Aakash Rai
Definition:
Corporate fraud refers to the illegal and unethical activities undertaken by any company or individual, which are mostly done to gain a competitive advantage over other corporations in the industry. This may also be done to showcase a better identity of the company in the market in order to attract better investors also. This can involve actions such as misrepresentation of financial statements, embezzlement, insider trading, bribery, and other forms of deceit to achieve unfair advantages or to hide losses or liabilities.
Introduction:
Directors have a legal and ethical responsibility to prevent and address corporate fraud. They are expected to exercise due diligence, oversee financial practices, and implement internal controls to detect and prevent fraudulent activities within the company. Failing to fulfil these duties can result in legal consequences, including personal liability and potential criminal charges. It’s essential for directors to prioritise transparency, accountability, and the best interests of the company and its stakeholders.
In the intricate realm of corporate law, the concept of director’s liability takes on significant importance, particularly when it comes to cases of corporate fraud. This blog post delves into key legal sections and provisions that outline the potential liabilities directors may face in such situations:
Provisions under the law:
- Section 149(12), Companies Act, 2013:
Independent directors, as per Section 149(12) of the Companies Act, 2013, are equally liable in cases of fraud if it is proven that they did not exercise reasonable diligence in their roles. Independent directors cannot be made directly liable if the alleged acts occurred without their knowledge.
It was very explained in the case of V. Selvaraja vs. State Bank of India:
Facts of the case:
The petitioner was a retired IAS officer working as a non-executive independent director of the said company, which was involved in the business of hiring, leasing, etc.
Petitioner joined the company as a non-executive independent director in 2012. In 2013, the RBI found accounting malpractices in the company during its annual inspection and issued certain actions against the company in the public interest. The petitioner also mentioned that the managing director created software for fictitious data entries.
Judgment:
The Madras High Court relied on Section 149(6) and Section 149(12) of the Companies Act, 2013 and also Clause 2.5 of the master circular of the RBI. It was clear that the petitioner was acting as an independent director, particularly for seven months, and during the said period, he participated in four board meetings of the company. But it showed no material on record that the petitioner was involved in day-to-day affairs of the company or also something apparent to show that the discrepancies occurred with his knowledge or connivance. So according to Section 149(12), which says that the Independent Director should only be held liable in such acts of commission or omission of the company that occurred with his knowledge, connivance, or consent. So, the petitioner here in this case be absolved from the charge of ‘wilful defaulter’ and no penalties against him shall lie.
- Section 164 of the Companies Act, 2013: Disqualification of Directors:
Under Section 164, directors can be disqualified if they are convicted of fraud and certain other offenses. This provision acts as a deterrent against directors engaging in fraudulent activities where the company fails to pay interest on deposits, if the director has applied for insolvency adjudication, etc.
- Fiduciary Duty:
Directors owe a fiduciary duty to the company and its stakeholders. This responsibility is enshrined in various corporate laws, such as Section 166 of the Companies Act, 2013. Under this section, directors are mandated to act in good faith, promote the company’s best interests, and exercise due care, skill, and diligence.
- Section 177: Whistleblower Protection:
Introduced by the Companies (Amendment) Act, 2019, Section 177 places an obligation on directors to report concerns about unethical behaviour or fraud within the company. Failure to comply can result in penalties, making it crucial for directors to actively address such issues.
- Section 212: Investigation into Affairs of Company by Serious Fraud Investigation Office (SFIO):
Section 212 of the Companies Act, 2013 pertains to the investigation into the affairs of a company by the Serious Fraud Investigation Office (SFIO). This section grants SFIO the power to investigate cases of fraud or other improper activities involving a company. The SFIO has authority to demand information, summon persons, and access records during the course of its investigation. In instances where corporate fraud is suspected, Section 212 of the Companies Act, 2013 empowers the government to order an investigation into the company’s affairs. If the investigation by SFIO reveals that the fraudulent activities were aided or abetted by the directors, they can be held liable under Section 447, which deals with fraud-related offenses. And liability under this section is cognizable and non-bailable. Some landmark cases investigated by SFIO are:
Deccan Chronicle Holding Ltd.
DHCL took a loan of approximately 1230 crores and was unable to repay it and there were also some financial irregularities in the company and many other violations. After investigation, it was found by SFIO that the company made the money available by the sale of non-convertible debentures and later on, the company was declared a sick company by BFIR.
