Fraudulent Transactions**

Fraudulent trading or carrying on business (Section 339)

This provision deals with the serious offense of carrying on a company's business with the intent to defraud creditors or for any fraudulent purpose, especially when the company is undergoing winding up. **Section 339 of the Companies Act, 2013**, provides that if, in the course of winding up of a company, it appears that any business of the company has been carried on with intent to defraud creditors of the company or any other persons or for any fraudulent purpose, the Tribunal, on the application of the Official Liquidator, or the Company Liquidator, or any creditor or contributory, may declare that any persons who were knowingly parties to the carrying on of the business in the manner aforesaid shall be personally responsible, without any limitation of liability, for all or any of the debts or other liabilities of the company as the Tribunal may direct.

The essence of fraudulent trading is the continuation of business and incurring of further debts when the persons managing the company know or ought to know that there is no reasonable prospect of the creditors being paid. It requires proving intent to defraud or a fraudulent purpose.

When directors can be made personally liable

Under **Section 339**, the liability is not limited to directors but extends to **any persons** who were "knowingly parties" to the fraudulent conduct of business. However, directors, being primarily responsible for the management of the company's affairs, are the most likely individuals to be held liable under this section. Other individuals involved in the management or control of the company, or even outsiders who colluded with the management, could potentially be held liable if they were knowingly involved in the fraudulent conduct.

Conditions for Personal Liability:

The company must be in the process of winding up.
It must be proven that the business of the company was carried on with intent to defraud creditors or for any fraudulent purpose.
The persons sought to be made liable must have been **knowingly parties** to the fraudulent trading. This means they must have had knowledge of the facts constituting the fraudulent trading.

Consequences:

If the Tribunal makes a declaration under this section, the liable persons become **personally responsible**, without any limitation of liability, for such debts or liabilities of the company as the Tribunal directs. This means their personal assets can be used to pay the company's debts. This is a significant departure from the principle of limited liability that normally protects shareholders and, to some extent, directors.

The object of Section 339 is penal and compensatory. It aims to punish those responsible for fraudulent activities and to compensate the creditors who have suffered loss as a result of such activities.

Fraudulent Preference (Section 531 of Companies Act, 1956, equivalent provisions in 2013 Act)

Fraudulent preference refers to an action taken by a company, typically when it is on the verge of insolvency or in financial distress, to repay or provide security to one or more of its creditors in a manner that puts them in a better position than other creditors of the same class would be in the event of the company being wound up. The essence is the **intent to prefer** that particular creditor over others.

Transfer of property with intent to prefer one creditor over others

The core of a fraudulent preference is a transaction (e.g., payment of money, transfer of property, creation of a charge, incurring an obligation) made by the company when it is unable to pay its debts as they become due, or when it is insolvent, with the dominant intention of giving a preference to one creditor over others. This is considered unfair to the general body of creditors who would share equally in the company's remaining assets during liquidation.

Legal Framework:

Under the Companies Act, 1956, **Section 531** specifically dealt with fraudulent preference, applying the rules of bankruptcy law to the winding up of companies. It stated that any transfer, mortgage, delivery of goods, payment, execution, or other act relating to property made or done by or against a company within **six months** before the commencement of its winding up, which would, if made or done by or against an individual, be deemed in his insolvency a fraudulent preference, shall in the event of the company being wound up, be deemed a fraudulent preference of its creditors and be invalid accordingly.

Under the **Companies Act, 2013**, the specific term "fraudulent preference" is not used in a standalone section equivalent to Section 531 of the 1956 Act. However, the principles are covered by provisions in different laws:

**Insolvency and Bankruptcy Code, 2016 (IBC):** The IBC is the primary law governing insolvency and liquidation of companies (Corporate Insolvency Resolution Process and Liquidation Process). **Section 43** of the IBC deals with **Preferential Transactions**. It allows the Adjudicating Authority (NCLT) to set aside a transaction as preferential if it transfers property or interest of the corporate debtor for the benefit of a creditor, surety or guarantor for or on account of an antecedent financial debt or operational debt or other liabilities owed by the corporate debtor, and has the effect of putting such creditor, surety or guarantor in a beneficial position than it would have been in the event of distribution of assets under Section 53 of the IBC.
- For transactions with a related party, the look-back period is **two years** preceding the insolvency commencement date.
- For transactions with a party other than a related party, the look-back period is **one year** preceding the insolvency commencement date.
- The transaction must not be in the ordinary course of business or a transfer creating a security interest in property acquired by the corporate debtor.
Unlike the old "fraudulent preference" which required proof of *intent* to prefer, Section 43 of IBC focuses more on the *effect* of the transaction, making it easier to challenge such transfers.
**Companies Act, 2013 (During Winding Up under the Act):** While IBC is dominant for corporate insolvency, the Companies Act, 2013 still contains provisions regarding fraudulent transfers during winding up proceedings initiated under the Act (which might occur for companies not covered by IBC or in specific scenarios). **Section 328** allows the Tribunal to declare any transfer of property by a company, made within **one year** before the presentation of a winding up petition, invalid if made with intent to defraud its creditors. **Section 329** deals with transfers of property to a purchaser in good faith and for valuable consideration, protecting such transactions. These sections cover similar ground as fraudulent preference but with a focus on *intent to defraud* the general body of creditors, rather than the specific criteria of preference under IBC.

In practice, for companies undergoing insolvency resolution or liquidation under the IBC, Section 43 of the IBC is the relevant provision to challenge preferential transactions. If a company is being wound up under the Companies Act, 2013, Sections 328 and 329 would be relevant regarding fraudulent transfers.

The effect of declaring a transaction a fraudulent preference or a preferential transaction (under IBC) is that it can be **set aside**, and the property or its value can be recovered by the liquidator or resolution professional for the benefit of the general body of creditors.

Ultra Vires Transactions

The term "**Ultra Vires**" is Latin for "beyond the powers." In company law, an ultra vires act is one that is beyond the legal powers or authority of a company as defined by its Memorandum of Association (MOA) or the Companies Act itself.

What constitutes an Ultra Vires Transaction?

The powers of a company are primarily derived from:

The **Objects Clause** in its Memorandum of Association, which specifies the business activities the company is authorised to undertake.
The provisions of the **Companies Act, 2013**.
Other relevant statutes.

An ultra vires transaction occurs when the company enters into a contract or carries out an activity that is not authorised by its objects clause or the Companies Act. For example, if a company's object is to carry on the business of manufacturing textiles, and it enters into a contract to build a railway line, that contract might be considered ultra vires the company's objects.

Consequences of Ultra Vires Transactions:

Historically, the doctrine of ultra vires was applied very strictly. An ultra vires contract was considered **void ab initio** (void from the beginning), meaning it had no legal effect, and neither the company nor the other party could enforce it. This was intended to protect shareholders (ensuring their investment was used only for stated objects) and creditors (ensuring company assets were not dissipated on unauthorised activities).

However, the strict application of the doctrine caused hardship to third parties who dealt with the company in good faith. Modern company law, including the Companies Act, 2013, has significantly diluted the strictness of the ultra vires doctrine:

**Section 4(1)(c) of the Companies Act, 2013** requires the MOA to state the objects for which the company is proposed to be incorporated.
**Section 17** allows for the alteration of the MOA, including the objects clause, by special resolution.
**Section 399** allows for inspection of company documents, including the MOA, at the RoC, providing potential notice of the company's objects to the public.

While an act beyond the objects clause might still be considered ultra vires the company, its effect on third parties is mitigated by principles like the **Rule in Royal British Bank v. Turquand** (the "indoor management" rule), which protects outsiders dealing with the company in good faith regarding internal irregularities, assuming procedural requirements have been met.

Liability of Directors:

Directors who cause the company to enter into ultra vires transactions can be held **personally liable** to the company for the loss suffered by the company as a result of such acts. This is because directors have a duty to act within the powers conferred by the MOA and the Companies Act. Such actions can be considered a breach of their fiduciary duty or duty of care and diligence. Shareholders can also bring an action against the directors to prevent them from entering into ultra vires transactions (injunction) or to recover damages for losses caused by past ultra vires acts.

In summary, while the doctrine of ultra vires transactions exists, its strict application has been softened to protect innocent third parties. However, directors are still accountable to the company and its shareholders for ensuring that the company acts within its defined powers.