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FRAUD AND CORPORATE GOVERNANCE : UNFOLDING THE SCANDALS WITH SPECIFIC REFERENCE TO DEVAS-ANTRIX CASE (By-Tushti Ratnapriya Thakur)
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FRAUD AND CORPORATE GOVERNANCE : UNFOLDING THE SCANDALS
WITH SPECIFIC REFERENCE TO DEVAS-ANTRIX CASE
Authored
By-Tushti Ratnapriya Thakur ( A3256120108)
Amity Law
School, Noida
LLB 3
YEARS, 2020-23
Abstract
If one wished to unearth the ground
stone of all legislation, beneath all considerations one may find that there
are three elements which are of paramount importance and hence take precedence
over every other statutory consideration, they are : firstly, mens rea or in
simpler terms the intention behind an action, secondly, national security
interests and thirdly, welfare of the citizens of a nation. The Devas-Antrix
deal challenges all three of these aspects by posing a threat to the nation's
income set-up and simultaneously breaching the boundaries of the nation's
security interest. This note discusses at length the implications that deals
such as Devas-Antrix, which are of such vast magnitude have when it clashes
with the government's armour, its resultant effect on corporate governance and
whether it initiates a need for a pragmatic approach in the Indian sea of
corporate governance. This discussion is initiated by tracing the trajectory of
the series of corporate scandals and frauds that resulted in the dissolution of
the corporations in question, followed by an analysis of the impact such frauds
have on the system of corporate governance. The conclusion focuses on the need
for more stringent laws and their observation to regulate the operations of
these firms so that they are in consonance with the public interests.
Introduction : What Is The Key To
Effective Corporate Governance?
Before dwelling into the aftermath of
the Devas-Antrix deal, its important to underline the meaning of corporate
governance and what it means in the economic and legal set up of any country.
To put simply, every organisation that comes into existence needs a set of
rules that are needed for its functioning and defining the limits of its
operations. To forumlate an analogy, corporate governance can be defined as a
set of rules that guide the operations of a corporation which is akin to the
way the brain sends signals to different parts of the body through the nervous
system for proper allocated working, where each organ has a unique and
distinctive function from the other. The brain in this case is formed by the
array of shareholders who have financial stakes in the growth of the company,
while the board of directors of the company form the nervous system through
which the management and supervision of the organs of the body, that is, the
executives is regulated, who are thereupon charged with the ground operations
and management of the day-to-day activities of their corporations. Another way of understanding the concept of corporate
governance can be by seeing it not as body of rules but rather as a dialogue of
exchange where power flows from one channel to another, starting with the
shareholders of the company that provide funds without which the company cannot
exist to begin with and thereby contribute by electing a supervisory body known
as the "board of directors" who further delegate their work upon the
executives by breaking it down into simpler pieces.
Just as there are three primary
elements that guide as legislative intent - mens rea, social welfare and
national security interests, there are three central principles of corporate
governance :
- Supremacy of Shareholders of the
corporation
- Security of interest holders of
the corporation
- Community participation and transparency
in the operations of the company[1]
Elaboratively, these three principles
can be seen as the key constituents for good corporate governance. The first of
these principles, focuses on the pre-eminent role of those who purchase the
shares of the company, and hence partake in the assests and liabilities of that
particular corporation. Financial stability is a prerequisite for the
forumlation of a company and as these shareholders part away with their capital
to utilize it for the functioning of the company, their voice in its operations
gains a fundamental superiority. These shareholders have an essentially
monetary interest in the growth of the company and hence voice their concerns
for the well being of the company both directly and indirectly. The former is
done through selecting the body of representatives who would compromise the
board of directors and the latter is achieved by initiating a conversation with
those outside the company who are nevertheless impacted by its existence,
therefore connecting the first and the last principle inevitably. For effective
engagement in the way a company functions and to regulate its impact on the
public of the nation, transparency in the rules and regulations of company is
required. This transparency is further linked to the accountability of the
company foremostly, to their shareholders and secondly, to those who buy the
services of the company, this is assured by insuring the security of the data
of these investors and consumers and preventing it against any fraudulent
activities and breach. Any leaks in the private data and trade secrets of the
corporation does not only negative impact the interests of those who have a
stake in the company, but it also impacts the reputation of the company in the
market and compromises its position in the eyes of the public who are potential
consumers of its services.
