Chapter 4 Fraud under Companies Act, 2013 and Indian Penal Code, 1860 – Resolution of Corporate Disputes Non Compliances & Remedies Notes is designed strictly as per the latest syllabus and exam pattern.
Fraud under Companies Act, 2013 and Indian Penal Code, 1860 – Resolution of Corporate Disputes Non Compliances & Remedies Study Material
Question 1.
“Breach of trust may be held to be a civil wrong but when mens-rea is involved, it gives rise to criminal liability also”. Comment on this statement with supporting judicial pronouncements. (June 2019, 5 marks)
Answer:
The essential elements of the offence of criminal breach of trust are:
- The accused must be entrusted with the property or with dominion over it.
- The person so entrusted must use that property, or;
- The accused must dishonestly use or dispose of that property or wilfully suffer any other person to do so in violation,
- of any direction of law prescribing the mode in which such trust is to be discharged, or;
- of any legal contract made touching the discharge of such trust.
The Supreme Court of India in VR. Dalai v. Yugendra Naranji Thakkar, 2008 (15) SCC 625, has held that the first ingredient of criminal breach of trust is entrustment and where it is missing, the same would not constitute a criminal breach of trust. Breach of trust may be held to be a civil wrong but when mens-rea is involved it gives rise to criminal liability also.
In a judgment of Pratibha Rani v. Suraj Kumar, AIR 1985 SC 628, the appellant alleged that her stridhan property was entrusted to her in-laws which they dishonestly misappropriated for their own use. She made out a clear, specific and unambiguous case against in-laws. The accused were held guilty of this offence and she was held entitled to prove her case and no court would be justified in quashing her complaint.
Question 2.
(i) ‘The term fraud’ has been defined for the first time in the Companies Act, 2013’ – Briefly, discuss the background and importance of the definition of ‘fraud’ under the Companies Act, 2013.
(ii) ‘De-criminalisation of most offences under the Companies Act, 2013 is key to E-adjudication framework’ – Elaborate highlighting recent developments in this context. (Dec 2020, 4 marks each)
Answer:
(i) The JJ Irani Committee set up by the government in 2004 submitted its report in 2005 with far reaching recommendations.
The recommendations of the committee have received shape in the Companies Act, 2013.
One of the recommendations of the committee was that there should be deterrent penalties for companies that show irresponsible behavior or conduct fraudulent activities.
Fraud consists of some deceitful practice or wilful device, resorted to with an intent to deprive another of his right, or in some manner to do him an injury.
As distinguished from negligence, it is always positive, intentional (Maher v. Hibernia Inst. Co., 67 NY292).
The Hon’ble Supreme Court of India in the matter of Dr. Vimla vs. Delhi Administration (29 November, 1962) citing Haycraft v. Creasy(1) LeBlanc, noted that: “by fraud is meant an intention to deceive; whether it be from any expectation of advantage tc the party himself or from the ill-will towards the other is immaterial.”
Till the commencement of the Companies Act, 2013, the term fraud was not defined in the Indian corporate laws. Even the Indian Penal Code, 1860, did not touch upon the fraud directly.
Though, as per Section 17 of the Indian Contracts Act, 1872, the term “fraud” means an act committed by a party to a contract or with his connivance, or by his agent, with an intention to deceive another party thereto or his agent, or to induce him to enter into the contract:
- the suggestion, as a fact, of that which is not true, by one who does not believe it to be true;
- the active concealment of a fact by one having knowledge or belief of the fact;
- a promise made without any intention of performing it;
- any other act fitted to deceive;
- any such act or omission as the law specially declares to be fraudulent.
Further, mere silence as to facts likely to affect the willingness of a person to enter into a contract is not fraud, unless the circumstances of the case are such that, regard being had to them, it is the duty of the person keeping silence to speak, or unless his silence is, in itself, equivalent to speech.
According to regulation 2(1)(c) of SEBI (Prohibition of Fraudulent and Unfair Trade Practices relating to Securities Market) Regulation, 2003 “fraud” includes any act, expression, omission or concealment committed whether in a deceitful manner or not by a person or by any other person with his connivance or by his agent while dealing in securities in order to induce another person or his agent to deal in securities, whether or not there is any wrongful gain or avoidance of any loss, and shall also include:
- a knowing misrepresentation of the truth or concealment of material fact in order that another person may act to his detriment;
- a suggestion as to a fact which is not true by one who does not believe it to be true;
- an active concealment of a fact by a person having knowledge or belief of the fact;
- a promise made without any intention of performing it;
- a representation made in a reckless and careless manner whether it be true or false;
- any such act or omission as any other law specifically declares to be fraudulent,
- deceptive behaviour by a person depriving another of informed consent or full participation,
- a false statement made without reasonable ground for believing it to be true.
- the act of an issuer of securities giving out misinformation that affects the market price of the security, resulting in investors being effectively misled even though they did not rely on the statement itself or anything derived from it other than the market price. And “fraudulent” shall be construed accordingly;
Companies Act, 2013, formally defined the term “fraud” w.r.t. the corporate actions. As per sub-clause (i) to the Explanation to Sec 447 “fraud” in relation to affairs of a company or any body corporate, includes any act, omission, concealment of any fact or abuse of position committed by any person or any other person with the connivance in any manner, with intent to deceive, to gain undue advantage from, or to injure the interests of, the company or its shareholders or its creditors or any other person, whether or not there is any wrongful gain or wrongful loss, wherein “wrongful gain” means the gain by unlawful means of property to which the person gaining is not legally entitled and “wrongful loss” means the loss by unlawful means of property to which the person losing is legally entitled.
(ii) Ministry of Corporate Affairs (MCA) seeks to review offences under the Companies Act, 2013 as some of the offences may be required to be decriminalised and handled through an in-house mechanism, where a penalty could be levied in the events of default, which would also reduce the burden on the trail courts by allowing them to pay more attention on offences of serious nature.
The Essential Recommendations of the MCA Committee on Review of Penal Provisions of Companies Act 2013 are as under:
Restructuring of Corporate Offences to relieve Special Courts from adjudicating routine offences:
(a) re-categorization of 16 out of the 81 compoundable offences by shifting them from the jurisdiction of special courts to an in-house E-adjudication framework wherein defaults would be subject to levy of penalty by the authorised adjudicating officer (Registrar of Companies);
(b) remaining 65 compoundable offences to continue under the jurisdiction of special courts due to their potential misuse;
(c) similarly, status quo recommended in respect of all non-compoundable offences, which relate to serious corporate offences;
(d) instituting a transparent online platform for e-adjudication and E-publication of orders; and
(e) Necessitating a concomitant order for making good the default at the time of levying penalty, to achieve better compliance.
The decriminalisation of the offence paved the way for e-adjudication framework. The system has become effective as the offences are decriminalised and the minor offences are dealt by e-adjudication framework.
Question 3.
As per the provisions of the Indian Penal Code, 1860, “the offences relating to cheating, intention to deceive is to be proved and mere negligence is not cheating”. Explain the main ingredients of the offence “cheating” with relevant case. laws/Judicial pronouncements. (Aug 2021, 4 marks)
Answer:
Sections 415 to 420 of Indian Penal Code, 1860 deals with the offence of cheating. In most of the offences relating to property the accused merely get possession of thing in question, but in case of cheating, he obtains possession as well as the property in it.
Section 415 states that whoever, by deceiving any person, fraudulently or dishonestly induces the person so deceived to deliver any property to any person, or to consent that any person shall retain any property, or intentionally induces the person so deceived to do or omit to do anything which he would not do or omit if he were not so deceived, and which act or omission causes or is likely to cause damage or harm to that person in body, mind, reputation or property, is said to “cheat”. A dishonest concealment of facts is a deception within the meaning of this section.
