This practice guide provides an insight into the Indian legal framework, special rules, laws and procedures governing fraud and asset tracing, the various types of fraud claims that arise, their characteristics, the enforcement measures, privileges involved, etc.
1. Fraud Claims
1.1 General Characteristics of Fraud Claims
Fraud has been expressly defined in various statutes such as the Companies Act, 2013 (“the Companies Act”) and the Indian Contract Act, 1872 (“the Contract Act”). However, in all cases, a basic characteristic of fraud claims is that there must be an intention to deceive another person, take undue advantage of them, or to injure their interests. Generally, a dishonest concealment of facts amounts to fraud as much as overt actions or the making of false statements. In fact, the occurrence of a loss is also not needed to set up a case of fraud. Specifically, under the Companies Act, an abuse of position with intent to deceive is also covered under fraud.
There is a more nuanced definition of fraud under the Securities and Exchange Board of India (Prohibition of Fraudulent and Unfair Trade Practices relating to Securities Market) Regulations, 2003, made under the Securities and Exchange Board of India Act, 1992 (“the SEBI Act”), which deals with fraud committed while dealing in securities. This definition includes any act, expression, omission or concealment committed, whether in a deceitful manner or not, by a person while dealing in securities in order to induce another person or his agent to deal in securities, whether or not there is any wrongful gain or avoidance of any loss.
Under Indian law, the general penal statute, ie, the Indian Penal Code, 1860 (“the IPC”) does not define fraud as a distinct offence. However, it provides for fraudulent intention as an ingredient of various specific offences. The IPC defines “fraudulently” to mean with an intent to defraud.
Dishonest misappropriation of property, or dishonest conversion of a property for one’s own use, is also a penal offence. This offence takes the form of “cheating” where, by deceitful or fraudulent means, someone induces a person to deliver a property to himself. On the other hand, where a person has been entrusted with this property and dishonestly or illegally misappropriates or converts it for his own use or benefit, this comprises the offence of “criminal breach of trust”.
It is to be noted that not only the commission of a fraudulent act per se, but any agreement or conspiracy to enter into a fraudulent act, entered into by two or more persons, is also penalised under the IPC, regardless of whether the actual fraud is committed.
Paying illegal gratification (corrupt payments) to a public or a government official, is punishable under a special statute, the Prevention of Corruption Act, 1988 (the “PC Act”). The PC Act penalises a government servant as well as any person or organisation (including its officers) who makes the corrupt payment to the public official to obtain a benefit. The term “payments” is defined very broadly under the Act, and includes getting any undue advantage, whether pecuniary or otherwise. Likewise, “public servant” has been defined broadly to include officials working in corporations controlled or aided by the government, and anyone performing a public duty (such as bank officials, irrespective of whether they are employed by the government). There is no de minimus standard for the quantum that would qualify as a bribe.
1.2 Causes of Action after Receipt of a Bribe
The PC Act
As mentioned in 1.1 General Characteristics of Fraud Claims, where the person receiving any illegal gratification, monetary or otherwise, in return for an undue advantage to a person or organisation providing the bribe is a public servant, the offence is covered under the PC Act. Claims relating to bribery in India can only be brought against public servants, and persons or organisations who bribe or attempt to bribe such public servants. Receipt of a bribe by an agent of a claimant in general is also punishable under the PC Act where such a bribe has been received to induce a public servant to perform his public duty improperly or dishonestly.
The claimant in that case may proceed to file a complaint with specialised investigative agencies such as the Central Bureau of Investigation (“CBI”), or the state Anti-Corruption Bureau. However, the claimant may not be able to get the CBI to act on a complaint, and the CBI may treat the complaint as information upon which it initiates its own investigation.
The Companies Act
Under the Companies Act, it is the directors’ responsibility to create adequate internal financial controls that enable the prevention and detection of fraud and other irregularities within a company. Such internal controls include the setting up of channels for reporting of the receipt of a bribe by an agent. In the event of a failure to do so, various recourses are available under the Companies Act, such as prosecution for fraud, an action for disgorgement pursuant to a class action (in the case of egregious default), or an action for unfair prejudice or oppression and mismanagement.
A statutory auditor of the company is obliged to report fraud if he detects that a bribe has been received by a company official. The auditor is obliged not only to detect any fraud in the company but also to ensure that the company takes satisfactory action to remedy it, failing which the auditor is obliged to report it to the Central Government. In the event that the auditor fails to do so, he is exposed to various legal liabilities, as explained in 1.3 Claims against Parties Who Assist or Facilitate Fraudulent Acts.
The company may also pass a Special Resolution that its affairs are required to be investigated and inform the Serious Fraud Investigation Office (“SFIO”) constituted under the Companies Act.
1.3 Claims against Parties Who Assist or Facilitate Fraudulent Acts
In India, abetment of an act is defined as providing any instigation or aid to facilitate the commission of an offence, and is a punishable act in itself, regardless of whether the intended offence is committed. It is important to note that the definition of abetment in India also includes engaging with one or more person(s) in any conspiracy for committing a fraudulent act, if any act or omission takes place in pursuance of that conspiracy. Parties who conspire towards, assist in or facilitate such fraudulent acts are punished with the same punishment as though they had committed the intended offence. The claims for abetment would extend to situations wherein a party’s assistance towards the commission of a crime consists of receiving or harbouring fraudulently obtained assets, but only if the party had knowledge that the assets were fraudulently obtained.
The Companies Act
In the event that the statutory auditor of the company fails to perform his duties, or does not detect fraud despite it being brought to his notice, the auditor may face various actions such as a class action for disgorgement, regulatory action including disbarment and criminal prosecution for fraud. In addition to other actions, he may also be removed from his position through a government action for removal, and may be debarred for a period of five years if he is found to be guilty of directly or indirectly having acted in a fraudulent manner or having colluded in a fraud by the company, its officers, or its directors.
The Prevention of Money Laundering Act, 2002 (“the PMLA”)
Under the PMLA, knowingly receiving, possessing or concealing such fraudulently obtained property may constitute the crime of money laundering. Such property is liable to be classified as a “proceed of crime” under the Act, and can also be attached during the investigation stage itself.
