Rise of inspections, inquiries and investigations under the Companies Act, 2013

“No law however, well-conceived or well drafted, can be altogether fool-and-knave proof and it is impossible. for any law to protect the fool from the consequences of his acts or omissions. Nevertheless, we consider that it is the function of law to prevent dishonest and unscrupulous people from creating conditions and circumstances, which will enable them to make fools of others.”

– Bhabha Committee Report [Company Law Committee Report 133(1952)]

INTRODUCTION

In last few decades, there has been a radical shift in the perception towards businesses and companies. A company’s accountability on legal, economic, and social grounds has become vital for its growth and the country’s reputation. In National Textile Workers’ Union and Others v. P.R Ramakrishnan And Others, AIR 1983 SC 75, the Supreme Court of India noted how the doctrine of laissez faire is fading away and that a company is now no longer a mere profit-making enterprise, but it has assumed the role of a social institution. The Court recognised a company as a species of social organisation, with a life and dynamics of its own and exercising a significant power in contemporary society.

There is clear and a close relationship between corporate governance and ethics but conflicts between the two are certain. Such conflicts if not taken care of reduce the confidence of potential investors and affect the global credibility of the Government. Keeping the same in mind, the law on inspection, inquiry and investigation of companies has been tightened. The main objective of an investigation is a form of deeper probe into the affairs of a company. It is a fact-finding exercise to collect evidence and to see if any illegal acts or offences are disclosed and then decide the action to be taken.

Its only efficient and smooth functioning of the corporate that can ensure an adequate return on capital invested by the shareholders. Thus, with the introduction of Chapter XIV (Sections 206 to 229) of the Companies Act, 2013 (“2013 Act”), companies are now forced to introspect and leave no stone unturned. The aforesaid chapter deals with the provisions relating to Inspection, Inquiry and Investigation of the affairs of companies and are thus, very critical towards building an environment of good corporate governance.

DEVELOPMENT AND EVOLUTION

The Securities and Exchange Board of India (“SEBI”) in 1999 had set up the Kumar Mangalam Birla Committee (“KMBC”) under the Chairmanship of Shri Kumar Mangalam Birla, member SEBI, to promote and raise the standards of good corporate governance. The primary objective of KMBC was to view corporate governance from the perspective of the shareholders and investors, since they are the raison de etre for corporate governance and also the prime constituency of SEBI.

Before the 2013 Act, the Companies Act,1956 (“1956 Act”) prevailed. The 1956 Act included provisions for organisational, financial and managerial aspects of a company, empowering the Government to inquire the books of accounts of a company. The 1956 Act has been amended from time to time to keep up with the developments however the complexities in the corporates were growing at an alarming rate and proving to be less effective and was not enough.

With the introduction of the 2013 Act, fraud has taken a wider meaning. Fraud has been defined as any act, omission, concealment of any fact or abuse of position committed by any person or any other person with involvement 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 there is any wrongful gain or wrongful loss.

In relation to the aspects of the 2013 Act on investigation, it refers to a search of the affairs of a company. The main aim is to obtain any evidence or facts regarding any malpractice during business, although these may not be the only reason. Investigations may also be undertaken to identify the profits and losses of a business, the assets and liabilities and so on.

Investigation into the affairs of the Company (Sec. 210),

The investigation is done on the receipt of report of the Registrar or Inspectors under Section 208, on intimation of a special resolution passed by a company that the affairs of the company ought to be investigated, or in public interest, by the inspector appointed by the Central Government, ‘may’ order an investigation into the affairs of the company.

The use of the word ‘may’ indicate that the Central Government can exercise its discretion and need not compulsorily order an investigation.

On the other hand, Section 210(2) is a mandatory provision which states that the Central Government “shall’ order an investigation into the affairs of that company, when an order to this effect is passed by a Court/ Tribunal.

Investigation by the Serious Fraud Investigation Office (Sec. 212).

Serious Fraud Investigation Office (“SFIO”) is an investigation agency created under Section 211 of the 2013 Act, to investigate into the affairs of a company upon orders of the Central Government. The SFIO has been armed with the power to arrest, and upon conclusion of investigation, file a complaint along with an Investigation Report (deemed charge sheet).

The operating model adopted for the functioning of the SFIO drew inspiration from the United Kingdom and the United States of America. In the United Kingdom, the Serious Fraud Office collaborates with other agencies (such as the Financial Conduct Authority and the Economic Crime Directorate) for tackling corporate fraud and in the United States of America the Corporate Fraud Task Force does the job.

