Corporate Frauds and Illegal Companies



The word “Company” is derived from two Latin words i.e., “Com” which means together, and “panis” means bread. Together it means a group of people having their meals. In ordinary terms, a company means doing a task with a similar mindset or achieving a similar kind of goal. Yet, there are some companies in India which are termed as illegal companies due to their ill mindset and achievement of illegal results. This article provides an insight, about Corporate Frauds, Shell Companies, Lifting of Corporate veil, and Illegal partnerships arising out of Section 464 of Companies Act, 2013 and its proviso.

Corporate Fraud:

White collar crimes are those perpetrated by well-meaning people in high-ranking positions in both public and private organizations. Today, the focus of white-collar crime has shifted from individuals to organizations, with individuals committing illegal acts alone or in partnership with others. Corporate fraud is one such example of white-collar crime.

A fraud is a deliberate deception carried out for personal gain or to cause harm to another individual or organization. ‘Fraus Omnia Vitiate’ – Everything is tainted by fraud. Corporate fraud occurs when a company intentionally presents false information with the intent of concealing the facts and deceiving the data receiver in order to obtain an advantage.

Corporate fraud as per the dictionary, means which has emerged as one of the most significant threats to which businesses are exposed, and it is rapidly evolving as a major danger. Incidents of such frauds are on the rise at an alarming pace, and in the process:

  • Investors’ confidence in financial markets will be shattered.
  • As a result, huge sums of money are lost by investors.
  • tarnish the company’s, management’s, and board of directors’ reputations
  • Corporate Frauds can be conducted in the form of:

(a) Financial Frauds – It includes manipulation, falsification, and alteration of accounting documents, deliberate misrepresentation or omission of numbers, misapplication of accounting rules, and deliberately incorrect, deceptive, or omitted statements are all examples of financial fraud.

(b) Misappropriation of Assets: Internal or external theft of tangible assets, sale of confidential knowledge, and improper payments.

(c) Corruption: Making or accepting improper payments, providing bribes to public or private officials, receiving bribes, kickbacks, or other payments, and assisting and abetting fraud by others are all examples of corruption.

Regulations are tightened on a regular basis to ensure that oversight, vigilance, and transparency processes, such as whistle-blower lawsuits, are in place. However, fraudsters are still able to upkeep one step ahead of regulators.

Companies should have solid procedures, processes, corporate governance standards, and a rigorous recruiting process to ensure that frauds do not occur.

It is also critical to raise employee awareness of areas vulnerable to fraud through robust training mechanisms, and to ensure that frauds are impartially investigated, and perpetrators are disciplined in a timely manner.

Shell Companies:

As per Companies Act, 2013, or any other Act, there is no such clear definition of Shell Companies. In general terms, a shell company is that which is created for the purpose of diverting the money or for laundering by creating multiple layers of companies. These companies are created mostly for meeting the financial transaction. They hold assets in the form of papers and not in reality. To be honest, these companies do not conduct economic activities.

Section 248 of the Companies Act, 2013 specifies that, “Registrar of Companies has the power to remove name of a company from the registrar of companies where a company fails to commence its business within 1 year of its incorporation or the subscribers to the memorandum have failed to pay their subscription within a period of 180 days or where a company is not carrying on any business or operation for a period of 2 years.”

According to statistics, there are approximately 1.5 million companies that are registered in India, whist there are 6,00,000 companies in India that file their returns annually. The Ministry stated that, “This means that a large number of these companies may be indulging in financial irregularities.”

But this does not prove that all shell companies are involved in money laundering activities. Many shell companies in India continue their operations by maintaining the rules, laws and regulations mentioned and do not have any financial irregularities. Instances of such conformity can be seen in cases where legal entity which continues their operations like any other legal firms or companies, or companies that separates its Human Resource (HR) functions into another company.

But to be on the safest side, it is better to be away from investing in shell companies (for equity investors) which have financial irregularities. Even though if an investor wants to invest in a shell company, then he/she must make proper research about that shell company and try to get the way they conduct their operations, businesses, and financials. Do not forget to conduct a proper due diligence of the company.

As on August 2017, the Securities and Exchange Board of India (SEBI) had initiated their actions against 331 suspected shell companies and had suspended their trading operations. The Ministry of Corporate Affairs (MCA) had cancelled the registrations of about 2,09,032 defaulting companies and the Ministry of Finance had barred the banks to suspend their transactions of such companies or their authorised representatives. As on 12 September 2017, as per Section 164(2)(a) of the Companies Act, 2013, the Ministry of Corporate Affairs (MCA) had identified 1,06,578 disqualified directors. Section 164(2)(a) of Companies Act, 2013 mentions that if a company has not filed the annual statement or annual returns for any consecutive three years, then the directors will be disqualified for a period of five years.

Lifting of Corporate Veil:

The incorporation of a company is critical for the start-up of a firm and the creation of a separate legal entity. Offenders have always taken advantage of the doctrine of independent legal entity. The lifting of the corporate veil is a tool that allows the judge, police, and others to recognize criminals as well as the true people in charge of the company’s day-to-day operations.

A corporate veil is a legal term that distinguishes the activities of corporations and organizations from those of their shareholders. It shields shareholders from being held accountable for the company’s conduct. This is not an absolute right; the court will decide whether the shareholder is liable or not based on the facts of the case.

However, there may be cases where dishonest or immoral actions are committed in the shadow of this. Since artificial persons are incapable of doing any unlawful or fraudulent acts, the corporate identity must be stripped away to reveal the true criminals. The raising of the corporate veil is a principle that goes against the general rule under Salomon.

As a result, removing the corporate veil is used to learn about the facts hidden under the corporate veil. Despite the fact that it contradicts the rule in Salomon, it does not make the rule null. The theory assumes the presence of a corporate identity that can be lifted for the benefit of all members or in the public interest to recognize and hold those who abuse the privilege accountable.

Instances of the Corporate Veil Being Lifted:

(a) Under a statute

(b) Under Judicial interpretation

(c) Under Indian Jurisprudence

A business, like all other natural entities, has a legal personality; the only difference is that a company, even with its legal personality, cannot operate or conduct its affairs in the same way that a natural person can. The corporation operates under the principle of the corporate curtain, which, if abused for dishonest purposes, reveals the company’s true existence and true beneficiaries.

Illegal Partnership Companies according to Section 464 of Companies Act, 2013:

As per Companies Act, 2013, Section 464 mentions that there should be maximum of 100 members in a partnership company. Yet, the Companies Miscellaneous Rules, 2014 states that maximum members that are allowed in a partnership company is 50, and if the number is exceeded, then that partnership company will be termed as an illegal partnership company. One must remember that a Rule does not go beyond an Act, and therefore, the Rule must be followed. Another point that must be taken into consideration is that Section 464 of the Companies Act, 2013 does not apply to two types of partnership companies. They are as follows:

(a) A partnership company formed under the Hindu Succession Act, 1956, which includes mainly the Hindu Undivided Family (HUF), and

(b) A partnership company formed under a special statute like, a partnership company formed under ICSI Act, 1980 (Institute of Company Secretaries of India Act) or a company formed under ICAI Act, 1949 (Institute of Chartered Accountants of India Act), etc.

The Section also mentions that if the limit of 100 members in that partnership exceeds 100 people, then, that firm will be fined up to Rs. 1,00,000 and shall also be liable for all the liabilities incurred in such a business.

Author: Kinkini Chaudhuri & Ankita Sen,
Amity University, Kolkata

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