Section 7 vs Section 66 IBC: Debt, Default and Fraud

Introduction

Section 7 of the Insolvency and Bankruptcy Code, 2016 (“Code”) provides the statutory gateway for commencement of the Corporate Insolvency Resolution Process (“CIRP”) upon proof of a financial debt and default. Once a proceeding under Section 7 is initiated, the Resolution Professional (RP) conducts a Transaction Audit to identify avoidance, fraudulent or wrongful transactions under the Code. This investigation aids in collection of evidence to prove whether the business is being conducted in a fraudulent manner, and if the report Transaction Audit Report indicates that a fraudulent or wrongful transactions were entered into, proceedings under Section 66 may be initiated. It is at this stage that questions frequently arise regarding the relationship between the threshold jurisdiction under Section 7 and the remedial framework under Section 66.

Statutory Schemes

Section 7 operates as the threshold mechanism for commencement of the Corporate Insolvency Resolution Process. Its enquiry is confined to whether a financial debt exists and whether a default has occurred. Once these jurisdictional requirements are satisfied, the Adjudicating Authority admits the application and the insolvency resolution process commence.

Section 66, in contrast, is not concerned with the initiation of CIRP. It is a remedial provision that becomes relevant only after commencement of CIRP or liquidation, empowering the Adjudicating Authority to hold persons liable for making contributions to the assets of the Corporate Debtor. Rather than determining whether insolvency should commence, Section 66 seeks to remedy misconduct that contributed to the depletion of the Corporate Debtor's assets.

While both Sections 7 and 66 may arise from the same factual matrix, they perform fundamentally different functions under the Code.

The Misconception: Does Section 66 Allegation Negate Admission Under Section 7

A recurring issue between Sections 7 and 66 is the misconception that where the very transaction giving rise to the financial debt is alleged to be fraudulent or otherwise falls within the scope of Section 66, the existence of such allegations necessarily undermines the debt itself. Since an application under Section 7 requires the Adjudicating Authority to determine only the existence of a financial debt and the occurrence of a default, respondents often contend that a debt arising from a transaction under challenge cannot constitute a valid basis for initiating the CIRP. This argument, if accepted, fundamentally alters the architecture of the Code. It would transform every allegation of fraudulent conduct into a defense against the admission or continuation of insolvency proceedings, thereby requiring the Adjudicating Authority to first determine complex questions of fraud before deciding whether a financial creditor has established debt and default. Such an approach effectively imports the inquiry contemplated under Section 66 into the threshold determination under Section 7. The central issue, therefore, is whether allegations that a transaction is fraudulent, or proceedings initiated under Section 66 in relation to that transaction, can have the effect of negating the existence of the financial debt itself or postponing the insolvency process until those allegations are finally adjudicated. This approach would strike at the very root of the Code, and be completely contrary to the intention to resolution of corporate debtors in a time bound manner. Merely questioning the legitimacy of an underlying transaction or alleging that it attracts Section 66 does not, by itself, negate the existence of the debt or preclude the admission of a Section 7 application.

Various judicial precedents affirm that proceedings under Section 66 can be entertained during the pendency of a Section 7 application as they are independent of each other, and are adjudicated on their own respective merits. It does not concern the Adjudicating Authority whether any fraud has taken place when dealing with an application under Section 7 as long as it can be proven that there has been a default in repayment of the debt owed by the Corporate Debtor. Proceedings under Section 7 are proceedings initiated in rem whereas the proceedings under Section 66 are proceedings in personam and therefore the burden of the proceedings fall on different entities. Since both hold different individuals accountable therefore the pendency of one cannot and should not hinder the initiation of the other.

Judicial Positions

The judiciary treats the two as operating on independent tracks. In Satichidananda Joshi v. Sandip Kumar Kejriwal & Anr, the NCLAT held that pendency of proceedings under Section 66 does not preclude consideration of an application under Section 7 and both provisions operate independently. It further held that any observations made in deciding the Section 7 application would not influence the adjudication of pending Section 66 proceedings.

In New Era Propcon Pvt. Ltd. & Anr. v. SREI Equipment Finance Ltd. & Anr., the NCLAT held that mere pendency of a Section 66 application does not impede the hearing of a Section 7 application. It reasoned that even if a transaction is alleged to be sham or collusive, that allegation alone does not negate an actual disbursement of funds, thereby confirming that an undisputed disbursement/adjustment of funds or assets was enough to sustain the Section 7 finding of debt and default, regardless of a pending fraud allegation.