1.4 Limitation Periods
In India, the Limitation Act, 1963 (“the Limitation Act”) provides that the period of limitation in the case of fraud commences from the time the fraud is actually discovered, or could have been discovered using reasonable measures, by the victim.
In general, the limitation period of an offence is dependent on the period of imprisonment prescribed for a particular offence. For example, if an offence is punishable with imprisonment for up to three years, it must be taken cognisance of by a judge within three years from the commission of the offence. In the case of offences relating to fraudulent acts, the limitation period would depend upon the specific offence made. Moreover, for offences punishable with imprisonment of more than three years, no limitation period has been prescribed. Thus, a court can take cognisance of the offence of cheating and dishonestly inducing delivery of property (punishable with up to seven years’ imprisonment), or the forgery of a valuable security or will (punishable with up to ten years’ imprisonment) at any point in time. However, criminal courts have inherent powers to condone delay where the delay has been properly explained or it is in the interests of justice to do so.
As regards civil claims, the period of limitation is specified under the schedule to the Limitation Act. The periods differ depending upon the causes of action; however, the cause of action would commence from the time that the fraud is discovered or was discoverable.
1.5 Proprietary Claims against Property
The Contract Act
Under the Contract Act, where an agreement is deemed to be void or voidable on account of fraud, the person who has received an undue advantage under such an agreement is bound to restore it, or make suitable compensation to the aggrieved party. However, where restoration of such property is not possible on account of conversion of the proceeds of fraud, a claimant will still be entitled to compensation on account of the loss that he may have suffered.
The Insolvency and Bankruptcy Code, 2016 (“the IBC”)
The IBC provides for various processes in order to claw back or disgorge any undue benefit received by any creditor or related party of a corporate debtor. Section 66 provides that during the liquidation process or the corporate insolvency resolution process, where any resolution professional or liquidator finds that the corporate debtor has conducted his business with intent to defraud creditors or for any fraudulent purpose, the adjudicating authority may direct any persons (including directors or partners) who were knowingly parties to it to make such contributions to the assets of the corporate debtor as it may deem fit.
The obligation is also cast on the resolution professional to claw back such preferential transactions (if they qualify for the conditions in Section 43) or undervalued transactions (if they qualify for the conditions in Section 46) by making an application under Section 44 or 45 of the IBC, respectively. However, such processes only allow these transactions to be restored to a corporate debtor and not a claimant. Any person applying for such transactions to be reversed will be entitled to proceeds from such transactions in accordance with the resolution plan or the scheme provided for the distribution of assets in liquidation under Section 53 of the IBC.
The Insolvency and Bankruptcy Board of India (“the IBBI”) has also been given powers to direct “any person” who has made an unlawful gain or averted loss by contravening the IBC to disgorge an amount equivalent to such unlawful gain. The IBBI has also been given the power to take appropriate steps in order to restitute the loss suffered by such a person on account of this contravention, if such a person is identifiable and the loss suffered is directly attributable to the contravener.
Under the CrPC, the police are also empowered to seize any property or evidence that they suspect may have been involved in any fraudulent act. Where the claimant seeks to establish his proprietary rights in a criminal proceeding to recover property, he may make a claim before the court. The court can in that case order the restoration of property after the end of the trial. Such release and restoration of property may be without conditions or with conditions that the claimant shall execute a bond, with or without securities, to the satisfaction of the court.
As stated in 1.3 Claims against Parties who Assist or Facilitate Fraudulent Acts, under the PMLA, “proceeds of crime” are defined widely and constitute not only the property obtained through fraudulent activities, but also its equivalent value. Therefore, even if the proceeds of fraud have been mixed with other funds, the value of these proceeds may be identified under the enactment. This is important because it recognises that the tainted property may no longer be available.
The Directorate of Enforcement (“the ED”), which is the investigating agency under the PMLA, is entitled to attach/freeze such properties derived or obtained, directly or indirectly, from the proceeds of crime. If upon completion of trial the offence of money laundering is proved, such property stands confiscated by the Central Government and vested free from all encumbrances. If, however, the trial results in an acquittal, the property is released to the persons entitled to receive it. Regardless, the special court trying the offence of money laundering is entitled to direct the Government to restore the confiscated property to a bona fide claimant, who may have suffered a loss due to the offence of money laundering, at any point after or during the trial.
1.6 Rules of Pre-action Conduct
In the case of a criminal complaint in relation to fraudulent acts, there are no rules of pre-action conduct. The complainant should approach the magistrate, or, where the offence is cognisable, the police authorities in order to initiate investigation into the offence.
Civil Law Proceedings
In the case where a claimant is filing a civil claim in relation to a fraud alleged to have been perpetrated under a contract, such a party should furnish a legal notice (usually a demand notice) or such pre-action steps as required under the dispute resolution clause in the contract.
Moreover, specific legislations or provisions may have their own particular rules of pre-conduct action: for example, a claim under the Commercial Courts Act, 2015 (“the CC Act”) requires the parties to have undergone pre-institution mediation of the dispute where no urgent interim relief/s are sought by the claimant; a civil action against the government or a public official may only be instituted after a written notice has been served two months in advance, unless waived by the court. It is pertinent to mention that failure to adhere to pre-conduct action may be fatal to the claim in certain instances, specifically where the statute provides for this.
1.7 Prevention of Defendants Dissipating or Secreting Assets
A victim of fraud can, while pursuing civil claims, file an application for a temporary injunction to prevent a party from alienating assets while adjudication upon the claim is ongoing. The application must show that the common law criteria for an injunction is satisfied: that there is a prima facie case in favour of the claimant, the balance of convenience lies in favour of the claimant, and irreparable injury would be caused to the claimant if such an injunction is not granted. This injunction is in personam. However, the injunction may also apply to third parties, where such third parties interfere with or obstruct the course of justice.
