Category: Article

“The entire Community is aggrieved if the economic offenders who ruin the economy of the State are not brought to books. A murder may be committed in the heat of moment upon passions being aroused. An economic offence is committed with cool calculation and deliberate design with an eye on personal profit regardless of the consequence to the Community. A disregard for the interest of the Community can be manifested only at the cost of forfeiting the trust and faith of the Community in the system to administer justice in an even handed manner without fear of criticism from the quarters which view white collar crimes with a permissive eye unmindful of the damage done to the National Economy and National Interest.”

– State of Gujarat v. Mohanlal Jitamalji Porwal & Ors. (1987) 2 SCC 364

The above quote of the Supreme Court (SC) may seem general – but it puts the importance given to economic offenses in context. In the never-ending game of cat and mouse, it is always the law enforcement that seems to play catch up with the offenders. The last decade has seen an increased focus on special laws with the aim of curbing economic offenses. These laws are special – they have special agencies with special powers for investigation, special courts for prosecution and special procedures – for specific offenses, all justified to prevent economic offenders from escaping punishment. However, some of the amendments brought about to these Acts have raised a peculiar problem that gives the public a cause for concern. Can I be punished for an act that was not an offence at the time of its commission? Can criminal liability be fastened upon me by a retrospective amendment? What repercussions does this have for the concept of mens rea?

The SC has examined two different Acts in two different judgments, both in 2022. Both these judgments are considered a landmark in their own field and the legislations that they consider are of particular interest to Chartered Accountants – The Prohibition of Benami Transactions Act,  1988 (the Benami Act) and the Prevention of Money Laundering Act, 2002 (the PMLA). The issue, however, is still live – very recently, the Bombay High Court issued notice on a petition that challenges what it considers the retrospective application of the Black Money (Undisclosed Foreign Income and Assets) and Imposition of Tax Act, 2015 and contends that this Act should not penalize transactions that were entered into before it came into force.

The words “retrospective” and “retroactive” have different meanings in law. However, often these terms work in tandem like in the two SC judgments covered in this article. The SC in the case of Vineeta Sharma v. Rakesh Sharma, 2020 (9) SCC 1, described the nature of prospective, retrospective, and retroactive laws as follows: “The prospective statute operates from the date of its enactment conferring new rights. The retrospective statute operates backwards and takes away or impairs vested rights acquired under existing laws. A retroactive statute is the one that does not operate retrospectively. It operates in futuro. However, its operation is based upon the character or status that arose earlier. Characteristic or event which happened in the past or requisites which had been drawn from antecedent events.”

Readers may read this article and interpret these terms accordingly.

A. THE PROHIBITION OF BENAMI TRANSACTIONS ACT, 1988

The Benami Act was one of those Acts that stood quietly on the sidelines waiting to fulfill its avowed objectives. In 2016, sweeping changes were made to the Act in line with the government’s objective to crack down on economic offences and undesirable practices. The Benami Act has been the subject of much debate and discussion especially as benami transactions in India are neither new nor rare. Traditional civil remedies were often exercised in those transactions that were benami in nature. The courts had dealt with various civil disputes with regard to benami properties. Though the Benami Act was brought out in order to prohibit benami transactions, it was widely considered toothless and was rarely invoked.

Post-2016 amendments, however, the Benami Act is looked upon as having the colour of being criminal legislation. This is primarily because though entering a benami transaction was prohibited even prior to 2016, the criminal provisions lacked teeth. In recent years a variety of legislations have been enacted for special purposes and these are an amalgam of both civil and criminal provisions. The name of the Benami Act is self-explanatory, it seeks prohibition of benami transactions. This is a clear indication that the Act does not exist merely to punish, its raison d’être is to prohibit them altogether. It cannot, however, be doubted that the amending Act brought in wide-ranging changes to the original Act.

The judgment of the SC in UOI v. Ganpati Dealcom Pvt. Ltd. (2023) 3 SCC 315 is a watershed moment for many reasons. The judgment reaffirms the basic principle of the criminal law of not imposing criminality retroactively. How can it be that an act that is not an offence at the time of its commission be considered an offence subsequently? While this may seem like common sense, the manner in which the SC  arrives at this conclusion while considering Sections 3 and 5 of the Benami Act warrants consideration.

What is a Benami Transaction?

Post the 2016 amendment, the definition of ‘benami transaction’ given in section 2(9) of the Benami Act is as follows:

“benami transaction” means,—

(A)    a transaction or an arrangement—

(a)    where a property is transferred to, or is held by, a person, and the consideration for such property has been provided, or paid by, another person; and

(b)    the property is held for the immediate or future benefit, direct or indirect, of the person who has provided the consideration,

except when the property is held by—

(i)    a Karta, or a member of a Hindu undivided family, as the case may be, and the property is held for his benefit or benefit of other members in the family and the consideration for such property has been provided or paid out of the known sources of the Hindu undivided family;

(ii)    a person standing in a fiduciary capacity for the benefit of another person towards whom he stands in such capacity and includes a trustee, executor, partner, director of a company, a depository or a participant as an agent of a depository under the Depositories Act, 1996 (22 of 1996) and any other person as may be notified by the Central Government for this purpose;

(iii)    any person being an individual in the name of his spouse or in the name of any child of such individual and the consideration for such property has been provided or paid out of the known sources of the individual;

(iv)    any person in the name of his brother or sister or lineal ascendant or descendant, where the names of brother or sister or lineal ascendant or descendent and the individual appear as joint-owners in any document, and the consideration for such property has been provided or paid out of the known sources of the individual; or

(B)    a transaction or an arrangement in respect of a property carried out or made in a fictitious name; or

(C)    a transaction or an arrangement in respect of a property where the owner of the property is not aware of, or, denies knowledge of, such ownership;

(D)    a transaction or an arrangement in respect of a property where the person providing the consideration is not traceable or is fictitious.

Explanation.—For the removal of doubts, it is hereby declared that benami transaction shall not include any transaction involving the allowing of possession of any property to be taken or retained in part performance of a contract referred to in section 53A of the Transfer of Property Act, 1882 (4 of 1882), if, under any law for the time being in force,—

(i)    consideration for such property has been provided by the person to whom possession of property has been allowed but the person who has granted possession thereof continues to hold ownership of such property;

(ii)    stamp duty on such transaction or arrangement has been paid; and

(iii)    the contract has been registered;”

What are the broad repercussions of entering into a Benami Transaction?

Chapter II of the Benami Act deals with the prohibitions of benami transactions. Section 3 and Section 5 deal with the repercussions of entering into a benami transaction as amended in 2016 while Sections 4 and 6 deal with certain consequences with regard to civil remedies. Section 5 is punitive in nature while Section 3(2) and 3(3) make entering into a benami transaction a criminal offense.

Sections 3 and 5 are reproduced below:

“Section 3 – Prohibition of benami transactions.

3. (1) No person shall enter into any benami transaction.

(2)    Whoever enters into any benami transaction shall be punishable with imprisonment for a term which may extend to three years or with fine or with both.

(3)    Whoever enters into any benami transaction on and after the date of commencement of the Benami Transactions (Prohibition) Amendment Act, 2016, shall, notwithstanding anything contained in sub-section (2), be punishable in accordance with the provisions contained in Chapter VII.

“Section 5 – Property held benami liable to confiscation.

5.    Any property, which is subject matter of benami transaction, shall be liable to be confiscated by the Central Government.”

