- Introduction
Corporate fraud has increased globally, especially in recent years due to economic and geopolitical challenges. In the UK, PwC’s Global Economic Crime Survey (2022) revealed that 64% of businesses had experienced fraud or financial crimes in the previous two years, up from 56% in 2020. In India, the 2023 LexisNexis True Cost of Fraud Study reported a 54% increase in corporate fraud. Corporate fraud encompasses embezzlement, financial misrepresentation, and corruption, causing financial loss, reputational harm, and in extreme cases insolvency (e.g., WireCard and FTX).
An increasing amount of corporate fraud is internal, perpetrated by employees or those in control of the company. To combat this, derivative actions allow shareholders to protect company interests when harmed by those in control. This article explores how corporate fraud is addressed in England and India.
- Derivative Actions in England & Wales
In England and Wales, derivative actions are allowed under both statutory and common law, but the Companies Act 2006 (Part 11) tends to govern most claims. Shareholders can file derivative actions on behalf of the company, primarily against directors involved in fraudulent activities.
Procedural Requirements
To proceed with a derivative action, the shareholder needs must obtain the Court’s permission, which is obtained through a two-stage process:
- First Stage: is conducted on ex parte basis. The Court examines whether the shareholder has a prima facie case, ensuring the company has been wronged. This is a high hurdle to overcome. The shareholder must demonstrate that the action benefits the company and is not motivated by improper intentions.
- Second Stage: If the case passes the first stage, the defendant directors are notified and can respond at a full hearing. The Court evaluates the merits of the case, the shareholder’s good faith, and whether alternative remedies, like an unfair prejudice petition (Section 994 of the Act), are available.
Overseas companies
In Durnont Enterprises Ltd v Fazita Investment Ltd [2024] EWCA Civ 299, the Court allowed a derivative action to proceed against a foreign company because there was a significant connection to England but refused to allow claims against certain overseas defendants due to insufficient prima facie evidence. This case highlights the high threshold for pursuing derivative actions and the importance of establishing causation, not just wrongdoing.
Remedies for corporate fraud in England
The primary goal of derivative actions is to address the wrongs committed against the company, not the shareholder. Remedies can include:
- Orders for an account of profits or the return of assets
- Damages and equitable compensation
- Rescission or restitution
- Injunctions to stop further misconduct by directors
- In extreme cases, the court may appoint a receiver to manage the company’s assets and operations temporarily.
The court can also order the wrongdoers or the company to cover the legal costs of the shareholder pursuing the action.
The Directors liability
Criminal charges can also be brought against fraudster directors and if found guilty, they can be fined, and in the most serious cases imprisoned. Directors can also have their criminal gains confiscated by the police, and be disqualified from acting as a director for a set period of time (which could be years)
- Corporate Fraud and Remedies in India
The Companies Act, 2013 (ICA) provides the key provisions to address corporate fraud in India.
Fraud Under the ICA and Its Consequences
The ICA offers both civil and criminal remedies for corporate fraud. Section 447 defines fraud broadly, covering any act, omission, or concealment done to deceive, gain undue advantage, or harm a company’s stakeholders. Punishments for fraud can include imprisonment of up to 10 years and fines of up to three times the amount involved. Fraud can relate to several corporate activities, such as during incorporation, inviting investments, auditing, conducting business, or winding up.
Civil consequences for fraud under the ICA include:
- Unlimited personal liability: Directors or officers involved in fraudulent activities may be held personally liable for the company’s debts (Section 339).
- Disgorgement: Offenders may be required to repay or restore any misappropriated company assets (Section 340).
Detection and Investigation of Fraud
The ICA dedicates a chapter (Chapter XIV) to inspections, inquiries, and investigations into company affairs, potentially leading to the consequences mentioned above:
- Inspections and inquiries: The Registrar of Companies conducts these based on company documents or information received (Section 206).
- Investigations: Conducted by the Central Government, investigations can be based on a Registrar’s report, a company resolution, or in the public interest (Section 210). Minority shareholders may also apply for investigations through the National Company Law Tribunal (NCLT) under Section 213.
The Serious Fraud Investigation Office (SFIO) is empowered to handle cases referred by the Central Government (Section 212). The SFIO has broad investigative powers, including search, seizure, and arrests.
Remedies for Minority Shareholders
Minority shareholders have several avenues for redress under the ICA, either before or after an investigation under Section 213. Shareholders can seek orders if the company’s affairs are conducted in a manner that is oppressive or prejudicial to their interests (Section 241). The NCLT has wide discretion to issue remedies, including granting injunctions, removing directors and recovering undue gains.
Recent rulings have recognised Section 241 as enabling derivative actions (ICP Investments (Mauritius) Ltd. v. Uppal Housing Pvt. Ltd. and Ors. (2019)) and emphasised that the NCLT has exclusive jurisdiction over such matters (Section 430) (SAS Hospitality Pvt Ltd v. Surya Constructions Pvt Ltd (2018)).
Parallel Criminal Proceedings
Despite the remedies under the ICA, minority shareholders often initiate parallel criminal proceedings. However, this may decrease due to two factors:
- Courts have ruled that parallel investigations by different agencies are not permitted once the SFIO has initiated an investigation (e.g., Ashish Bhalla v. State and Vijayraj Surana v. Central Bureau of Investigation).
- The threshold for fraud under the ICA is lower than criminal law, as it does not require proof of wrongful gain or loss.
IV Conclusion
The underlying purpose of both regimes is to protect the interests of the company, not the individual shareholder. The Courts in both jurisdictions play a crucial role in filtering out frivolous claims and ensuring that legitimate and well-founded actions proceed.
This article is co-authored by Lydia Danon, Partner and Tulsi Bhatia Associate, at Cooke Young & Keidan alongside Tushar Shankar Nagar, Associate, Ashish Joshi, Counsel and Daksh Ahluwalia, Founder & Principal of Aikyam Law Offices.