Where a suit is instituted for seeking damages/permanent injunction, the court fees payable will be computed as per the Court Fees Act, 1870, as well as the rules governing that specific court, which may be ad valorem (with or without caps, depending on where the action takes place). However, the fees payable for seeking an ad interim injunction under the suit may be a nominal fee. Such fees may differ for different courts and would need to be computed accordingly.
A similar right would be available to a party if it prefers an application under Section 9 of the Arbitration and Conciliation Act, 1996, wherein such a party can seek an ad interim injunction for preservation of assets or the substratum of an arbitration, before, during, and after the constitution of an arbitral tribunal but before execution of an arbitral award.
The CrPC allows police officers to seize any property that may be involved in the commission of any fraudulent offence. As mentioned in 1.5 Proprietary Claims against Property, the property may be released to the claimant upon conclusion of the trial.
Civil Law Remedies in the Case of Violation of Injunction
The violation of the aforementioned orders granting an interim injunction would amount to contempt of court by the opposite party, and is punishable with civil imprisonment and/or a fine. The court would also be entitled to declare any transaction in violation of such orders null and void.
Criminal Law Remedies in the Case of Violation of Injunction
Under the IPC, any fraudulent removal or dissipation of assets to prevent a property from being forfeited for the satisfaction of an order or a decree that has been passed, or is likely to be passed, is punishable by imprisonment of up to two years, or with a fine, or both.
While there is no statutory requirement for the claimant to give a cross-undertaking in damages, the courts (while keeping in mind equitable principles), or the arbitral tribunal (by way of the principles governing commercial arbitrations), may require a cross-undertaking to be given by a claimant to indemnify the losses suffered by a party on grant of injunction against it, if such a party ultimately succeeds in its defence. Further, while granting an injunction or an interim relief, a court can put parties to terms.
Under Section 144 of the Code of Civil Procedure, 1908 (“the CPC”), where any order is varied, reversed or modified subsequently, a party can apply to the court for restitution of its position to before the making of such an order, which could include refund of costs and payment of interest, damages and compensation.
2. Procedures & Trials
2.1 Disclosure of Defendants’ Assets
With respect to criminal actions, under Section 91 of the CrPC, any person may be compelled by a court or a police officer vide a written notice to produce any specified documents that aid in the investigation of any fraudulent act. The person may be compelled to disclose documents in relation to assets held by himself or herself as well as nominees on his or her behalf. Omission to produce documents in this regard may be punishable with simple imprisonment up to six months and a fine of up to INR1,000.
In civil proceedings, a claimant may make an application to a court to seek discovery, inspection and admission of certain documents in control of the opposite party. Furthermore, where the court is satisfied that in the usual course of business, assets of the opposite party are held by a third party, then the court, following the submission of an application, may direct the third party to disclose such assets. The opposite party may also be required to answer specific questions (termed as “interrogatories”) served by the claimant. A wrongful disclosure or failure to disclose may be punishable as civil contempt under the Contempt of Courts Act, 1971. Further, the court may impose costs upon any party, if it believes that such a party has issued interrogatories which are unreasonable, vexatious, or exceedingly lengthy in any manner.
As explained in 1.7 Prevention of Defendants Dissipating or Secreting Assets, a party can be put to terms. Under Section 144 of CPC, a court has the power to restore a party to its original position in case an order against it is subsequently vacated or modified. This power includes the power of the court to order that a party be paid such costs that are properly consequential on such variation, reversal, or modification.
2.2 Preserving Evidence
Law enforcement agencies often have their own manuals or rules that provide for the preservation and storage of evidence. For example, the CBI manual provides that all documents and material objects seized during an investigation must be promptly sealed in a scientific manner and deposited in the designated property room. Furthermore, the details of such documents and material objects must be entered in the sub-module of crimes, or register where the sub-module is not operational. These documents/items can be issued to the investigating officer as and when required for the purpose of investigation, by proper receipt. Further, such documents/items shall be returned as soon as they are not required by the investigating officer. The manual also states that every investigating officer shall be personally responsible for the safe custody of such documents/items at all stages of the investigation.
As mentioned in 1.3 Claims against Parties who Assist or Facilitate Fraudulent Acts, 1.5 Proprietary Claims against Property and 1.7 Prevention of Defendants Dissipating or Secreting Assets, under the PMLA, the ED is entitled to attach any property that it reasonably suspects is a “proceed of crime”. This enables preservation of such proceeds of crime that may be used as evidence in the trial. Under the PMLA, specific rules have also been enacted under the Prevention of Money Laundering (Receipt and Management of Confiscated Properties) Rules, 2005 which provide for proper identification, maintenance, and custody of confiscated properties.
Moreover, the police and the courts are given the power to seize and attach any property that is suspected of being involved in the commission of any fraudulent offence. Under these criminal statutes, “property” is defined extremely widely to include movable or immovable property, corporeal or incorporeal property, as well as the instruments relating to such assets, and includes bank accounts.
It may be noted that the IPC provides that any person who secretes or destroys any document to prevent its production in legal proceedings shall be punished with imprisonment of two years or a fine, or both. This acts as a deterrent to a party to not tamper with or destroy evidence.
The CPC provides that a court may regulate and control the evidence placed before it. The High Courts in India have their own specific rules in relation to maintenance of evidence. For example, the rules formulated by the High Court of Delhi provide that old and delicate documents should be safeguarded from any damage, such as by using a protective covering, or by using a photocopy while keeping the original document sealed. The CPC also provides for the appointment of a receiver, under Order XL, to protect and preserve a property which is the subject matter of a suit for realisation, management or improvement of a property, or to collect rent and profits while the suit is pending.
Physical Search of Documents
The Indian Evidence Act, 1872 gives broad powers to the court to seek production of any document at any time, as the court may deem fit (unless this falls under a recognised privileged communication). However, under the criminal law, the rights of the victim are limited and do not extend to conducting a physical search of documents at the defendant’s residence or place of business.