The case for Retroactive Application

Though the amendments were carried out in 2016, the effect of the 2016 amendment Act to the Benami Act (amending Act) was that transactions that could be captured under the definition of ‘Benami Transaction’ entered into before the year 2016 were also liable for prosecution. The stand of the Union of India, in this case, was clear – the 2016 amendments, according to the Union of India, only clarified the unamended 1988 Act (unamended Act) and were made to give effect to the older Act. It was in a sense enacted to fill up certain lacunae in the unamended Act and therefore could be given a retroactive application. It was the case of the Union of India that the 1988 Act had already created substantial law for criminalising the offence of entering into a benami transaction and therefore the 2016 amendments were merely clarificatory and procedural.

The SC’s Judgement with regard to retroactive Application

As the basic argument advanced on behalf of the Union of India was that the amending Act was merely clarificatory in nature, the SC decided to first consider the provisions of Section 3 of the Benami Act as it stood prior to its amendment. It is reproduced for ready reference as hereunder –

“3. Prohibition of benami transactions.—

(1)    No person shall enter into any benami transaction.

(2)    Nothing in sub-section (1) shall apply to—

(a)    the purchase of property by any person in the name of his wife or unmarried daughter and it shall be presumed, unless the contrary is proved, that the said property had been purchased for the benefit of the wife or the unmarried daughter;

(b)    the securities held by a—

(i)    depository as registered owner under sub-section (1) of section 10 of the Depositories Act, 1996

(ii)    participant as an agent of a depository.

Explanation.—The expressions “depository” and “Participants shall have the meanings respectively assigned to them in clauses (e) and (g) of sub-section (1) of section 2 of the Depositories Act, 1996.

(3)    Whoever enters into any benami transaction shall be punishable with imprisonment for a term which may extend to three years or with fine or with both.

(4)    Notwithstanding anything contained in the Code of Criminal Procedure, 1973 (2 of 1974), an offence under this section shall be non-cognizable and bailable.”

The SC observed that the criminal provisions envisaged under the unamended Section 3(2)(a) along with Section 3(3) did not expressly contemplate mens rea and that mens rea is an essential ingredient of a criminal offense.

This observation is interesting because it was the cornerstone for the SC to strike down the retrospective criminality put in place by this act. The importance of the existence of the ‘mental intention’ to be convicted in criminal proceedings is the fundamental cornerstone of criminal law. An individual cannot be said to commit a crime without intent, and where the requirement of intent is whittled down, without knowledge (As in the cases of the second part of Section 304 of the Indian Penal Code – culpable homicide not amounting to murder).

The SC found that the absence of mens rea creates the harsh result of imposing strict liability. The Court further found that ignoring the essential ingredient of beneficial ownership exercised by the real owner also contributes to making the law stringent and disproportionate with respect to benami transactions that are tri-partite in nature and that Section 3 as it stood prior to the amendment was susceptible to arbitrariness. The Court alluded to Article 20(1) of the Constitution of India to emphasise that a law needs to be clear, not vague and should not have incurable gaps that were “yet to be legislated/ filled in by judicial process”. The SC also held that a reading of Section 3(1) with Section 2(a) of the unamended Act would have created overly broad laws susceptible to being challenged as manifestly arbitrary.

It was also considered by the Court that the Union of India fairly conceded that the criminal provision had never been utilised as there was a significant hiatus in enabling the function of the provision.

Having considered the above four broad factors – the SC concluded that Section 3 which contained the criminal proceedings with regard to the unamended benami Act was unconstitutional. The Court held that the criminal provisions in the unamended Act had serious lacunae which could not have been cured by judicial forums, even through harmonious forms of interpretation. Regarding Section 5 of the unamended Act, the Court observed that the acquisition proceedings contemplated therein were in rem against the property itself – and that such rem proceedings transfer the guilt from the person who utilised a property which is a general harm to the society on to the property itself.

The SC held that Section 3 (and Section 5) of the unamended Act did not suffer from gaps that were merely procedural but that the gaps were essential and substantive. In absence of such substantive positions, the omissions in the unamended Act created a law which was both fanciful and oppressive at the same time and that such an overly broad structure would be ‘manifestly arbitrary’ as it did not incorporate sufficient safeguards. The Court held that as the Sections were stillborn (never utilised) in the first place, the said Section 3 was unconstitutional right from the inception.

As a natural corollary to Section 3 (and 5) of the unamended Act being held to be unconstitutional, the SC held that the 2016 amendments are in effect, creating new provisions and offences. The Court held that the law cannot retroactively reinvigorate a still-born criminal offence and therefore, “There was no question of retroactive application of the 2016 Act.”

The Fundamental take away from Ganpati Dealcom

The fundamental takeaway from the judgment of the SC in the case of Ganpati Dealcom with regard to the retroactive application of criminal statutes is that the retroactive application of the amended Section 3 of the Act was struck down not merely on the broadly accepted principles that criminal statutes cannot operate retroactively, but the reasoning was deeper. The primary reason of why the statute could not operate retroactively was that the provisions of the Act prior to the 2016 amendments were held to be unconstitutional and void ab initio. This automatically meant that the 2016 amendment could not claim to be merely ‘procedural or clarificatory’ but gave rise to substantial new offences – for the first time. Given the peculiar nature of the factual matrix of this statute, the retroactive operation of the amended Section 3 was held to be bad in law.

However, the Ganpati Dealcom Judgement is significant for another important reason – the SC had just a few months earlier passed another landmark Judgement in the case of Vijay Madanlal Choudhary & Ors. v. Union of India & Ors. 2022 SCC OnLine SC 92.

The Indian SC does not sit en banc – as a whole, but as a combination of various ‘divisions’ and benches of various strengths. That is the reason why it’s often been called ‘Many Supreme Courts in one.’ Within a few months of the Vijay Choudhary Judgment, some apprehensions were already being cast upon its veracity – one such apprehension has been explicitly mentioned in Ganpati Dealcom.

B. THE PREVENTION OF MONEY LAUNDERING ACT, 2002

The PMLA also seemed to wait in the wings for fulfilling its objectives until post-2014, when it started being invoked in earnest to curb the menace of money laundering. The PMLA, its provisions and its applications have all been criticised in the recent past for their draconian nature. A preventive law rather than a prohibitive one like the Benami Act, it was not ‘still born’. It had been amended from time to time in line with India’s global commitments. The Scheme of the PMLA clearly shows that it does not seek only to punish the offence of money laundering but also to prevent it. A substantive part of the legislation is dedicated to compliance and preventive powers given to the authorities under the PMLA.

While benami transactions were primarily a problem in India (and perhaps in the Indian sub-continent), PMLA is global in its outreach.  Primarily set up to combat some of the greatest evils in the form of drug trade, arms trade and flesh trade, today the framework covers a very wide variety of subjects, each perhaps not as dire as the other. The  PMLA, however, has the most motley assortment of legislations included in its Schedule. Various offences under the Indian Penal Code, Narcotic Drugs and Psychotropic Substances Act, Explosive Substances Act, Unlawful Activities Prevention Act, Arms Act, Companies Act, Wildlife Protection Act, Immoral Traffic (Prevention) Act, Prevention of Corruption Act, Explosives Act, Antiques and Art Treasures Act, Customs Act, Bonded Labour Law, Child Labour Law, Juvenile Justice Law, Emigration, Passports, Foreigners, Copyrights, Trademarks, Biological Diversity, Protection of plant varieties and farmer’s rights, Environment Protection Act, Water / Air Pollution Control law, Unlawful Acts against safety of Maritime Navigation and fixed platforms on Continental Shelf, etc.

What is Money Laundering according to the PMLA?

Section 3 of the PMLA defines the offence of money laundering –

“3.     Whosoever directly or indirectly attempts to indulge or knowingly assists or knowingly is a party or is actually involved in any process or activity connected with the [proceeds of crime including its concealment, possession, acquisition or use and projecting or claiming] it as untainted property shall be guilty of offence of money-laundering.