The Appellate Tribunal in its ruling in Sandeep Jain v. IDBI Trusteeship Services Ltd. , held that any dispute, including ongoing arbitral proceedings, does not in any manner prohibit the Financial Creditor from taking remedy under Section 7, as also affirmed by the Supreme Court. Along the same lines, the NCLAT in Rakesh Kumar Jain v. Jagdish Singh Nain & Ors. has held that moratorium under Section 14 does not bar the initiation of Section 66 proceedings against a Corporate Debtor already in CIRP. The Hon'ble Bench clarified that Section 14(1)(a) bars only the institution and prosecution of suits, proceedings, or execution of orders and decrees in other courts or Tribunals. It does not bar the Adjudicating Authority itself from passing appropriate orders in pending proceedings against the resolution professional, suspended directors, or related parties during the CIRP or liquidation process. Section 66 is, therefore, treated as a freestanding statutory remedy that is not suspended when other IBC provisions operate concurrently. Conversely, the High Court of Tripura in Smt. Sudipa Nath v. UOI held that pendency of proceedings under Section 66 neither bars nor affects the maintainability of independent proceedings and the same are to be determined on their own statutory requirements.

A conjoint reading of these judgments demonstrates a consistent judicial approach of preserving the independent operation of Sections 7 and 66. Rather than treating allegations of fraudulent trading as a bar to insolvency proceedings, the courts have recognized that both provisions operate concurrently, independently, and in furtherance of distinct statutory objectives.

Legislative Intent

The recommendations of the report of the Bankruptcy Law Reform Committee (“BLRC”), published in 2015, laid down the blueprint of the Code. The focus of the of the recommendations was on the depletion of the estate as a consequence of the decisions taken in the course of running the business. This is clear from the presumption of due diligence on the part of the directors and partners contemplated in the provision. The Supreme Court has clarified that recoveries from Section 66 proceedings are distinct from “avoidance transactions” under Sections 43–51, and that their treatment in an approved resolution plan falls within the commercial wisdom of the Committee of Creditors, underscoring that Section 66 serves a separate remedial function from the Code’s asset recovery provisions.. It is also worth noting that Section 32A insulates the Corporate Debtor’s assets from certain proceedings once a resolution plan is approved, but does not extinguish personal liability of those found to have knowingly participated in fraudulent trading under Section 66, a distinction the Supreme Court implicitly recognised when addressing how Section 66 recoveries are to be treated post-resolution.

The Insolvency Law Committee Report (ILC Report) observed that Sections 43 to 51, 66 and 67 of the IBC collectively constitute the Code’s framework for “avoidable transactions”. The provisions empower the Resolution Professional (“RP”) or liquidator to flag and avoid such transactions, and the actions that may be taken against erstwhile management for fraudulently or wrongfully trading in insolvency. The ILC Report further emphasized that, although avoiding transactions and punishing unethical trade practices are frequently associated with upholding business ethics, their primary objective is to expand the pool of assets that can be distributed to creditors.

The Report of the Select Committee on IBC (Amendment) Bill 2025 observed that:

“Section 66 of the IBC is specifically designed for corporate debtors under Part II to address fraudulent or wrongful trading by persons managing the company, recognizing the separate legal personality of corporations and the potential for misuse by directors or management.”

A careful reading of the legislative materials demonstrates that Parliament intended Sections 7 and 66 to perform distinct yet complementary functions under the Code. While Section 7 facilitates the timely commencement of insolvency proceedings upon proof of debt and default, Section 66 provides a post-commencement remedy to address fraudulent conduct. The legislative intent, therefore, reinforces the judiciary’s consistent view that the operation of one provision is neither contingent upon nor impeded by the other.

Conclusion

There are a plethora of judicial decisions treating Section 7 and Section 66 as operating in distinct legal spheres. Parallel proceedings under Sections 7 and 66 ensure that insolvency resolution can proceed while simultaneously preserving the ability to hold the responsible individuals personally accountable and contributing to the assets of the Corporate Debtor. This interpretation advances the objective of the Code by providing complementary remedies that maximize value of the assets of the Corporate Debtor and protect the interests of creditors without making one proceeding contingent upon the other. The consistency in approach adopted reinforces the principle that factual overlap does not translate into legal overlap, permitting both remedies to proceed independently without one prejudicing the adjudication of the other.