Fraudulent Transfers
Introduction
When a person has a debt and is not paying, then the creditor can approach the Court for an attachment of debtor’s property. If the debtor were to transfer his property with an intent to defraud the creditor, then the creditor would be left without any source to recover his debts. This act of transferring the property on the part of the debtor is known as ‘fraudulent transfer’. Various laws have dealt with this subject of fraudulent transfer by giving it different terminologies, such as voluntary transfer, private alienation, etc. Let us look at some of the important laws dealing with the subject of fraudulent transfer. In this age where several agencies, such as the Enforcement Directorate, are contemplating attaching properties of businessmen/companies the subject of fraudulent transfers assumes importance.
Meaning of fraud
Since we are examining the concept of a fraudulent transfer, let us first understand the meaning of the term fraud. U/s.25 of the Indian Penal Code, 1860, a person is said to do a thing fraudulently if he does so with an intent to defraud and not otherwise. Hence, to prove a charge of fraud, mens rea or a culpable state of mind is a must. The term defraud has not been defined in the Code. However, its general meaning presupposes two elements, deceit or intention to deceive and an injury to someone. The Supreme Court in the case of Dr. Vimla v. Delhi Administration, 1963 SCR Supl. (2) 585, has held as follows:
“. . . . . . the two adverbs, ‘dishonestly’ and ‘fraudulently’ are used alternatively, indicating thereby that one excludes the other. That means they are not tautological and must be given different meanings . . . . . . . . The word ‘defraud’ includes an element of deceit. Deceit is not an ingredient of the definition of the word ‘dishonestly’, while it is an important ingredient of the definition of the word ‘fraudulently’. The former involves a pecuniary or economic gain or loss, while the latter by construction excludes that element. Further the juxtaposition of the two expressions ‘dishonestly’ and ‘fraudulently’ used in the various sections of the Code indicates their close affinity and therefore the definition of one may give colour to the other. To illustrate, in the definition of ‘dishonestly’, wrongful gain or wrongful loss is necessary enough. So too, if the expression ‘fraudulently’ were to be held to involve the element of injury to the person or persons deceived, it would be reasonable to assume that the injury should be something other than pecuniary or economic loss. Though almost always an advantage to one causes loss to another and vice versa, it need not necessarily be so. Should we hold that the concept of ‘fraud’ would include not only deceit but also some injury to the person deceived, it would be appropriate to hold by analogy drawn from the definition of ‘dishonestly’ that to satisfy the definition of ‘fraudulently’ it would be enough if there was a non-economic advantage to the deceiver or a non-economic loss to the deceived. Both need not co-exist. . . . . . ”
In S. P. Changalvaraya Naidu v. Jagannath, 1994 (1) SCC 1, it was held that a fraud is an act of deliberate deception with the design of securing something by taking unfair advantage of another. It is a deception in order to gain by another’s loss. It is a cheating intended to get an advantage. Fraud as is well known vitiates every solemn act. Fraud and justice never dwell together. Fraud is a conduct either by letter or words, which includes the other person or authority to take a definite determinative stand as a response to the conduct of the former either by word or letter. It is also well settled that misrepresentation itself amounts to fraud. Indeed, innocent misrepresentation may also give reason to claim relief against fraud. A fraudulent misrepresentation is called deceit and consists in leading a man into damage by willfully or recklessly causing him to believe and act on falsehood. It is a fraud in law if a party makes representations, which he knows to be false, and injury inures therefrom, although the motive from which the representations proceeded may not have been bad. An act of fraud on court is always viewed seriously. A collusion or conspiracy with a view to deprive the rights of the others in relation to a property would render the transaction void ab initio. Fraud and deception are synonymous.
Fraud is a conduct either by letter or word, which induces the other person or authority to take a definite determinative stand as a response to the conduct of the former either by word or letter — State of Andhra Pradesh v. T. Suryachandra Rao, Appeal (Civil) 4461 of 2005 (SC).
The Supreme Court in Ram Chandra Singh v. Savitri Devi, 2003 (8) SCC 319, held that it is well settled that misrepresentation itself amounts to fraud. Indeed, innocent misrepresentation may also give reason to claim relief against fraud. A fraudulent misrepresentation is called deceit and consists in leading a man into damage by willfully or recklessly causing him to believe and act on falsehood. It is a fraud in law if a party makes representations which he knows to be false, and injury ensues from the same, although the motive from which the representations proceeded may not have been bad. In an ‘action of deceit’ the plaintiff must prove actual fraud. Fraud is proved when it is shown that a false representation has been made knowingly, or without belief in its truth, or recklessly, without caring whether it be true or false.
In Ram Preeti Yadav v. U.P. Board of High School, JT 2003 (Supp. 1) SC 25 it was held that fraud is a conduct either by letter or word, which induces the other person, or authority to take a definite determinative stand as a response to the conduct of former either by word or letter. Although negligence is not fraud, but it can be evidence on fraud.