Explanation.—For the removal of doubts, it is hereby clarified that,—

(i)    a person shall be guilty of offence of money-laundering if such person is found to have directly or indirectly attempted to indulge or knowingly assisted or knowingly is a party or is actually involved in one or more of the following processes or activities connected with proceeds of crime, namely:—

(a)    concealment; or

(b)    possession; or

(c)    acquisition; or

(d)    use; or

(e)    projecting as untainted property; or

(f)    claiming as untainted property,
    in any manner whatsoever,

(ii)    the process or activity connected with proceeds of crime is a continuing activity and continues till such time a person is directly or indirectly enjoying the proceeds of crime by its concealment or possession or acquisition or use or projecting it as untainted property or claiming it as untainted property in any manner whatsoever.”

But this definition is incomplete without considering the definition of proceeds of crime as laid out in Section 2(1)(u) of the PMLA:

Proceeds of crime is defined u/s 2(1)(u) of  PMLA as under:

“(u) “proceeds of crime” means any property derived or obtained, directly or indirectly, by any person as a result of criminal activity relating to a scheduled offence or the value of any such property [or where such property is taken or held outside the country, then the property equivalent in value held within the country or abroad.

Explanation. —For the removal of doubts, it is hereby clarified that “proceeds of crime” include property not only derived or obtained from the scheduled offence but also any property which may directly or indirectly be derived or obtained as a result of any criminal activity relatable to the scheduled offence;”

It would be incorrect to assume that the offence of money laundering would be triggered upon the laundering of money. In fact, Section 3 of the PMLA makes even the possession of proceeds of crime a part of the offence of money laundering. If the section as reproduced above are read, it can be observed that both of them contain ‘explanations’. The retrospective application of these explanations were some of the issues that were brought up before the SC.

What are the broad repercussions of the offence of money laundering?

The broad repercussions of money laundering activity are laid down in Section 4 of the PMLA.

What is the most troublesome though is that the maximum punishment for money laundering that may arise out of all the above-assorted activities is the same – up to seven years (not less than three years) and a fine of five lakh rupees, with a single exception of Narcotic Drugs and Psychotropic Substances Act – the money laundering relating to which attracts a sentence of up to ten years (not less than three years) and a fine of up to five lakh rupees. This punishment is not graded based upon the severity of the scheduled offense.

The case for Retroactive/Retrospective Application

The landmark case on the PMLA is Vijay Madanlal Choudhary & Ors. v. Union of India & Ors. 2022 SCC OnLine SC 92. In this, the case for retrospective/retroactive application of the amendments made in 2019 made to Sections 3 and 2(1)(u) was fairly simple – what was inserted were merely explanations as a part of the statute. It was contended, inter alia, that these explanations were clarificatory in nature and did not increase the width of the definition itself.

What is important is that the constitutional validity of the provisions of Section 3 prior to the insertion of the explanation was not in doubt. What contended was that this amendment was merely clarificatory. It is trite law that the parliament is empowered to make laws that operate retroactively and retrospectively, and such action cannot be challenged especially if the changes are merely clarificatory and/or procedural in nature.

The Supreme Court’s Judgement with regard to Retroactive Application

In Vijay Madanlal Choudhary the SC held that the Explanation as inserted in 2019 in Section 3 of the PMLA (making the offence of money laundering a continuous one) did not entail expanding its purport as it stood prior to 2019. It held that the amendment is only clarificatory in nature in as much as Section 3 is widely worded with a view to not only investigate the offence of money laundering but also to prevent and regulate that offence. This provision (even de hors explanation) plainly indicates that any (every) process or activity connected with the proceeds of crime results in offence of money laundering. The Court held that projecting or claiming the proceeds of crime as untainted property is in itself an attempt to indulge in or being involved in money laundering, just as knowingly concealing, possessing, acquiring, or using of proceeds of crime, directly or indirectly. The Court held the inclusion of Clause (ii) in the Explanation inserted in 2019 was of no consequence as it does not alter or enlarge the scope of Section 3 at all as the existing provisions of Section 3 of the PMLA  as amended until 2013 which were in force till 31.7.2019, have been merely explained and clarified by it.

Similarly, for the changes in the definition of ‘proceeds of crime’ and ‘property’ it was held that the Explanation added in 2019, did not travel beyond that intent of tracking and reaching upto the property derived or obtained directly or indirectly as a result of criminal activity relating to a scheduled offence. Therefore, the Explanation was in the nature of a clarification and not to increase the width of the main definition of “proceeds of crime”. The Court held that the Explanation inserted in 2019 was merely clarificatory and restatement of the position emerging from the principal provision i.e., Section 2(1)(u) of the PMLA.

There is a stark difference in the approach of the SC in both cases. However, it cannot be challenged that the statutory matrix and the circumstances of the application of both laws were also very different. The PMLA was hardly in a state of stasis before the 2019 amendment. The constitutional validity of the sections sought to be amended was not in doubt, the challenge was limited to the amendment itself. However, it would be curious to see if the ‘continuing nature’ of the offence of PMLA will stand up to judicial scrutiny if dissected in a manner similar to the way it has been done in Ganpati Dealcom.

The Fundamental take-away from Vijay Madanlal Choudhary

The key take-away from the Vijay Madanlal Choudhary Judgment with regards to retrospective/retroactive application of criminal statutes is that the manner in which such amendments are brought about in the statute book does matter. Though the law as interpreted by the apex court now states that the explanations are merely clarificatory, the repercussion of making the offence of money laundering a continuing activity is far more sinister.

Though money laundering is an offence by itself, it is what can be termed as a predicate offence, it does not exist in the absence of a primary offence. That primary offence may be any of the offences that have been included in the schedule to the PMLA. By making the offence of money laundering a continuing one, however, the statute has empowered itself to virtually prosecute those accused of offences that may have been committed not only before their insertion into the schedule to the PMLA, but also before the PMLA ever came into force. It is possible that someone may be prosecuted for the offence of money laundering decades after the primary offence is committed, even though such an accused may not have been involved in the commission of the primary offence. This aspect of the retroactive application of the PMLA has been the subject of much litigation before various High Courts. The Vijay Madanlal Choudhary Judgment paves the way for such prosecutions at will, by upholding the explanation that states that the offence of money laundering never ends and also by upholding the explanation that makes proceeds of crime include any property ‘directly or indirectly’ obtained as a result of any criminal activity related to the scheduled offence.

It is not that the concept of manifest arbitrariness of various provisions of the PMLA has not been considered. Those claims however, have been dismissed.

C. CONCLUSION

The retrospective/retroactive application of criminal provisions of special laws cannot be countered by a broad sweeping observation that ‘Criminal legislation does not have retrospective application’. The approach of the Courts is always nuanced. Though certain amendments to the criminal provisions of the Benami Act were held to be prospective and certain amendments to the criminal provisions of the PMLA were considered retroactive/retrospective, this was done given due weightage to the type of amendment contemplated in the amending Act and the sort of lacunae that were sought to be filled by the amendments. The two judgments are harmonious in law, but a view can be taken that there is a difference in the approach and the jurisprudential philosophy between the both of them. It’s telling that just a few months after the Vijay Madanlal Choudhary judgment, in Ganpati Dealcom with regard to the principles regarding confiscation / forfeiture provisions the SC observed:

“In Vijay Madanlal Choudhary v. Union of India 2022 SCC OnLine SC 929, this Court dealt with confiscation proceedings under Section 8 of the Prevention of Money Laundering Act, 2002 (“PMLA”) and limited the application of Section 8(4) of PMLA concerning interim possession by the authority before conclusion of final trial to exceptional cases. The Court distinguished the earlier cases in view of the unique scheme under the impugned legislation therein. Having perused the said judgment, we are of the opinion that the aforesaid ratio requires further expounding in an appropriate case, without which, much scope is left for arbitrary application”.