Under civil law, such a claimant would be able to seek discovery and inspection of the evidence upon making an application for this to the court. Such an inspection would usually take place at the office of the defendant’s pleader, or at the usual place of custody of such evidence. No undertaking is required to be given by the claimant in such cases, but the application is required to be made on oath to ensure that such documents are relevant for the purposes of the proceedings in question. However, the inspection is limited to documents referred to and/or relied upon by the defendant in its pleadings, or specific documents that the claimant affirms that the defendant has, and does not take on the nature of a general search of the defendant’s premises. The CPC also provides for the appointment of commissions under Order XXVI, where the court finds the need for local investigation/inspection or of ascertaining the amount of any mesne profits or damages, or annual net profits. After such an investigation/inspection, the commissioner has to reduce his evidence into writing and, together with his report, submit this to the court. Such commissioners have the power to take evidence from a witness by examination on interrogatories or otherwise, as well.
2.3 Obtaining Disclosure of Documents and Evidence from Third Parties
As stated in 2.1 Disclosure of Defendants’ Assets, Section 91 of the CrPC can be utilised by a court or the police to summon any person to produce any document or thing necessary for investigation or trial. The Section is not limited to obtaining disclosure from an accused person alone, but can be used to seek documents from any person in whose possession or power such document or thing is believed to be.
Further, under the CPC and the Indian Evidence Act, 1872, a court has broad powers to seek production of any document or evidence from any party, either on its own or pursuant to an application filed by a claimant in this regard.
2.4 Procedural Orders
Under the CPC, a claimant seeking a temporary injunction (such as to preserve any property or prevent any further injury) may be granted an ex parte injunction if the court believes that the delay in notifying the other party may defeat the purpose of the injunction sought for. However, the claimant will be required to inform the opposite party of this and send all documents forthwith. Such an injunction is also liable to be vacated upon an application filed by the opposite party if the claimant has knowingly made a false or misleading statement in its application for the purpose of obtaining such an injunction. The CPC also states that once such an ex parte interim injunction is granted, the court is required to hear and dispose of the application of the claimant for injunction within 30 days of passing the interim order.
2.5 Criminal Redress
Victims of fraudulent acts or fraud have two avenues through which they can seek redress against perpetrators: initiation of criminal proceedings or the filing of a civil suit. In practice, the route chosen by victims depends upon what form of redress they are seeking. In India, there are limited provisions for providing compensation to victims in criminal proceedings; and the grant of such compensation is recoverable from the fine imposed by the court, and is subject to the discretion of the court. Hence, if the overarching goal of initiation of proceedings is recovery, a victim will be well advised to pursue civil proceedings; but, if the goal is to seek punishment for the perpetrator, criminal proceedings may be a better option.
The victim can also pursue both civil and criminal remedies simultaneously for the same cause of action. Such proceedings take place before different courts and hence do not impact the speed at which they are disposed. It should be noted, however, that the standard of proof required to hold against the perpetrator in both cases is different. In civil proceedings, it is sufficient for the victim to show on “preponderance of probabilities” that the perpetrator is at fault, whereas in criminal proceedings, it is the duty of the prosecution (for example, the State) to show that the perpetrator is liable “beyond reasonable doubt”. While in theory, both proceedings are independent and don’t have a bearing on each other, in practice an adverse ruling in one may be prejudicial for the party in the second proceeding, depending on the facts dealt with and if the conviction precedes the civil determination.
2.6 Judgment without Trial
Under the CrPC, there are no provisions that allow for the obtaining of a judgment without a full trial being conducted. However, if an accused is absconding and there is no immediate prospect of arresting him, the CrPC provides for the recording of evidence against the accused in his absence. Such evidence may then be used against the accused when his trial can take place. The court may also dispense with the presence of the accused if it is satisfied that his presence is not necessary, or that the accused has persistently disturbed the court proceedings. In fact, the Supreme Court of India has noted that absconding persons cause undue delay in adjudication of trials and the CrPC needs to be amended to allow for “trial in absentia”.
The Courts can also issue an ex parte decree in the absence of a defendant provided that sufficient opportunity has been provided to the defendant, and despite which the defendant failed to appear before such a court.
With respect to civil cases, the CPC also provides for the claimant filing an application before the court seeking a summary judgment in certain commercial disputes, without the recording of any oral evidence. Extensive procedure has been laid down in Order XIII-A pursuant to the CC Act for summary judgements. The CPC, read along with the CC Act, also empowers the court to pronounce judgment at the first hearing of the suit itself when it appears that the parties are not at issue on any question of law or fact. Moreover, there is also a separate provision for institution of summary suits that involve the plaintiff seeking recovery from the defendant for an ascertainable amount based on an instrument executed between the parties. Such summary suits only allow the hearing of defence if the leave to participate is granted, and if such leave is refused by the court, the suit is decreed in favour of the plaintiff.
2.7 Rules for Pleading Fraud
Courts in India have given an expansive and inclusive definition to fraud. The primary component that must be alleged and proved in claims pertaining to fraud is that the claimant was fraudulently or dishonestly induced to act in a certain manner by the perpetrator. While proving that a wrongful gain was caused to the perpetrator and a wrongful loss was caused to the claimant may not be necessary in every instance, the Supreme Court of India has repeatedly held that the party alleging fraud must set forth full particulars of fraud and the case can only be decided on the basis of the particulars laid out. Mere bald allegations or pleadings of fraud by the claimant are not sufficient to proceed with a claim for fraud. Order VI Rule 4 of the CPC also states that in all cases where a party’s pleadings rely on any misrepresentation, fraud, breach of trust, wilful default, or undue influence, particulars (with dates and times if necessary) shall be stated in the pleadings.
2.8 Claims against “Unknown” Fraudsters
A claim against unknown fraudsters can be made in India, especially when seeking an ex parte interim injunction against an unknown party, in order to protect the claimant’s interests where there is an imminent threat to the same, and the identify of the fraudster is unknown. The courts in India have granted such “John Doe” orders (referred to as “Ashok Kumar” orders in India) frequently in cases involving fraudulent misrepresentations or frauds in relation to intellectual property claims.
