Introduction
Corporate fraud has appeared as a significant challenge in India which is increasing day by day, mainly due to the expansion of less corporate frameworks, layered ownership models, and progressive methods of financial manipulation. Practices in corporate entities which are the creation of shell entities, misuse of related-party transactions in the corporate entities, and manipulative accounting techniques in the companies have enabled fraudulent actions to remain invisible, that creates serious triggers for regulators, investors, and other stakeholders in that particular corporate entity. In order to resolve these concerns and actions, the Companies Act, 2013 was enacted as an inclusive legislative reform intended to reinforce corporate governance standards that ensure greater accountability in companies. Fraud under company law is identified as a serious offence which is due to its wide-ranging and disturbing impact to companies. It can be seen as substantial financial harm to shareholders, creditors, and the individuals at large, while simultaneously maintaining trust in that corporate entity and destabilising the wide economic system. The purpose of this article is to examine the challenges of corporate fraud under the Companies Act, 2013 by analysing the relevant legal provisions, identifying the liability of fraud, and examine the enforcement mechanisms which are established for prevention, detection, and to penalise the corporate fraud under companies Act.
Meaning and Concept of Fraud under Company Law
Fraud describes as any act, omission, concealment of the facts, or abuse of position which are carried out by a person with the intention to deceive, gain an undue advantage, or cause loss to the company or entity, shareholders of the company, creditors, or any other person in wide range under Companies Act, 2013. The Companies Act (2013) also includes deliberate misstatements of company, falsification of records, and dishonest conduct carried out during the affairs of that company, regardless of whether there is actual wrongful gain or loss along with limit fraud to financial deception.
Corporate fraud is completely different from negligence or mismanagement of the company. Negligence usually arises from a lack of due care, oversight, or competence by the entity and is generally unintentional in nature. Mismanagement involves poor decision-making or inefficient administration but it does not involve dishonest intent, where fraud requires a deliberate intention to deceive or manipulate towards company along with making it a conscious and wilful act where it does not include an error or failure arising from carelessness or poor judgment.
Fraud is treated more seriously other than the other corporate defaults of the corporate entity because of its intentional and deceptive character along with its potential to cause widespread harm towards that particular entity. Fraudulent conduct directly compromises the trust in corporate governance, also damages the investor confidence towards entity, and threatens the integrity of financial markets of company unlike the procedural or technical violation. Due to this serious impact on stakeholders and the economy, the law imposes stricter penalties and enforcement mechanism to warn fraudulent behaviour towards company and also ensure accountability of that particular entity.
Definition of Fraud under the Companies Act, 2013
Fraud is defined in Section 447 of Companies Act, 2013.
Definition of Fraud (Section 447):
“Fraud, in relation to the affairs of a company or any other corporate body, includes any act, omission, concealment of any fact, or abuse of position committed by any person with intent to deceive, to gain undue advantage from, or to injure the interests of the company, its shareholders, creditors, or any other person, whether or not there is any wrongful gain or wrongful loss.”
- Wrongful gain means gain by unlawful means of property to which the person gaining is not legally entitled.
- Wrongful loss means loss by unlawful means of property to which the person losing it is legally entitled.
Essential Ingredients of Fraud under the Companies Act
- Act, Omission, or Misuse of Position
Fraud may arise from a positive act, a deliberate failure to act, suppression of material facts, or improper use of authority or position. - Committed by Any Person
The offence can be committed by directors, officers, employees, key managerial personnel, or any other individual associated with the company. - Presence of Mens Rea (Intent to Deceive)
The conduct must be intentional and carried out with the knowledge and purpose of misleading or deceiving others. - Object of Obtaining Undue Benefit or Causing Harm
The intention behind the act should be either:- to obtain an unfair or unlawful advantage, or
- to cause damage to the interests of the company, its members, creditors, or any other person.
- Actual Gain or Loss Not Essential
The existence of fraud does not depend on actual wrongful gain or wrongful loss; the intent alone is sufficient.
Fraud under the Companies Act, 2013 involves intentional deception through misuse of position or concealment of facts, with the objective of securing undue advantage or causing harm, irrespective of actual loss or gain.
Types of Fraud Recognised under the Companies Act
1. Financial Statement Fraud
Financial statement fraud states the intentional fabrication of false of accounting records to create the misleading portray of a company’s financial position, this often described as manipulating or cooking the books. This is shown by inflating revenue figures through false sales, reducing expenses, overstating asset values, or hiding existing liabilities.
The primary aim of this is to mislead the stakeholders such as investors, lenders, and regulatory authorities of the entity while into believing the business is financially profitable. In the Satyam Computers scandal, the company’s founder overstated profits by more than $1 billion by fabricating false invoices and false bank account balances.
2. Misrepresentation in a Prospectus
A prospectus is an official document which is issued to invite public investment by the company. Misrepresentation in the prospectus arises when that document includes false statements, misleading claims, or also omits critical information that could influence any investor’s decision regarding any particular. This misrepresentation may involve false future earnings potential, conceal legal disputes, or provide inaccurate details about the company’s financial strength. Investors may be affected by such deception which may seek compensation, and also responsible the company officials could face criminal penalties, including imprisonment.
