Contents

1. Introduction
2. Who is responsible for Fraud under the Companies Act?
3. Offence of Fraud
4. Cases
5. Mechanisms to Tackle Fraud
6. Conclusion
7. Bibliography

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Introduction

“The director of a company is responsible for smooth carrying out the business and managing the
day to day affairs of the company. They are appointed by the shareholders for theefficient and
effective running of the company as professionals.”

“The relationship existing between a director and the shareholder is that of a ‘fiduciary’ one (i.e.
based on trust). Therefore, directors areexposed to liabilities whether it may be ‘civil’ or
‘criminal’ in nature in case of breach of duties by them. In cases of civil liabilities, the liability is
set off by making payment or compensating the affected party whereas criminal liabilities,
mentioned under various statutes, attract punishments for the person responsible for such
breach.”

Liabilityfor Fraud under the Companies Act?

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“It is to be noted that no person can be held liable on the basis of their designation. In order to fix
liability, that person needs to fulfil certain legal requirements to be held responsible in law.
Therefore, the persons who are held criminally liable for any non-compliance are those who
were in charge or responsible for conducting the business at the time of the commission of the
offence, i.e. the directors or ‘officer-in-default’ under whose directions any one or more directors
is/are accustomed to act. The concept of ‘vicarious liability’ has also evolved in recent years
which has brought senior management officials such as directors under the court’s purview for
imposing liability.” 

Director’s Liability

“The ubiquitous issue of corruption and the high risk of internal fraud raise serious concerns
about the liability of corporate directors. American litigators who represent Indian companies or
advise clients interested in becoming corporate officers in India would do well to brush up on the
changing landscape of director and officer liability under Indian law. India has learned a lot in
recent years, and its laws have gradually evolved in this context. Director liability in India can be
divided into two principal areas: (1) liability under the Companies Act of 1956 (the 1956 Act),
which has now transitioned to the Companies Act of 2013 (the 2013 Act); and (2) liability
under other Indian statutes.”

“There has been a seminal shift in the Indian corporate legal regime with theenactment of the
2013 Act and more recent amendments. For instance, penalties under the 1956 Act that were
seen as ineffective have been significantly amplified under the 2013 Act. The 2013 Act also
provides statutory recognition to the duties of a director, such as exercise of due and reasonable
care, skill, diligence, and independent judgment. One of the key concepts of the Companies Act
is the meaning of the term officer who is in default. Under the act, liability for default by a
company has been imposed on an officer who is in default. By virtue of their positions in the
company, the managing director, the whole-time director, and the company secretary directly fall
within the scope of this term. Under the 1956 Act, certain key employees such as the chief
executive officer and chief financial officer did not directly come within the ambit of the term,
which raised serious concerns because these personnel were viewed as key officials in any

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company. The 2013 Act corrects this anomaly and significantly expands the scope of
theexpression officer in default. The term also includes the following:”

“1. any individual who, under the superintendence, control, and direction of the board of
directors, exercises the management of the whole, or substantially the whole, of the affairs
of a company;”

“2. any person on whose advice, directions, or instructions the board of directors is
accustomed to act, other than persons giving advice in a professional capacity; and”

“3. every director aware of wrongdoing by virtue of knowledge of or participation in

proceedingof the board without objection.”+a569Offence of Fraud

“As the punishment for fraud is both imprisonment and fine, it is considered a non-
compoundable offence. It shows that, the commission of fraud has become a serious offence in
the eyes of law. The Act has provided punishment for fraud under section 447 and about 20
sections of the Act talk about fraud committed by the directors, key managerial personnel,
auditors and/or officers of company. Thus, the new Act goes beyond professional liability for
fraud and extends it to personal liability, if a company contravenes such provisions. Here, the
provisions of the Act for act with an intention to deceive are also considered as fraud; to name a
few acts amounting to fraud:”

“Section 34 – Issue of Prospectus with untrue or misleading statements”

“According to this section, every person who authorizes the issue of such prospectus which
contains untrue or misleading statements in the form of inclusion or omission thereby inducing
another person to buy shares on that faith will be subject to imprisonment which may extend
from minimum 6 (six) months to 10 (ten) years.”

“Section 229 – Penalty for False statement and destruction of documents”

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“This section provides for a penalty for furnishing false statement, mutilation or destruction of
documents by any person bound to cooperate during an investigation. If the statement made by
him turn out to be false he shall be liable for punishment under the provisions of Section 447.”

“Section 447 – Penalty for fraud”

“This section is related to commission of fraud by any person of the company or wrongful loss to
shareholders or wrongful gain to himself, such person shall be liable for imprisonment for period
of at least six months which may extend to ten years or fine which shall beequal to amount of
fraud and not any less but which may also extend to three times of the amount involved.”

“Section 448 – Penalty for providing false statement or omission of fact"

“This section provides for punishment for false statements. It states that if any report, financial
statement, return, prospectus, filing or another document under any provision of this Act made
by any person is false or omitted any material fact despite having knowledge of the same, then
such person will be liable under provisions of Section 447.”