Justice YK Sabharwal (the then Chief Justice of India) is said to have said in 2006 “We are final not necessarily because we are always right – no institution is infallible – but because we are final.”

The Supreme Court may be final – but that may not hold necessarily true for its judgments. Both these Judgments have come out in 2022. Review Petitions by aggrieved parties were filed against them and the Apex Court has already agreed (albeit separately) to consider the review of both of them, though such a review may take place well into the future.

 

Co-location (Colo) is nothing but proximity hosting of broker servers with NSE’s master order matching engine in the exchange premises at Bandra-Kurla Complex (BKC). It gives a superior trading speed and advanced information on price moves and order books. As I have detailed in my book, The Market Mafia, the Colo scandal goes back to 2010. When NSE started co-location trading, it lacked the necessary study from the market regulator SEBI and hence safeguards. There were flaws in the system, which investigations post 2015 revealed were deliberate. The flaws gave a few an advantage in connecting first and hence faster data and so on. Had SEBI made a proper study of NSE trading systems in 2010 or carried out a thorough audit and then given its go-ahead after a public consultation, the scenario would have been different. The deliberate flaws in the system were a result of corporate governance lapses at NSE, for which the accountability has to be fixed.   

Q.2. How was the matter unearthed?
In January 2015, an unknown whistle-blower first informed SEBI about the co-location scandal and certain flaws in the system. The then SEBI whole time-member Rajeev Agarwal pushed his officials into action, and the probe started in the weeks following the whistle-blower complaints. But even after Agarwal set the ball rolling, SEBI was slow in its approach and investigations since NSE’s top bosses enjoyed high patronage in New Delhi, and the regulators were scared to take them head-on. Multiple forensic and system audits by IIT Mumbai were carried out under SEBI’s instructions. NSE’s top management was hostile towards these investigations since they would not share the data and other inputs with the investigators. Yet certain facts on governance lapses and flaws in the system emerged. CBI registered an FIR in 2018 on the basis of a complaint but for four years the Co-location file kept gathering dust since no major investigation was done by the agency. It was believed by many that key players in the scam were difficult to identify. In November 2020, I published my book The Market Mafia – Chronicle of India’s High Tech Stock Market Scandal & The Cabal That Went Scot Free. The book detailed the nuts and bolts of NSE’s trading system and, for the first time, gave an inside into the working of a Co-location scam and other aspects that most of the market investors were unaware about. The book also gave vital details of the key characters in the co-location scam and brought into the public domain several hidden communication between NSE officials and SEBI with regard to the ongoing probe. The book laid bare how NSE flouted norms with relative ease and impunity, and even senior SEBI officials looked the other way. The Market Mafia carries a detailed account of brokers, NSE officials, financial market experts and policymakers who benefited from the Co-location scam and the happening within NSE. For the first time in 30 years after the Harshad Mehta scam, a book has revealed true events to show how India’s stock markets are rigged by those very people who are supposed to protect the system.

In February 2022, SEBI released an order against former NSE MD and CEO Chitra Ramkrishna, who was among the key managerial persons when the co-location scam was taking place and was later in charge of NSE between 2013 and 2016. The SEBI order stated that Ramkrishna was taking instructions from an unknown person to run the exchange, whom she called a Yogi dwelling in the Himalayas. All this attracted public attention to the NSE scandal, which I say is several times bigger than the Harshad Mehta scam.

Q.3. As the first line of oversight, has NSE performed its obligation when the matter came to light?

From the beginning, NSE has been lax in diving deep into the scandal, which came to light in 2015. It has shielded and protected its officials who could have turned a blind eye to the various lapse or who could have engineered the flaws in the trading system. Simple instance of NSE shielding its officials can be gauged from the fact that Ramkrishna was allowed to exit NSE with dignity and was also paid Rs 44 crore in dues in 2016. Instead, the exchange was required to conduct investigations into her bad governance practices and slap some serious charges. Several other instances, like sharing data illegally with Ajay Shah and Susan Thomas, the two well-known market researchers by NSE, show that the officials within the exchange were complacent with the scamsters.

Q.4. Was SEBI aware of the irregularities at NSE, and for how long?

SEBI officials can be charged with ‘Omission and Commission of Duty’ which implies complacency in the scandal. It is one of the directions in which the CBI is now probing SEBI officials. The regulator is alleged to have hidden facts from the public, investigators and government about the scam. This is clear from the various arguments of CBI in the court.

Q.5. As a regulator, has SEBI been fair in investigating the matter and discharging its obligation in terms of timeliness of action, quality of investigation, quantum of punitive action taken and taking corrective action?

SEBI failed to conduct due diligence of NSE co-location trading systems from the day it started in January 2010. SEBI has been very slow in ordering proper investigations and even conducting its own probe. It left the probe to NSE to investigate itself. SEBI’s orders are childish and loosely knit. It has broken down the scam into various instances of small violations and not imposed charges of fraud and other stringent provisions laid down in the SEBI Act. The regulator has wide-ranging powers to probe such scandals, which it has not used at all. The list of SEBI’s inaction is long. All this points to SEBI’s lack of willingness in bringing the real culprits to book.

Q.6. Was a similar matter also detected at any other exchanges, and has SEBI dealt with other exchanges differently?

Yes, a forensic audit by TR Chaddha and Co. points out a scandal in sharing data by MCX with Susan Thomas and one New Delhi based algo trading Chirag Anand in an unauthorised manner. But SEBI and MCX have buried this scandal. NSE data, which was illegally obtained by Ajay Shah and Susan Thomas was going into algo trading work. Similarly, data obtained from MCX without following proper checks and balances were also going into algo trading work. SEBI has failed to take the MCX probe further and bring the actual culprits to book.

Q.7. How, in your view, will these irregularities impact the credibility of the Indian securities market, especially when one out of two exchanges and its regulator is found inactive or even complicit?

Both foreign investors and domestic institutions strongly believe that India follows the rule of law. Retail investors believe that Indian markets are most efficient and scam free. All the investors have placed their faith in SEBI and exchanges like NSE, BSE and MCX who are the larger players. They invest and trade billions of dollars at the blink of an eye. But the scandal at NSE and data sharing at MCX in a dubious manner, both of which show SEBI in poor light, can erode the trust of these investors. The credibility of the market has already been impacted but would be in ruins till the time the culprits are not found and brought to book by the government.

Q.8. You have been covering the colo and corporate governance matter at NSE in detail at various forums for quite a long time and have also covered these irregularities in detail in your book – ‘The Market Mafia’ – What is the whole idea behind this book?

You will find that The Market Mafia is a unique book since it gives all the real names of those behind the scandal at NSE and dubious happenings at MCX. The book exposes SEBI and the government’s lack of will for the past few years to investigate the scandal. It also reveals the conflict of interest that prevails in the governing structures of the stock markets and, above all, the bureaucratic rut that has exposed SEBI as a lame paper tiger.

With the onset of the infamous Satyam scam of 2008-2009, where major accounting frauds were exposed, SEBI initiated a detailed investigation in the books of accounts of Satyam. Post investigation, SEBI issued a Show Cause Notice to the statutory auditor of Satyam, namely Price Waterhouse Co. (PWC). The power of SEBI to issue such a Show Cause Notice to a Chartered Accountant (firm) was challenged by PWC before the Hon’ble Bombay High Court (Writ Petition No. 5249 of 2010) under Article 226 of the Constitution. The Hon’ble Bombay High Court (vide its order of 13th August, 2010) put the controversy to rest by allowing SEBI to initiate action and bring Chartered Accountants within its fold – subject to not encroaching on the ICAI’s powers under the Chartered Accountants Act, 1949 (CA Act).

