The wizard of Fraud strikes purchasers in a Public Auction: To what extent is due diligence required


The Bombay High Court in the case of Dilip Parulkar (Third Party) in the matter between the Reserve Bank of India v. Laxman Mahadeo Devare (the Liquidator) and Bank of Karad Limited (in Liquidation) on 12 January 2022 held that fraud vitiates everything. An encompassing fraud negates all acts.


Briefly, the issue concerned an order of the Bombay High Court dated 24 December 2013 and the subsequent Sale Certificate issued by the Official Liquidator (OL) regarding sale of a plot of land in Pune. Basis an intervention by Third Party, Dilip Parulkar, it was brought to notice of the court (almost a decade after the order permitting sale) that the plot was already sold to a bona fide purchaser through registered deed by the guarantor much before the liquidation. Bombay High Court protected the rights of the bona fide purchaser over the rights of the purchaser under auction by the liquidator.


It is argued that such a position would be extremely tricky under the present Insolvency and Bankruptcy Code, 2016 (IBC) as the corporate debtor, in a case where the resolution is accepted, still survives under a different garb. Thus, to permit a prior claim a decade later would be anathema to the efficient implementation of the resolution plan or revival of the corporate debtor.


Dilip Parulkar decision:


To delve deeper into the peculiar facts of the Bombay High Court decision – a plot of land was acquired by the Dilip Parulkar (Third Party) from one late Chudasama, who claims to be in possession of the said land. This transfer took place through a registered Sale Deed dated 9 October 1989. Fast forward to 2013, the Bombay High Court accepted the OL’s report for sale of the said plot to repay the loan advanced by the Bank of Karad to M/s Drillwell, the repayment of which was guaranteed by the late Chudasama. To fulfil his obligations as the guarantor, the late Chudasama, sold the said plot of land, allegedly dishonestly and incorrectly representing himself to be the owner. The purchasers of the plot, the Respondents in the case, paid the sale proceeds directly to the OL.


Consequently, in vehement opposition, the Respondents alleged significant delay in approaching the Court (almost a decade after the order permitting sale) and themselves claimed to be the bona fide purchasers, having purchased the plot through a court-approved public auction. The Respondents stated that a prior claim of the Third Party was required to be adjudicated by a civil court. The OL had already received the sale proceeds and appropriated the same. As a result it would be impossible to achieve status quo ante, given the facts of the case.


The Court refused to accept noting that, “The contentions of late Chudasama in my view are dishonest and he had perjured himself in having made statements which were false to his own knowledge”. The fact of prior registered-sale to the Third Party was no longer in dispute. The contention of the late Chudasama in his affidavit that the Third Party had consented to the sale to discharge his liability as guarantor was ‘a figment of [his] imagination’. The casual approach taken by the OL was also met with stern comments by the Court.


The court noted that fraud vitiates all and placing reliance on two Supreme Court decisions that held that fraud vitiates all judicial acts whether in rem or in personam and that the order or decree obtained by fraud is treated as nullity. Further, on limitation, the Court relying on precedence held that while condoning the delay that in cases of fraud and suppression of material facts, the aspect of merits may also be taken into consideration while adjusting equities. Thus, the order of the Court dated 24 December 2013 was recalled.


Consequently, OL Report, the Sale Certificate which had its foundation in that Order cannot survive. More importantly, the Court held that it was not necessary to relegate the applicant to a trial in a suit.


The law under IBC:


It is pertinent to note here that this decision stems from the pre-IBC era. Recently, the Supreme Court in Ghanashyam Mishra v. Edelweiss Asset Reconstruction Company Ltd.[3] while dealing with the Resolution Plan has stated that once the Resolution Plan is approved, the successful Resolution Applicant starts afresh with a clean slate and all other claims which are not the part of the approved Resolution Plan shall stand extinguished. In Ebix Singapore[4], the Supreme Court also held that once a Resolution Plan is approved, the Applicant cannot backtrack, even by claiming common law exceptions to contract such as force majeure. Thus, it is doubtful whether other exceptions to contract law, such as fraud, could be used as justification to depart from the Resolution Plan.


This may be justifiable as the Resolution Applicant cannot be made to face a surprise claim. No person will be entitled to continue any proceeding in respect to any claim which is not part of the Resolution Plan. Even the claims of the Government, both centre and state, including the tax authorities extinguishes if they are not included in approved Resolution Plan. This creates a break in the regular chain towards liquidation of the corporate debtor. The Resolution Plan is only approved by the creditors given the financial standing of the corporate debtor at that stage. If subsequently it is brought to notice that a claim over the properties of the corporate debtor is pending, that has the risk to vitiate the commerciality of the resolution plan and cause grave disadvantage as it is not permissible to backtrack from a Resolution Plan once approved.


The Issue:


The law in the case where the real owner challenges the sale of his property to the bona fide purchasers in a legal process such as auction sale or liquidation/Resolution Process after it is concluded or liquidation/Resolution Process is started as the case may be favours the bona fide purchaser or liquidator/ successful Resolution Applicant.


There exists a lacuna with respect to protection of rights of the owner whose property is wrongly taken over as property of Corporate Debtor in the Code. A provision is needed to be added in the Code that any auction purchaser or Resolution Applicant if confronted with the claim regarding title to any property what would be rights of such owner.


Therefore, it becomes imperative for the real owner to be vigilant about the property being auctioned. This statement is also placing excess onus on the real owner as there may be circumstances where the real owner may not be informed of such an auction until such auction purchaser comes to take possession or is otherwise prevented from enforcing his rights. It opens another debate regarding the extent of due diligence to be undertaken by the Resolution Applicant and the Resolution Professional.

 

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