CS Professional:Resolution of Corporate Disputes,Non-Compliances & Remedies [Ch-4 Fraud under Co.Act,2013 and IPC,1860]

JJ Irani committee set up in 2004 submitted its report in 2005 with recommendations that took shape of co. act,2013

one recommendation being stringent/deterrent penalties for co. with irresponsible behaviour/conduct fraudulent activities and that compliances should be subject to strict penalty regimes.

The committee took note that corporate frauds might be too intricate for state law enforcement and should be referred to Serious Fraud Investigation Officer (SFIO).consequently, current co. act vide section 211 has provided SFIO establishment.

if investigation reveals fraudulent whereabouts,corporate veils should be lifted and promoters/shareholders can be held responsible. if co. is made aware of default,advisable to avail compounding so that co. remains fully compliant.

FRAUD

generally, refers to wrongful/criminal deception practiced intended to result in financial/personal gain or loss

per BUSINESS DICTIONARY,it's a deception act/course,intentional concealment,omission or truth perversion to:

1. gain unlawful/unfair advantage
2. induce another to part with some valuable item/surrender legal right
3. inflict injury

• 'wilful fraud' is a criminal offence calling for severe penalties/prosecution and punishment and not bound by limitation statute.
• however,incompetence/negligence/reckless wastage doesn't constitute fraud unless a clear deceitful intention is established but it does invites legal liabilities.
• fraud can be a civil as well as criminal wrong or it may cause no loss but still be an element of another wrong.

per the BLACK LAW DICTIONARY, it refers to all multifarious means which human ingenuity can devise and are resorted to get advantage over another by false suggestion/suppression of truth.

commonly understood as dishonesty calculated for advantage

Punjab National Bank scam added CRIMINAL BREACH OF TRUST under IPC 409 along with fraud under IPC 420.

fraud is an act of deceit subject to legal action as follows

UNDER CRIMINAL PROCEDURE CODE, 1973 (CrPC)

CrPC is a procedural law containing elaborate details/procedures regarding investigations, inquiry and trial but doesn't provide definitions except specific terms but Section 2(y) states "words and expressions used herein and undefined but defined in IPC 45 have meanings as respectively assigned.

In general, 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.

UNDER INDIAN PENAL CODE,1860 (IPC)

Section 25 defines what would amount to "fraudulently"- to do something with intention to defraud but not otherwise.

=deceit intention

=injury

implications of fraud are found in IPC 421,422,423 and 424

UNDER THE INDIAN CONTRACT ACT,1872

Section 17 defines FRAUD

means and includes any of the following committed by a party to contract,with connivance or by his agents with intent to deceive or to induce him to enter into a contract.

[17(1)] suggestion as to a fact which is not by one who doesn't believe it to be true=SUGGESTIO FALSI (suggestion of falsehood)

[17(2)] active concealment of a fact by having knowledge/belief=SUPPRESSIO VERI (fact suppression)

[17(3)] promising without intending to perform/falsely inducing for a reciprocal promise

[17(4)] another act fitted/designed to deceive

[17(5)] another act/mission declared by law

EXPLANATION:mere silence likely to affect willingness isn't fraud except when-duty to speak or silence=speech.

ILLUSTRATIONS:

• A sells, by auction, to B, a horse which A knows to be unsound. A says nothing to B about the horse's unsoundness. This is not fraud in A.
• B is A's daughter and has just come of age. Here, the relation between the parties would make it As duty to tell B if the horse is unsound.
• B says to A—“If you do not deny it, I shall assume that the horse is sound.” A says nothing. Here, As silence is equivalent to speech
• A and B, being traders, enter upon a contract. A has private information of a change in prices which would affect Bs willingness to proceed with the contract. A is not bound to inform B.