The Hon’ble Bombay High Court emphasized the fact that only if the Chartered Accountant was involved in falsification and fabrication of books of a listed company, then SEBI could invoke its powers under Section 11(4) r.w.s. 11B of the SEBI Act, which reads as under:

Section 11B.

(1)    Save as otherwise provided in section 11, if after making or causing to be made an enquiry, the Board is satisfied that it is necessary:

(i)    in the interest of investors, or orderly development of securities market; or

(ii)    to prevent the affairs of any intermediary or other persons referred to in section 12 being conducted in a manner detrimental to the interest of investors or securities market; or to secure the proper management of any such intermediary or person

it may issue such directions:

(a)    to any person or class of persons referred to in section, or associated with the securities market; or

(b)    to any company in respect of matters specified in section 11A, as may be appropriate in the interests of investors in securities and the securities market.

An important facet of the aforesaid definition is whether an auditor of listed companies (and registered intermediaries) can be considered to be a ‘person associated with the securities market’ and thereby under the jurisdiction of SEBI. The Hon’ble Bombay High Court clarified that if SEBI concludes that there was no ‘mens rea or connivance’ to fabricate and fudge the books of accounts, then SEBI ought not to issue any direction(s) against the auditor.

Within the aforesaid contours, the proceedings (qua PWC) continued at the SEBI level and finally concluded with an Order against PWC (on 10th January, 2018), inter-alia, imposing a restraint on PWC on issuing a certificate to a listed company for two years, amongst other directions. PWC challenged the SEBI Order before the Hon’ble Securities Appellate Tribunal (SAT). In the said case (decided on 9th September, 2019), the Hon’ble SAT went into the question as to whether SEBI could have proceeded against an auditor in connection with the work which they have undertaken for a listed company in respect of maintaining its books of accounts. After deliberation, the Hon’ble SAT ruled that SEBI’s enquiry ought to be only restricted to the charge of conspiracy and involvement in ‘fraud’. SEBI cannot take action against the auditing firm on the charge of professional negligence – since the CA firm was under the jurisdiction of ICAI. The said SAT Order has been challenged by SEBI before the Hon’ble Supreme Court – in which the regulator obtained a limited stay in its favour (Supreme Court Order dated 18th November, 2019 in Civil Appeal No(s). 8567-8570/ 2019). Until the Hon’ble Supreme Court finally adjudicates the matter – the question of SEBI’s jurisdiction of taking action against the Chartered Accountant(s) remains an open-ended one.

However, in the recent past, SEBI has been penalizing auditors of listed companies and registered intermediaries in respect of their auditing functions by alleging that the concerned auditor had violated Sections 12A(a), 12A(b) and 12A(c) of the SEBI Act, which reads as under:

12A. No person shall directly or indirectly:

(a)    use or employ, in connection with the issue, purchase or sale of any securities listed or proposed to be listed on a recognized stock exchange, any manipulative or deceptive device or contrivance in contravention of the provisions of this Act or the rules or the regulations made thereunder;

(b)    employ any device, scheme or artifice to defraud in connection with issue or dealing in securities which are listed or proposed to be listed on a recognised stock exchange;

(c)    engage in any act, practice, course of business which operates or would operate as fraud or deceit upon any person, in connection with the issue, dealing in securities which are listed or proposed to be listed on a recognised stock exchange, in contravention of the provisions of this Act or the rules or the regulations made thereunder.

RECENT RULING BY HON’BLE SAT

Through recent decisions in the M. V. Damania case (Appeal No. 335 of 2020 decided on 17th January, 2022) and Mani Oommen case (Appeal No. 183 of 2020 decided on 18th February, 2022); the Hon’ble SAT has set aside the SEBI orders penalising the auditors:

I.    In the M. V. Damania case, the concerned auditor had certified the expenditure incurred by Paramount Printpackaging Ltd (PPL) towards Initial Public Offering (IPO) expenses out of the IPO proceeds. The crux of SEBI’s allegation was that auditor negligently certified that an amount of Rs. 36.60 crores was utilized towards objects of the IPO. SEBI had alleged that:

(i)    PPL made payment to the various vendors in crore of rupees without having any invoices;

(ii)    in some cases, bills from the vendors were issued at a later date, post remittance by PPL; and

(iii)    the auditor did not raise any red flag against doubtful payments made by PPL.

In view of the aforesaid, SEBI imposed a monetary penalty of Rs. 15 lakhs on the auditor firm (and its partner), jointly and severally, for alleged violation of provisions of Section 12A(a), 12A(b) and 12A(c) of the SEBI Act r.w. Regulations 3 and 4 of the SEBI (Prohibition of Fraudulent and Unfair Trade Practices relating to Securities Market) Regulations, 2003 (PFUTP Regulations).

In Appeal, the concerned auditor contended the following, amongst other arguments:

(i)    audit of the financial statements of PPL was based on the information provided by the management;

(ii)    in the process of the audit, the endeavour was to obtain audit evidence that is sufficient and appropriate to provide a basis for forming an independent opinion;

(iii)    all the payments made by PPL were supported by bank statements; and

(iv)    in any case, SEBI had no jurisdiction to proceed against Chartered Accountants, who are members of the ICAI.

The Hon’ble SAT ruled that the provisions of Section 12A(a) and 12A(b) of the SEBI Act do not apply to Chartered Accountants since ‘they are not dealing in the securities’. Similarly, the provisions of Section 12A(c) cannot be made applicable because the concerned auditor has carried out no ‘fraud’. Most importantly, the Hon’ble SAT ruled that in the absence of connivance, deceit, or manipulation by the auditor, the provisions of Regulation 3 and 4 of the PFUTP Regulations cannot be made applicable. Consequently, the SEBI Order was set aside.

II.    In the Mani Oommen case, SEBI alleged that DCHL (a listed company) had understated its outstanding loans to the tune of Rs. 1,339.17 crores in 2008-09 and wrongly disclosed the difference between the actual and reported outstanding loans for 2009-10 and 2010-11. Also, its promoters, the owner of the Deccan Chronicle Marketers (DCM) had wrongly transferred loans on the last day of the financial year and reversed on the first day of the next financial year. SEBI had alleged that:

(i)    As per Sections 224 and 227 of the Companies Act, 1956, an auditor owes an obligation to the shareholders to report true and correct facts about the company’s financials, and the auditor was duty bound to report correct facts under Section 227 of the Companies Act.

(ii)    SEBI opined that the concerned auditor overlooked the reporting of the outstanding loans, and he was not diligent in his obligation to check outstanding loans details from the bank and other independent sources.

In view of the aforesaid, SEBI held that the auditor did not adhere to the Auditing and Assurance Standard – 5 (AAS) prescribed by ICAI. SEBI alleged that the concerned auditor had violated the provisions of Section 12A(a) and 12A(b) of the SEBI Act r.w. Regulations 3 and 4 of the PFUTP Regulations. Consequently, SEBI penalized the said auditor and prohibited him from issuing any certificate of audit and rendering any auditing services to any listed companies and registered intermediaries for one year. Additionally, SEBI directed listed companies and intermediaries registered with SEBI not to engage any audit firm associated with the said auditor in any capacity for issuing any certificate w.r.t compliance of statutory obligations, which SEBI is competent to administer and enforce.

In Appeal, the concerned auditor contended the following, amongst other arguments:

(i)    as a statutory auditor, the responsibility was to express an opinion on the financial statement based on the internal audit;

(ii)    the auditor was not involved in the preparation of the books of accounts of the company; and

(iii)    the accounting adjustment, namely non-disclosure of the loans by transferring the same to the another entity was brought to his notice for the first time during audit of the books of accounts of DCHL in October-2012 (at a later point in time).