2.9 Compelling Witnesses to Give Evidence
As stated in 2.1 Disclosure of Defendants’ Assets and 2.3 Obtaining Disclosure of Documents and Evidence from Third Parties, Section 91 of the CrPC can be invoked by the police or a court to direct a person to produce certain specified documents in their possession as evidence. Further, as stated in 2.3 Obtaining Disclosure of Documents and Evidence from Third Parties, courts in India generally have broad powers to summon a witness, either on their own motion, or upon an application by a claimant, and compel production of any evidence or document.
Even arbitral tribunals can seek court assistance in taking evidence under Section 27 of the A&C Act by exercising the stipulated powers. These powers have also been elucidated in the Indian Evidence Act. Powers have also been granted to courts under Order XXVI of the CPC to appoint a commission to depose a witness or pursue interrogatories in cases where the witness is within local limits and cannot be compelled to appear before a court, or where there is apprehension of evading jurisdiction before such a person can be compelled to appear before a court, or when such a witness is incapable of attending evidentiary proceedings.
3. Corporate Entities, Ultimate Beneficial Owners and Shareholders
3.1 Imposing Liability for Fraud on to a Corporate Entity
Indian courts have laid down that where an offence requiring mens rea or a guilty mind, such as fraud, is committed by persons exercising control over the affairs of a corporate entity, then the offence would also be imputed to the entity. Such imputation will be dependent upon the degree to which the corporation can be said to be acting through such persons, so as to make such persons the “alter ego” of the entity. Therefore, the corporate entity will be held to be liable for the actions of its director or officer if such persons are acting in the course of their regular duties.
3.2 Claims against Ultimate Beneficial Owners
When a corporate entity has been used as a vehicle for fraud, and its separate identity has been misused to commit such frauds, the courts in India use the well-established common law doctrine of piercing of the corporate veil to uncover the individuals who are the ultimate beneficial owners of the entity. In such circumstances, the courts will disregard the separate legal identity generally accorded to corporations in order to punish the actual perpetrators of the fraudulent conduct. The courts have frequently lifted the corporate veil when they suspect that the company itself is a sham entity created for an unlawful purpose or through unlawful means.
It is important to note that in order to aid the identification and regulation of such individuals, in 2018 the Ministry of Corporate Affairs in India introduced the Significant Beneficial Ownership Rules, which define the criteria for constituting a Significant Beneficial Owner (SBO) in a company. The Rules require the reporting company to submit specified information pertaining to SBOs to the Registrar of Companies, thereby providing investigative and regulatory agencies with ready access to ultimate beneficiaries in complex ownership structures. Similar rules also exist under the PMLA, wherein banks and financial institutions are charged with the responsibility of maintaining records of their clients and their respective beneficial owners. The Securities and Exchange Board of India (SEBI) has also issued multiple guidelines and circulars to identify ultimate beneficial ownership amongst companies listed on a stock exchange.
3.3 Shareholders’ Claims against Fraudulent Directors
Under the Companies Act, shareholders may institute oppression and mismanagement proceedings against the company and its director(s) where, inter alia, the affairs of the company have been or are being conducted in a manner that is prejudicial to public interest or prejudicial to such shareholders’ interests. The requisite requirement for initiating such proceedings has been provided for under the Companies Act as not less than 100 members or one-tenth of the total members (whichever is less) or any member(s) holding one-tenth of the paid-up share capital of the company, in the case of a company that has a share capital. In the case of a company that does not have a share capital, not less than one-fifth of the total members of such a company can initiate such proceedings.
It should be noted that the High Court of Delhi has read that provisions under the Companies Act, including Sections 241 and 242, allowing for initiation of proceedings and the relief of freezing assets and disgorgement of property as disgorgement, is a civil action in the nature of an equitable relief.
The Companies Act also permits institution of a class action, where members can approach the National Company Law Tribunal to, inter alia, seek certain orders, such as to claim damages or to demand any other suitable action from or against the company or its directors for any fraudulent, unlawful or wrongful act or omission on their part. In the case of a company having a share capital, a “class” is defined as not less than 100 members, or not less than 5% of the total members, whichever is less, or member(s) holding not less than 5% of the share capital of a company in the case of an unlisted company, and not less than 2% of the issued share capital in the case of a listed company. In the case of a company not having a share capital, a “class” has been defined as not less than one-fifth of the total members of such a company.
4. Overseas Parties in Fraud Claims
4.1 Joining Overseas Parties to Fraud Claims
Fraud under the Contract Act
Any suit for declaration of contract rendered void in terms of Section 17 of the Contract Act, or for claiming damages on account of fraud committed by a private party in a contract, may require joinder of an overseas party to such a suit. Such a joinder would be governed by the provisions of the CPC. While the CPC does not create a distinction between joinders of an overseas party and a domestic party, a joinder is allowed on account of liability under the same contract (Order I Rule 6) or on account of a cause of action (Order II Rule 3). In such cases, the courts allow issuing a notice/summons to an overseas party. However, if the overseas party fails to appear and defend its case, the courts may proceed ex parte to decide the suit.
A decree passed by an Indian court against an overseas party, specifically for damages on account of fraud, may need to be enforced specifically. In cases where the jurisdiction in which the decree is to be executed is a reciprocating country notified under the CPC, the decree would become enforceable in the reciprocating country. However, for non-reciprocating countries, a decree may only hold evidentiary value and may have to be adjudicated on merits.
Arbitrability of Fraud
The law in India now allows fraud of a civil nature to be arbitrated between parties. Any allegation of fraud that affects the private dispute between parties is arbitrable, unless the allegation is that the arbitration agreement itself is vitiated by fraud. However, fraud amounting to criminal consequences falls within the realm of public law, and can only be adjudicated by a court.
Indian law has made a lot of strides in terms of joining non-signatories to an arbitration, and a composite reference to domestic and overseas parties in the same arbitration agreement has been accepted by Indian courts.
Fraud under the Companies Act
While the Companies Act provides punishment for fraud under Section 447, the applicability of the Companies Act on an overseas entity is limited. A foreign company, for the purposes of the Companies Act, is defined under Section 2 (42) to mean any company or body corporate incorporated outside India which:
- has a place of business in India whether by itself or through an agent, physically or through electronic mode; and
- conducts any business activity in India in any other manner.
