Navigating the Abyss: Corporate Insolvency, the BUDS Act, and Piercing the Corporate Veil in Unregistered Financial Schemes
For corporate practitioners in India, particularly in jurisdictions like Kerala characterized by stringent financial regulatory enforcement, the intersection of the Insolvency and Bankruptcy Code (IBC), 2016, and the Banning of Unregulated Deposit Schemes (BUDS) Act, 2019, represents a perilous landscape.
When a Private Limited Company operating a financial or chit fund business faces severe insolvency—compounded by unregistered schemes and missing books of accounts—the fundamental protection of limited liability rapidly evaporates. Here is a detailed breakdown of the legal realities, recent jurisprudence, and strategic survival mechanisms for directors caught in a scenario where liabilities (e.g., ₹5 Crores) overwhelmingly eclipse available assets (e.g., ₹50 Lakhs).
I. The Illusion of a Clean Exit: Statutory Bars on Dissolution
When a company is drowning in debt, directors often mistakenly look toward voluntary closure mechanisms to gracefully wind up operations. However, the law explicitly bars the exit doors for insolvent entities with regulatory breaches.
- Strike-Off (Section 248, Companies Act, 2013): Striking off a company requires the directors to swear an affidavit extinguishing all liabilities. With a massive deficit, executing such a declaration constitutes perjury and actionable fraud.
- Voluntary Liquidation (Section 59, IBC, 2016): This route mandates a strict Declaration of Solvency by the majority of directors, affirming under oath that the company can pay its debts in full and is not being liquidated to defraud creditors. This is legally impossible in a severely insolvent scenario.
Therefore, the only formal path to dissolution is through a Tribunal-monitored liquidation or resolution process, which acts as a powerful catalyst for directorial liability.
II. The Trap of IBC Section 66: Fraudulent Trading and Personal Liability
If the company attempts to initiate the Corporate Insolvency Resolution Process (CIRP) voluntarily under Section 10 of the IBC, or if a creditor drags the company to the National Company Law Tribunal (NCLT) under Section 7 or 9, an Interim Resolution Professional (IRP) immediately takes over the board's powers. This is where the failure to maintain proper books of accounts becomes catastrophic.
The Mandate of Section 66(1): If the IRP/RP determines during the CIRP that the business was carried on with the intent to defraud creditors or for any fraudulent purpose, they are statutorily obligated to apply to the NCLT to hold the directors personally liable, without limitation, to make good the deficit to the corporate debtor's estate.
The Evidentiary Burden & Recent NCLAT Rulings
Recent jurisprudence underscores how courts view missing accounting records during insolvency:
III. The Apex Threat: The BUDS Act, 2019
While the IBC targets civil financial recovery, the BUDS Act, 2019, represents an immediate, existential criminal threat. In Kerala, the enforcement of the BUDS Act is exceptionally rigorous, with designated Competent Authorities acting swiftly against financial irregularities.
- The Unregistered Chit Trap: While chits registered strictly under the Chit Funds Act, 1982, enjoy exemptions, unregistered chits are entirely illegal. Funds collected under unregistered chits are immediately classified as "Unregulated Deposit Schemes" under the BUDS Act.
- Personal Asset Attachment (Section 14): The State's Competent Authority does not stop at the corporate boundary. They possess sweeping powers to provisionally attach the personal properties, bank accounts, and private assets of all directors and promoters to repay the depositors. The corporate veil cannot shield personal wealth from a BUDS attachment order.
- Strict Criminal Liability: Operating an unregulated scheme is a cognizable, non-bailable offense under Sections 21 and 22 of the Act, attracting rigorous imprisonment of up to 7 years.
IV. Intersecting Statutory Violations
Beyond the IBC and BUDS Act, directors in this scenario face compounded legal exposure under specific corporate and financial statutes:
- Chit Funds Act, 1982 (Sections 4, 76 & 77): Conducting a chit without prior sanction is a direct violation. Section 77 explicitly holds every person in charge of the company at the time of the offense personally liable, resulting in heavy fines and potential imprisonment.
- Companies Act, 2013 (Sections 128 & 447): The failure to keep detailed books of accounts at the registered office is an independent statutory offense. When coupled with missing public funds, it readily triggers investigations under Section 447 (Punishment for Fraud), which carries severe, mandatory imprisonment terms.
V. Strategic Way Forward: A Defensive Blueprint
For corporate counsel advising directors in this highly precarious position, a Section 10 (voluntary) IBC filing is tantamount to a self-indictment and must be strictly avoided. The strategy must instantly shift to aggressive damage control.
2. Emergency Financial Reconstruction: The directors must urgently engage forensic auditors or chartered accountants to reconstruct the books of accounts from bank statements, cash receipts, and digital footprints. They must be able to visually trace the missing funds to defend against NCLT Section 66 applications and criminal fraud charges.
3. Tactical Deployment of Assets: The remaining liquid assets (e.g., the ₹50 Lakhs) should not be distributed indiscriminately. From a risk-mitigation standpoint, priority must be given to settling the dues of the unregistered chit subscribers. Eliminating these specific creditors neutralizes the immediate trigger for BUDS Act complaints and police FIRs, which carry the highest personal risk.
4. Preparation for Creditor CIRP: The directors must prepare for the inevitable. When registered chit subscribers or other creditors initiate NCLT proceedings under Section 7 or 9, the reconstructed accounts and executed settlement agreements will be the directors' primary shield against allegations of fraudulent trading.