The Hon’ble SAT ruled that, in the entire SEBI Order, there is no finding that the concerned auditor was instrumental in preparing false and fabricated accounts or has connived in the falsification of the books of account. The only finding by SEBI was that due diligence was not carried out by the said auditor. There was no finding (by SEBI) that the auditor had manipulated the books of accounts with knowledge and intention, in the absence of which, there is no deceit or inducement by the auditor. In the absence of any inducement, the question of fraud committed by the auditor does not arise. Consequently, the SEBI Order was set aside.

FRAUD VIS-À-VIS NEGLIGENCE

It is clear from the aforesaid rulings of the Hon’ble SAT that lack of due diligence can only lead to professional negligence, which would amount to misconduct – which could be under the purview of other regulators (like ICAI / NFRA). While the much-needed clarity on the jurisdiction of the SEBI vis-à-vis auditors is being awaited from the Hon’ble Supreme Court, the Chartered Accountant(s) must bear in mind that presently SEBI can act against them – if found that there was an element of ‘fraud’ while auditing listed companies and regulated intermediaries.

The Regulation 2 (c) of PFUTP Regulations define the term ‘fraud’ in two parts:

(i)    First part includes any act, expression, omission, or concealment committed whether in a deceitful manner or not by a person or by any other person with his connivance or by his agent 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; and

(ii)    The second part includes specific instances which may tantamount to be fraudulent.

In the Kanaiyalal Baldevbhai Patel case (2017 15 SCC 1 – decided on 20th September, 2017), the Hon’ble Supreme Court has ruled that the term ‘fraud’ under the PFUTP Regulations is an act or an omission (even without deceit) if such an act or omission had the effect of ‘inducing’ another person to ‘deal in securities’.

The term ‘negligence’ as quoted in the PWC Order (SAT Appeal No. 6 of 2018) means the failure to use such care as a reasonably prudent and careful person would use under similar circumstances; it is the doing of some act which a person of ordinary prudence would not have done under similar circumstances or failure to do of a person of ordinary prudence would have done under similar circumstances (Black’s Law Dictionary, 6th edition).

RISK OF REGULATORY OVERREACH

The regulatory overlaps between SEBI and other regulators in the financial service space has been an ongoing issue. With SEBI having powers under the Securities and Exchange Board of India Act, 1992 (SEBI Act), there arises a situation where SEBI exercises jurisdiction against all persons on the ground that they are ‘associated with the securities market’. Consequently, the casualty is usually the regulated entities and professionals who advise them on lawfully navigating this complex regulatory space. In the past, there have been instances of such regulatory overlaps of SEBI with Insolvency and Bankruptcy Board of India (IBBI), Competition Commission of India (CCI), Reserve Bank of India (RBI), Central Electricity Regulatory Commission (CERC), etc.

One cannot deny that the SEBI is an apex regulator when it comes to protecting the sanctity of the securities market and, in fact, has been armed with powers to protect the interest of investors. If the regulator demonstrates that an auditor was involved in fabricating and fudging the financial statements or had ‘colluded’ with the listed company / promoters, a charge of fraud can be fastened. However, the question is whether SEBI ought to adjudicate on issues pertaining to professional conduct of practising Chartered Accountant(s). At the end of the day, the bible for Chartered Accountants is the auditing standards – which are prepared and deliberated upon by the ICAI. The hazard of over-regulation may result in moving away from a solution-oriented regime and create a situation where every audit report will carry more caveats than it already carries. There being a thin line between a ‘fraudulent’ and ‘negligent’ act, to avoid anomaly, inter-agency coordination is desirable.

THE WAY FORWARD

In October 2010, the central government constituted Financial Stability and Development Council (FSDC) – an apex regulatory Council to resolve regulatory overlaps. FSDC’s role is to enhance inter-regulatory coordination and promote financial sector development. The Chairman of the Council is the Finance Minister, and its members include the heads of financial sector Regulators (RBI, SEBI, PFRDA, IRDA, etc.), Finance Secretary and/or Secretary, Department of Economic Affairs, Secretary, Department of Financial Services, and Chief Economic Adviser. The Council is empowered to invite experts to its meetings as and when required. FSDC may consider inviting representatives from the ICAI and NFRA for inter-regulatory coordination to resolve the regulatory overlap.

The Insolvency and Bankruptcy Code, 2016 (IBC) was passed four years ago with the objective ‘to consolidate and amend the laws relating to reorganisation and insolvency resolution in a time-bound manner for maximisation of value of assets of such persons, to promote entrepreneurship, availability of credit and balance the interests of all the stakeholders including alteration in the order of priority of payment of Government dues and to establish an Insolvency and Bankruptcy Board of India, and for matters connected therewith and incidental thereto.’ The NCLAT in Binani Industries Limited vs. Bank of Baroda & Anr. laid down the objective of the code as ‘reorganisation and insolvency resolution of Corporate Debtor (CD), maximising value of assets of the company and promoting entrepreneurship, availability of credit and balancing the interests of all stakeholders’.

Since then, the IBC has moved on and benefited with the help of the rich source of knowledge as provided by jurisprudence. After all, it was time for Government to take steps that would further improve the ease of doing business. Especially with the impact of the pandemic, there is every possibility that businesses will suffer from greater stress due to external reasons beyond their control. This could also put many businesses into greater trouble, making them go through the stress of insolvency through the Courts.

The IMF, through its ‘Special Series on Covid’, identifies three potential phases of the crisis, viz., a first phase where there is a need for interim measures to halt insolvency and debt enforcement activity; a second phase, in cases of severe crisis, where transitional measures may be required to respond to the wave of insolvency cases, including special out-of-court restructuring mechanisms; and a third phase in which countries strengthen their regular debt resolution tools to address the remaining debt overhang and support economic growth.

While the harsh truth of such turmoil is flailing and failing businesses, the pressing need is to allow genuine businesses to sustain themselves and provide options for them to recoup and bounce back. Legislative options may create a lucrative, conducive environment to rescue those affected in these challenging times. ‘Prepack’ emerges in the midst of all this as a decoction which combines the formal and informal option to lessen the burden. Addressing this necessity, the Ministry of Corporate Affairs constituted a sub-committee on 24th June, 2020 to propose a detailed scheme for implementation of prepacked and prearranged resolution processes.

As of today a company in stress in India has four options: the Compromise and Arrangement scheme under the Companies Act, 2013; the Corporate Insolvency Resolution Process (CIRP) under the IBC; RBI’s prudential framework for early recognition, reporting and time-bound resolution of stressed assets; and fourth, the out-of-court settlement framework. The then Finance and Corporate Affairs Minister, the Late Mr. Arun Jaitley, once said, ‘I think today may not be the right time to go in for this discussion (informal option) because of the huge rush of companies coming to the insolvency process, but once this rush is over over the next couple of years, and business comes back to usual, honest creditor-debtor relationship is restored on account of IBC, a situation may arise when we may then have to consider a need to marry the two processes together so they may well exist simultaneously’. Thus, the necessity to introduce an ecosystem of informal options was foreseen at the time of legislation of the IBC and prepack has emerged as an innovative corporate rescue method that incorporates the virtues of both informal (out-of-court) and formal (judicial) insolvency proceedings1.

GETTING TO KNOW ABOUT PREPACK
Prepack is a process to conclude in advance an agreement by a company which is stressed before moving for statutory administration of the same. This provides it an opportunity to continue its business as a going concern and enables the promoter to rationally decide the options, and to save the time and money cost, along with erosion of goodwill, had this been routed through the CIRP channel.

