THEORIES THAT GOVERN CORPORATE CRIMINAL LIABILITY

1. Identification Theory
This theory anchors corporate criminal liability by attributing the actions and intentions of
high-level executives and managers directly to the corporation itself. When a senior officer
(often referred to as a "directing mind") within the corporate hierarchy commits an offense in
the scope of their authority, the corporation is deemed to be criminally liable. This is
grounded in the belief that these individuals' decisions represent the corporate intent, thus
merging their mens rea with the corporation's liability .
Case: Rachana Flour Mills Pvt. Ltd. v. Lalchand Bhanadiya
2. Vicarious Liability
Derived from tort law, this legal doctrine is adapted for corporate criminal liability,
suggesting that a corporation can be held accountable for the acts of its employees if these
acts are committed within the employment scope. Essentially, it extends the responsibility for
an individual’s actions to the employer, underlining a broader scope of liability within
corporate structures.
Case: Canadian Dredge & Dock Co. v. The Queen (1985) 1SC R662)
3. Optimal Penalty Theory
This economic theory posits that penalties for corporate crimes should equate to the social
harm caused by the crime, adjusted by the probability of detection and conviction. The theory
advocates for fines over incarceration for corporations, considering that incarceration (apart
from being practically impossible for non-human entities) is socially and economically costly.
When fines are not feasible, due to financial insolvency of the corporation, only then is
incarceration considered for the individual actors within the corporation.
4. Deep-Pocket Hypothesis
This theory suggests that corporations, due to their substantial financial resources, are often
treated less favorably in the legal system compared to individual defendants. The "deep
pockets" of corporations can lead to higher financial penalties and settlements, as they are
seen as able to pay substantial sums compared to individuals.

JUDGEMENTS
1. TESCO SUPERMARKETS V NATTRASS [1972] AC 153:
Context: This case involved Tesco Supermarkets being accused of false advertising, a breach
of the Trade Description Act, 1968. A manager at one of Tesco's stores failed to update the
price tags to reflect the end of a sale, leading to overcharging of customers.
Judgment: The House of Lords decided that the manager, although high-ranking, was not
acting as the company's "directing mind" at the time of the violation. Therefore, his actions
could not be seen as those of the corporation. The court's ruling emphasized the necessity of
linking the wrongdoing directly to individuals who could genuinely represent the corporate
decision-making authority—Tesco was acquitted of the charges.
Legal Principle: The case is critical for its emphasis on the "directing mind" theory in
corporate criminal liability, which holds that only actions and intents of individuals at the
highest executive level can be attributed to the corporation.

2. OSWAL VANASPATI & ALLIED INDUSTRIES V STATE OF UTTAR PRADESH

(1993) 1 COMP. LJ 172:
Context: The case arose when a criminal complaint was lodged against the corporation,
citing a law that prescribed mandatory imprisonment and fine for the violation.
Judgment: The Allahabad High Court concluded that the legal provision for punishment by
imprisonment does not exempt corporations from being prosecuted; instead, the company
could be fined as per applicable statutes. The court held that since a corporation cannot be
imprisoned, the fine remains enforceable.
Legal Principle: This judgment clarifies the application of laws that prescribe imprisonment
for offenses when the accused is a corporation, setting a precedent that fines can still be
imposed.