The Important elements of cheating are as under:
1. Deception of any person.
2. (a) Fraudulently or dishonestly inducing that person:
(i) to deliver any property to any person; or
(ii) to consent that any person shall retain any property; or
(b) Intentionally inducing that person to do or omit to do anything which he would not do or omit if he were not so deceived, and which act or omission causes or is likely to cause damage or harm to that person in body, mind, reputation or property.
The Supreme Court in Iridium India Telecom Ltd. v. Motorola Incorporated and Ors., (2005) 2 Sec. 145, has held that deception is necessary ingredient under both parts of section. Complainant must prove that inducement has been caused by deception exercised by the accused. It was held that non-disclosure of relevant information would also be treated a misrepresentation of facts leading to deception. In T. R. Arya v. State of Punjab, 1987 CrLJ 222, it was held that negligence in duty without any dishonest intention cannot amount to cheating. A bank employee when on comparison of signature of drawer passes a. cheque there may be negligence resulting in loss to bank, but it cannot be held to be cheating.
Question 4.
Explain the meaning of Exit Checks and Clawbacks. (Aug 2021, 4 marks)
Answer:
Exit interviews, particularly when employees are performing and are remunerated well, can raise red flags about possible involvement in fraud. Somewhere there are likely to be some answers which do not add up. The organization can then investigate. Clawback provisions in employment agreements; which enable the company to recover incentive and additional compensation paid to executives are an effective deterrent tool, since executive compensation tends to be largely performance linked. Clawback provisions would provide for recovery of such compensation (usually other than the base salary) in case of fraudulent misrepresentation or misstatements.
The biggest fraud prevention mechanisms are, in reality growth oriented companies which have appropriate recognition and remuneration mechanisms and thus, a high employee morale. A positive community environment is difficult to quit, and even more difficult to ditch.
Question 5.
“Mere breach of contract cannot give rise to criminal prosecution under section 420 unless fraudulent or dishonest intention is shown, right at the beginning of transaction when the offence is said to have been committed.” Explain. (Dec 2021, 4 marks)
Answer:
Cheating and Dishonesty Inducing Delivery of Property: As per Section 420 of Indian Penal Code, 1860, states that whoever cheats and thereby dishonestly induces the person deceived to deliver any property to any person or to make, alter or destroy the whole or any part of a valuable security, or anything which is signed or sealed, and which is capable of being converted into a valuable security, shall be punished with imprisonment of either description for a term which may extend to seven years, and shall also be liable to fine.
In Shruti Enterprises v. State of Bihar and ors, 2006 CrLJ 1961, it was held that mere breach of contract cannot give rise to criminal prosecution under section 420 of the Indian Penal Code, 1860, unless fraudulent or dishonest intention is shown right at the beginning of transaction when the offence is said to have been committed. If it is established that the intention of the accused was dishonest at the time of entering into the agreement, then liability will be criminal and the accused will be guilty of offence of cheating. On the other hand, if all that is established is that a representation made by the accused has subsequently not been kept, criminal liability cannot be fastened on the accused and the only right which complainant acquires is to a decree of damages for breach of contract.
In the given situation, it may be said that “Mere breach of contract cannot give rise to criminal prosecution under section 420 of Indian Penal Code, 1860 unless fraudulent or dishonest intention is shown, right at the beginning of transaction when the offence is said to have been committed”.
Question 6.
State whether the following offences under the Companies Act, 2013 are compoundable, if yes, also mention the Compounding Authority:
(i) Failure to comply with the provisions relating to transfer and transmission of securities.
(ii) A Company fails to repay the deposit or part thereof or any interest thereon within the time specified or such further time as may be allowed.
(iii) Failure to distribute dividend within thirty days.
(iv) Contravention of provisions relating to charges. (Dec 2021, 4 marks)
Answer:
1. Failure to comply with the provisions relating to transfer and transmission of securities
As per Section 56(6) of the Companies Act, 2013 (the Act), where any default is made in complying with the provisions of sub-sections (1) to (5) relating to transfer and transmission of securities, the company and every officer of the company who is in default shall be liable to a penalty of ₹ 50,000.
Since the offence is not punishable with imprisonment only, or with imprisonment and also with fine, and the monetary penalty leviable under Sec 56(6) is less than the limit of twenty five Lakh rupees, prescribed under Sec 441(1) of the Act, the offence may be compounded by Regional Director (RD).
2. A Company fails to repay the deposit or part thereof or any interest thereon within the time specified or such further time as may be allowed
As per Section 76A of the Companies Act, 2013, if a company fails to repay the deposit or part thereof or any interest due thereon within the time specified under section 73 or section 76 or rules made thereunder or such further time as may be allowed by the Tribunal-
(a) the company shall, in addition to the payment of the amount of deposit or part thereof and the interest due, be punishable with fine which shall not be less than ₹ 1 crore or twice the amount of deposit accepted by the company, whichever is lower but which may extend, to ₹ 10 crore; and
(b) every officer of the company who is in default shall be punishable with imprisonment which may extend to seven years and with fine which shall not be less than ₹ 25 lakh but which may extend to two crore rupees.
Since the offence is punishable with imprisonment and fine, the same is non-compoundable under Sec 441.
3. Failure to distribute dividend within thirty days
As per Section 127 of the Companies Act, 2013, where a dividend has been declared by a company but has not been paid or the warrant in
respect thereof has not been posted within 30 days from the date of declaration to any shareholder entitled to the payment of the dividend, every director of the company shall, if he is knowingly a party to the default, be punishable with imprisonment which may extend to two years and with fine which shall not be less than ₹ 1,000 for every day during which such default continues and the company shall be liable to pay simple interest at the rate of 18% per annum during the period for which such-default continues.
Since the offence is punishable with imprisonment and fine, the same is non-compoundable under Sec 441.
4. Contravention of provisions relating to Charges
As per Section 86 of the Companies Act, 2013, if any company is in default in complying with any of the provisions of Chapter VI(Registration of Charges etc.), the company shall be liable to a penalty of ₹ 5 lakh and every officer of the company who is in default shall be liable to a penalty of ₹ 50,000.
Since the offence is not punishable with imprisonment only, or with imprisonment and also with fine, and the monetary penalty leviable under Sec 86 is less than the limit of twenty five lakh rupees, prescribed under Sec 441(1) of the Act, the offence may be compounded by Regional Director.
Question 7.
Paras finds that his name is mis-spelt in his property document, so he makes the correction and keeps the document with himself . A year later, he tries to sell his property and delivers the copy of the document to the proposed buyer. The Advocate of the proposed buyer informs him that the document is a forged document. Evaluate whether this act of Paras amounts to forgery. (Dec 2021, 4 marks)
Answer:
The making of a false document or false electronic record is defined under section 464 of the Indian Penal Code, 1860. As per the said section a person is said to make a false document or false electronic record –
First: Who dishonestly or fraudulently –
(a) makes, signs, seals or executes a document or part of a document;
(b) makes or transmits any electronic record or part of any electronic record;
(c) affixes any electronic signature on any electronic record;
(d) makes any mark denoting the execution of a document or the authenticity of the electronic signature;
With the intention of causing it to be believed that such document or part of document, electronic record or electronic signature was made, signed, sealed, executed, transmitted or affixed by or by the authority of a person by whom or by whose authority he knows that it was not made, signed, sealed, executed or affixed; or
Secondly: Who, without lawful authority, dishonestly or fraudulently, by cancellation or otherwise, alters a document or an electronic record in any material part thereof, after it has been made, executed or affixed with electronic signature either by himself or by any other person, whether such person be living or dead at the time of such alteration; or
Thirdly: Who dishonestly or fraudulently causes any person to sign, seal, execute or alter a document or an electronic record or to affix his electronic signature on any electronic record knowing that such person by reason of unsoundness of mind or intoxication cannot, or that by reason of deception practised upon him, he does not know the contents of the document or electronic record or the nature of the alteration.
The Supreme Court in Ramchandran v. State, has held that to constitute an offence of forgery document must be made with dishonest or fraudulent intention. A person is said to do a thing fraudulently if he does that thing with intent to defraud but not otherwise.