In this context, Section 379 of the Companies Act provides that where not less than 50% of the paid-up share capital of a foreign company is held by:
- one or more citizens of India; or
- one or more companies or bodies corporate incorporated in India; or
- one or more citizens of India, and
- one or more companies or bodies corporate incorporated in India, whether singly or in the aggregate,
such a company shall comply with certain provisions as may be prescribed with regard to the business carried on by it in India as if it were a company incorporated in India.
Section 380 provides for service of any process, notice, or other document required to be served on a foreign company. Section 228 provides for inspection, inquiry or investigation in relation to foreign companies.
An Indian court would have jurisdiction over criminal acts committed with a fraudulent intent under the IPC when the act has been committed by:
- any citizen of India residing beyond India; and
- any person on a ship or aircraft registered in India wherever it may be.
In case an Indian Court can exercise jurisdiction over an overseas entity, the CrPC provides for an elaborate process for service of summons or warrants etc in any contracting “state”, through an authority for transmission. In this regard, India has entered into Mutual Legal Assistance Treaty/Arrangements (MLATs) with various countries which provide for reciprocal arrangements for the serving of such judicial documents. Such requests are processed by the Ministry of Home Affairs, which transfers such documents to the relevant Indian missions/embassies.
The difference between the two categories of countries is that the country involving an MLAT has an obligation to consider serving the documents, whereas non-MLAT countries do not have any obligation to consider such a request. Similarly, India has entered into various bilateral treaties that allow knowledge-sharing, mutual assistance and extradition to enable investigation, arrest and production of accused persons in India.
Some expropriatory statutes such as the PMLA also allow attachment of property of equal value in India for any tainted property held in a foreign country.
5.1 Methods of Enforcement
Where a decree has been obtained by a petitioner based on a claim of fraud in contractual disputes, such a decree may be executed either by the court which passed it, or by the court to which it is sent for execution. Order XXI of the CPC provides a detailed procedure for executing a decree in an Indian court.
A decree obtained from a foreign jurisdiction may also be enforced in an Indian court provided it passes the test of finality as laid down in Section 13 of the CPC. Section 44A of the CPC provides that a decree of any superior court of a reciprocating territory is executable in India as a decree passed by an Indian district court.
Similarly, a domestic arbitral award passed under the Arbitration and Conciliation Act, 1996 (“the A&C Act”) can be enforced in accordance with the provisions of the CPC, in the same manner as if it were a decree of the court. Such an enforcement under Section 36 of the A&C Act is subject to any appeal that may lie under Section 34 of the A&C Act. An international arbitral award may be enforced in India where the court is satisfied that it fulfils the conditions provided for in Sections 44 and 57 of the A&C Act. Such an executable foreign award is deemed to be a decree of the court.
While cognisance of criminal fraud can only be taken by an Indian court exercising criminal jurisdiction, there are various agencies that can investigate criminal acts of a fraudulent nature. Powers of investigation, as provided under the CrPC, can be exercised by state police, and officers of special divisions such as the Economic Offence Wing and CBI. Special multidisciplinary agencies have also been given powers to investigate fraud under specific statutes, ie, the SFIO to investigate fraud under the Companies Act and the ED to investigate the predicate offence of fraud under the PMLA.
6.1 Invoking the Privilege against Self-incrimination
A right against self-incrimination is innate in Indian jurisprudence and has been guaranteed as a fundamental right by Article 20(3) of the Constitution of India. This fundamental right is echoed in various other statutes including the CrPC and the Evidence Act. The protection not only extends to oral testimony but also to the production of documents. It is important to note here that this constitutional protection is not only available at the pre-trial stage but also during the trial, and a witness may refrain from giving evidence that may result in self-incrimination. In such cases, since the burden of proof is on the investigation agencies and the prosecution, negative inference cannot be drawn from exercising this fundamental right.
However, in special statutes where the burden of proof is on an accused to prove that punitive actions should not be exercised against him, for example in cases of attachment of property under the PMLA, exercising such a right may result in a negative inference being drawn by courts and no protection can be sought under Article 20(3) of the Constitution of India in this regard.
On the same principle, since civil disputes do not lead to “self-incrimination”, no right to silence is available in civil proceedings for adjudication of fraud and a court may draw adverse inferences on issues wherein the defendant does not adduce evidence or refuses to give testimony to defend his case. This is in line with the principle enshrined in Section 114 of the Evidence Act.
6.2 Undermining the Privilege over Communications Exempt from Discovery or Disclosure
In India, privilege from disclosing communications between a lawyer and his client is statutorily recognised under Section 126, 128 and 129 of the Evidence Act and Section 227 of the Companies Act. This privilege from disclosing communication between a client and lawyer exists even after such a relationship has ended. There are few exceptions to this rule, ie:
- where any such communication was made in furtherance of any illegal purpose; and
- where any fact observed by any lawyer, in the course of his employment as such, shows that any crime or fraud has been committed since the commencement of his employment.
This privilege is also waived in cases where a client expressly waives his privilege or adduces evidence and offers himself as a witness, in which case he may be compelled to disclose any communication, which, in the opinion of the court, is necessary in order to explain any evidence he has led, and no other. The same has to be read in the context of Section 128 of the Evidence Act wherein by merely volunteering to give evidence, such a privilege is not waived. The section also contemplates that if a party calls in his lawyer as a witness, he may be deemed to have consented to such disclosure only if he questions his lawyer on fact, which otherwise would have been protected from disclosure under Section 126.
While Section 126 provides for privilege in communication with a “barrister, attorney, pleader or vakil”, the same distinction is not visible in the Advocates Act, 1961 (“the Advocates Act”), wherein only an “advocate” is permitted to practise the “profession of law” in India. It is pertinent to note that the term “advocate” is not used in either Section 126 or Section 129 of the Evidence Act. The terms used for a legal professional are very wide under Section 126 and are not restricted to “advocate” as defined in the Advocates Act. While the Advocates Act, 1961 does not make a distinction between different types of legal professionals, the intent of the legislature is clear and intended to use an inclusive definition. Further, the language used in Section 129 uses an even wider connotation of “legal professional adviser”, which has not been defined in the Advocates Act.