3. STANDARD CHARTERED BANK & ORS. V DIRECTORATE OF ENFORCEMENT &

ORS. (2005) 4 SCC 530:
Context: Standard Chartered Bank was accused of violating foreign exchange laws under the
Foreign Exchange Regulation Act, 1973. The allegations involved illegal activities in foreign
exchange dealings.
Judgment: The Supreme Court of India ruled that corporations are included in the definition
of 'persons' under the General Clauses Act, which allows them to be prosecuted and fined
under criminal statutes. The court upheld that legal statutes could impose criminal liability on
corporations, provided there are provisions for fines.
Legal Principle: This ruling is pivotal as it solidifies the stance that corporations, while they
cannot serve prison time, can still be held criminally liable and subjected to monetary
penalties.
4. IRIDIUM INDIA TELECOM LTD. V MOTOROLA INC.:
Context: Iridium India accused Motorola Inc. of cheating and conspiracy under the Indian
Penal Code, involving financial and operational misrepresentations in the satellite telephone
services business.
Judgment: The court held that Motorola, as a corporate entity, could be criminally liable for
cheating and conspiracy, recognizing that a corporation can possess mens rea, or a guilty
mind, through its senior executives.
Legal Principle: This case extends the identification theory further, showing that corporate
criminal liability can be applied in complex cases involving intentional deception and
conspiracy, not just procedural misdemeanors.

5. ZEE TELEFILMS LTD. V. SAHARA INDIA CO. CORP. LTD (2001) 3 RECENT
CRIMINAL REPORTS 292:
Context: Sahara India Co. Corporation Ltd filed a criminal defamation suit against Zee
Telefilms following a broadcast that allegedly defamed Sahara. The case focused on whether
a corporation could possess the mens rea necessary for defamation.
Judgment: The court found that Zee Telefilms, as a corporate entity, could not form the
requisite mens rea to commit defamation, which is highly personal in nature.
Legal Principle: This decision highlights the limitations of applying criminal liability to
corporations for crimes requiring a personal intent to harm, such as defamation, reinforcing
the complexities in attributing mens rea to corporate entities.

VARIOUS PROVISIONS WHICH ATTRACT CORPORATE CRIMINAL LIABILITY

IN INDIA
Section 141 of the Negotiable Instruments Act, 1881.
It states that when any sort of offence committed under Section 138 of the Negotiable
Instruments Act, then every person who ever have committed the offence shall be charged for
the criminal act and conduct of the business of the company. If the person is the company
itself even then the company shall be held to be guilty of the offence and shall be held liable
to be proceeded against and will be punish accordingly
Section 7 of the Essential Commodities Act, 1955.
Section 7 states about penalties under the Act. It states that if any person contravenes any
order made under Section 3 of the Act then he shall be liable to imprisonment to a minimum
of three month and maximum of seven years and will also be liable to pay a fine of certain
amount. By this it can be seen that it is not a compoundable offence as it attracts both
imprisonment as well as penalty provision. And the term “person” includes “individuals as
well as corporations and companies” as per the GENERAL CLAUSES ACT, 1897.
Section 276-B of The Income Tax Act, 1961.
The section states about the failure to pay tax deducted at source [TDS] In case of this section
it attracts criminal liability if any sort of contravention occurs in the payment of TDS then it
will lead to rigorous imprisonment which will be minimum of three months and maximum it
may extend to seven years and also certain amount of fine will be levied.

