A framework of fear

The risk of roping in bank officials whenever there is a fraud at the borrower's end is a stringent deterrent to bank officials taking credit decisions

A very vital declaration of the law by the Supreme Court earlier this month provides much-needed relief to senior bank officials, who ran the risk of being thrown under the bus in the course of investigations into the affairs of companies to whom the bank had lent money.  

Section 339 of the Companies Act, 2013 entails personally holding responsible persons who were “knowingly parties to the carrying on of the business” of the company with an intent to defraud creditors of the company without any limitation of liability, for all or any of the debts or other liabilities of the company. The check and balance against this extreme power is that such a decision can only be taken by the National Company Law Tribunal. If this power is invoked and the Tribunal declares any person to be covered by this provision, directions may be issued to “make provision” for securing the liability.

In the Nirav Modi case, this power came to be used in proceedings relating to the borrower, that is, the company promoted by Nirav Modi (not proceedings relating to the bank). The Ministry of Corporate Affairs invoked the oppression and mismanagement jurisdiction in public interest, and in the course of those proceedings, the assets of the Chairman of Punjab National Bank (chair for the period of a year and nine months) were attached. The National Company Law Appellate Tribunal too agreed that the assets of the chairman of the lender too could be attached using such power. All that the individual could have access to was cash withdrawal of Rs 1 lakh per month for living expenses. The basis of doing so was that the Central Bureau of Investigation (CBI) had included the chairman as an accused when it initiated criminal prosecution of bank officials for alleged omission of putting in place checks and balances in the conduct of the affairs of the bank.  

The Supreme Court has made it clear that the reach and scope of the wide power in Section 339 is to secure the interests of the company in which the alleged mismanagement has taken place. The conduct of business referred to in the provision is the business of the company in question and not the business of other companies and other persons. “It is clear that powers under these sections cannot possibly be utilised in order that a person who may be the head of some other organisation be roped in, and his or her assets be attached,” the Supreme Court has ruled.  

The risk of roping in bank officials whenever there is a fraud at the borrower’s end is in itself a stringent deterrent to bank officials taking credit decisions. While it would be tough to attribute with precision how much of the absence of credit expansion is attributable to fear of bank officials and how much is attributable the conditions of the economy, the fact is that bank officials dread the midnight knock on their doors for loan decisions that were taken by them to provide credit to lenders, who are discovered to have committed fraud. The use of powers under Section 339 of the Companies Act was a new feature that got added to this framework of fear in which bank officials would operate. In the case at hand, the person involved was chairman for a period shy of two years, with the banking relationship already being in existence.  
 

The CBI could well probe whether there was any criminality and would eventually have to deal with evidence in a criminal trial. However, the role of the perpetrator and victim cannot be interchangeable. When a bank is defrauded by a borrower company, the company would most likely also be mismanaged. In the fraud on the bank, the borrower is the perpetrator and the bank is the victim. In mismanagement of a company, it would not follow that the bank officials are defrauding the company and have taken money out of the company. The victim cannot become the perpetrator for those proceedings. When a fraud is discovered, and that too a large one, there is a lot of noise that emerges, which can lead to the logical reasoning from the words in the law being drowned out. The CBI probe would stand or fall on merits but for all assets to be held hostage as a perpetrator of fraud on the borrower company was a severe deterrent to normal functioning by bank officials. Thankfully, the Supreme Court has spoken.

The author is an advocate and an independent counsel. Tweets @SomasekharS