However, it is to be considered that under the Bar Council of India Rules (“the BCI Rules”), when lawyers join a company under full-time employment, they are under an obligation under such rules to surrender their registration as an advocate. This conundrum creates a complexity in recognising privilege on communication with “in-house” legal counsels in India.
There have been instances where the High Courts have considered the nature of advice or the scope of work of an in-house legal counsel to extend legal privilege to communications with in-house counsels or departmental lawyers engaged in government employment. However, there has been a view taken by some High Courts that that an in-house counsel cannot claim to be an “advocate” under the Advocates Act, and hence the legal privilege enshrined under the Evidence Act would not be available to such lawyers.
7. Special Rules and Laws
7.1 Rules for Claiming Punitive or Exemplary Damages
In Indian jurisdiction, exemplary damages are only granted in cases relating to libel, claims in tort along with economic aspects, such as slander of goods, or IPR matters. The principles for granting damages are enshrined under Sections 73 and 74 of the Contract Act.
Section 73 of the Contract Act deals with compensation for breach of a contract which results in actual damage. Such damages are in the nature of unliquidated damages. Section 73 of the Contract Act itself provides that a party can claim compensation for any loss or damage caused to him which “naturally arose in the usual course of things”. Furthermore, Section 73 also provides that compensation therein is not to be given for any remote and indirect loss or damage sustained by reason of the breach. Even the explanation provided in Section 73 states that in estimating the loss or damage arising from a breach of contract, the means which existed for remedying the inconvenience caused by the non-performance of the contract must be taken into account.
A conjoint reading of this principle makes it clear that the principles under Section 73 only allow for a party to be placed, as far as money can allow, in as good a situation as if the contract had been performed and a duty has been cast on the plaintiff to take all reasonable steps to mitigate the loss suffered by him. These principles do not allow the courts to grant exemplary or punitive damages in fraud claims.
Section 74 of the Contract Act provides that if a sum is named in the contract as the amount to be paid in case of such a breach, or “if the contract contains any other stipulation by way of penalty”, the party complaining of the breach is entitled, whether or not actual damage or loss is proved to have been caused thereby, to receive from the party who has broken the contract reasonable compensation not exceeding the amount so named or, as the case may be, the penalty stipulated for.
While the principle enshrined under Section 74 of the Contract Act allows any amount stipulated in the contract, even by way of penalty, to be granted as damages to a plaintiff, the Indian courts have diluted the principle under Section 74 to reasonable compensation only if it is a “genuine pre-estimate of damages” fixed by both parties and found to be such by the court. The courts have therefore held that the expression “whether or not actual damage or loss is proved to have been caused thereby” means that where it is possible to prove actual damage or loss, such proof is not dispensed with. It is only in cases where damage or loss is difficult or impossible to prove that the liquidated amount named in the contract, if a genuine pre-estimate of damage or loss, can be awarded without proving the actual loss. However, amounts stipulated in contracts in terrorem cannot be granted under Indian law. This principle therefore limits the scope of exemplary or punitive damages under the Contract Act.
It should be noted that the aforementioned principles may not be applicable, stricto sensu, in cases involving fraud as fraud unravels all and any contract obtained by fraud would make it voidable. In such cases, the principles under Section 65 of the Contract Act apply, which provide that any person who has received any advantage under such an agreement or contract is bound to restore it, or to make compensation for it to the person from whom he received it. The term “received any advantage” provides for restitution of an innocent party to a position as if he had not entered into such a contract. This allows any undue gain received under such a contract to be restituted to an innocent party. This principle has been further diluted by Indian courts to the effect that the primary aim of awarding compensation is not to penalise the defaulting party, but to put an innocent party in the same position as if it had not entered into such a contract. Therefore, where compensation can be determined based on principles of computing damages under the Contract Act, there may not be any need to award compensation by restitution.
It may be noted that provisions relating to disgorgement of unlawful gains typically obtained through wrongful means (which is inclusive of fraud) have been introduced in the Securities and Exchange Board of India Act, 1992 (“the SEBI Act”) and have been subsequently introduced vide Section 212(14A) of the Companies Act, which came into effect from August 15 2019. As stated in 3.3 Shareholders’ Claims against Fraudulent Directors, the Companies Act already allows for initiation of proceedings and the relief of freezing assets and disgorgement of property as disgorgement is a civil action in the nature of an equitable relief, and not a penal action. Therefore, the SFIO would also be bound by the same principle for disgorgement.
Similar principles have also been accepted by the Securities Appellate Tribunal to direct disgorgement under the SEBI Act. It was noted that a repayment of ill-gotten gains that is imposed on wrongdoers is a monetary equitable remedy that is designed to prevent a wrongdoer from unjustly enriching himself as a result of his illegal conduct, and is not a punishment. Therefore, the principle applied under the statutes is caveated by the fact that the disgorgement has to be limited to the unlawful gains obtained and should never exceed them.
It is now a settled principle that disgorgement of ill-gotten proceeds can be directed under various expropriatory statutes, however, this is limited to attachment/confiscation of property to the extent of monies that have been appropriated illegally. These provisions therefore do not allow for exemplary damages for illicit acts committed by a party.
7.2 Laws to Protect “Banking Secrecy”
Indian law statutorily imposes the duty of fidelity, confidentiality and secrecy upon various intermediaries such as banks, public financial institutions, and credit information companies. However, these obligations are subject to certain exceptions. The obligation to maintain secrecy, fidelity and confidentiality is cast upon banks under the Banking Regulation Act, 1949 (Section 34A), public financial institutions through the Public Financial Institutions (Obligation as to Fidelity and Secrecy) Act, 1983, credit information companies through the Credit Information Companies (Regulation) Act, 2005 and on intermediaries processing payments under the Payment and Settlement Systems Act, 2007. These obligations are punishable through various regulatory, monetary and criminal sanctions. The Bankers’ Book Evidence Act, 1891 also protects any banker from being compelled to produce any bankers’ book, and appear as a witness to prove the matters, transactions and accounts recorded in such books unless specifically mandated by the court for a special cause.
