Definition of “Fraud” under the Companies Act: A case of a blurred signpost to criminality

“When I use a word,” Humpty Dumpty said, in rather a scornful tone, “it means just what I choose it to mean—neither more nor less.”

“The question is,” said Alice, “whether you can make words mean so many different things.”

“The question is,” said Humpty Dumpty, “which is to be master—that’s all.”

Who is the master of them all? The written letter of the law, or the subjective whim of an investigator?

This is the question that Section 447 of the Companies Act (CA, 2013) poses.

Section 447 makes fraud a penal offence. Prior to introduction of Section 447, provisions under the Penal Code, 1860 (IPC) such as Sections 406, 420, 465, 477-A, etc. would normally be pressed into action in such cases. But, given the complex nature of corporate frauds, their sheer impact, and the heightened need to investigate and punish them more effectively, the need for a special provision was felt.

This is the genesis of Section 447 of the CA, 2013. So far so good.

The definition of “fraud” under CA, 2013, however, leaves a lot to be desired. In fact, it is a definition that fails to define. Let us see how.  Section 447 reads:

447. Punishment for fraud.—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 per cent 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: 

Interestingly, the section itself does not define what fraud is. This is what takes us to the Explanation.

Explanation.—For the purposes of this section—

(i) “fraud” in relation to affairs of a company or any body corporate, includes any act, omission, concealment of any fact or abuse of position committed by any person or any other person with the connivance in any manner, with intent to deceive, to gain undue advantage from, or to injure the interests of, the company or its shareholders or its creditors or any other person, whether or not there is any wrongful gain or wrongful loss;

On a mere glance, two things immediately stand out:

1. There is no definition of fraud in the main provision. It is the Explanation to the section that seeks to define what fraud is. The definition in the Explanation is – and wait for it – an inclusive one. It is merely illustrative. Simply put, this means that the section does not define fraud exhaustively and there can be other acts which may qualify as “fraud”, over and above those stated in the section.
2. Finally, the last part of the section which renders culpable the act of injuring of the “interests” of “any other person” is simply too wide.

Let us unpack each of the above briefly:

First things first, the definition comes out of the Explanation and not the section itself. There is substantial jurisprudence on the purpose of an “Explanation” to a provision. An Explanation is supposed to clarify. But here the Explanation does just the opposite. It obfuscates. It does illustrate what would qualify as “fraud” but leaves the door wide open. Put differently, it says “x, y, and z” would be fraud, but, wait a minute, there may be other things that may qualify as “fraud”  too. Now, this is where the problem lies.  Who decides what those other things may be? The investigator? And that too post facto. This is not how criminal laws are supposed to work.

The provision is astonishingly open ended, and in my humble opinion, unconstitutionally vague. It is an established legal position that there cannot be blurred signposts to criminality. There is a constitutional requirement that a criminal statute be precise, specific, and unambiguous. The idea being that a citizen cannot be kept guessing about what is criminal and what is not and should be able to understand as to what exactly constitutes a crime. Criminal laws which do not explicitly and definitively state which conduct/omission attracts criminal sanctions – may be challenged on the ground of being void for vagueness. This is because vague statutes can lead to arbitrary and discriminatory prosecutions and concentrate too much power in the hands of the investigators.

A definition such as the one for fraud that we saw above would leave the investigators with way too much latitude to, mean what they mean out of the term. Such breadth may lead to over-criminalisation and abuse.

In Skilling v. United States1, it was held that:

… a penal statute [must] define the criminal offense (1) with sufficient definiteness that ordinary people can understand what conduct is prohibited; and (2) in a manner that does not encourage arbitrary and discriminatory enforcement.

Closer to home, in Shreya Singhal v. Union of India2, the infamous Section 66-A IT Act was struck down for over-breadth and held to be unconstitutionally vague.  Similarly, in State of M.P. Baldeo Prasad3, the Court struck down a law criminalising “goondas” on the basis that it did not really define who a “goonda” was. In this case, the definition of a goonda laid down by the Central Provinces and Berar Goondas Act, 1946, was of an inclusive character, and indicated no definitive tests for deciding whether the person was a “goonda” or not.

Section 447 of the CA, 2013 suffers from a similar anomaly.

The way it is worded and the kind of discretion it gives an investigator reminds one – of what Bentham calls – dog law:

“Just as a man makes laws for his dog. When your dog does anything you want to break him of, you wait till he does it, and then beat him for it. This is the way you make laws for your dog….” 

This cannot be the way laws are made for men, especially in a jurisprudence governed by the rule of law, and not the rule of men. And, for greater reason, when personal liberty is at stake.

 The vagueness of what “fraud” is under Section 447 of the Act is further compounded by the use of expressions such as: acts/omissions injuring the “interests” of “any other person”. Now what are these “interests” and who all can fall within the scope of the expression “any other person” are left to the investigator, and then – the court. The inclusive nature of the definition and both these expressions are capable of too wide a meaning, and add to the vagueness of the section, and possibility of abuse.

Conclusion

Given the above, there is a need to either read down, or statutorily amend Section 447 of CA, 2013 and tailor it narrowly – and with precision and clarity. In the present shape, the section is unconstitutionally vague, subjective, open ended and prone to misuse and over-criminalisation. In our enthusiasm to check the scourge of white-collar crime and corporate frauds, we must not cut corners with fairness and due process. A just, fair and reasonable criminal justice system mandates clear signposts to criminality. In other words, what we need is: the rule of law, and not the rule of the investigator.

† Former Judge and Independent Counsel, e-mail contact@bharatchugh.in.

1 2010 SCC OnLine US SC 82 : 177 L Ed 2d 619 : 561 US 358, 402-403 (2010).

2 (2015) 5 SCC 1.

3 AIR 1961 SC 293.