The new Companies Act is ushering in a fresh approach to tackling fraud. Yogesh Chande and Manendra Singh of Economic Laws Practice summarize the changes and discuss what they mean for companies in India.

The Companies Act, 2013, has introduced several provisions aimed at battling fraud. One key change is that the Serious Fraud Investigation Office (SFIO), a body that was established in 2003 by the Ministry of Corporate Affairs following the Satyam debacle, has been granted statutory powers. As such, it can make arrests and order the seizure of documents, books and accounts. The act has also reformed the manner in which the inspection, investigation and inquiry into potential fraud will be carried out.

Defining ‘corporate fraud’

The previous Companies Act, which came into law in 1956, was silent on the definition of “fraud”. Instead it detailed the circumstances under which penalties could be imposed for acts of fraud; for example, misstatements in a prospectus (section 63) or fraud committed during the winding up of a company (section 540). The term “fraud” is actually defined under the Indian Penal Code, 1860, and as such, perpetrators of such crimes would ordinarily have been prosecuted under this code. However, a successful prosecution under the Indian Penal Code was difficult and required proof of elements of the crime; in other words proof of intention as well as action in furtherance of the intention.

Section 447 of the new Companies Act provides a comprehensive definition of fraud. It is defined as follows: “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”.

Anyone can be punished for acts of fraud and face imprisonment for a period of six months to 10 years as well as fines of up to three times the amount involved in the fraud. Most importantly, the new act has recognized that corporate fraud may stretch beyond specific persons and affect the public at large. For this reason, it states that where the fraud in question involves public interest, the term of imprisonment cannot be less than three years.

Role of SFIO

Section 211 of the new act provides that until a formal SFIO is established, the body established in 2003 will function as the SFIO.

The SFIO is not permitted to act suo moto, and therefore requires cases to be referred to it by the central government. The government may refer a case to the SFIO in the following instances: (i) following a report by the Registrar of Companies or an inspector under the 2013 act; (ii) on a special resolution passed by a company; (iii) if it is deemed to be in the public interest; and (iv) upon request from any department of the central or state governments.

Once a proceeding is initiated with the SFIO, any inquiries being carried out by other investigating agencies are automatically halted. These agencies must then transfer to the SFIO any documents and records relating to the inquiry in question.

Various types of fraud have been made cognizable and bail cannot be obtained easily. The director, additional director, and assistant director of the SFIO have all been empowered to arrest persons charged with such offences.

Inspectors appointed to carry out an investigation have been granted extremely wide powers, including investigating the affairs of subsidiaries, holding companies and exemployees. Indeed, since inspectors are officers of the central government, they enjoy the same powers as those vested in civil courts under the Code of Civil Procedure, 1908. Furthermore, they do not have to obtain an approval from a magistrate to undertake a search and seizure in an investigation (under the 1956 act they were required to do so).

Unlike the SFIO report, an inspector’s report can be made public and obtained by making an application to the central government. If an inspector’s report reveals fraud or undue advantage derived by a director, key managerial personnel, other  

officer of the company or any other person or entity, whether in the form of any asset, property or cash or in any other manner, it may result in the disgorgement of any such asset, property, or cash, as well as detainment of those charged without any limitation of liability.

 The new act also introduces the concept of a special court to take cognizance of all offences committed under the act. The new provisions are expected to speed up the judicial process and empower authorities to tackle fraud in a more efficient and meaningful way.

Disclaimer: This article was first published in the May 2014 issue of the India Business Law Journal magazine. It has been authored by Yogesh Chande, who is an Associate Partner and Manendra Singh, who is an Associate at Economic Laws Practice (ELP), Advocates & Solicitors. They can be reached at yogeshchande@elp-in.com or manendrasingh@elp-in.com for any comment or query. The information provided in the article is intended for informational purposes only and does not constitute legal opinion or advice. The contents of this article/update are intended for informational purposes only and do not constitute legal opinion or advice. Readers are requested to seek formal legal advice prior to acting upon any of the information provided herein.