A Step Towards Enhancement Of Corporate Governance: Provisions For Fraud
Author: Rishab Aggarwal & Harshil Vijayvargiya, Gujarat National Law University.
The article is on one of the most important and emerging areas of jurisprudence in corporate law that is on the issue of corporate fraud. Its contribution in strengthening the corporate governance structure of the country is analysed. Whenever the headlines about corporate fraud surface, the trust reposed in the corporate entities gets affected. It therefore, becomes pertinent to note how the corporate law deals with this menace of fraud that has permeated in to the transactions and leads to lowering down of confidence of investors and shareholders.
In the recent past, India has witnessed some massive corporate scams such as UTI Scam, Saradha Chit Fund[i], Satyam Computers, and the Cobbler Scam, among others. The fraudsters took measures such as grossly inflating revenues, operating profits, interest liabilities and cash balances in order to defraud people. It is said that corporate fraud takes place when a corporation purposefully provides dishonest information with the purpose of obscuring truth and deceiving the recipient of the data with the intent to gain an advantage.[ii]
Meaning of Fraud
Before beginning, it is important to know how Fraud is actually defined, according to Merriam Webster Dictionary; Fraud is defined as intentional perversion of truth in order to induce another to part with something of value or to surrender a legal right.[iii]
Furthermore the Companies Act, 2013 (hereinafter “Act”) defines fraud in section 447 of Act.[iv] It says that in relation to affairs of a company or any corporate body, fraud includes “any act, omission, concealment of any fact or abuse of position …with intent to deceive, to gain undue advantage from, or to injure the interests of the company…”
The old Companies Act, 1956 already provided punishments for fraud in various sections, however the new Companies Act, 2013 came up with more specific and clear provision with regards to fraud and fraud reporting.
There are around 20 sections of the Act talk about fraud committed by the directors, key managerial personnel, auditors and/or officers of company. Some of the acts which amount to fraud are misrepresenting material information in prospectus,[v] inducing any person fraudulently to invest money[vi], among others.
Special Courts are also established under section 435[vii] for speedy disposal of such offences which are punishable with imprisonment of 2 years or more.
Lack of mens rea
For imputing criminal liability upon the person concerned, mens rea is an essential element.[viii] It stands for the state of mind of the person concerned which accompanies his or her act. Naturally, culpability would arise once the actus proven to be done negligently, knowingly, recklessly and negligently.[ix]
This is why Salmond referred to the maxim, “actus non facit reum, nisi mens sit rea”.[x] For the liability to arise, the acts must be coupled with a guilty mind.[xi] This fundamental principle has been firmly rooted in the criminal jurisprudence throughout the history.[xii]
But when the subject of liability becomes a company or a body corporate, difficulty arises in tracing this mens rea. Clear reason is the separate legal personality with a company.[xiii] Hence, it becomes questionable to impute mens rea upon an artificial person. On the basis of this per requisite, Calcutta High Court refused to prosecute since it had no physical body hence could not be imprisoned.[xiv] Thus courts have been reluctant to accept complaints of criminal nature against corporations.[xv]
Evolving interpretation for imputing liability
The U.S. Supreme Court took a novel approach while deciding that for things prohibited by statute there exists “no good reason why corporations may not be held responsible for and charged with the knowledge and purposes of their agents, acting within the authority conferred upon them.”[xvi] This is how corporate criminal liability was put into place by interpretation of common law by judges and jurists.[xvii] It was later held that a director can be held for breach of contract or other liabilities along with the company if the conduct was that of being other than the company’s agent.[xviii]
The blanket immunity given to companies on the ground that a sentence of mandatory imprisonment would not be possible was taken away by Indian Supreme Court also in the Constitution Bench judgment of Standard Chartered Bank v. Directorate of Enforcement[xix]. The ground taken is similar to that of the U.S. Supreme court. A clear legislative intent could not be done away with.
The cynosure of this evolving jurisprudence became the landmark Iridium[xx]case (discussed in detail later). The criminal intent could be traced through the company’s alter ego or the directing mind of the company. It stands for those people who guide the business of the particular company.
Doctrine of Attribution
This doctrine states that in any event which leads to violation of law, the mens rea, that is, the criminal intention of that act can be attributed to the people who are in the position to ‘direct the mind and will of the company’. This doctrine found its origin in UK in the landmark case of Lennard’s Carrying Co. Ltd. v. Asiatic Petroleum Co Ltd.[xxi] In this case, the House of Lords applied the doctrine of attribution to identify Mr. Lennard, who was the owner of the ship and also responsible for the management of the ship, as the ‘directing mind and will’ of the company.
This approach was adopted in India by supreme court in Iridium Case[xxii], wherein it was held it was held that the companies and corporate houses can no longer claim immunity from criminal prosecution on the ground that they are incapable of possessing the mens rea for the commission of criminal offences. The criminal intent of the alter ego of the company/body corporate, that is, the persons or group of persons in control of the affairs of the company or who guide the business of the company, would be imputed to the corporation.[xxiii]
However, now the question arises, that whether the principle of attribution could be applied in reverse? What if a company (through its employees) commits actions that have criminal consequences? Can the directors of the company be attributed these actions such that they can be held responsible for the criminal consequences?[xxiv]
The debate was settled in the landmark Sunil Mittal / 2G Spectrum[xxv] case wherein the three-bench court relying upon the law laid down in Iridium stated that the ‘principle of attribution’ is applied to impute criminal intention to the company on account of the criminal intention of its ‘alter ego’ and cannot be applied in a reverse scenario to make the directors liable for offences committed by the company.[xxvi]
Importance with regards to corporate governance
Business corporations are guided, directed and controlled through the system of corporate governance.[xxvii] The stakes and interests of all the stake holders including long term shareholders is being protected.[xxviii] But, the unfortunate part is when business tycoons or successful ventures fall prey to malpractices like fraud.