The United Nations Commission on International Trade Law (UNCITRAL) in its ‘Legislative Guide on Insolvency’ uses the word ‘Expedited reorganisation proceedings’ and Paragraph 76 defines prepack as ‘to involve all creditors of the debtor and a reorganisation plan formulated and approved by creditors and other parties in interest after commencement of the proceedings. Reorganisation may also include, however, proceedings commenced to give effect to a plan negotiated and agreed by affected creditors in voluntary restructuring negotiations that take place prior to commencement, where the insolvency law permits the court to expedite the conduct of those proceedings’.

The USA was the first to introduce prepack in the Bankruptcy Reform Act of 1978. It soon gained momentum with more than 20% of the bankruptcies going through prepack2.The plan ‘is negotiated, circulated to creditors and voted on before the case is filed’3.

With a slight variation, the United Kingdom requires an administrator to conclude the sale. The Insolvency Practitioners Association issued a Statement of Insolvency Practice which defines prepack sale as ‘an arrangement under which the sale of all or part of a company’s business or assets is negotiated with a purchaser prior to the appointment of an Administrator and the Administrator effects the sale immediately on, or shortly after, appointment.’

In Singapore, the Insolvency, Restructuring, and Dissolution (Amendment) Bill, 2020 proposes to introduce a new prepack scheme for micro and small companies in the Covid-19 environment. An automatic moratorium would come into play when a company is accepted into the scheme. There would be no requirement to convene a meeting of the company’s creditors. Instead, the Court can approve the scheme, provided that the company can satisfy it that if a meeting had been called a majority representing at least two-thirds in value of the creditors would have approved the proposed scheme.

BENEFITS OF PREPACK
Faster resolution and cost effective: The greatest advantage of prepack lies in early disposal of the case. A majority of the terms are negotiated at the stage before the same are administered by the courts, which allows sufficient time for the debtor to fructify the negotiations. The time taken in courts reduces substantially, together with an increase in the possibility of a resolution. This eventually reduces the cost of administrator / Insolvent Professional (IP) consultant. On the other hand, increase in the time involved in the process of resolution would mean that the CD may have to sustain the stress until the resolution, which in turn reduces the value of the business and also the overall chances of resolution. After introduction of the IBC, the time for resolving insolvency also came down significantly from 4.3 years to 1.6 years. Now, prepack intends to bring it down even further. In countries which are in advanced stages of implementation of the insolvency law, such as the UK and the USA, the time of resolution in prepack can be as low as a few hours!

Goodwill retention and value maximisation: The threat to any business during the resolution process is the disruption that it causes on its normal business, which eventually threatens and hampers its goodwill. Even the Act tries to resolve this concern by introducing a moratorium on admission of CIRP, but the concern is that of loss of goodwill which would otherwise impact the right resolution options. Prepack as an option would enable the CD to safeguard the goodwill which otherwise would be impacted in the formal process.

Increases the possibility of resolution: Once a debtor opts for CIRP, he loses control of the decision-making process which goes to the creditors. It is believed that the defaulting debtor must not be in control of the decision-making process, but then this reduces the possibility of resolution and leads to liquidation. The incidental option for a defaulting debtor in CIRP is that of liquidation, but the statistics reveal that debtors that stay long at CIRP are more prone to end in liquidation. Liquidation is a consequence of failed resolution and a non-desirable situation for the debtor, the creditors, the employees, etc. With prepack invoking informal methods, the chances of resolution increase with intent to move with commercial wisdom, which the debtor can assist and resolve.

Less reliance on courts: The report of the sub-committee of the Insolvency Law Committee on prepacked Insolvency Resolution process mentions withdrawal of applications filed for initiation of CIRP in respect of 14,510 Corporate Debtors at pre-admission stage, closure of CIRPs of 218 CDs u/s 12A of the Code, 27 terminations of CIRPs by the Adjudicating Authority (AA), closure of CIRPs on taking note of settlement recorded by the mediator, and even settlements at the level of the Apex Court. The volume of cases is testimony to the success of out-of-court settlements which if nurtured and guided can enable courts to decide and resolve.

CONCERNS IN PREPACK
Transparency: In the existing CIRP, section 29A of the IBC, 2016 imbibes the importance of transparency and concern of involvement of the related party in the process. Over the concerns of serial prepacking or phoenix companies hangs the fear of failure of prepack. This may also necessitate the Government to work the whole process in a controlled environment to ensure that any unscrupulous elements do not fail the process.

Defaulting debtor in decision-making: The process of CIRP shifts the decision-making power from the CD to professionals who are independent and work for the common commercial good of all. This ensures that the CD is not in control of but only a part of the decision-making process. The RP and the COC decide the course of action which is further supervised by the Courts. Prepack in contract empowers the defaulting corporate to decide on the course of resolution, whereas administrator / RP / IP have a limited role in the resolution process, that of overseeing and approval. This ensures that the CD does not hijack the resolution in his favour if left unchecked.

Framework on prepackaged Insolvency Resolution Process as suggested by the sub-committee
Different jurisdictions have legislated prepack under insolvency with various options; but it is necessary to make a law which is country-specific because one size may not fit all. The three principles that the sub-committee suggested to guide the design of the prepack framework are,
(i)    the basic structure of the Code should be retained;
(ii)  there should be no compromise of the rights of any party; and
(iii) the framework should have adequate checks and balances to prevent any abuse.

The report mentions the following as the main features of prepack:

•  Prepack as an option must be part of the same law which governs IBC and also part of the same legislation.

•  Prepack as an option must be available to all CDs for any stress, pre-default and post-default.

•  The CD shall initiate prepack with consent of simple majority of (a) unrelated FCs and (b) its shareholders. No two proceedings – prepack and CIRP – shall run in parallel.

•  Promoters and management of the CD to be in control of the decision-making process, except for decisions on matters enumerated u/s 28 of the Code, including interim finance, which shall be taken by the CD with the approval of the CoC.

•  List of documents and reports like outstanding claims, including contingent and future claims, and a draft Information Memorandum, etc., shall be prepared by the CD and certified by the MD.

•  The moratorium u/s 14 shall be available from the Prepack Commencement Date (PCD) till closure or termination of the process.

•  IP shall be appointed by unrelated FC’s who shall not run the business like in CIRP but only administer / conduct the process of prepack.

•  Similar to CIRP, RP shall make public announcements but on electronic platform, he shall verify the claim, constitute CoC (Committee of Creditors), get valuation report, conduct due diligence, make application to AA (Adjudication Authority) in case of avoidance transaction, etc.

•  As in CIRP, the CoC shall take decisions with regard to approval by majority of votes except that of liquidation which requires 75% vote.

• ? Section 29A related to persons not eligible to be resolution applicants to remain sacrosanct even in the prepack process.

•  Prepack to have the Swiss challenge method to counter the first offer to ensure better proposals. Two-option approach: (i) without Swiss challenge but no impairment to Operational Creditors (OCs), and (ii) with Swiss challenge with rights of OCs and dissenting FCs subject to minimum provided u/s 30(2)(b). Prepack should allow 90 days for market participants to submit the resolution plan to the AA and 30 days thereafter for the AA to approve or reject it.

BRIEF ABOUT THE PREPACK INSOLVENCY RESOLUTION PROCESS (PIRP) PASSED BY ORDINANCE DATED 4TH APRIL, 2021

The Government, aware of the urgent need for prepack, has inserted a Prepackaged Insolvency Resolution Process (PIRP) under Chapter III-A in Part II of the IBC through the ordinance route. The following is a brief, along with some highlights, about the process:

•  An application for initiating a PIRP may be made in respect of a CD classified as a micro, small or medium enterprise under sub-section (1) of section 7 of the Micro, Small and Medium Enterprises Development Act, 2006.