Bad Corporate Governance: Scandal
Stories Around The Globe
An analysis of these principles takes
us to the next question - what if these principles are comprised? An easy
answer would be that jeopardizing such essential features would lead to bad or
inefficient corporate governance. As mentioned before, accountability of a
corporation to its shareholders and the general public is ensured by the
transparency in its operations, an important aspect of which is maintaining
true accounts of the company's finances and reporting them correctly to the
shareholders. When a company fails to abide by these principles, it could
result in not only huge fiscal losses to its contributors but also its
liquidation. It's important to look at examples of bad corporate governance
that exist beyond the territorial boundaries of India as well as those that are
rooted inside the country to gain a more holistic and drone like view of the
implications of failing to achieve
these three principles.
Two of the most momentous scandals
that can be located internationally involves the fallacy in making the true
accounts of the company known to the shareholders by the United States based
giants - Encron, a Texas based energy, commodities, and services company and
Waste Management Inc. which as the name suggests deals in waste management
services. In the Encron scandal the executives of the company utilized
loopholes in the system of accounting to hide the debt of the company by
overstating the capital inflow from the assests of the company to the
Securities and Exchange Commission (SEC).[2]
The losses suffered by the company were hidden by the top executives of the
company including the CEO Jeff Skilling by bringing into existence a number of
shell companies which were to be utilised for primitive method cost accounting
making it difficult to to trace the transactions to Enron Corporation.
Therefore, while the company suffered huge financial losses the numbers
reported to the shareholders by the board of directors manifested an altogether
different reality. However, when the scandal surfaced in front of the public
and the true accounts of the company became known, it culminated in the company
being declared bankrupt with executives charged with numerous felonies and a
loss to the shareholders much beyond the company was in a position to
compensate. This not only hurt the shareholders but also the other employees of
the company as it made their pension funds redundant.
The second scandal, that is, the 1998
Waste Management Scandal, was of similar magnitude where the scale of the fake
reporting of accounts amounted to nearly 2 billion dollars, 1.7 billion to be
exact. Similar to the Encron scam, this accounting fraud also comprised of the
involvement of its CEO, Dean L Buntrock in addition the five top tier
executives of the corporation. In terms of capital losses suffered by the
investors, this scandal is marked as one the biggest corporate frauds in the
history, defrauding the stakeholders of a hefty amount of 6 billion dollars
which was initiated through the fall in the share prices of the company as the
fraud came into light. In an action against the company and the six officials
involved in the scam which was filed by the shareholders, the company was
declared by the Court to be liable to compensate the shareholders with an
amount of 457 million dollars cumulatively.[3]
Within the domestic boundaries, a
scandal which becomes a imperative part of the discuss is the Satyam Computer
Services scandal, which was until the last decade India's largest fraud in the
corporate scandal. Much like its counterparts in the United States, this fraud
also involved showcasing non-existent profits by the company which inflated its
prices in the share market. This scandal involved the founder and the board of
directors of the company who stole the companies funds to invest into several
properties located in the Indian state of Hyderabad. The fraud was discovered
through a confession by Byrraju Ramalinga Raju, the chairman of the corporation
which was preceded by the collapse of the property market in Hyderabad. The
downfall of India's fourth largest exporter in softwares also witnessed an
eight year ban of the company from contracting and conducting business with the
World Bank. The Indian arm of the auditors of the corporation,
PricewaterhouseCoopers (PWC) were also bye the US Securities and Exchange
Commission (SEC) for non-observance of proper code of conduct and failing to
conform to the required standards of auditing.
Corporate scandals are also not
unknown to the corporations having its functioning above the solid grounds of
the nation, that is, the corporations in the airline industry. The first of
these scandals was the infamous Kingfisher Airlines scam, where the company
made its funds redundant by taking out huge loans from banks and other
financial institutions against the guarantee of its financial value, which
turned out to be grossly overestimated. An estimate of 1600 crores was taken
out as a loan from State Bank of India alone, followed by other banks namely -
IDBI Bank (800 crores), Punjab National Bank (800 crores), Bank of India (650
crores), Bank of Baroda (550 crores), United Bank of India (430 crores),
Central Bank (410 crores), UCO Bank (320 crores), Corporation Bank (310
crores), State Bank of Mysore (150 crores), Indian Overseas Bank (140 crores),
Federal Bank (90 crores), Punjab & Sind Bank (60 crores), Axis Bank (50
crores) and three other banks (603 crores) - amounting to a total of 6963
crores.[4] The scam
thus severely threatened the fiscal condition of the banking sector of the
country and resulted in loss of jobs of the employees of the companies and a
correlative impact on the owner Vijay Mallya's subsidiary liquor business from
the same name. This scandal, however, while being one of its kind, was not the
only scandal in this industry as Jet Airways stepped in the shoes of the
Kingfisher Airlines in the years that followed thereafter.[5]
An illustration of these cases is
indicative of the fact that at the heart of all scandals is the involvement of
the top personnel of the company and the party most affected party is the group
of shareholders who have stakes in the company. Therefore, the risk and reward
in share trading is severely high, while the shareholders stand to gain
colossal margins of profit from the purchase of shares of growing firms, in
cases of inflated share prices they are also hit the hardest and some have to
compromise with their life savings as well.