CLASSIFICATION OF GOVERNANCE FLAWS

CLASSIFICATION OF GOVERNANCE FLAWS: RATIONALE FOR CORPORATE
CRIMINALITY
Governance flaws in corporations can lead to substantial risks and are a common cause
behind corporate scandals. These flaws are typically systemic and often overlooked until a
crisis emerges. The document categorizes these flaws into several broad categories:
1. Failure of the Board of Directors:
- Lack of Independence/Conflicts of Interest: Boards that lack independence can be overly
influenced by CEOs or major shareholders, leading to decisions that serve a narrow set of
interests rather than the broader health of the corporation.
- Lack of Board Strength: A weak board may fail to provide sufficient oversight or
pushback against management proposals that are risky or poorly conceived.
- Unwillingness to Challenge Dominant CEOs: Boards may fail to check CEOs who have
accumulated excessive power, often leading to reckless decisions without adequate oversight.
- Combination of Board Chairman and CEO Roles: This dual role can concentrate too
much power in a single individual, reducing the effectiveness of the board's governance role.
- Insufficient Skills of Directors: Boards without the necessary skills and industry expertise
cannot provide effective oversight or strategic guidance.
2. Controlling Dishonest CEOs:
CEOs who dominate their environments can manipulate outcomes to serve their personal
agendas. This often includes financial manipulation to meet market expectations or to
personally benefit at the company's expense. The report by COSO indicated that CEOs were
involved in 72% of fraudulent financial reporting cases, often as the chief instigators.
3. Defects in Corporate Strategies:
Poor corporate strategies, often devised without a clear understanding of market conditions or
company capabilities, can lead to financial losses and operational failures. Strategies overly
focused on short-term gains can neglect the company’s long-term health.
4. Collapse of Internal Controls:
Effective internal controls are crucial for preventing fraud and ensuring that company
operations align with legal and ethical standards. The breakdown of these controls often
precedes corporate scandals.
5. Faults in External Audit:
Auditors play a critical role in ensuring the accuracy of corporate financial reports. Failures
in audit processes can arise from negligence, the use of faulty auditing methods, or conflicts
of interest, leading to significant oversight failures.
6. Deficient Regulatory Frameworks:
Weak regulatory frameworks and enforcement can allow governance failures to proliferate.
Companies may comply with the letter of the law while entirely circumventing its spirit,
facilitated by lax or poorly implemented regulations.
7. Independency of Independent Directors:
Independent directors (IDs) play a crucial role in corporate governance, acting as mentors to
management and supervisors ensuring value creation for shareholders, particularly in
protecting minority interests. Regulatory bodies have consistently tightened norms, including
defining the roles of IDs and audit committees comprehensively. However, the effectiveness
of these measures is often undermined by Indian promoters who adopt a minimalist ‘tick-the-
box’ approach to compliance.

Unfortunately, in many Indian companies, IDs are only nominally independent, often having
close ties with promoters, which can compromise their ability to act autonomously. Despite
the presence of IDs on the boards of companies like Enron, WorldCom, and Satyam, their
failure to prevent these corporate disasters has cast doubt on their actual influence and
effectiveness. While companies may formally comply with the independence requirements
for directors set by the Companies Act and SEBI regulations, these often do not adequately
assess the competencies and knowledge necessary for IDs to fulfill their responsibilities.
Instead, appointments should focus on the skills and experiences that enhance board diversity,
promote independent evaluations, and enable leadership that represents the company globally.
Each of these categories reflects a different aspect of corporate governance that can
fail, leading to potential legal and financial crises. Effective governance requires robust
systems and processes to manage these risks, including strong, independent boards, rigorous
audit functions, and comprehensive regulatory compliance.

CASE STUDIES OF CORPORATE GOVERNANCE FAILURES

1. Satyam Computers Fraud:
Details of the Fraud: The fraud at Satyam was orchestrated by the company’s chairman, B.
Ramalinga Raju, along with several other senior executives. They falsified accounts and
financial statements to inflate earnings and assets over several years, creating more than
7,000 fake invoices and fictional employees to divert funds.
Governance Failures:
Auditing Issues: The auditors, PwC, failed to verify cash balances and receivables, which
were grossly overstated. This negligence or complicity in the fraud undermined the audit's
integrity and the financial oversight mechanism.
Internal Controls: The internal controls at Satyam were either inadequately enforced or
skillfully bypassed by the management, showing a catastrophic failure in internal corporate
governance.
Whistleblower Ignorance: The company's whistleblower policy was ineffective; warnings and
anomalies reported by junior staff were ignored or suppressed.
Regulatory and Legal Outcomes: Following the scandal, the Indian government intervened,
overhauling the management and ownership of Satyam. The Securities and Exchange Board
of India (SEBI) also implemented stricter auditing and corporate governance norms. Raju and
other involved executives faced prison sentences.