The Supreme Court in Parminder Kaur v. State of UP, has held that mere alteration of document does not make it a forged document. Alteration must be made for some gain or for some objective.
Conclusion: In the above situation, the act of Mr. Paras does not amount to Forgery as there is no material alteration in the document and also there is no intention to defraud anyone.
Question 8.
‘Fraud is an act of deliberate deception with the design of securing something by taking unfair advantage of another. It is a deception in order to gain by another’s loss. To clearly understand the term ‘fraud’ in reference of penalizing, preventing and regulating this act, one should be well-versed with the elements of fraud’. Comment on this statement by detailing essential elements of Fraud. (Dec 2021, 8 marks)
Answer:
Under the Indian law a penal offence of fraud, demands for successful prosecution, the twin elements of ‘intent to defraud’ of the offender i.e.:
- An intent to deceive another; and
- An intent to cause, by that deception, injury to some person.
Now to clearly understand the term ‘fraud’ in reference of penalizing, preventing and regulating this act, one should clearly understand the elements of fraud.
Few Essential Elements of Fraud are listed as below:
1. False and Wilful representation or Assertion: To constitute fraud there must be some representation or assertion, which is untrue. In the absence of representation or assertion except in the following two cases, there can be no fraud.
(i) Where silence may itself amount to fraud, and
(ii) Where there is active concealment of facts.
The person making the representation should not believe it to be true, otherwise he/she will not be guilty of fraud. Moreover, to constitute fraud, the false representation must have been made wilfully or intentionally.
2. Perpetrator of Representation: The false representation or misstatement must have been made by a party to the contract or by anyone with its connivance, or by its agent. If a stranger makes the misstatement to the contract, it cannot result in fraud.
3. Intention to deceive: Intention to deceive the other party is the essence of fraud. In order to commit a fraud, one person asserts or misstates the fact with the intention that it should be acted upon. As a matter of fact, misrepresentation elevates to the level of fraud when it is prefixed by the element of intention to deceive the other party.
4. Representation must relate to a fact: The representation made by the party must relate to a fact, which is material to the formation of the contract. A mere statement of opinion, belief, or commendation cannot be treated as fraud.
5. Active concealment of facts: “Active concealment must be distinguished from passive concealment”. Passive concealment implies mere silence as to material facts, which barring a few cases, does not amount to fraud. Whereas, active concealment implies ‘when the party takes positive or deliberate steps to prevent information from reaching the other party and this is treated as fraud.
6. Promise made without intention of performing it: If a person while entering into a contract has no intention to perform his/her promise, there is an intent to defraud on his/her part, for the intention to deceive the other party is there from the very beginning.
7. Any other act fitted to deceive: The expression ‘any other act fitted to deceive’ obviously means any act, whioh is done with the intention of committing fraud. This category includes all tricks, dissembling, and other unfair ways, which are used by cunning and clever people to cheat others.
8. Any such Act or omission that the law specially declares as void: This category includes the act or omission that the law specially declares to be fraudulent.
9. Material defects: Material defects, if any, in the property such as, cracks in the wall or in beams, and/or Any defect or dispute as regards transferor’s title, such as property is subject to encumbrance, i.e., mortgaged or is subject to some dispute pending in a court of law. An omission to make such disclosure on the part of transferor amounts to fraud.
10. Wrongful Loss and Wrongful Gain is immaterial: For the purposes of “Fraud” under the provisions of Sec 447 of the Companies Act, 2013, it is immaterial whether there has been some wrongful loss to one and/or wrong gain to another. The only important thing is intention to deceive and the act or omission actually deceiving the victim.
11. On the same principle, Indian Penal Code (IPC) too works, as for IPC to constitute an offence, two elements are required which are Mens Rea – intention to Commit Offence and Actus Reus- The Wrongful Act.
In the given situation, it may be said that ‘Fraud is an act of deliberate deception with the design of securing something by taking unfair advantage of another. It is a deception in order to gain by another’s loss.
To clearly understand the term ‘Fraud’ in reference of penalising, preventing and regulating this act, one should be well versed with the elements of Fraud.
Question 9.
“Though the concept of ‘Whistle Blower’ is a landmark for the Corporate Governance and Section 177 of the Companies Act, 2013 has specific mention about vigil mechanism, its implementation is not upto the mark in the Indian corporate context.” Comment. (June 2022, 4 marks)
Answer:
Question 10.
“The Company’s management is taken care of by the Board of Directors and the directors are expected to perform in the best interests of the company as they are in a fiduciary position. Even a single director’s intentions to gain an undue advantage out of stakeholders’ money can result in fraud.” Will fraud by just one director make the other directors liable ? (June 2022, 4 marks)
Question 11.
During the Statutory audit of MOP Limited, the auditors found that a fraud has been committed against the Company by its officers amounting to more than ? 10 Crore. What are the duties of statutory auditors in the given case under the Companies Act, 2013? (June 2019, 8 marks)
Answer:
If an auditor of a company, in the course of the performance of his duties as statutory auditor, has reason to believe that an offence of fraud, which involves or is expected to involve individually an amount of rupees one crore or above, is being or has been committed against the company by its officers or employees, the auditor shall report the matter to the Central Government. Section 143 of the Companies Act, 2013 confers certain powers on the auditors of the company as well as casts certain duties on them.
The auditor shall report the matter to the Central Government as under:
- The auditor shall report the matter to the Board or the Audit Committee, as the case may be, immediately but not later than two days of his knowledge of the fraud, seeking their reply or observations within forty-five days.
- On receipt of such reply or observations, the auditor shall forward his report and the reply or observations of the Board or the Audit Committee along with his comments to the Central Government within fifteen days from the date of receipt of such reply or observations.
- In case the auditor fails to get any reply or observations from the Board or the Audit Committee within the stipulated period of forty-five days, he shall forward his report to the Central Government along with a note containing the details of his report that was earlier forwarded to the Board or the Audit Committee for which he has not received any reply or observations.
- The report shall be sent to the Secretary, Ministry of Corporate Affairs in a sealed cover by Registered Post with Acknowledgement Due or by Speed Post followed by an e- mail in confirmation of the same.
Question 12.
PSU Bank Limited, a public sector bank has detected a fraud being committed by one of its large corporate customers. The alleged fraud seems to have been perpetrated over a period of time, by diverting the funds received from the Bank to offshore tax heavens by the promoter group. A forensic audit was ordered to examine the details of such transactions. Meanwhile, the Central Government has asked the Central Bureau of Investigation (CBI) to investigate the fraud.
Discuss which division of CBI would investigate this case. (Dec 2019, 4 marks)
Answer:
Central Bureau of Investigation (CBI) has grown into a multidisciplinary investigation agency over a period of time. Today it has the following three divisions for investigation of crime
- Anti-Corruption Division – for investigation of cases under the Prevention of Corruption Act, 1988 against Public officials and the employees of Central Government, Public Sector Undertakings, Corporations or Bodies owned or controlled by the Government of India – it is the largest division having presence almost in all the States of India.
- Economic Offences Division – for investigation of major financial scams and serious economic frauds, including crimes relating to Fake Indian Currency Notes, Bank Frauds and Cyber Crime.
- Special Crimes Division – for investigation of serious, sensational and organized crime under the Indian Penal Code and other laws on the requests of State Governments or on the orders of the Supreme Court and High Courts.
The laws under which CBI can investigate Crime are notified by the Central Government under section 3 of the Delhi Special Police Establishment Act, 1946.
According to Section 3, The Central Government mayt by notification in the Official Gazette, specify the offences or classes of offehces which are to be investigated by the Delhi Special Police Establishment.
As the fraud in PSU Bank is a major financial scam. It would be investigated by the Economic Offences division of CBI.
Question 13.
