors or partners, as the case may be, and shareholders & related parties, should be treated as preferential transactions. Accordingly, “Look back” period for preferential transactions under section 43, is required to be redefined to start from the date the net-worth of the company turns negative.
Disclaimer: The sole purpose of this blog is to create awareness on the subject and must not be used as a guide for taking or recommending any action or decision. A reader must do his own research and seek professional advice if he intends to take any action or decision in the matters covered in this blog.
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