JUDICIAL VIEW

in Dr. S. Dutt v. State of Uttar Pradesh upon the words “with intent to deceive” 

• doesn't indicate mere intent but to cause a person to act,omit to act on deception
• defraud intention not synonymous with deceit intention and requires some action resulting in some disadvantage
• penal offence of fraud demands successful prosecution with elements of
• intention to deceive
• cause injury

FRAUD ELEMENTS

1. false/wilful representation/assertion which is untrue (doesn't believe to be true) except in case of:
• silence amounts to fraud
• active concealment of fraud
2. perpetrator be a party to contract/with connivance or an agent
3. intention to deceive is it's essence and assertion/misstatement made to be acted upon
• misrepresentation elevates to fraud when prefixed with intention
4. representation must relate to a fact material to contract
• mere opinion,belief,commendation can't be fraud
• an opinion on something general isn't included unless it states the specifics and if that specific is found to be incorrect, then it's fraud
5. active fact concealment distinguished from "passive concealment" which implies mere silence
• active is when positive/deliberate steps are taken to prevent info from reaching the other party
6. promise made without intention of performing it
7. representation must have actually deceived the other party by them being relied on it and so an attempt doesn't amount to fraud
8. another act fitted to deceive with intention to deceive
9. such act/omission that law specially declares as void
10. wrongful gain/loss is immaterial under co. act

as for IPC, only mens rea and actus reus matter, i.e. the foul intention and the wrongful act

examples of corporate fraud

• personal purchases from corporate funds
• ghost employees
• skimming payments through interception
• tax avoidance
• asset theft
• unauthorized use
• falsification of docs

these can be difficult to contain/impossible to stop if senior mgmt. engages too which contemplates the importance of forensic audit

fraud consists of deceitful practice/wilful devices,resorted to with intention to deprive another of his right or to cause injury. distinguished from negligence, it's always positive/intentional (Maher v. Hibernia Inst. Co., 67 N. Y. 292) 

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 means an intention to deceive; whether it be from any expectation of advantage to the party himself or from the ill-will towards the other is immaterial.”

SEBI (PROHIBITION OF FRAUDULENT AND UNFAIR TRADE PRACTICES RELATING TO SECURITIES MARKET) REGULATIONS, 2003

reg. 2(c) fraud includes any act,omission or concealment in a deceitful manner by person/connivance/agent to induce another/agent to deal in securities and shall include all elements as prescribed.

proviso provides that nothing shall apply to comments made in good faith regarding economic policy/situation/trends.

COMPANIES ACT,2013

Section 542 in erstwhile act  frauds detected at winding up were dealt with but in current act Section 447 explains fraud and related terms.

on close analysis,following are observed:

• inclusive definition
• relate to any body corporate,thus a large horizon
• intention matters
• gain or loss arising can't be a basis for deciding violation/punishment

USE IN VARIOUS PLACES

PUNISHMENTS 

Section 38: max in 68A of 1956 act=5 years but max in 2013 act=10 years

Section 46(5): (section 84 of 1956 act) fined 5-10 times FV of shares involved or 10 crores, whichever HIGHER and officers charged under 447

COMPOUNDABLE & NON-COMPOUNDABLE OFFENCES

co. (amendment) act,2019 & 2020 has decriminalized various compoundable offences of minor violations.

non-compliance will entail penalties/imprisonment

Section 441 compounding=process whereby an entity/person committing default will apply to a compounding authority accepting committing an offence and that same should be condoned. compounding authority may compound offence and ask the defaulting party to deposit the compounding fee as decided.

COMPOUNDABLE:offences with fine only OR offences with fine or imprisonment

NON-COMPOUNDABLE:offences with only imprisonment OR with imprisonment & fine

COMPOUNDING AUTHORITY: Regional Director ≺ 25 lakhs ≤ NCLT amended by co. (amendment)

after amendment, 447 reads as :

without prejudice to liability of debt repayment,person guilty of fraud involving at least 10 lakhs/1% turnover, whichever LOWER, imprisoned 6 months to 10 years + fined with amount involved upto 3 times.

if fraud involves public interest,imprisoned for 3 years/more

if fraud involves less than 10 lakhs/1% and doesn't involve public interest, the guilty are imprisoned for up to 5 years/fined up to 50 lakhs/both from the personal liability.

Section 143 : AUDITORS/CS/CMA on fraud reporting

(12) carries a non-obstante clause and casts a duty on auditors/PCS/PCMA to report to CG an offence of fraud. The first proviso requires auditors to report to the audit committee/board as specified. co. (audit and auditors) rules, 2014 contains operational procedures for fraud reporting.

non-compliance attracts the following penalty:

listed=5 lakhs

unlisted=1 lakh

WHO CAN COMMIT FRAUD ON CO. AND WHY?

limiting discussion to directors/employees since co. is vulnerable to their actions. motive can be greed/bringing disrepute to co. for being ousted/thrill of having power to circumvent law.