In Rex v. Kylsant (1932), the company spotlights a consistent dividend history along with failing to disclose of that dividends were paid from accumulated reserves rather than actual profits, giving a false impression of financial structure.
3. Siphoning of Funds
Siphoning of funds occurs when company money is unlawfully diverted from its legitimate business purpose for personal or unauthorized use. This is often done through shell companies, fabricated invoices, or exaggerated expense claims that allow funds to be transferred out of the organization.
The intent is usually personal enrichment or repayment of private debts, frequently leading to financial distress or loan defaults for the company. In the Nirav Modi–Punjab National Bank case, funds were routed through numerous shell entities located in countries such as the UAE and Hong Kong.
4. Related Party Fraud
Related party fraud takes place when transactions between a company and its related parties such as directors, promoters, or their relatives are conducted on unfair terms rather than at market value, it results corporate fraud. For example purchasing goods at inflated prices from entities which is controlled by insiders or selling company assets to their knowns at low prices which are below to their actual worth.
Such practices result corporate fraud and are designed to divert the profit of company for personal profit. In the CG Power case, company assets were transferred to related entities at less valued prices, which cause losses to the entity.
5. Insider Manipulation (Insider Trading and Market Manipulation)
Insider manipulation involves exploiting confidential, price-sensitive information for trading purposes along with engaging in deceptive practices to artificially influence share prices. To create the false market activity, This also includes trading securities with major undisclosed announcements or techniques like circular trading .
The goal of this is to secure unfair financial interests at the expense of ordinary investors. In the Ranbaxy case, the executives of the company traded shares using insider knowledge of company related to regulatory actions by the U.S. FDA.
Persons Liable for Fraud under the Companies Act
Under company act, these person are liable for fraud which are as follows-
1. Directors
According to Section 166 of the Companies Act 2013, directors are entrusted with fiduciary responsibilities and are responsible to act honestly, diligently, and in the best interests of the company. They can be held personally liable for acts involving fraud, negligence, breach of duty, or for issuing incorrect or misleading statements in a prospectus. This liability extends to executive directors, non-executive directors, and even shadow directors who exercise control over the company’s decisions.
2. Key Managerial Personnel (KMP)
Section 2(51) defines Key Managerial Personnel to include the Managing Director, Chief Executive Officer, Chief Financial Officer, and Company Secretary. Responsibility for the company’s day-to-day administration and financial management is as individuals, KMPs holds accountability for particular fraudulent accounting practices, manipulation of financial statements of entity, or misappropriation of company assets.
3. Officers in Default:
The term “officer in default” includes whole-time directors, Key Managerial Personnel, and any individual specifically entrusted by the Board which is also ensuring statutory compliance, with accordance to the section 2(60) of Companies Act (2013). In this context where no officer is expressly assigned for such responsibility, all directors of that company may be treated as officers in default and would hold liable for that non-compliance or the fraudulent acts.
4. Auditors and Professionals:
In identification and report of the fraud; auditors, cost accountants, and company secretaries engaged in audit functions play a critical role in such term. They are required to report any detected fraud to the Central Government under section 143. Failure to do so may result in penalties, fines, or disciplinary action for negligence or professional misconduct.
5. Any Person Knowingly Involved:
The Companies Act adopts a wide approach to liability by including any individual who knowingly participates in fraudulent activities. This includes employees, agents, consultants, or third parties who assist, facilitate, conspire, or unlawfully benefit from fraudulent conduct, making them equally liable under the law.
Punishment and Penalties for Fraud
The punishment and penalties or fraud under company act are mentioned under section 447 which says,
“Without prejudice to any liability including repayment of any debt under this Act or any other law for the time being in force, any person who is found to be guilty of fraud involving an amount of at least ten lakh rupees or one percent. of the turnover of the company, whichever is lower, shall be punishable with imprisonment for a term which shall not be less than six months but which may extend to ten years and shall also be liable to fine which shall not be less than the amount involved in the fraud, but which may extend to three times the amount involved in the fraud:
Provided that where the fraud in question involves public interest, the term of imprisonment shall not be less than three years.”
- Imprisonment: Minimum 6 months, extending to 10 years.
- Fine: Minimum of the amount that is equal to involved in the fraud, extending up to three times that amount.
- Public Interest: The minimum imprisonment would increase to 3 years if the fraud involves the public interest.
Reporting of Fraud under the Companies Act
Auditors must examine accounts along with verifying the compliance with auditing standards of the company, and report to members which shows whether financial statements provide a true and fair view under section 143 of Companies Act, 2013. Key duties of the responsible authority include auditing subsidiaries, reporting on frauds (≥₹1 crore to Central Government), and accessing all necessary records of that entity under companies act.
Key Duties of Auditors (Section 143)
- Access to Records: Section 143 provides the right to access books of account, vouchers, and information from subsidiaries to the auditor.
- Inquiry Rights: Auditors has the right to inquire into matters such as loans/advances, personal expenses charged to revenue, and transactions prejudicial to company interests according to this particular section.
- Reporting Obligation: A report for the corporate fraud must be made to members of that company regarding financial statements, which is ensuring that they reflect a true and fair view of that fraud.