Mr. Ze, a Company Secretary has recently set up a Practice. Mr. Almora a businessman reached out to Mr, Ze, to incorporate a Company. Mr. Ze assisted him with the list of information required and also extended his professional services for incorporation of the Company. When Mr. Ze was reviewing the documents provided to him, for uploading the forms, he noticed that the documents contained false information. Mr. Ze was apprehensive to go ahead with the incorporation of the Company. Advise Mr. Ze. (Dec 2019, 4 marks)
Answer:
Section 7 of the Companies Act, 2013 deals with the documents to be filed with the concerned Registrar of Companies (ROC) for incorporation of a company. While dealing with the requirements, under Section 7(5) of the Companies Act, 2013 it has been stated that if a person furnishes false information or incorrect particulars or suppresses material information then the person is liable for action under Section 447 of the Companies Act, 2013.
Further, Section 7(6) also provides that the promoters, the first directors and the fiduciaries viz, the Chartered Accountant, the Company Secretary in practice or the Cost Accountant or the’Advocate, the Managing Director or the Secretary of the Company who have given a declaration in the prescribed format shall also be liable for action under Section 447 of the Companies Act, 2013. Thus the penal provision extends to the professionals also apart from the officers of the company.
Hence, Mr. Ze should take note of the aforementioned provisions and shall go for incorporation of the company with the correct information only otherwise, he should not go ahead with the incorporation of the Company, knowing that the documents provided contains false information.
Question 14.
Mr. Krish, a resident of Mumbai is a friend of Mr. Parth, who stays in Manali. As Mr. Parth did not have much exposure and information about personal finance and investment options in Manali, he trusted his friend for his investments. As per their agreement, Mr. Parth remitted ₹ 1 Lakh to Mr. Krish to invest in mutual funds and stock market. Mr. Krish employs the money in his own business ignoring his understanding with Mr. Parth.
Has Mr. Krish committed criminal breach of trust ? (Dec 2019, 4 marks)
Answer:
According to Section 405 of the Indian Penal Code, 1860, the essential ingredients of the offence of criminal breach of trust are as under:
(a) The accused must be entrusted with the property or with dominion over it,
(b) The person so entrusted must use that property, or;
(c) The accused must dishonestly use or dispose of that property or wilfully suffer any other person to do so in violation of any:
- direction of law prescribing the mode in which such trust is to be discharged, or
- legal contract made touching the discharge of such trust.
In the given case, there is an express or implied contract between Mr. Parth and Mr. Krish, that the money would be invested by Mr. Krish on behalf of Mr. Parth. But Mr. Krish invests the same in his own business which is violation of section 405 of the Indian Penal Code, 1860.
Hence, he has committed criminal breach of trust.
Question 15.
Ms. Rekha was working as ‘Gram Sachiv’ for ten gram panchayats. She was a trusted person of the local villagers and they respected her. Ms. Rekha, collected a sum of ₹ 5 Lakhs from fifty villagers in the gram panchayats saying she would pay their house tax and issued receipts to them. Later it was found that she did not deposit the money into Government treasury, but utilized it for her personal purposes. The villagers wanted to file a case against Ms. Rekha, when they came to know of the misappropriation done by her.
Will the villagers be successful in filing a case against Ms. Rekha? (Dec 2019, 4 marks)
Answer:
According to Section 409 of the Indian Penal Code, 1860, when a person in his capacity of a public servant, commits criminal breach of trust as specified under section 405 of the Indian Penal Code, 1860, shall be punished with imprisonment for life, or with imprisonment of either description for a term which may extend to ten years, and shall also be liable to fine.
The facts mentioned are similar to Bachchu Singh v. State of Haryana case. The appellant was working as ‘Gram Sachiv’ for eight gram panchayats. He collected a sum of Rupees 648 from thirty villagers towards the house tax and executed receipts for the same. As he was a public servant, and in that capacity he had collected money as house tax but did not remit the same, he was charged under Section 409 of Indian Penal Code, 1860. It was held that the appellant dishonestly misappropriated or converted the said amount for his own use and his conviction under section 409 of Indian Penal Code, 1860 was upheld by the Supreme Court.
Mrs. Rekha was working as a Gram Sachiv and collected money from the villagers. She misappropriated the funds for her personal benefits.
In the background of the aforementioned case law, she can be charged under section 409 of Indian Penal Code, 1860 for breach of trust by public servant as she is a public servant.
Question 16.
In the Annual General Meeting (AGM) of Jollydays Limited, the matter of re-appointment of Mr. Jolly, the Executive Director (ED) came up for voting. During such discussion, allegations of fraud and financial irregularities were levelled against him by some members, which resulted in chaos in the meeting. The situation was normal only after the Chairman promised to initiate an inquiry against Mr. Jolly. The resolution at AGM to reappoint Mr. Jolly as ED, was not passed. The matter was published in the newspapers next day.
Under the Companies Act, 2013, can a Court take cognizance of the matter and suo moto initiate action against Mr. Jolly based on the media reports? (Dec 2019, 4 marks)
Answer:
Section 439 of the Companies Act, 2013 provides that:
1. Notwithstanding anything in the Code of Criminal Procedure, 197-3, every offence under this Act except the offences referred to in sub-section (6) of section 212 shall be deemed to be non-cognizable within the meaning of the said Code.
2. No court shall take cognizance of any offence under this Act whioh is alleged to have been committed by any company or any officer thereof, except on the complaint in writing of the Registrar, a shareholder or a member of the company, or of a person authorised by the Central Government in that behalf.
Further, the court may take cognizance of offences relating to issue and transfer of securities and non-payment of dividend, on a complaint in writing, by a person authorised by the Securities and Exchange Board of India.
Thus, in the given situation, a Court shall not initiate any suo moto action against Mr. Jolly without receiving any complaint in ‘writing of the Registrar of Companies, a shareholder of the company or a members or of a person authorized by the Central Government in this behalf.
Question 17.
Greenary Limited, a Public Limited Company was in the business of generation and supply of electricity and had its factory near Krishnapatanam Beach. Mr. Pond, was the Vice-President (Operation), and was authorized by the Board of Directors of the Company to be in charge of the factory operations. As the factory was located on sea-shore, the Company was subject to the provisions of various Environmental Laws. The Company had not complied with the provisions relating to dumping/discharge of its production wastes, etc. Summons were issued against Mr. Pond by the adjudicating authority. Mr. Pond sent an email to you, the Company Secretary stating his designation would not tantamount to officer in default.
Would you agree with Mr. Pond? (Dec 2019, 4 marks)
Answer:
According to section 47 of the Water (Prevention and Control of Pollution) Act, 1974, where an offence under this Act has been committed by 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 the guilty of the offence and shall be liable to be proceeded against and punished accordingly:
Provided that nothing contained in this sub-section shall render any such person liable to any punishment provided in this Act if he proves that the offence was committed without his knowledge for that he exercised all due diligence to prevent the commission of such offence.
Where an offence under the Act has been committed by a company and it is proved that the offence has been committed with the consent or connivance of, or is attributable to any neglect on the part of, any director, manager, secretary or other officer of the company, such director, manager, secretary or other officer shall also be deemed to be guilty of that offence and shall be liable to be proceeded against and punished accordingly.
Mr. Pond, has been authorised by the Board of Directors to be the in charge of factory operations. As per section 47 of Water (Prevention and Control of Pollution) Act, 1974 he is deemed to the guilty of the offence and shall be liable to be proceeded against and punished accordingly.
Question 18.
Mr. Raj owned 50 acres of land. He agreed to sell the land to Mr. Sham for ₹ 5 crore and executed a conveyance for the same. Despite the execution of conveyance, Mr. Raj later mortgages the entire 50 acres to Mr. Rohit. He conceals the fact of previous sale to Mr. Sham and receives money from Mr. Rohit.