• by promoters/directors
• [Saradha chit fund scam]
• [Kingfisher Airlines / IDBI Bank]
• [Speak Asia scam]
• [Recent GST fraud]
• as they are expected to perform in the best interests of co. but it is not difficult for them to bend the rules.
• even if a single director intends to gain undue advantage, it can result in fraud of a significant amount
• fraud by one director makes others liable?
• non-executive/independent directors cannot escape responsibility
• 2(60) implies "every director" including 447 who consented to/aware of the fraud by participating in board proceedings without objecting OR receipt of proceedings which are circulated to the whole board per SS-1
• co. might be able to recover the loss from the director after making good third party losses/penalties
• In a 2013 UK case Jetivia SA & Anr 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 made it default in VAT 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.
• if any director is sentenced between 6 months to 7 years,appointment can be done after 5 years of sentence expiry but not if sentenced for more than 7 years.
• by senior mgmt./employees as they impact functioning of board is relevant after it has discovered that fraud actually took place and after discovery of who was involved.
• safeguarding strategies
• proper training about documented policies
• prevention/detection measures
• screening & background checking
• strong internal controls
• responsibility statements
• whistle blowing
• adequate remuneration
• exit checks and claw back provisions
• independent audit systems
• operational reporting system
• professional expert for fraud prevention

INTENTION TO COMMIT FRAUD

intention=essential condition to commit fraud

in 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.

in The State of Mysore vs. Padmanabhacharya etc., the Hon’ble Supreme Court of India held a view that the intention can be assumed and has been accorded wider amplitude and applicability.

unintentional/mere accidental omission/commission won't stand legal scrutiny.

in Ketan Parekh vs. Securities & Exchange Board of India (Appeal No. 2 of 2004) dated 14/07/2006, transaction executed with intention to manipulate/defeat mechanism will depend upon intention inferred from attending circumstances which are inclusive so that any one factor may or may not be decisive.

the object need not necessarily reap direct gain/loss, a deceit has to be established.

CRIMINAL BREACH OF TRUST

Section 405:criminal breach of trust

• whomever entrusted with property/given dominion, dishonestly misappropriated/converts to own use/disposes violating law/legal contract or wilfully suffers another so to do, commits criminal breach of trust.
• employers entrusted with deductions for other funds should deduct a sum as prescribed or said to have committed such.
• for illustrations, refer to ICSI study material

ESSENTIALS:

1. The accused must be entrusted with property/given dominion over it
• fiduciary relationship
• includes movable as well as immovable property
2. entrusted must use the property
3. dishonestly used/disposed by violating (crucial)
• law
• legal contract

in V.R. Dalal v. Yugendra Naranji Thakkar, 2008 (15) SCC 625, has held that the first ingredient of criminal breach of trust is entrustment.

in 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.

in Onkar Nath Mishra v. State (NCT of Delhi), 2008 CrLJ 1391 (SC), has held that in the commission of offence of criminal breach of trust, two distinct parts are involved. obligation + misappropriation/dishonest dealing.

in Suryalakshmi Cotton Mills Ltd. v. Rajvir Industries Ltd., 2008 (13) SCC 678, it was held that a cheque is property

in S.K. Alagh v. State of U.P.and others, 2008 where demand drafts were drawn in the name of company for supply of goods and neither the goods sent by the company nor the money was returned, the Managing Director of the company cannot be said to have committed the offence under Section 406 of IPC.It was pointed out that in absence of any provision laid down under statute, a director of a company or an employer cannot be held vicariously liable.
Section 406: PUNISHMENT FOR 405

imprisoned up to 3 years/fine/both

Section 407/8: 405 by CARRIER,WHARFINGER OR WAREHOUSE-KEEPER/CLERK OR SERVANT

imprisoned  up to 7 years and also liable to fine

Section 409: 405 by PUBLIC SERVANT,BANKER,MERCHANT OR AGENT BROKER, ATTORNEY

imprisoned up to 10 years and liable to fine

done by strangers is treated less harshly as fiduciary relationship has honesty

IMP CASE LAWS

1. Bagga Singh v. State of Punjab, the appellant was a taxation clerk in the Municipal Committee, Sangrur. He had collected
2. Bachchu Singh v. State of Haryana, AIR 1999 SC 2285, the appellant was working as ‘Gram Sachiv’ for eight gram panchayats
3. Girish Saini v. State of Rajasthan

CHEATING 

whoever by deceiving fraudulently/dishonestly induces another to deliver property/consent that another shall retain/intentionally induce to do or omit which they wouldn't do had it not been for such deception and which cause damage or harm in body,mind,reputation or property is said to "cheat".