- Compliance: Compliance with auditing standards is mandatory.
- Fraud Detection: Duty to report fraud (≥₹1 Crore) to the Central Government.
Reporting to the Audit Committee/Board
- Initial Reporting: If an auditor has reason to believe a fraud involving the company has been committed by officers/employees, they must report it to the Audit Committee or Board immediately, but not later than 2 days of their knowledge.
- Seeking Observations: The auditor must request a reply or observations from the Board/Audit Committee within 45 days.
- Board Report: If not reported to the Central Government, details of fraud must be disclosed in the Board’s Report.
Reporting to the Central Government
- Procedure: If the auditor does not receive a reply within 45 days, or the reply is unsatisfactory, the auditor must send a report to the Central Government within 15 days of the expiry of the 45-day period.
- Method: The report must be submitted in the prescribed format (Form ADT-4), including the Board’s response, or a note indicating a lack thereof.
- Immediate Action: For significant frauds, the report must be submitted immediately but not later than 60 days of knowledge.
Investigation of Corporate Fraud
The investigation method in corporate fraud is the combination of legal procedure, detect the financial irregularities from cutting edge technology and comprehensive. Companies act, SEBI, PMLA are such regulations that empowers investigation body to investigate if the companies found in engaging in any fraud activity such as misleading the financial statement, insider trading etc.
Enforcement Mechanism for Fraud under the Companies Act
The companies act provides various enforcing mechanism for fraud to manage such corporate fraud and other fraudulent activities. Such authorities are as follows-
1. Serious Fraud Investigation Office
The office of Serious Fraud investigation Office is established under companies act under section 211. This agency is established to detect for various fraudulent activities and contains the experts to do so. The tea of SFIO includes the investigation in different sectors such as forensic audits, IT Sector, taxation sector, banking sector and capital markets etc. this authority has power to investigate and to detain the person relating to commit frauds who found guilty. This authority investigates complex matters with multidisciplinary aspects etc. This agency also took the satyam scandal case and also submitted the report.
2. National Company Law Tribunal
NCLT is the quasi-judicial authority which is established by companies act. NCLT manages the corporate dispute matters and has the powers for mismanagement, to provide relief in action suits etc. It also has the powers to award damages (pecuniary damages) and penalties for any act or offence committed by any officer of company. The decision of NCLT are bases on natural justice.
Corporate Governance and Prevention of Fraud
A good corporate governance leads an important role in prevention of corporate fraud and corruption. In terms of prevention of corporate fraud, the companies would have the written protocols, procedures and policies to maintain the individuals of the company regarding complains and financial reporting. A good corporate governance provides confidiencility and accountability in the company and organisation which provide help in detecting the irregularities in the companies’ activities. Good corporate governance is based upon good conscience and natural justice. It provides the balanced accountability of the board members and also helps in detect the mistakes of the company.
In terms of preventing the corporate fraud technology plays an important role, because it offers various tools in prevention of corporate fraud and also increase good governance. Te technology has blockchain technology, digital identity verification technology, cyber security, fraud detection software, data analytics and artificial intelligence etc.
Challenges in Addressing Corporate Fraud in India
There are any challenges and impacts in addressing the corporate fraud in India. These challenges are as follows-
- Fraudsters used the high advance technologies for the scam such as cyberattackes , AI driven scams, data manipulation.
- There is the weak governance and business structures that lead to undetected fraud.
- The hidden fraudulent activities are difficult to detect and investigate such as insolvent companies so that there is lack of access to data and evidences.
- There are also reputational risks so the entities usually hesitate to report, this leads to continue the fraud activities.
- The lack of integrated data for example device fingerprinting and achine learning analysis which limits the ability of authorities to detect the fraudulent activities
Conclusion
Corporate fraud is the combination of fraudulent activities which attacks the management of the companies, business structure and also extends to financial mismanagement. It destroys the trust of individuals, stakeholders etc. and also destroy the reputation of the company. The reason behind the corporate fraud are competitions in market, economic pressure such as achievement of financial targets, increase investors and other factors. The legislation authorities such as courts, NCLT, Serious Fraud Investigation Office etc. helps in preventing fraudulent activities and act according to companies act, SEBI act and PMLA.
About Author
Swati, A Practicing Advocate in District Court Gurugram, Haryana, combining a rigorous academic background from GD Goenka University, Sohna with specialization of LLM in corporate law and BA. LLB. from Maharshi Dayanand University(Rohtak).Swati is dedicated to demystifying the law, providing transparent and accessible counsel in an increasingly complex world through legal research and writing.
Frequently Asked Questions
What is corporate fraud under companies act, 2013?
Fraud refers to any act, omission, concealment of facts, or abuse of position carried out by a person with the intention to deceive, gain an undue advantage, or cause loss to the company, its shareholders, creditors, or any other person.
What are the punishment and penalties for fraud under companies act, 2013?
Imprisonment: Minimum 6 months, extending to 10 years.
Fine: Minimum equal to the amount involved in the fraud, extending up to three times that amount.
Public Interest: If the fraud involves public interest, the minimum imprisonment increases to 3 years