Civil Procedure Code The Civil Procedure Code, 1908 (‘the Code’) deals with the provisions relating to a Court decree and its execution. In case of a decree from a Court, the Court may require any person to pay any sum to the decree holder (or the plaintiff). In case the defendant fails to do so, the Court can, in execution of its decree, attach the movable and immovable properties of the defendant and recover the amount due by disposal of these assets. According to the CPC, an attachment prevents a private-transfer and no person can benefit from a subsequent transfer of the attached property.
Section 64 of the Code provides for such private alienation. Once a property has been attached, any private alienation of such property by private transfer or delivery and any payment to the judgment debtor of any debt, dividend, etc., contrary to such attachment shall be void as against all claims enforceable under the attachment. Section 64 applies whether the property stands in the name of the judgment debtor or any other person who is a name lender, i.e., benami property — Pradyut Shah, AIR 1979 Bom. 166. However, if the transfer is by an operation of law or pursuant to a Court order, then section 64 does not apply. For instance, a sale consequent to a later attachment would prevail even if there was an earlier attachment on the sale date — Rukmani v. Ram AIR, 1942 Nag. 36. It only covers private transfers, such as, voluntary sales, gifts, mortgages. It may be noted that the private transfers are not void ab initio, but only void as against all claims enforceable under the attachment. There is a difference of opinion amongst various Courts as to whether or not any private transfer after attachment but in pursuance of a contract of sale executed prior to attachment is covered by section 64. Various decisions have held that in order that an attachment renders a subsequent alienation as void u/s.64, the attachment must follow the due process laid down under the Code, e.g., Rules 41 to 57 of Order 21.
Indian Penal Code, 1860
Under the Indian Penal Code (IPC) if the following four conditions are satisfied:
(a) the accused removes, conceals, delivers the property or transfers it or causes to transfer it to someone;
(b) the above is done without adequate consideration;
(c) the intention of the accused was to prevent the distribution of that property among his creditors or some other person’s creditors; and
(d) he must act in a dishonest or fraudulent manner then the accused shall be punished with imprisonment of a term up to 2 years and/or fine.
Similarly, if a person fraudulently or dishonestly prevents any debt which is due to him from being made available to him for the payment of his debts, then the person shall be punished with imprisonment of a term up to 2 years and/ or fine. Thus, this provision seeks to prevent debtors from dodging their dues by preventing receipts from accruing to themselves.
A dishonest or fraudulent execution of an instrument which purports to transfer/charge any property and which contains any false statement with respect to the consideration for such transfer/ charge or to the beneficiaries of such transfer/charge is punishable with imprisonment of a term up to 2 years and/or fine. Benami conveyances would be covered within the scope of this provision.
A person who dishonestly or fraudulently conceals or removes property belonging to himself/ some other person or dishonestly releases any demand or claim to which he is entitled shall be punished with imprisonment of a term up to 2 years and/or fine.
We have already examined the meaning of the term fraud. Let us now see the meaning of the term ‘dishonestly’. Section 24 of the IPC defines ‘dishonesty’ as doing anything with the intention of causing wrongful gain to one person or wrongful loss to another person. Wrongful gain is defined as the gain by unlawful means of property to which the person gaining is not legally entitled. Conversely, wrongful loss means the loss by unlawful means of property to which the person losing it is legally entitled. A person wrongfully gains when he retains/acquires wrongfully. A person loses wrongfully when he is wrongfully kept out or deprived of property. Thus, in order to attract a charge of dishonesty, wrongful gain or loss is a must.
Presidency-Towns Insolvency Act
The Presidency-Towns Insolvency Act, 1909 deals with the law relating to insolvency as applicable in the cities of Mumbai, Chennai and Kolkata. Section 56 of this Act enunciates the doctrine of Fraudulent Preference. Every transfer by a debtor of his property, every payment made, every obligation incurred and every judicial proceeding taken or suffered by him is fraudulent and void against the Official Assignee, if all the following conditions are satisfied:
(i) at the time of the transaction, the debtor was unable to pay his debts
(ii) the transfer must be in favour of a creditor
(iii) the transfer must be with a view to give a preference to that creditor over other creditors
(iv) the creditor has in fact been preferred over other creditors
(v) the debtor must have entered into the transaction without any compulsion
(vi) the debtor must be adjudged insolvent on a petition presented within 3 months after the date of the transaction.
However, the rights of a bona fide person acquiring a title in good faith and for valuable consideration are not affected by the above doctrine.
Section 57 of the Act provides for the protection of bona fide transactions. Subject to the provisions relating to fraudulent preferences, in case of an insolvency, the following would not be affected:
(i) any payment by the insolvent to any of his creditors
(ii) any payment or delivery to the insolvent
(iii) any transfer for valuable consideration; or
(iv) any contract or dealing by or with the insolvent for valuable consideration.