EXPLANATION:dishonest concealment=deception under this section

MAIN INGREDIENTS:

• deception
• fraudulently/dishonestly inducing
• to deliver a property
• to consent another to retain
• intentionally inducing to do/omit by deception causing damage/harm

IMP. CASE LAWS

Iridium India Telecom Ltd. v. Motorola Incorporated and Ors., (2005)

M.N. Ojha and others v. Alok Kumar Srivastava and anr, (2009)

T.R. Arya v. State of Punjab, 1987

Section 416 : CHEATING BY IMPERSONATION 

pretending to be some other person,knowingly substituting one for another, representing another person (whether a copied person is real/imaginary).

Section 417:PUNISHMENT FOR CHEATING

imprisoned up to a year/fined or both

Section 418:CHEATING WHICH MAY CAUSE WRONGFUL LOSS TO PERSON WHOSE INTEREST OFFENDER IS BOUND TO PROTECT

bound by law/legal contract imprisoned up to 3 years/fined/both

Section 419:PUNISHMENT FOR CHEATING BY PERSONATIONS

imprisoned up to 3 years/fined/both

Section 420:CHEATING/DISHONESTLY INDUCING PROPERTY'S DELIVERY

to make,alter or destroy,anything which is signed/sealed/capable of being turned into a valuable security,as a result of deceiving.

imprisoned up to 7 years and also be liable to a fine

IMP CASE LAWS

1. Kuriachan Chacko v. State of Kerala, (2004)
2. Mohd. Ibrahim and others v. State of Bihar and another, (2009)
3. Shruti Enterprises v. State of Bihar and ors, (2006)

Section 421:DISHONEST/FRAUDULENT REMOVAL/CONCEALMENT OF PROPERTY TO PREVENT DISTRIBUTIONS AMONG CREDITORS

without consideration preventing or knowing it would thereby prevent distribution according to law to creditors

imprisoned up to 2 years/fined or both

essential ingredients held in Ramautar Chaukhany v Hari Ram Todi & Anr, 1982 

• accused,removed,concealed/delivered/transferred
• transfer without considerations
• accused intended to prevent/likely to prevent distribution among creditors by law
• acted dishonestly and fraudulently

section refers to frauds connected with insolvency as it consists of wrongful loss to creditors; applies to movable/immovable property

Section 422:DISHONESTLY/FRAUDULENTLY PREVENTING DEBT AVAILABLE TO CREDITORS

imprisoned up to 2 years/fined or both

debt is defined in judicial pronouncements

Section 423:DISHONEST/FRAUDULENT TRANSFER DEED EXECUTION CONTAINING FALSE STATEMENT OF CONSIDERATION

imprisonment up to 2 years/fined/ or both

Section 424:DISHONEST/FRAUDULENT REMOVAL/CONCEALMENT OF PROPERTY

imprisoned up to 2 years/fined or both

ESSENTIAL INGREDIENTS:

1. property
2. accused concealed/removed such or assisted
3. done dishonestly/fraudulently

Section 463:FORGERY

making false doc/false records intending to cause damage/injury/supporting claim or injury/entering into a contract intending to commit fraud.

Section 464:MAKING A FALSE DOC

Section 465:PUNISHMENT FOR 463

imprisoned up to 2 years/fined or both

IMP CASE LAWS

1. Ramautar Chaukhany v Hari Ram Todi & Anr, 1982
2. Parminder Kaur v. State of UP
3. Balbir Kaur v. State of Punjab, 2011

FRAUD UNDER SEBI REGULATIONS 

Regulation 2 (c) SEBI (Prohibition of Fraudulent and Unfair Trade Practices) Regulations, 2003 deals with fraud as mentioned above.

Regulation 3 provides that no person shall

• buy/sell/deal fraudulently
• use or employ/purchase or sell a manipulative/deceptive device or contrivance in contravention
• employ device/scheme/artifice to defraud
• engage act,practice,course of business which operates/would operate as fraud or deceit contravening provisions/regulations

Regulation 4 prohibits manipulative,fraudulent and unfair trade practices