A fool proof prevention system is the need of the hour, otherwise, once caught, not only the company will start losing its good will but also the market share. In India, one finds prevalence of family businesses, poor deterrents since the fraud uncaught is having no consequences.[xxix] Thus, mischievous directors continue to embezzle funds.
This easily substantiates the result of a survey conducted by KPMG.[xxx] It was categorically found that 75% of the top executives of the country believe that corporate fraud on a rise in these days. Since that is the situation, it is very necessary to have effective legal regime in place for punishing the person who committed the fraudulent act.
Lifting of corporate veil
It is a methodology where the court is required to interfere within the company therefore, disturb its regular processes. It would be directors who would have to bear the burden of other sectors. Primarily there are four situations, wherein courts give the order for piercing the corporate veil:-
- If statute allows such lifting;
- If fraud or improper conduct is sought to be prevented;
- If the intention is to violate a taxing provision or evade taxes; or
- If group companies are so involved in each other as to form a single entity[xxxi]
Supreme Court of India has given so far in holding that a director disguised in corporate character committing illegality or defrauding others would give a ground to the courts to pierce the corporate veil.[xxxii] The motive behind the transaction has to be traced. If the motive is to perpetrate fraud, it is held to be punishable and thus a valid ground to pierce the corporate veil.[xxxiii]
Hence, if any person is found to be providing any illegal gratification intended at obtaining or retaining business or advantage, it would be not only punishable as farud under the Companies Act but now, even under Prevention of Corruption Act, 1988.[xxxiv]
[i] Subrata Chattoraj v. Union of India, (2014) 8 SCC 768.
[ii] Akanksha Tomar, Corporate Frauds: An Analysis, Mondaq (Feb. 28, 2020, 10:04 AM), https://www.mondaq.com/india/Criminal-Law/696380/Corporate-Frauds-An-Analysis.
[iii] Merriam-Webster, https://www.merriam-webster.com/dictionary/fraud (last visited Feb. 20, 2020).
[iv] Companies Act, 2013, § 447, No. 18, Acts of Parliament, 2013 (India).
[v] Companies Act, 2013, § 34, No. 18, Acts of Parliament, 2013 (India).
[vi] Id. at § 36.
[vii] Id. at § 435.
[viii] Jerome Hall, General Principles of Criminal Law 70 (Bobbs Merrill Co. 1980).
[ix] Thomas Gardner et. al., Criminal Law 34 (Thomson Wadsworth 2006).
[x] P.J. Fitzgerald, Salmond On Jurisprudence 366 (Universal Law Publishing Company 2010).
[xii] Sherras v. De Rutzen, (1895) 1 QB 918; Brend v. Wood, (1946) 110 JP 317; Lim Chin Aik v. Regina, (1963) 1 All ER 223.
[xiii] Salomon v A Salomon and Co Ltd.,  AC 22.
[xiv] A.K. Khosla v. T.S. Venkatesan, 1992 CriLJ 1448.
[xv] Zee Telefilms Ltd. v. Sahara India Co. Corpn. Ltd., (2001) 1 CALLT 262 HC.
[xvi] New York Central & Hudson River Railroad Co. v. United States, 212 U.S. 481, 494-95 (1909).
[xvii] Washington Gaslight Co. v. Lansden, 172 U.S. 534, 544.
[xviii] Said v. Butt,  3 KB 497.
[xix] Standard Chartered Bank v. Directorate of Enforcement, AIR 2005 SC 2622.
[xx] Iridium India Telecom Ltd. v. Motorola Inc, (2011) 1 SCC 74.
[xxi] Lennard’s Carrying Co. Ltd. v. Asiatic Petroleum Co Ltd.,  A.C. 705 HL.
[xxii] Iridium India Telecom v. Motorola Incorporated and Ors., (2011) 1 SCC 74.
[xxiv] Nigam Nuggehalli, Vicarious Corporate Criminal Liability, Azim Premji University (Feb. 28, 2020, 10:05 AM), https://azimpremjiuniversity.edu.in/SitePages/pdf/Vicarious-Corporate-Criminal-Liability%20.pdf.
[xxv] Sunil Bharti Mittal v. Central Bureau of Investigation, (2015), 4 SCC 609.
[xxvii] Dr. Ponduri.S.B, Mrs. V. Sailaja & Mrs. Syeda Amina Begum, Corporate Governance – Emerging Economies Fraud and Fraud Prevention, 16 IOSR JBM 1, 7 (2014).
[xxix]Nishant Tiwari, Corporate Fraud: Problem of Developing India, Taxmann (Feb. 25, 2020, 10:00 AM), www.taxmann.com.
[xxx] KPMG, http://www.in.kpmg.com/pdf/KPMG_Chemtech_Report.pdf (last visited Feb. 25, 2020).
[xxxi] Life Insurance Corpn. of India v. Escorts Ltd.,  59 Comp. Cas. 548 (SC).
[xxxii] Delhi Development Authority v. Skipper Construction Co. (P.) Ltd.,  89 Comp. Cas. 362 (SC).
[xxxiii] Gilford Motor Co. Ltd. v. Horne,  Ch D 935.
[xxxiv] Prevention of Corruption Act, 1988, § 10, No. 49, Acts of Parliament, 1988 (India).