INVESTIGATION INTO THE AFFAIRS OF THE COMPANY IN OTHER CASES (SEC. 213)

The National Company Law Tribunal (“Tribunal”), a quasi-judicial body in India that adjudicates issues relating to Indian Companies, can order investigation of cases after giving reasonable opportunity of being heard to the concerned parties.

The investigation can be ordered where there is reasonable cause to believe that business of the company is being conducted with intent to defraud or otherwise for an unlawful purpose or in a manner oppressive to any of its members, or where persons engaged in the formation of company or its affairs have been guilty of fraud or other misconduct towards the company or any of its members or even when the members of the company have not been given all the information with respect to its affairs including information relating to calculation of commission payable to a managing or other director or manager of the company.

An application can be made by not less than one hundred members or members holding not less than one-tenth of the total voting power in the case of a company having share capital or not less than one-fifth of the persons on the company’s register of members in case the company has no share capital.

INVESTIGATION OF OWNERSHIP OF A COMPANY (SEC. 216)

The Central Government may if it has reason to believe or shall upon the direction of the Tribunal that the affairs of the company ought to be investigated as regards membership of company, appoint one or more inspectors to investigate and report on matters relating to the company and its membership for determining the true persons:

(a) who are or have been financially interested in the success or failure

(b) who are or have been able to control the policy of the company.

Central Government shall appoint one or more inspectors if the Tribunal directs by an order that the affairs of the company ought to be investigated. While appointing an inspector, the Central Government may define the scope, the matters and the period of investigation and in particular limit the investigation to matters connected with particular shares or debentures.

The scope of the Chapter XIV-Inspections, Inquiries and Investigations is very wide. It includes within its purview the senior managerial personnel such as Managing Director, Chief Finance Officer etc., retired employees and even the past employees. Irrespective of when the tenure of employment ended, they can be called upon to provide information pertaining to their tenure. If the inquiry or inspection reveals that the business of the company has been/is being carried on for “fraudulent/unlawful” purpose, every officer of the company who is in default can be prosecuted for “fraud” under Section 447 of the 2013 Act. The same was held in an Order by National Company Law Appellate Tribunal (NCLAT), in Mr. Lagadapati Ramesh Vs. Mrs. Ramanathan Bhuvaneshwari (dated 20.09.2019) that if the Tribunal is satisfied that there are circumstances suggesting that either of the conditions given in Section 213 of the 2013 Act are corresponding, that is either the business of the company is being conducted with intent to defraud its creditors, members, any other person or in a manner oppressive to any of its members, that the company was formed for any fraudulent or unlawful purpose or by any persons concerned in the formation of the company or the management of its affairs have in connection therewith been guilty of fraud, misfeasance or other misconduct towards the company or towards any of its members etc. In such cases, the Tribunal after giving a reasonable opportunity of being heard to the parties concerned, and if the affairs of the company ought to be investigated by an Inspector or Inspectors appointed by the Central Government, pass the order, and in such case, the Central Government is bound to appoint one or more competent persons as Inspectors to investigate into the affairs of the company in respect of such matters and to report thereupon to it in such manner as the Central Government may direct. If after investigation any of the abovementioned is proved then, every officer of the company who is in default and the person or persons concerned in the formation of the company or the management of its affairs shall be punishable for fraud in the manner as provided in section 447 of 2013 Act.

Another issue that arises with the reading of these provisions is whether there exist any grounds in ordering inspection and what is the prima facie satisfaction that such grounds exist. The same was dealt with in M/s. Hyderabad Pollution Controls Ltd v Union of India, Writ Petition Nos. 10201 of 2017 & 12296 of 2019. The High Court of Telangana noted that recording satisfaction to take action means to form an opinion which again is traceable to the nature of allegations against the person/Company or both. Non recording of reasons for satisfaction in the order itself or if not manifestly appear from the order, is not fatal and the impugned order cannot be invalidated on that ground alone when the allegations are serious in nature touching upon the very functioning of the Company that too by a share-holder group of 50% of the Company. It was further held that in a petition for prevention of oppression and mismanagement and where there is a prayer to investigate into the affairs of the Company, though sometimes it is called a motivated complaint, if there are serious many allegations made in it, there is no reason why inspection, inquiry be not ordered against such a Company.

