Companies Bill: Fraud of the flies

Dhe Companies (Amendment) Bill, 2016 was one of the major legislations introduced in the country in the past year, introducing several amendments to the Companies Act, 2013 (Act), to fortify corporate governance, simplify procedures, and make the statute more amenable to compliance. One of the major proposals in the Bill was an amendment to section 447, on ‘punishment for fraud’, by putting monetary thresholds, and restricting the scope of the term ‘fraud’ to offences involving an amount of at least `10 lakh, or 1% of the turnover of the company, whichever is lower; and creating a distinction between frauds that involve public interest, and those that do not.

The genesis of this provision dates back to the year 2009, which started on a dangerously bad note. One of India’s biggest corporate frauds in Satyam Computer Services Ltd was unearthed, and the Companies Act, 1956 was analysed afresh, with a view to charting a better future. The Standing Committee in its 21st Report (2009-10) expressed serious concern over the lack of a definition of ‘fraud’ in the then statute, and the lack of mechanisms to efficaciously deal with such cases.

This was followed by the Standing Committee’s 57th Report (2011-12) which recommended a number of strategies to counter fraud and accord a statutory status to the Serious Fraud Investigation Office (SFIO), along with prescribing due safeguards to it (section 212). Accordingly, the Act, as we now know it, included several aspects of these recommendations to strengthen the corporate law regime in the country.

However, in 2016, the Report of the Companies Law Committee found that there were a number of concerns in respect of the punishments accorded to different provisions. It would be worthwhile to note that one of the larger recommendations of the Committee was to draw attention to the regime of penalties, and to make it “commensurate to the gravity of the crime”. Thus, an attempt was made in the Amendment Bill to segregate the offences into procedural, and other offences.

The inherent philosophy behind section 447 was the assumption that all frauds were of equal measure, and in any case, must be dealt with seriously, and hence liable to be penalised in the same manner. While it was understood that in the context of what had transpired in 2009, the penalty provision in section 447 of the Companies Act, 2013 was deliberately kept very stringent, with imprisonment for a term not less than six months, extending up to 10 years, along with fine not less than the amount involved in the fraud, extending up to three times the amount involved in the fraud. The concepts of “wrongful gain” and “wrongful loss” itself being inconsequential to the commission of the fraud, the recommendation of the Committee was to introduce a monetary threshold to the provision. This was perhaps also an homage to the JJ Irani Committee, which in its report in 2004 noted that the Companies Act ought to provide flexibility for the levying of penalties, which could include factors such as the “the size of company, nature of business, injury to public interest, nature and gravity of default, repetition of default, etc.” This also flows from the general principle of criminal law, which already allows for various courts and tribunals to exercise due discretion in the adjudging penalty, depending on various factors.

The Standing Committee’s 37th Report of 2016-17 on the Bill has concurred, and added that the prescription of monetary thresholds to the provision adds more clarity both “to the nature of fraud and for categorising the offence as compoundable or non-compoundable.”

The Kroll Annual Global Fraud Report, 2017, released earlier this year presented a chilling reality, when it stated that “fraud, cyber, and security incidents are now the new normal for companies across the world.” It further noted that while corporate frauds in 2016 were reported to be 80% less than 2015, India continued to be on top of the list, reminding us once again of the debilitating impact of corporate frauds. The aim of the statute is not just to deter people from committing frauds, but also to encourage the recruitment of the best managerial personnel. As such, indiscriminate and severe penalties for even minor infractions could be a cause of concern, rather than act as deterrence; not allowing talented personnel from joining.

Further, it should also be noted that section 447 does not operate on a standalone basis, and is in fact, intrinsically linked to a host of other provisions. Severe punishments, without reasonable qualifications could not only cripple the operation of the statute, but also affect a number of related provisions. A number of legislations across the world, including the UK Companies Act, 2006, and the Singapore Companies Act, 2006 have enshrined the principle of differential treatment of companies and offences, based on globally accepted norms, to ensure a higher rate of compliance, and discriminate between minor infractions.

The concept of fraud has been encapsulated under other legislations as well, including the Indian Contract Act, 1872 and the Indian Penal Code, 1860. However, by allowing for a distinct definition of fraud in the Companies Act, 2013, and catering to the twin objectives of deterrence, and promotion of ease of business, the Bill has attempted to break new grounds in legal jurisprudence. As William Golding sounds a cautionary note in his famous book, ‘Lord of the Flies’, “Which is better—to have laws and agree, or to hunt and kill?”