In the background of decided case law, indicate whether Mr. Raj would be held liable for cheating. (Dec 2019, 4 marks)
Answer:
Section 415 Indian Penal Code, 1860, provides that whoever, by deceiving any person, fraudulently or dishonestly induces the person so deceived to deliver any property to any person, or to consent that any person shall retain any property, or intentionally induces the person so deceived to do or omit to do anything which he would not do or omit if he were not so deceived, and which act or omission causes or is likely to cause damage or harm to that person in body, mind, reputation or property, is said to “cheat”.
In Chinthaman vs. Dyaneshwarand Anr. [1973] case, the accused sold the propertyto the complainant. In fact, they said property was already mortgaged to some other person. The accused concealed the mortgage and registered it in favour of the complainant and received full consideration. The High Court held that it was a clear cheating offence.
Yes, in the given case, Mr. Raj would be liable for offence of cheating as he dishonestly mortgaged the land to Mr. Rohit.
Question 19.
A Bank lent money to borrowers against security of gold ornaments. The Gold ornaments were valued by a Gold Appraiser. The Bank lent 60% of the certified value of the gold. An employee of the Bank who is a man of integrity realised that the Gold Appraiser had colluded with the Loan Manager and the security provided was not ‘gold ornaments’ but ‘gold plated ornaments’. Advise the employee on his course of action. (Dec 2020, 4 marks)
Answer:
The employee can make use of the vigil mechanism/whistle blower mechanism required to be established under Section 177 (9) of the Companies Act, 2013.
The said section provides that listed and prescribed companies, shall establish a vigil mechanism/whistle blower mechanism for directors and employees to report genuine concerns in such manner as may be prescribed.
Every listed company, companies which accept deposits from the public and companies which have borrowed money from banks and public financial institution in excess of ₹ 50 crores have to establish a vigil mechanism/whistle blower mechanism for directors and employees to report their genuine concerns about unethical behaviour/misconduct/actual or suspended faults/violation of rules/ guidelines.
As per Section 177(10) of Companies Act, 2013, the vigil mechanism/whistle blower mechanism under sub-section (9) shall provide for adequate safeguards against victimisation of persons who use such mechanism and make provision for direct access to the chairperson of the Audit Committee in appropriate or exceptional cases.
The proviso to this sub-section state that the details of establishment of such mechanism shall be disclosed by the company on its website, if any, and in the Board’s report.
The employee of the Bank can directly email his concern to the chairman of the Audit Committee as mentioned in the “Whistle Blower” & vigil mechanism/whistle blower mechanism policy.
All directors or employee are assured that this mechanism provides adequate safeguard against victimization of the concerned director/ employee.
Accordingly, the employee can inform the Chairman of the Audit Committee about the fraud, without any fear of victimization.
Question 20.
A company, engaged in the real estate business, intend to come out with Initial Public Offer (IPO), filed a prospectus with the SEBI for its approval. In the prospectus, the company mentioned that it is having land bank in Mumbai and Pune and the proceeds of the IPO shall be utilised for the construction of residential flats at such places. Ashok invested in the IPO and also got the allotment. Later on it was discovered that company was not having any land bank either at Mumbai or at Pune. At the time of the issue of the prospectus, it had only entered into an agreement with the owner of the land for its redevelopment and thereafter construction of residential flats on lease basis. However, due to some disputes, the land owner refused to company to use the land for the aforesaid purposes. What recourse is available to Ashok, who had invested in the IPO? (Aug 2021, 4 marks)
Answer:
Since, Ashok is the original allottee and he had relied on the information given in the prospectus, and invested in the Initial Public Offer, he may initiate legal action against the company and its directors.
As per Section 37 of the Companies Act, 2013 provides that a suit may be filed or any other action may be taken under section 34 of the said Act(Criminal Liability for Mis-statements in Prospectus)
Section 35 of the said Act (Civil Liability for Mis-statements in Prospectus)
Section 36 of the said Act (Punishment for Fraudulently Inducing Persons to Invest Money) by any person, group of persons or any association of persons affected by any misleading statement or the inclusion or omission of any matter in the prospectus.
Section 34 of the Companies Act, 2013 provides for criminal liability for mis-statement in prospectus. In this section, where a prospectus issued, circulated or distributed under chapter III of said Act, includes any statement which is untrue or misleading in from or context in which it is included or where any inclusion or omission or any matter is likely to mislead, every person who authorises the issue of such prospectus shall be liable for punishment for fraud under section 447 of the said Act.
Section 35 of Companies Act, 2013 provides civil liability for mis-statements in a prospectus. In section, where a person has subscribed for securities of a company acting on any statement included, or the inclusion or omission of any matter, in the prospectus which is misleading and has sustained any loss or damage as a consequence thereof, the company and every person who-
(a) Is a director of the company at the time of the issue of the prospectus
(b) Has authorised himself to be named and is named in the prospectus as a director of the company, or has agree to become such director, either immediately or after an interval of time
(c) Is a promoter of the company
(d) Has authorised the issue of the prospectus; and
(e) Is an expert referred to in sub-section(5) of section 26,
Shall, without prejudice to any punishment to which any person may be liable under section 36 of the said Act, be liable to pay compensation to every person who has sustained such loss or damages.
Section 36 of Companies Act, 2013 provides for the punishment for fraudulently inducing persons to invest money. According to said section, any person who, either knowingly or recklessly makes any statement, promise or forecast which is false, deceptive or misleading or deliberately conceals any material facts to induce another person to enter into or to offer to enter into-
(i) Any agreement for or with a view to acquiring disposing of subscribing for or underwriting securities; or
(ii) Any agreement, the purpose of the pretended purpose of which is to secure a profit to any of the parties from the yield or securities or by reference to fluctuations in the value of securities; or
(iii) Any agreement for or with a view to obtained credit facilities from any or financial institutions,
Shall be liable for action under section 447(Punishment for Fraud) of the said Act.
Ashok may initiate legal action against the company and its directors.
Question 21.
SEBI issued an order against the directors of the Shyam and Company Ltd., a listed entity, against their failure to comply with the some of the provisions of the SEBI .(LODR) Regulations, 2015 and levied penalty for the same.
However, the directors of the company are of the opinion the penalty levied by the SEBI for non-compliance of the provisions are not applicable to the company since these provisions came into effect after the amendment in the SEBI (LODR) Regulations, 2015 and company had complied with the old provisions, which were applicable on the company at the prevailing time. Advise the company the legal recourse available to it, quoting the relevant provisions of the law. (Aug 2021, 4 marks)
Answer:
The recourse available to the company is to make an appeal before the Securities Appellate Tribunal.
Section 15T of the Securities Exchange Board of India Act, 1992: states that any person aggrieved,
(a) by an order of the SEBI made, on and after the commencement of the Securities Laws (Second Amendment) Act, 1999, under this Act, or the rules or regulations made thereunder; or
(b) by an order made by an adjudicating officer under this Act or, (c) by an order of the Insurance Regulatory and Development Authority or the Pension Fund Regulatory and Development Authority, may prefer any appeal to a Securities Appellate Tribunal (SAT) having jurisdiction in the matter.
As per Section f5T(3) of the SEBI Act, 1992, every appeal under section 15T(1) shall be filed within a period of forty-five days from the date on which a copy of the order made by the SEBI or the Adjudicating Officer or the insurance Regulatory and Development. Authority (IRDA) or the Pension Fund Regulatory and Development Authority, as the case may be, is received by him and it shall be in such form and be accompanied by such fee as may be prescribed :
It has been provided that the Securities Appellate Tribunal (SAT) may entertain an appeal after the expiry of the said period of forty-five days if it is satisfied that there was sufficient cause for not filing it within that period.
Section 15T(4) of the Act states that on receipt of an appeal under section 15T(1), the SAT may, after giving the parties to the appeal, an opportunity of being heard, pass such orders thereon as it thinks fit, confirming, modifying or setting aside the order appealed against.
Section 15T(5) of the Act states that the Securities Appellate Tribunal shall send a copy of every order made by it to the SEBI, or the Insurance Regulatory and Development Authority (IRDA) or the Pension Fund Regulatory and Development Authority, (PFRDA) as the case may be the parties to the appeal and to the concerned Adjudicating Officer.