Sharadha Chit Fund Case
The Saradha Chit Fund case involves a major financial scandal in West Bengal, India. The Saradha Group, headed by Sudipto Sen, duped investors through chit fund schemes promising high returns. Instead of investing the money, they used it to pay returns to earlier investors, running a Ponzi scheme. The Serious Fraud Investigation Office (SFIO) investigated the case, uncovering financial irregularities, embezzlement, and breaches of financial regulations. The scam emerged in 2013, causing the group’s collapse and leaving countless investors in distress. Allegedly involving politicians and bureaucrats, the case exposed a complex network of deceitful transactions and manipulated records. The investigation led to arrests, raids, and legal action. This incident underscored the necessity for stricter oversight and regulations in India’s chit fund and investment sectors, exposing the vulnerabilities within the financial system.
- Section 245 of the Companies Act, 2013: Class Action Suits:
Section 245 permits shareholders to file class action suits against directors for oppressive actions or mismanagement that affect the company’s affairs. If fraudulent activities are proven to be a result of directorial negligence or misconduct, this provision can be invoked by shareholders seeking remedies.
- Criminal Liability:
Directors can face criminal liability under various sections of the Companies Act, such as Section 447, which deals with fraudulent actions. Depending on the severity of the offense, directors may face imprisonment and fines.
- Director’s vicarious liability and also provisions under PMLA:
In Sunil Bharti Mittal vs. CBI, the Supreme Court ruled that an individual can be held liable for a company’s offence if they display criminal intent, supported by sufficient evidence, or if specific laws, such as the PMLA, impose direct liability on directors. The 2018 Finance Bill was brought in which corporate fraud was included as schedule offences which means ‘fraud’ under Section 447 is now included in the Schedule List of offences, and this amendment also brought a change in PMLA that said that proceeds from corporate fraud will now be considered as money-laundering. When something is considered proceeds of crime, ED has the power to attach and confiscate the property that is considered a proceeds of crime. Directors of the company can also be arrested if found guilty under this new law.
- Section 48 of the Competition Act, 2002:
Section 48(1) of the Competition Act says that if a company is found to contravene the law, each and every person responsible for such contravention shall be liable according to the provisions of the law.
- Section 141 of the Negotiable Instruments Act, 1881:
If the person committing an offence under Section 138 is a company, every person who, at the time the offence was committed, was in charge of, and was responsible to the company for the conduct of the business of the company, as well as the company, shall be deemed to be guilty of the offence and shall be liable to be proceeded against and punished accordingly.
We will try to understand this aspect through Ashok Shewakramani vs. State of Andhra Pradesh, Criminal Appeal No.879 of 2023:
Issue:
Can a person be held liable if he is managing a company’s affairs in a cheque issue matter?
Judgment:
If an offence is committed under Section 138 of the NI and it is committed by a company, then Section 141 of the Act says that every person who was in charge of and was responsible to the company for the conduct of business of the company at the time the offence was committed will be guilty of the offence. The High Court already didn’t quash the complaint against the appellant under Section 482 of the CrPC filed by the complainant. The Supreme Court said that the words “was in charge of and” was responsible to the company” should be read conjunctively always.
The most important averment that is required by sub-Section (1) of Section 141 of the NI Act is that the directors were in charge of and were responsible for the conduct of the company. The appellants are neither the signatories to the cheques nor are whole-time directors. So though the company’s director was only involved in the day-to-day affairs of the company, it cannot be construed that they were in charge of the company also, and accordingly, this case doesn’t fulfil the criteria of sub-section 1 of Section 141 of the NI Act. So the directors were not held liable.
Conclusion:
In the past few years, the Central Bureau of Investigation (CBI) has also registered multiple cases against companies and their officials for bank frauds, such as Gitanjali Gems and Simbhaoli Sugars. Coupled with such revelations is the response of the government, which has brought the investigative authorities out of their usual course of action. In conclusion, the legal landscape surrounding directors’ liability in cases of corporate fraud is multifaceted and encompasses various sections and provisions under the Companies Act, 2013. Directors must navigate this complex terrain by upholding their fiduciary duty, actively participating in ethical governance, and taking steps to prevent and address fraudulent activities within their companies. Staying informed about these legal aspects is essential for directors to fulfill their responsibilities and avoid potential liabilities.
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