2. Kingfisher Airlines Scandal:

Details of Mismanagement: Kingfisher Airlines, led by Vijay Mallya, faced persistent issues
due to rapid expansion and heavy debt incurred from acquiring Air Deccan. The financial
pressures were compounded by high fuel prices and operational inefficiencies.
Governance Failures:
Strategic Misalignment: The airline's decision to shift from a budget carrier to a premium
service provider without a clear market strategy or adequate capital destabilized its business
model.
Financial Overreach: The company continually secured loans with aggressive projections and
inadequate collateral, which led to unsustainable debt levels.
Regulatory Evasion: The management frequently clashed with aviation regulators and failed
to adhere to operational best practices, compromising safety and operational reliability.
Legal and Financial Fallout: The airline's collapse was precipitated by its inability to pay
debts, leading to aircraft repossessions and license suspensions. Mallya left India amid legal
battles over unpaid loans and allegations of financial crimes.

3. Sahara Case:
Details of the Scandal: Sahara Group used two of its companies to issue OFCDs, claiming a
loophole exempted it from public issue norms prescribed by SEBI. This massive fund-raising
was done without proper regulatory approval, effectively bypassing the rules meant to protect
investor interests.
Governance Failures:
Regulatory Manipulation: Sahara manipulated regulatory frameworks to avoid scrutiny under
public issue norms, using the cover of privately placed instruments to collect funds from
millions of small investors.
Lack of Transparency: The investment scheme was marketed through a vast network of
agents who were not fully honest about the risks and terms, reflecting a systemic lack of
transparency in Sahara’s operations.
Legal Repercussions: SEBI intervened and the matter escalated to the Supreme Court, which
ruled against Sahara, ordering refunds of billions to investors. This case highlighted the need
for robust regulatory oversight and better investor protection mechanisms in corporate
finance.

Satyam Computers Fraud Summary

Background:
On January 7, 2009, B. Ramalinga Raju, the Chairman of Satyam Computers, publicly
confessed to inflating the company's cash and bank balances by ₹5,040 crore, essentially
admitting to a massive financial fraud that ultimately escalated to about ₹7,000 crore. This
confession revealed deep-seated issues in corporate governance and triggered widespread
regulatory and legal actions.
Governance Flaws:
1. Failure of the Board of Directors:
The board, despite consisting of reputed individuals, failed in its primary duty of governance
and oversight. They were either unaware of or ignored the fraudulent activities that had been
ongoing for years. Independent directors approved transactions that were not in the
company's typical line of business, specifically the acquisition of Maytas Infra and Maytas
Properties, which were owned by Raju's family, indicating a severe conflict of interest and a
disregard for other shareholders' interests.
2. Failure of the Audit Committee:
The audit committee did not act on early warnings and did not perform their role of oversight
effectively. They failed to investigate and address the anomalies brought to their attention,
which could have mitigated the fraud at an earlier stage.
3. Deficiencies in External Audit:
The external auditors, Price Waterhouse, failed to detect the financial irregularities and
breaches of auditing standards, which included inflated revenues and understated liabilities.
The Securities and Exchange Commission (SEC) noted specific failures in adherence to
auditing standards by the auditor.
4. Regulatory Framework Weaknesses:
The regulatory bodies and auditors were not effective in identifying or preventing the
fraudulent activities despite various red flags over the years. This case highlighted significant
gaps in the regulatory framework governing corporate financial practices in India.

5. Non-Disclosure and Insider Trading Issues:

Raju and other executives had pledged their shares for loans without disclosing this to the
board or the shareholders, further complicating the governance landscape and undermining
shareholder trust.
6. Small Holding of the Promoters:
The promoters of the company held a small percentage of equity. Their concern was that poor
performance would result in takeover or divesting of their control over the company. The
promoters especially Mr. Raju built up his clout in the company and outside by showing
fabulous results and floating success stories. The numerous awards conferred on Mr. Raju
placed him as the charismatic leader of the company. He had unquestioned control over the
company.
Outcome and Lessons:
Post-scandal, the company underwent significant restructuring. Tech Mahindra acquired
Satyam, and the new entity was named Mahindra Satyam, marking a fresh start for the
troubled firm. This case remains a critical study in corporate governance failures,
highlighting the need for stringent oversight, independent audit functions, and robust
regulatory frameworks to safeguard stakeholders' interests.