However, the transaction should take place before the date of the order of adjudication and that person with whom such transaction takes place does not have notice of any insolvency petition.
Transfer of Property Act
The Transfer of Property Act, 1882 also deals with the concept of a fraudulent transfer. According to section 53, every transfer of immovable property made with the intent of defeating or defrauding the creditors of the transferor shall be voidable at the option of any creditor who is defeated or delayed. Thus, the following important conditions must be satisfied:
(i) The transfer must be of an immovable property. Unlike the previous two Acts, this section only applies to immovable property. What is an immovable property would be a matter of fact and unless it is a clear-cut case of classic land and building, it would have to be ascertained on a case-by-case basis.
(ii) Section 5 of this Act defines a transfer of property to mean any act by which a living person conveys present or future property to one or more other living persons. The expression living person has been defined to include a company, AOP and BOI.
(iii) The transfer must be made with an intention to delay or defraud one’s creditors. Hence, mens rea or a culpable state of mind on the part of the transferor must be demonstrated. Unless the same is proved, section 53 would not apply. Further, if the intention is to give preference to one creditor over another, then this section would not apply — Sharp v. Jackson, (1899) AC 19. The transfer must be to delay the creditors.
(iv) The transfer is not void ab initio. It only becomes voidable at the creditor’s option. If the creditor sues to avoid the transfer, then he must do so on behalf of all the creditors. The onus of proving that the transfer was made with an intent to delay or defeat creditors lies on the creditors — Daulat Ram v. Ghulam Fatima, (1926) 89 IC 953. However, once the fraud is established, then the onus of proving good faith shifts to the debtor — Amarchand v. Gokul, (1903) 5 Bom LR 142.
However, section 53 does not impair the rights of a buyer in good faith and for consideration. Hence, if a buyer has purchased immovable property without notice of the intention on the part of the debtor to delay his creditors and he has paid good consideration for the same, then his title is not impacted by section 53. This section is subject to the law of insolvency.
Companies Act
U/s.531 of the Companies Act, 1956, any transfer of property, whether movable or immovable, delivery of goods, payment, execution, etc., taken or done by or against a company within 6 months before the commencement of winding-up of a company, is invalid and is treated as a fraudulent preference of the creditors if the same would, in the case of an individual’s insolvency petition, be deemed to be a fraudulent preference. The preference is fraudulent when the substantial and dominant motive was to prefer one creditor or particular creditors — Mohandas v. Tikamdas, (1917) 37 IC 250. It is important to prove that both the transferor and transferee had a common intent to defraud creditors and if the transaction was made in good faith for valuable consideration then the same is not void — Official Liquidator v. MD, AP State Financial Corp., 115 Comp. Cases 284 (AP).
Similarly u/s.531A, such transfer made by a company is void against the liquidator if it is made within one year before the presentation of a winding- up petition. This however, excludes a transfer in its ordinary course of business or in favour of a purchaser in good faith and for valuable consideration. The person who has been fraudulently preferred would be subject to the same rights and liabilities as if he had personally agreed to become a surety for the company’s debt. The extent of his liability is equal to lesser of the mortgage or charge on the property or the value of his interest. The value of his interest is to be determined as on the date of the transaction which constitutes the fraudulent preference as if the interest was free of all encumbrances other than those to which the mortgage or charge for the company’s debt was then subject. This section even applies to transfers made by book entries — Jayanti Bai v. Popular Bank Ltd., 36 Comp. Cases (Ker.).
Income-tax Act
Section 281 of the Act provides that where during the pendency of any tax proceedings or after the completion of the same but before the service of a tax recovery notice, any assessee creates a charge or transfers any of his assets in favour of any other person, then such a charge/transfer would be void as against any tax claim. However, this section does not apply where the transfer is made for adequate consideration and without notice of any previous proceedings/tax demand or with the prior approval of the Assessing Officer. This section applies to any asset being land, building, machinery, plant, securities, bank deposits, provided the same are not stock-in-trade of the assessee. The Bombay High Court has, in the case of Twinstar Holdings Ltd. 260 ITR 6 (Bom.) held that where shares held as investment were converted into stock-in-trade and the only purpose of such conversion was to avoid attachment of the shares by the Department to recover tax, the transfer was void.
Conclusion
Although the legal position appears quiet straight-forward on this issue, its practical implementation is a different ballgame altogether. Whether or not a particular transfer is a fraudulent transfer is a matter of fact, circumstances and evidence. One would have to make a deep study of the evidence before arriving at any conclusion. For instance, whether a settlement by a person on a trust amounts to a fraudulent transfer or is an act of valid asset protection, needs to be carefully scrutinised.