Section 15T(6) states that the appeal filed before the SAT under 15T(1) shall be dealt with by it as expeditiously as possible and endeavour shall be made by it to dispose of the appeal finally within six months from the date of receipt of the appeal.
Constantly, Shyam and Company Ltd may prefer an appeal against the impugned order, before the Securities Appellate Tribunal.
Question 22.
Gaj, Managing Director of MGR Ltd. retired on March 31, 2021 upon attaining superannuation. The Company had allotted residential premises during his tenure, for his stay as part of his remuneration. At the time of full and final settlement of the amounts like gratuity, leave pay and other amounts payable to him, it was noticed that Gaj had let out the Company’s leased premises to Val, his distant relative. The management decided to hold back the full and final settlement amount and was considering to file a complaint against Gaj for breach of trust and misuse of Company’s property. Is the management’s contention tenable ? (June 2022, 5 marks)
Question 23.
SWR is a director of Ml Real Estate Ltd. whose wife Van, also works in the Company as part of the management. Van has applied for housing loan of ₹ 35 lakhs for construction of a house. Can the Company grant such loan ? Evaluate with reference to the provisions of the Companies Act, 2013 and also explain the penal provisions, if any. (June 2022, 4 marks)
Question 24.
2022 – June [2A] (Or) (ii) Excellent & Co., Company Secretaries were the Secretarial Auditors of Opoco Ltd. During the secretarial audit, the Secretarial Auditor was verifying the board approvals and other documentation for the loan taken by the Company and they found that a fraud of ₹ 3.5 crores was committed against the Company, by its officers which was not observed by the Statutory Auditors of the Company. In this background, explain the duties and responsibilities of Secretarial Auditors under the Companies Act, 2013. (June 2022, 4 marks)
Question 25.
Hoso Transport Company (HTC), is a transport corporation which is exempted under Section 17 of the Employees, Provident Funds and Miscellaneous Provisions Act, 1952. During the current year, the corporation deducted the employees contribution from the wages payable to the employees. The amount deducted by the corporation was not remitted to the EPF Trust, maintained by the corporation, due to acute financial crunch. Evaluate whether this amounts to Criminal Breach of trust. (June 2022, 4 marks)
Question 26.
Write short note on Fraud.
Answer:
“Fraud” in relation to affairs of a company or any body corporate, includes any act, omission, concealment of any fact or abuse of position committed by any person or any other person with the connivance in any manner, with intent to deceive, to gain undue advantage from, or to injure the interests of, the company or its shareholders or its creditors or any other person, whether or not there is any wrongful gain or wrongful loss.”
Question 27.
Write short note on officer in default.
Answer:
Officer in default
- The Companies Act, 2013, has brought in various changes to the Companies Act, 1956 to make the new law more practical to the changing times and also to make more offences punishable with strict provisions.
- Any act of fraudulent nature would have a telling effect on the Directors/Key Managerial Personnel of a company. In this regard, it is interesting to note that the term officer in default has been massively re-hauled in order to make more types of persons accountable.
- As per Section 2(60) of the Companies Act, 2013, “Officer who is in default” includes, for the purpose of the any provisions of the act, the whole time director, the KMP, or the persons who were providing directions to the company etc.
- Also, when it comes to issue or transfer of shares, the Registrar and Share Transfer Agent or the Merchant Banker Is also classified as the officer who is in default.
- Again, Section 2(51) when defining the term “Key Managerial Personnel” in relation to a company includes the CEO or the MD /WTD or the Manger or the Company Secretary or the CFO, such person who is one level below the Directors designated as KMP or such other officer.
- Thus, it becomes, even more important for directors and other professionals to act diligently in order to save themselves. As officers they may attract the penal provisions for fraudulent acts.
Question 28.
Write short note on Whistle Blowing.
Answer:
Whistle blowing
That an established vigil mechanism/whistle blower mechanism and its reporting methods finds a specific mention in the provisions of Section 177(9) of the Act and that the LODR requires listed entities to devise effective whistle blower mechanism reflects on how necessary the lawmakers think these systems are. It is so important that the Act expressly requires that whistleblowers be provided direct access to the Chairman of the Audit Committee and for adequate safeguards to avoid victimisation of the whistleblowers. The ineffective protection mechanisms for whistleblowers might result in creating an atmosphere of fear for whistleblowers. However, it still doesn’t stop some crusaders from going ahead and blowing off the lid of corruption. The stronger the protection to the whistleblowers, more can be the chances of early fraud detections.
Question 29.
Write short note on cheating.
Answer:
Cheating
Sections 415 to 420 of Indian Penal Code, 1860 deal with the offence of cheating. In most of the offences relating to property the accused merely get possession of thing in question, but in case of cheating he obtains possession as well as the property in it.
Section 415 provides that whoever, by deceiving any person, fraudulently or dishonestly induces the person so deceived to deliver any property to any person, or to consent that any person shall retain any property, or intentionally induces the person so deceived to do or omit to do anything which he would not do or omit if he were not so deceived, and which act or omission causes or is likely to cause damage or harm to that person in body, mind, reputation or property, is said to “cheat”.
Question 30.
Write short note on cheating by personation.
Answer:
Cheating by personation
As per Section 416 a person is said to “cheat by personation” if he cheats by pretending to be some other person, or by knowingly substituting one person for another, or representing that he or any other person is a person other than he or such other person really is.
Explanation. The offence is committed whether the individual personated is a real or imaginary person.
Illustrations
(a) A cheats by pretending to be a certain rich banker of the same name. A cheats by personation.
(b) A cheats by pretending to be B, a person who is deceased. A cheats by personation.
Punishment for cheating
Section 417 provides that whoever cheats shall be punished with imprisonment of either description for a term which may extend to one year, or with fine, or with both.
Question 31.
What are the essential ingredients of the Offence of Criminal Breach of trust?
Answer:
Criminal Breach of Trust – Essential Ingredients
The essential Ingredients of the offence of criminal breach of trust are as under:
- The accused must be entrusted with the property or with dominion over it,
- The person so entrusted must use that property, or;
- The accused must dishonestly use or dispose of that property or wilfully suffer any other person to do so in violation,
- of any direction of law prescribing the mode in which such trust is to be discharged, or;
- of any legal contract made touching the discharge of such trust. The Supreme Court of India in V.R. Dalai
v. Yugendra Naranji Thakkar, 2008 (15) SCC 625, has held that the first ingredient of criminal breach of trust is entrustment and where it is missing, the same would not constitute a criminal breach of trust. Breach of trust may be held to be a civil wrong but when mens-rea is involved it gives rise to criminal liability also. The expression ‘direction of law’ in the context of Section 405 would include not only legislations pure and simple but also directions, instruments and circulars issued by authority entitled therefor,
Question 32.
What do you mean by forgery? Describe the Punishment for forgery.
Answer:
Forgery (Section 463)
Whoever makes any false document or false electronic record or part of a document or electronic record, with intent to cause damage or injury, to the public or to any person, or to support any claim or title, or to cause any person to part with property, or to enter into any express or implied contract, or with intent to commit fraud or that fraud may be committed, commits forgery.
Punishment for forgery (Section 465)
Whoever commits forgery shall be punished with imprisonment of either description for a term which may extend to two years, or with fine, or with both.
The making of a false document or false electronic record is defined under Section 464 of the Indian Penal Code, 1860.
The Supreme Court in Ramchandran v. State, AIR 2010 SC 1922, has held that to constitute an offence of forgery document must be made with dishonest or fraudulent intention. A person is said to do a thing fraudulently if he does that thing with intent to defraud but not otherwise. The Supreme Court in Parminder Kaur v. State of UP, has held that mere alteration of document does not make it a forged document. Alteration must be made for some gain or for some objective.