SERIOUS FRAUDS INVESTIGATION OFFICE

The SFIO as it existed under the 1956, Act, operated without a statutory backing. Although the SFIO did not have statutory backing under the 1956 Act, Section 235 of the 1956 Act allowed a member of a company to make an application for investigating the company’s affairs. Section 210 of the 2013 Act broadly corresponds to Section 235 of the 1956 Act and allows for an investigation into the affairs of a company.

PROCEDURE

The procedure for investigation by the SFIO is laid down under Section 212 of the 2013 Act. Section 212(1) of the 2013 Act provides that without prejudice to the provisions of Section 210 of the 2013 Act, where the Central Government “is of the opinion” that it is necessary for the SFIO to investigate into the affairs of a company, as per the grounds provided under Section 212(1) of the 2013 Act, the Central Government may, by order, assign the investigation of the said company to the SFIO. The Madras High Court in the case of Church of South India v. Union of India, 2021 SCC OnLine Mad 332 held that the words ‘is of the opinion’ imposes a jurisdictional duty on the Central Government to form an opinion on the necessity of an investigation by the SFIO. Any order passed by the Central Government without forming an “opinion” under Section 212 of the 2013 Act shall lack merit. The investigation report filed with the Court for framing of charges shall be deemed to be a report filed by a police officer under Section 173 of the Code of Criminal Procedure, 1973 (popularly called the ‘charge-sheet’) (“CrPC”). It is pertinent to note that in K. Veeraswami v. Union of India, (1991) 3 SCC 655, the Supreme Court of India held that the final investigation report filed by an investigating officer under Section 173 of the CrPC is nothing more than an opinion of the investigating officer and shall not constitute legal evidence.

POWERS

The investigator of the SFIO, has certain powers vested in a civil court under the Code of Civil Procedure, 1908 (“CPC”) with respect to discovery and production of books of accounts and other documents and the summoning of and enforcing of attendance of persons. Another point to be noted is that tendering false statement under oath to registrar could constitute the offence of ‘perjury’. Besides, statements given to SFIO, depending on facts are also admissible. As was held in Punjab & Haryana High Court in Siddharth Chauhan vs SFIO, 2019 SCC OnLine P&H 4986 that although the investigating officer is bound by several conditions and restriction prescribed under the Companies Act; but at the same time, he has also been conferred the power to record the statement on oath and certain powers of Civil Court for enforcing attendance and seeking documents etc.

In complex cases involving allegations of fraud, which are usually based on textual evidence, ironically an accused person will also prove his innocence using the same textual evidence. In JP Srivastava & Sons (Rampur) Ltd v. Gwalior Sugar Co. Ltd 2002 CLC 1792 MP there was a petition for the prevention of oppression and mismanagement, the finding of facts by the Company Law Board (as it then existed) was that even the preliminary requirements were not satisfied. The Court refused to interfere as it found that the finishing was based on the evidence that was already in records.

CONCLUSION

Many a times companies are incorporated for carrying out of acts which may not necessarily be legal in the strictest sense or for evading liabilities and responsibility under a certain legislation. These activities impact the other members such as creditors, depositors and the financial system in general. It is with the intent to nail such persons hiding behind the corporate veil that the 2013 Act includes provisions on the investigation of companies. It is with the intent to bring out all the misconducts and frauds in light, while creating examples for all that the 2013 Act attempts to include all possible areas and loopholes and leave no stone unturned. It also provides vide powers to the inspectors and Tribunals to perform their duties. These provisions are, thus, very critical towards building an environment of good corporate governance. Corporate governance if implemented properly has immense benefits for all stakeholders, including shareholders, customers, employees, and community at large. Whether the authority acting under a statute has the duty to act judicially depends on the express provisions of the statute read along with the nature of the rights affected, the manner of the disposal and the effects of the decision on the persons affected. With this arises a duty to act judicially in all circumstances. Every citizen is protected against the exercise of the arbitrary authority of the state or government. Thus, any case or investigation should be decided on the facts and evidence before it and not on any extraneous consideration. The 2013 Act seems to create a sense of respect for law in those sectors of business community which are not scrupulous about business approaches and practices, but not to cause unnecessary worry to well-run and law-abiding companies by ordering investigations merely based on complaints unsupported by facts or reasonable doubt.

Vanita Bhargava (Partner), Shivank Diddi (Senior Associate) and Natasha Syal (Associate) are part of the Dispute Resolution practice of Khaitan & Co LLP, New Delhi.

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