“Section 449 – Penalty for providing false evidence to authorities

This section deals with punishment for providing false evidence. According to this, if any person
intentionally provides false evidence in the course of the examination upon oath or in the form of
deposition, affidavit or winding up process of the company. Then, in that case, such person
would be liable for imprisonment of at least three years which may extend to ten years or fine
which may go up to ten lakh rupees.”

Other related sections with Fraud

Section Fraud Defaulter

S7(5) “Furnishing false information or suppressing material “Any person who does

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 information” so”
S8 “Affairs of the company conducted fraudulently” “Every officer in
default”
S36 “Fraudulently inducing persons to invest money” “Any person who does
so”
S38 “Personation for acquisition, etc. of securities” “Any person who does
so”
S46(5) “Issuance of duplicate certificate of shares” “Every officer who
defaults”
S75(1) “Company fails to repay deposits/ interests” “Every officer of the
company”
S206 “Business  being carried out for fraudulent or unlawful “Every officer who
purpose” defaults”
S251 “Application is made for removal of name from register with “Persons in charge of
the object of evading liabilities or deceiving or defrauding the management of the
creditors” company”
S266 “If Tribunal concludes that an employee during the period of “Any person who is
his employment with a company was guilty of any found so guilty”
misfeasance, malfeasance or non-feasance in relation to the
sick company”

Cases

 Sunil Bharti Mittal v. CBI

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“The Supreme Court held that an individual can be held liable for an offence by the company (i)
if there is sufficient evidence of the individual’s active role coupled with criminal intent; or (ii)
where the statute itself stipulates the liability of directors and other officials, such as under the
PMLA. Under the Companies Act, an exception has been specifically carved out for independent
and non-executive directors, ensuring that they are liable only in cases where their knowledge
and involvement can beestablished or where they, despite having knowledge, failed to act
diligently. However, such exceptions are generally not prevalent in other statutes like the PMLA.
Given that investor directors are usually non-executive in nature, they should normally not be
liable for actions which are largely promoter-driven. However, such non-executive directors
often find themselves explaining to the authorities that they were not involved or that they had
acted diligently. Once a fraud is discovered, authorities generally look at everyone with
suspicion, and merely being a non-executive director does not shield the individual from liability
or criminal prosecution.”

National Small Indus. Corp. Ltd. Vs Harmeet Singh Paintal& Another

“The Supreme Court has ruled that a managing director is prima facie in charge of and
responsible for the company’s business and can be prosecuted for misdeeds by the company. But
only those officers of the company who fall within the scope of the definition”“officer who is in
default”are covered. A simple averment in a complaint that a director was in charge of and
responsible for the conduct of the business of the company is sufficient to state a claim against
an officer who is in default.”

Mechanisms to Tackle Fraud (Under 2013 Act)

“There are certain mechanisms that have been cited by the Government by which the frauds can
be prevented under the Companies Act 2013.”

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  “Section 211 empowers the Central Government to establish an office called Serious
Fraud Investigation Office (SFIO) to investigate frauds relating to companies. No other
investigating agency shall proceed with investigation in a case in respect of any offence
under the Act, once the case has been assigned to SFIO. The SFIO has power to arrest
individuals if it has reason to believe that he is guilty based on the material in possession.
SFIO shall submit a report to the Central Government on conclusion of investigation.
Central Government may direct SFIO to initiate prosecution against the company. SFIO
shall share information they possess regarding a case being investigated by the latter and
vice versa.”

 “Auditors shall report material fraud to the Central Government within 30 days.
Immaterial fraud shall be reported to the board or the auditor of the company. Audit
committee is required to monitor that every listed company shall establish a vigilance
mechanism for directors and employees to report genuine concerns. The vigilance
mechanism shall provide for adequate safeguards against victimization of persons who
use such mechanism. It shall make provision for direct access to the Chairperson of the
Audit Committee in appropriate cases.”

 “Independent directors shall report concerns about actual or suspected fraud. They must
also ascertain and ensure that the company has an adequate and functional vigilance
mechanism and to ensure that the interests of a person who uses such mechanism are not
prejudicially affected on account of such use.”

 “Central Government can order investigation into the affairs of a company on the receipt
of a report of the Registrar or inspector; on intimation of a special resolution passed by a
company that the affairs of the company ought to be investigated; or in public interest.”

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Conclusion

“This article can be concluded as every director or officer-in-default (person who takes decision)
of a company has huge responsibility of complying with various provisions of the Companies
Act while dealing with the matters of the company and failure to abide by the provisions of the
Act can lead to huge penalties to the company as well as themselves individually which can be in
both civil and criminal form. Thus, they must be aware of the various compliance which is
needed to be performed. There is also the concept of vicarious liability which plays an important
role in determining the liability of a director. Therefore, a director must be careful while dealing
with the affairs of the company and must ensure the maximum amount of transparency in his
actions.”

Bibliography
Articles

Corporate Governance - Emerging Economies Fraud and Fraud Prevention by Dr. Ponduri.S.B

Financial and Corporate Frauds by Vidya Rao

Books

Corporate fraud: CIMA Publications, United Kingdom, www.cimaglobal.com

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