Similarly, in Balbir Kaur v. State of Punjab, 2011 CrLJ 1546 (P&H), the allegation against the accused was that she furnished a certificate to get employment as ETT teacher which was found to be bogus and forged in as much as school was not recognized for period given in certificate. However the certificate did not anywhere say that school was recognized. It was held that merely indicating teaching experience of the accused, per-se, cannot be said to indicate wrong facts. So the direction which was issued for prosecution is liable to be quashed.
Question 33.
Who can be performing a fraud on the company and why?
Answer:
- Understanding who can commit fraudulent acts and possible motives can help install appropriate prevention mechanisms. This can include directors or any of the employees or even auditors or external consultants.
- For the purposes of this article, we will limit the discussion to directors and employees, since the company can be considered to be quite vulnerable to consequences of their actions.
- The motives of such commission can be many – greed, intention to bring disrepute to the company on account of being ousted, and in some cases, just the thrill of having power enough to circumvent or make others circumvent the law.
- There may even be ‘Robinhood’ fraudsters who believe they are just increasing the balance in the society by defrauding the rich and bringing the benefits to the less fortunate.
Question 34.
What are the Duties of Auditor of the company on fraud reporting?
Answer:
Duties of Auditors of the company/ Company Secretary/ Cost Accountant on fraud reporting:
Section 143 of the Companies Act, 2013 confers certain powers on the auditors of the company as well it casts certain duties on them. Section 143 (12) carries a non-obstanate clause casting a duty on the auditors of the company to report to the central government an offence of fraud committed by the company or by its officers or employees. The first proviso to Section 143(12) also requires the auditors of the company to report to the audit committee of the company in cases of fraud involving amounts lesser than the specified amount or to the board in other cases. The companies (Audit and Auditors) Rules, 2014 contains the operational procedures for reporting of fraud as mandated in Section 143(12). Similar obligations are cast upon the company secretary in practice (secretarial auditor) and the cost accountant in practice (cost auditor) also. Non-compliance with the duties b\ an auditor attracts penalty:- As per Companies (Amendment) Act, 2020
(a) in case of a listed company, be liable to a penalty of five lakh rupees; and
(b) in case of any other company, be liable to a penalty of one lakh rupees.
Question 35.
What are the consequences of fraud by directors?
Answer:
Consequences of fraud by directors
Section 447 seeks to penalise any person guilty of fraud involving amounts of at least ten lakh rupees or one percent of the turnover, whichever is less, with imprisonment fnom six months to ten years and fine ranging from the amount involved in the fraud to three times such amount. If the fraud involves public interest, the imprisonment will not be less than three years.
If the amount involved is less than ten lakh rupees or one percent of the turnover and the fraud does not involve public interest, the punishment shall be imprisonment up to five years or fine up to fifty lakh rupees or both. It must be noted that the liability will be personal here i.e. the personal assets will be used to pay up the penalty.
It’s not just the above penalty that is relevant. If a director is found to be guilty of fraud and sentenced to imprisonment for six months or more, he would need to wait five years to be over after the expiry of the sentence to become a director of any other company. If the fraud involved public interest, this would take in the minimum eight crucial years out from the career of anyone seeking to become a director of a company again.
Question 36.
Will fraud by just one Director make the other Director liable?
Answer:
Executive directors can usually be caught in the net of suspicion of fraud, since they are hands on involved in the day to day operations of the company and are aware of where there are loopholes in the systems prevalent within the company. However, the non executive directors or the independent directors cannot escape responsibility simply by virtue of their position. Section 2(60) of the Act implicates ‘every director’ in respect of a contravention of the provisions of the Act (including Section 447 – Fraud as discussed above) who consented to the fraud or is aware of the contravention can become covered within the term ‘officer who is in default’.
The method of awareness is also provided for – this must be either by participating in board proceedings without objecting to the same or even by virtue of receipt of proceedings of the board. ‘Proceedings of the board’ can normally be understood to mean the minutes, but can it also include board papers? What if an independent director receives board papers relating to details of the annual financial statements? Often board papers can be so bulky that they comprise of an enti e lever arch file. Can the director be expected to reasonably read everything and will this prove his ‘awareness’ of the fraud? These are some questions to be pondered.
Resignation may seem to be the immediate recourse to a non executive director, but that does not absolve someone from liability, since the proviso to Section 168(2) of the Act clearly provides that the director who has resigned shall be liable even after his resignation, for the offences which occurred during his tenure.
Here’s where the attendance registers, board papers and minutes which you thought were mundane, suddenly become relevant. Attendance at the board meeting promptly brings a director within the ‘awareness’ purview discussed above. A recording of who attended the meeting, where they did not participate in the discussion and voting and where they dissented is very relevant to affixing liability.
The board papers need to be concise and clear. Board papers circulated over a period of time, if efficiently compiled, might be instrumental in throwing up a red flag for a director, and might result in an independent either recording his dissent or in extreme cases, resignation.
Interestingly, the SS-1: Secretarial Standard on Meetings of the Board of Directors requires that the draft minutes need to be circulated to all the members of the board of directors, not only those who attended the meeting. Thus the proceedings of the Board can be available even to those who did not attend the meeting and they can therefore be considered to be aware of a contravention. It certainly makes sense to have your minutes fairly detailed and also for the directors who receive the draft, to read it thoroughly.’
Question 37.
In a fraud by director, is the company the fraudster or the victim?
Answer:
When directors are acting on behalf of the company, if they deceive third parties, the company will also be penalised for this. In most legislations, the sections speaking about the offences by companies implicate the company and the officers in default. Although the company might be able to recover the loss from the director, this would be at a later stage. Initially, the company will have to make good the losses of the third parties or pay the penalties for the violations.
In a 2013 UK case Jetiviet SA & anor Vs. Bilta (UK) Limited (in liquidation) & ors [2013] EWCA Civ 968 the UK Court of Appeals decided that where the directors had acted to deprive the company of its assets and thus made it default in VAT (GST) payments to the UK HMRC, the company was the victim and did have a claim towards the breach of fiduciary duties owed to it by its directors.
Question 38.
How do you curb the Seed of fraud from sprouting in the first place?
Answer:
Screening and background checking If you are going to place such substantial power in the hands of a director (refer Section 179 (1) of the Companies Act, 2013) and involve a senior employee in the functioning of the company from scratch, it is only appropriate that there be abundant screening, background checking and verification before someone is recommended for and appointed to director and senior managerial level positions. In case of regulated entities, particularly, there would be some kind of ‘fitness and probity’ norms for someone to be appointed as directors. Further, in cases where foreign nationals are appointed as directors, this checking would be exhaustive since criminals in a country might flee and join entities in other countries.
Strong internal controls:
The importance of strong internal control systems can never be underestimated. In the London Whale story it was established that JP Morgan incurred a loss more because of the risk management systems in the bank were not adequately geared to prevent this from happening. The BFSI (Banks, Financial Services, Insurance) sector entities are required to follow regulatory directions in relation to internal audit and risk management systems since a lot of money changes hands in these entities and there is substantial public stake involved.
Nevertheless, the Companies Act, 2013 also realizes the importance cf internal controls. Section 134(5)(e) of the Act requires the directors of a listed company to confirm, in their responsibility statement, that they had laid down internal financial controls to be followed by the company and that such controls are adequate and operating effectively. Section 134(5)(f) further requires them to confirm that they had devised proper systems to ensure compliance with provisions of all applicable laws and that such systems are adequate and operating effectively.
As per the provisions of Regulation 17(8) of the Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015 (LODR), the CEO and CFO are required to furnish a compliance certificate to the board of directors confirming their responsibility to maintain adequate internal controls pertaining to financial reporting and that they have evaluated the effectiveness and disclosed any deficiencies and design and operation of such internal controls to the auditors and the audit committee. The board of directors will therefore, rely on such certificate. If this is fraudulently provided, chances are, the responsibility statement as discussed above will turn out to be incorrect too. Although in many cases, the CEO and CFO will both also hold the positions of directors.