Antrix-Devas Deal : An Attempt At
Innovation Or Fraud?
When a deal impacts the finances of
the State to such an extent that it alarms the Ministry of Finance, its
relevance to the current economic environment becomes prima facie evident.
Antrix-Devas is best categorised as a heated and over a decade long battle
between the machinery of the State and a Bengaluru based start-up company
called Devas Multimedia. Rewinding to the year 2005, a deal was signed between
Devas Multimedia and the commercial arm of the Indian Space Research
Organisation (ISRO) for the allotment of S-band satellite spectrum with such
high frequency which is otherwise made available solely for and essential to
national security purposes. Consequently, six years following this arrangement
between the then officials of Antrix and Devas Multimedia, the deal was
cancelled on grounds that the company gaining access to 70 MHz of S-band
satellite spectrum, a service reserved for the maintaining the "nation's
security interests" is driven by fraudulent and malicious intent as it
very evidently goes against the considerations of national security interests,
a provision that is often seen as a ground that overrides all over
considerations in the eyes of the law and is envisaged as such by the
constitution of India itself. According to reports, this deal also indicated
signs of being a "quid pro quo" entered into by the startup for
selling multimedia services to mobile service providers in the country and came
into light concurrently along with the disclosing of the 2G scam by the
Comptroller-Auditor General (CAG) of India in front of the Parliament.[6]
This legal tussle between the
Government of India and Devas transgressed the boundaries of the nation and was
litigated internationally as well. While within the confines of the nation the
Apex Court of India upheld the findings of NCLT (National Company Law Tribunal)
and its appellate
body NCLAT (National Company Law
Appellate Tribunal), internationally the tides were not in favour of India.
Devas Multimedia initiated arbitration in the International Chambers of
Commerce (ICC) in addition to two other arbitrations initiated simultaneously
by a German company named Deutsche Telekom and by the Mauritius based investors
of Devas under the Bilateral Treaty signed between the countries of Mauritius
and India. Taking a hit at all three of these arbitrations, the Indian
government was ordered to pay a total of 1.29 billion dollars in the way of
damages to Devas for cancellation of the deal. Commenting on this situation,
the Finance Minister of India Nirmala Sitharaman called out the UPA government
during whose reign this controversial deal was finalized. It was asserted that
the government was bound on litigating this matter to victory lest all of the
taxpayers' good money would go towards settlement of these international
arbitration awards in favour of Devas.
Winding Up Operations : Is Fraud A
Ground?
Winding up operations with relation
to corporations connote the liquidation of that particular organisation which
implies that all its affairs including operations would be brought to an end.
The liquidation of a corporation is set in motion based on three basic
considerations : firstly, the insolvency of that firm, secondly, the
corporation has become redundant in its functionality and is no longer needed
and thirdly, its existence is prejudicial to the interests of the public.[7] Winding up
can be both voluntary and involuntary, depending upon the will of the company
behind such decisions. In cases of voluntary winding up, the process is
kick-started through a resolution passed by the shareholders of the company in
order to escape bankruptcy and possible consequent individual liability to pay
off the debts of the company. The latter
case of liquidation is one insinuated through a compulsory order of the court,
similar as in the case of the Devas-Antrix deal. Such a compulsory winding up
process is to be followed up with the appointment of a liquidator charged with
the management of the assets of the company to set off its liability to
creditors.
In the context of the Devas-Antrix
case, where the Supreme Court sided with the NCLT and NCLAT in their concurrent
findings and analysis that it was right to order the liquidation of the company
based on evidence which was mined by the top investigation agencies, namely
Central
Bureau of Investigation and the
Enforcement Directorate of India, laying conclusive proof of fraud in the
execution of agreement, it therefore becomes imperative to analyse whether
fraud amounts to a just ground for winding up a company and if yes, then what
other considerations may be applied for such compulsory actions. A company may
be subjected to compulsory winding up based on the following plausible grounds
as provided by the Companies Act, 2013 and the Insolvency and Bankruptcy Code,
2016 :
- The first ground is when the
corporation's debts exceed their assets tremendously which makes the
company incapable of paying off its creditors to satisfy its debts to them
- The second ground is technical
and establishes that for a company to be recognised, it is mandatory for
it to commence business within a year of its incorporation, otherwise it
would be subjected to compulsory winding up.