Kingfisher Airlines Case Summary

Background:
Kingfisher Airlines, established in 2003 and owned by Vijay Mallya's United Breweries
Group, was once India's second-largest airline. Despite early successes, the airline's financial
troubles began to mount, culminating in its eventual collapse.
Governance Flaws:
1. Lack of Corporate Governance:
- Leadership Issues: Vijay Mallya, known for his flamboyant style, lacked practical
experience in airline management. This gap in expertise, coupled with a frequently changing
top management team, meant there was no stable strategic direction.
- Ineffective Board: The board of directors was unable to assert control over Mallya's
decisions, often resulting in rapid shifts in business strategy without thorough evaluation.
2. Faulty Business Strategy:
- Brand Confusion: The airline initially operated as an economy carrier before shifting to
luxury services and then reverting to low-cost under the Kingfisher Red brand. This constant
rebranding confused customers and diluted the airline's identity.
- Acquisition Missteps: The acquisition of the financially troubled Air Deccan was intended
to expedite Kingfisher's entry into international markets but instead exacerbated its financial
issues without solving its domestic market problems.
3. Erroneous Expansion:
- Premature International Expansion: Kingfisher expanded into international routes without
stabilizing its position in the domestic market. This overreach stretched the company's
resources thin and placed it in highly competitive markets for which it was unprepared .
4. Flawed Financial Model:
- Debt Reliance: Mallya's approach to finance was heavily reliant on debt, using other
companies within the UB Group as collateral. This strategy became unsustainable as the
airline's operational costs outpaced its revenue, leading to defaults on payments and
accumulation of massive debts.
Legal and Financial Fallout:
Kingfisher's operational license was suspended in 2012 due to non-compliance with
regulatory requirements and failure to clear dues. This was followed by a series of legal
battles, including charges of fraud and money laundering against Mallya, who eventually fled
to the UK. The case highlighted critical failings in corporate governance and regulatory
oversight within Indian aviation.

Sahara Case Summary

Background:
Sahara India Real Estate Corporation Limited (SIRECL) and Sahara Housing Investment
Corporation Limited (SHICL), part of the Sahara Group, were found to have collected
approximately Rs. 24,000 crores from over 30 million investors through Optionally Fully
Convertible Debentures (OFCDs) under the guise of a private placement. This vast collection
was conducted without following the regulatory norms applicable to public offerings, leading
to significant legal and regulatory scrutiny.
Governance Flaws:
1. Exploitation of Legal Loopholes:
- Regulatory Manipulation: Sahara utilized ambiguities in the regulatory definitions to
categorize massive public offerings as private placements, thus evading the stringent
disclosures and regulatory oversight required for public issues.
- Inadequate Disclosures: The group failed to provide clear and transparent disclosures to
the investors about the financial health and risks associated with the investment, misleading
primarily unsophisticated or illiterate investors .
2. Deficient Oversight by Regulatory Bodies:
- Regulatory Oversight Failure: The Securities and Exchange Board of India (SEBI)
initially overlooked the irregularities in Sahara's fund-raising activities. It was only after a
detailed investigation that SEBI ordered Sahara to refund the billions collected from
investors, highlighting the delayed response from financial regulators .
3. Internal Corporate Governance Failures:
- Board Complacency: Sahara's board was either complacent or complicit in allowing the
fundraising to proceed without proper checks and balances. This lack of effective internal
governance controls contributed significantly to the scale of the financial irregularities .
4. Legal and Financial Manipulations:
- Misuse of Funds: There were concerns about the actual utilization of the collected funds,
with allegations that the money was not used for the declared purposes, leading to further
legal complications for the group .
Legal and Regulatory Outcomes:
The Supreme Court of India, in a landmark judgment, ordered Sahara to refund the collected
funds with 15% interest to the investors. This case has become a pivotal example in Indian
corporate law, illustrating the consequences of exploiting legal loopholes and the importance
of robust corporate governance practices .