Clearly laid down internal control systems and techniques such as established policies and procedures, maker – checker processes (separate people to generate and authorise transactions), limits on operation, block leaves etc. can all contribute towards reducing the possibilities of fraud and early detection. Since certain internal controls like maker checker and transaction limits can be installed through software systems, this is one of the very few fear or bias free fraud prevention mechanisms.
Whistle blowing
That an established vigil mechanism/whistle blower mechanism and its reporting methods finds a specific mention in the provisions of Section 177(9) of the Act and that the LODR requires listed entities to devise effective whistle blower mechanism reflects on how necessary the lawmakers think these systems are. It is so important that the Act expressly requires that whistle blowers be provided direct access to the Chairman of the Audit Committee and for adequate safeguards to avoid victimisation of the whistle blowers. The ineffective protection mechanisms for whistle blowers might result in creating an atmosphere of fear for whistle blowers.
However, it still doesn’t stop some crusaders from going ahead and blowing off the lid of corruption. The stronger the protection to the whistle blowers, more can be the chances of early fraud detections.
Remuneration:
Remuneration seems to be a strange item to include in fraud prevention mechanisms, but the feeling of not being adequately remunerated can be one reason why a director or senior employee can be driven to ‘take what they are due’ from an entity irrespective of whether the means are acceptable. Appropriate board evaluation and remuneration policies can result in establishing a measure for rewards against performance.
The metrics should neither be so lenient that the management can achieve it easily nor should they be so strict to seem an insurmountable barrier. Once the yardstick is clear,in the minds of the management and employees, they will want to beat it and achieve the remuneration they desire. If that happens, there would be less chances of fraud.
Exit checks and clawbacks:
Exit interviews, particularly when employees are performing and are remunerated well, can raise red flags about possible involvement in fraud. Somewhere there are likely to be some answers which do not add up. The organisation can then investigate.
Clawback provisions in employment agreements, which enable the company to recover incentive and additional compensation paid to executives are an effective deterrent tool, since executive compensation tends to be largely performance linked. Clawback provisions would provide for recovery of such compensation (usually other than the base salary) in case of fraudulent misrepresentation or misstatements.
Question 14.
What are the essential Ingredients of cheating?
Answer:
The main ingredients of cheating are as under:
1. Deception of any person.
2. (a) Fraudulently or dishonestly inducing that person
(i) to deliver any property to any person; or
(ii) to consent that any person shall retain any property; or
(b) Intentionally inducing that person to do or omit to do anything which he would not do or omit if he were not so deceived, and which act or omission causes or is likely to cause damage or harm to that person in body, mind, reputation or property.
The Supreme Court in Iridium India Telecom Ltd. v. Motorola Incorporated and Ors., (2005) 2 SCC 145, has held that deception is necessary ingredient under both parts of section. Complainant must prove that inducement has been caused by deception exercised by the accused. It was held that non-disclosure of relevant information would also be treated a misrepresentation of facts leading to deception.
The Supreme Court in M.N. Ojha and others v. Aiok Kumar Srivastav andanr, (2009) 9 SCC 682, has held that where the intention on the part of the accused is to retain wrongfully the excise duty which the State is empowered under law to recover from another person who has removed non-duty paid tobacco from one bonded warehouse to another, they are held guilty of cheating.
In T.R. Arya v. State of Punjab, 1987 CrLJ 222, it was held that negligence in duty without any dishonest intention cannot amount to cheating. A bank employee when on comparison of signature of drawer passes a cheque there may be negligence resulting In loss to bank, but it cannot be held to be cheating.
Fraud under Companies Act, 2013 and Indian Penal Code, 1860 Notes
Fraud:
In relation to affairs of a company or any body corporate, includes any act, omission, concealment of any fact or abuse of position committed by any person or any other person with the connivance in any manner, with intent to deceive, to gain undue advantage from, or to injure the interests of, the company or its shareholders or its creditors or any other person, whether or not there is any wrongful gain or wrongful loss.
Wrongful Gain:
Means the gain by unlawful means of property to which the person gaining is not legally entitled.
Wrongful Loss:
Means the loss by unlawful means of property to which the person losing is legally entitled.
Intention to commit a fraud:
According to the act, intention is one of the essential ingredients to commit a fraud. In this regard it may be noted that the Hon’ble Supreme Court of India held in the matter of Dr Vimla Vs Delhi Administration in the year 1962, in the context of the matter that fraud has to satisfy two conditions viz., (a) deceit or injury to the person deceived (b) intention to deceive.
Officer in default:
The Companies Act, 2013, has brought in various changes to the Companies Act, 1956 to make the new law more practical to the changing times and also to make more offences punishable with strict provisions. Any Act of fraudulent nature would have a telling effect on the Directors/Key Managerial Personnel of a company. In this regard it is interesting to note that the term officer in default has been massively re-hauled in order to make more types of persons accountable.
Fraud by Promoters/Directors:
- Directors are expected to perform in the best interests of the company.
- However, the kind of power that they wield in the functioning of the company puts them in a position where it is not difficult for them to bend the rules.
- It’s difficult to have an entire board of directors acquiesce to fraudulent activities, but it is possible that even a single director’s intentions to gain an undue advantage out of stakeholders’ money can result in fraud of a significant amount.
Criminal breach of trust (Section 405):
Whoever, being in any manner entrusted with property, or with any dominion over property, dishonestly misappropriates or converts to’ his own use that property, or dishonestly uses or disposes of that property in violation of any direction of law prescribing the mode in which such trust is to be discharged, or of any legal contract, express or implied, which he has made touching the discharge of such trust, or wilfully suffers any other person so to do, commits “criminal breach of trust”.
Criminal Breach of Trust – Essential Ingredients:
The essential ingredients of the offence of criminal breach of trust are as under:
- The accused must be entrusted with the property or with dominion over it,
- The person so entrusted must use that property, or;
- The accused must dishonestly use or dispose of that property or wilfully suffer any other person to do so in violation,
- of any direction of law prescribing the mode in which such trust is to be discharged, or;
- of any legal contract made touching the discharge of such trust.
Cheating:
- Sections 415 to 420 of Indian Penal Code, 1860 deal with the offence of cheating. In most of the offences relating to property the accused merely get possession of thing in question, but in case of cheating he obtains possession as well as the property in it.
- Section 415 provides that whoever, by deceiving any person, fraudulently or dishonestly induces the person so deceived to deliver any property to any person, or to consent that any person shall retain any property, or intentionally induces the person so deceived to do or omit to do anything which he would not do or omit if he were not so deceived, and which act or omission causes or is likely to cause damage or harm to that person in body, mind, reputation or property, is said to “cheat”.
Cheating – Main Ingredients:
The main ingredients of cheating are as under:
1. Deception of any person.
2. Fraudulently or dishonestly inducing that person
- to deliver any property to any person; or
- to consent that any person shall retain any property;
Cheating by personation:
As per Section 416 a person is said to “cheat by personation” if he cheats by pretending to be some other person, or by knowingly substituting one person for another, or representing that he or any other person is a person other than he or such other person really is.
Forgery (Section 463):
Whoever makes any false document or false electronic record or part of a document or electronic record, with intent to cause damage or injury, to the public or to any person, or to support any claim or title, or to cause any person to part with property, or to enter into any express or implied contract, or with intent to commit fraud or that fraud may be committed, commits forgery.
Punishment for forgery (Section 465):
Whoever commits forgery shall be punished with imprisonment of either description for a term which may extend to two years, or with fine, 6r with both.
The Supreme Court in Ramchandran v. State, AIR 2010 SC 1922, has held that to constitute an offence of forgery document must be made with dishonest or fraudulent intention. A person is said to do a thing fraudulently if he does that thing with intent to defraud but not otherwise. The Supreme Court in ParminderKaurv. State of UP, has held that mere alteration of document does not make it a forged document. Alteration must be made for some gain or for some objective.