Furthermore, the Indian Information Technology Act, 2000 also recognises financial information to be sensitive personal data or information, ie, “financial information such as a bank account or credit card or debit card or other payment instrument detail” and prohibits any disclosure of the same unless it is personally consented to by the entity/person to whom it belongs, or without consent when sought by investigating agencies in accordance with the law. Last, the Companies Act also provides for a safeguard against disclosure of third-party sensitive financial information, in case such information is sought from bankers of any company under investigation (other than the information of the company itself).
While the right to banking secrecy has been recognised, as indicated, this is not absolute. It is possible under law to compel a bank through summons and processes issued in accordance with the law to disclose such information as it has in its possession. This right is clearly recognised in favour of investigating agencies, either through periodic reporting requirements such as those under the PMLA, or through a specific power to issue summons for disclosure of information vested with various authorities, such as the police, income tax authorities, ED, customs authorities, etc, who have been given power to compel a person to provide his books of accounts, or face penalty for non-compliance as specified under various statutes such as the Income Tax Act, 1961, the Foreign Exchange Management Act, 1999, the Customs Act, 1962, and the CrPC. In addition to this, the police, income tax authorities, ED, custom authorities, etc, have the power to search for and seize documents from banks in the course of their investigation. Lastly, banks and intermediaries are also subject to a limited disclosure under the Right to Information Act, 2005 in the case where information held by them qualifies as public information.
There is no legislation in India that specifically prohibits dealing with crypto-assets. In fact, the Government of India (GOI) has contemplated a specific bill dealing with crypto-assets, though this has not materialised into substantive legislation. The Finance Act, 2022 (“the Finance Act”) has for the first time recognised taxation of certain virtual digital assets as a basis to recognise the income generated from such virtual digital assets. However, this has not legitimised virtual digital assets expressly. The Finance Act has specifically referred to crypto-assets as “virtual digital assets” for the purposes of taxing any income from such assets at 30% and every transaction involving such “virtual digital assets” at 1% tax deducted at source.
The Finance Act has introduced a new clause (47A) in Section 2 of the Income Tax Act to define a virtual digital asset as “any information or code or number or token (not being Indian currency or any foreign currency), generated through cryptographic means or otherwise, by whatever name called, providing a digital representation of value which is exchanged with or without consideration, with the promise or representation of having inherent value, or functions as a store of value or a unit of account and includes its use in any financial transaction or investment, but not limited to, investment schemes and can be transferred, stored or traded electronically. Non-fungible tokens and any other token of a similar nature are included in this definition.” The connotation used by the GOI, ie, “virtual digital assets”, seems to be in consonance with the terminology adopted by the Financial Action Task Force (FATF).
In fact, the Finance Act recognises that the introduction of any cryptocurrency can only happen as a result of the Central Bank, namely the Reserve Bank of India (RBI) which alone has the power to issue a Central Bank Digital Currency as defined under the Finance Act. In light of this, cryptocurrencies are not recognised as legal tender under Indian law and the Finance Act clearly identifies that the power to issue currency coins and notes rests only with the RBI.
The RBI has repeatedly cautioned parties from dealing with cryptocurrencies and had, vide a circular dated April 6 2018 (April 6 Circular), asked banks and entities regulated by the RBI not to allow use of the banking system for trade in crypto-assets. However, the Supreme Court of India, in Internet and Mobile Association of India v RBI, struck down the April 6 Circular. Therefore, banks are presently dealing with accounts which relate to entities/persons dealing with crypto-assets. However, the RBI, vide its circular dated May 31 2021, has also advised its regulated entities to continue to carry out customer due-diligence processes for transactions in “virtual digital assets”, in line with regulations governing standards for Know Your Customer, Anti-Money Laundering, Combating of Financing of Terrorism obligations under the PMLA.
In a recent response to a parliamentary question on the use of cryptocurrencies in money laundering, the Minister of State (Ministry of Finance) stated that the Directorate of Enforcement was investigating seven cases under the PMLA in which it was alleged that crypto-assets were used to launder money. It was also revealed that monies worth INR135 Crores (INR1.35 billion) have been attached by the Directorate of Enforcement under the PMLA in such investigations.
In response to another parliamentary question in March 2022 on regulation of cryptocurrencies in India, the Minister of State (Ministry of Finance) stated that the RBI had issued various public notices on December 24 2013, February 1 2017, and December 5 2017 that dealing in “virtual digital assets” is associated with potential economic, financial, operational, legal, customer protection and security-related risks. Further, it was clarified that cryptocurrencies are unregulated in India and that the legal framework for the sector may be finalised only after all aspects are carefully examined in consultation with the stakeholders concerned.
It was also disclosed in response to another parliamentary question by the Minister of State (Ministry of Finance) that few cases of evasion of the Goods and Services Tax (GST) by cryptocurrency exchanges have been detected by the GOI. This demonstrates the following:
- the GOI is tracking the crypto-exchanges for evasion of tax and is increasingly regulating this space;
- the GOI considers transactions relating to crypto-assets as taxable, either as transactions of “goods”, or such exchanges to be providing “services”, and it is not clear as to how the tax regime is classifying this; and
- the GOI is taking steps to initiate recovery from crypto-exchanges and is increasingly monitoring and investigating intermediaries in this space as well.
Since these are ongoing investigations, not much information is available on this, and it is unclear as to the modus operandi of such attachment and whether the same attaches the crypto-asset in any digital form, whether digital wallets are being attached, or whether property/monies equivalent to the value of such crypto-assets have been attached. In a recent order by the Supreme Court, an accused was directed to provide details of his digital wallet to the Directorate of Enforcement.
This nuanced area is becoming a topic of debate, as by their very nature “asset tracing” of crypto-assets provides a challenge. “Blockchain” technology does not allow complete asset tracing and, as recognised by the Supreme Court of India, every crypto-asset differs in nature, whether it is anonymous or pseudo-anonymous, and regarding what will be the impact of attachment or confiscation of such property considering that a public ledger does not allow change of ownership in a traditional way.