- The third ground similarly
mandates that all requirements for the legal existence of a corporation
must be met, including the provision for having a minimum number of members
in the company.
- The fourth ground embraces the
importance of the stakeholders in a company and provides for winding up by
a special resolution where the process is initiated by the votes of 75%
shareholders of the company who deem that the company's existence must
come to an end.
- The fifth ground deals with the
misappropriation of funds by the board of directors who are responsible
for the supervision over the operations of the company.
- The sixth and the most important
ground in context of the discussion is one which provides for the
liquidation of the company on account that it was formed with a fraudulent
intent or for the conduct of fraudulent activities that can harm public
interest.
The sixth ground needs to be
elaborated while referencing the Supreme Court's stance or judgement in the
Devas-Antrix case.
Supreme Court's Take : An Analysis
The infamous instance of a
joint-venture between Antrix, ISRO’s commercial arm, and Forge Advisors LLC
that culminated in a ten year litigation battle in the case of Devas Multimedia
Private Limited vs. Antrix Corporation Limited[8]
is of utmost relevance with respect to corporate governance and how fraud
impacts it thereby putting the stakeholders in a compromising position of
fiscal and other losses that accompany it. The Supreme Court judgement was in
reference to an appeal filed by Devas against the observations of NCLT, which
were later confirmed by NCLAT and answered questions related to the importance
of fraud as a ground for compulsory winding up, the role of auditors in
preventing corporate frauds and whether the absence of fraud discovered by
these audit reports over the years estopped Antrix from withdrawing from the
deal.
It was with the introduction of
Section 271(c) of the Companies Act, 2013 that fraud was recognised as a valid
ground for initiating winding up operations against a corporation. Public
policy considerations matched by the regulations of the New York Convention
were the primary forces behind the addition of fraud as a legitimate ground for
the compulsory liquidation of a company. However, in relation to international
arbitrations the Supreme Court judgement falls short as it cannot prevent
rulings against the State by other countries which are invested with
discretionary powers for the endorsement of their separate orders by virtue of
Article V of the New York Convention.
The Top Court judgement becomes
significantly relevant to the diaspora of laws that govern the corporate world
in relation to its observations about the role of auditors in investigating
frauds with diligence. It was argued by the Court that Antrix cannot be
estopped from filing of the case against the deal solely on the grounds that
the auditors failed in reporting the connivance between the then officials of
Antrix and Devas timely. The Court pointed out that while it is the duty of the
auditors to prepare the report to the best of their ability, “the auditor’s
report can neither be taken as gospel truth nor act as estoppel against the
company”. This judgement, thus, in
contradiction to the previous judicial precedents that make it the ceremonial
duty of the auditor to act as watchdogs and protect the shareholders of the
company as established in the cases of Institute of Chartered Accountants vs
P.K. Mukherjee[9] and
Hindustan Lever Employees’ Union vs Hindustan
Lever Ltd[10],
functions to make the value of audit reports flaccid as evidence in the court
of law.
Conclusion And Recommendations
It is evident from the study of the
various cases of corporate fraud that firstly, on a micro level these instances
severely impact the trust of shareholders in the company causing them
irreparable monetary damage and secondly, on a macro level are a huge hit to
the nation's financial stability. It is important that the laws that govern
business transactions that are in numbers beyond the imagination of the common
man are more stringent and make the auditors and those who are charged with
maintaining the legality of these ventures more accountable to the public.
Further, in addition to monetary compensations the criminal remedies available
in such cases should be more strictly observed against the conspiring
individuals to act as a deterrent and prevent such instances in the future.
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Article Information
FRAUD AND CORPORATE GOVERNANCE : UNFOLDING THE SCANDALS WITH SPECIFIC REFERENCE TO DEVAS-ANTRIX CASE (By-Tushti Ratnapriya Thakur)
Authors: Tushti Ratnapriya Thakur
- Journal IJLRA
- ISSN 2582-6433
- Published 2022/08/23
- Volume 2
- Issue 7
About Journal
International Journal for Legal Research and Analysis
- Abbreviation IJLRA
- ISSN 2582-6433
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