•  Restrictions have been placed on the CDs who have recently concluded CIRP / PIRP within three years or are undergoing CIRP, or those against whom liquidation order is passed u/s 33.

•  An FC, not being a related party of more than 66% in value, has to propose an IP to be appointed as the Resolution Professional (RP). The CD shall also obtain approval for filing the PIRP from its FC not being its related parties representing not less than 66% in value of the financial debt due to such creditors.

•  The majority of directors / partners have to declare that the CD shall file an application for PIRP within the timeframe not exceeding 90 days along with other declarations as required u/s 54A(2)(f).

•   The special resolution in case of companies should have three-fourths of the total number of partners approving for filing the PIRP.

•  The IP to be appointed as RP in PIRP is duty-bound to confirm whether the CD confirms the eligibility requirement for application under PIRP.

•  Fees paid to the IP to perform his duties shall form part of the PIRP costs.

•  The AA shall, within a period of 14 days of the receipt of the application under PIRP, either accept or reject it after providing seven days’ time to rectify the defects, if any.

•  The PIRP shall commence from the date of admission of the application by the AA. The PIRP shall be completed within 120 days from its commencement and the RP shall submit the resolution plan within 90 days from the prepackaged insolvency commencement date. If the resolution plan is not approved by the CoC within the stipulated time, then the RP shall file for termination of the PIRP.

•  Moratorium as provided in sub-section (1) read with sub-section (3) of section 14 shall be applicable and shall cease to exist upon termination of PIRP.

•  CD shall submit within two days of commencement of PIRP a list of claims and preliminary information memorandum relevant to formulate the Resolution Plan.

•  Unlike in CIRP, the management of affairs shall vest with the Board of Directors. However, the management may be handed over to the RP if the Committee by a vote of not less than 66% of the voting share in value decides to do so, or the AA is of the opinion that the affairs had been conducted in a fraudulent manner or there has been gross mismanagement.

•  The CoC shall be constituted within seven days of the prepackaged insolvency commencement date and its first meeting shall be held within seven days of its constitution.

•  The CD shall submit the base resolution plan, referred to in clause (c) of sub-section (4) of section 54A, to the RP within two days of the prepackaged insolvency commencement date and the RP shall present it to the CoC.

•  The CoC may approve the base resolution plan for submission to the AA if it does not impair any claims owed by the CD to the operational creditors.

•  The RP shall invite prospective resolution applicants to submit a resolution plan or plans, to compete with the base resolution plan, in such manner as may be specified.

•  Sub-section (2) section 14, sub-section 2A of 14, section 14(3(c), section 17, section 19(3), section 18 clause g to e, section 19(2), section 21, section 25(1), clauses (a) to (c) and clause (k) of sub-section (2) of section 25, section 28, section 29, sub-sections (1), (2) and (5) of section 30, sub-sections (1), (3) and (4) of section 31, sections 24, 25A, 26, 27, 28, 29A, 32A, 43 to 51, provisions of Chapters VI and VII of Part II have been applied mutatis mutandis to the PIRP.

•  If the AA is satisfied that the resolution plan as approved by the CoC under sub-section (4) or sub-section (12) of section 54K, as the case may be, subject to the conditions provided therein, meets the requirements as referred to in sub-section (2) of section 30, it shall, within 30 days of the receipt of such resolution plan, by order approve the resolution plan.

Prepack is a great way if India can take a leaf out of the book of countries which have legislated, administered and have learnt from experience. It may also be necessary to implement the law in a controlled environment but with the caution of not excessively restricting the eco-system which the law would promulgate. This law would stretch to the fullest strength when it is allowed to resolve the stress, provided that it is allowed to be experimented with within the framework, with little interference from courts. Excess legislation and restrictions may dilute the intent of faster resolution; this requires that those involved in the process of prepack are sensitive to the consensus-building mechanism of debtors and creditors. This also means that creditor-debtor must also act maturely during this process as they must realise that the success of this process depends on its negotiation and approval of the same. On the point of restriction, such as the one in section 29A, views are divided on transparency and genuine related-party buyer.

References
1 Bo Xie (2016), Comparative Insolvency Law: The Prepack Approach in Corporate Rescue, Edward Elgar Publishing
2 Vanessa Finch, Corporate Insolvency Law Perspectives and Principles (2nd ed., Cambridge University Press, 2009) 454
3 John D. Ayer et al, ‘Out-of-court Workouts Prepacks and Pre-arranged Cases, a Primer’, (April, 2005), ABI Journal <https://www.abi.org/abijournal/out-of-court-workouts-prepacks-and-pre-arranged-cases-a-primer> [2] (2020) 8 Supreme Court Cases 531

.

Newspaper reports show that, on an average, every week in two to three cases a businessman, politician, banker or bureaucrat is booked under the Prevention of Money-Laundering Act (PMLA). Apart from attachment of property and freezing of bank accounts, another action started simultaneously against such a person is initiation of criminal proceedings. On a complaint made u/s 44 of the PMLA, investigation commences and the Special Court may take cognizance of the offence of money-laundering.

However, the terms ‘cognizance of offence’ and ‘cognizable offence’ are not defined in the PMLA. Indeed, section 65 provides that the provisions of the Code of Criminal Procedure, 1973 (CrPC) shall apply insofar as they are not inconsistent with the provisions of the PMLA for arrest, search and seizure, attachment, confiscation, investigation, prosecution and all other proceedings under the PMLA.

Accordingly, in the absence of any provision in the PMLA, one may refer to the provisions of the CrPC on a given aspect such as the definition of ‘cognizable offence’. This
term is defined in section 2(c) of the CrPC as follows:

‘Cognizable offence’ means an offence for which, and ‘cognizable case’ means a case in which, a police officer may, in accordance with the First Schedule or under any other law for the time being in force, arrest without warrant.

From a review of the above-mentioned definition one can see that where the offence is covered under the First Schedule of the CrPC or under any other law for the time being in force, the police officer may arrest without a warrant.

A reference to the First Schedule shows that it provides the following classification of offences:
• cognizable or non-cognizable,
• bailable or non-bailable, and
• the court which will try the offence.

Part II of the First Schedule refers to ‘classification of offences under other laws’. It provides that offences punishable with imprisonment for more than three years would be cognizable and non-bailable.

A reference to section 4 of the PMLA shows that the offence of money-laundering is punishable with rigorous imprisonment for more than three years which may extend up to seven years (ten years in the case of NDPS offences).

Accordingly, on the basis of the criteria specified in the First Schedule of the CrPC, the offence of money-laundering is cognizable.

WHETHER THE OFFENCE OF MONEY-LAUNDERING IS COGNIZABLE?
The issue whether the offence of money-laundering is cognizable had come up for consideration before the Courts in the following cases:
•  Jignesh Kishorebhai Bhajiawala vs. State of Gujarat [2018] 90 taxmann.com 320 (Guj);
• Rakesh Manekchand Kothari vs. UoI (Manu/Guj/0008/2015);
• Chhagan Chandrakant Bhujbal vs. UoI [2017] 78 taxmann.com 143 (Bom);
• Vakamulla Chandrashekhar vs. ED [2019] 356 ELT 395 (Del);
• Virbhadra Singh vs. ED (Manu/Del/1813/2015);
• Moin Akhtar Qureshi vs. Union of India [2017] 88 taxmann.com 66 (Del);
• Rajbhushan Omprakash Dixit vs. Union of India [2018] 91 taxmann.com 324 (Del).

The Courts gave views which were divergent and in many cases the matter was carried to the Supreme Court by way of SLPs which are pending.

However, an Explanation to section 45 has now settled the issue. The Explanation was added to section 45 w.e.f. 1st August, 2019 to clarify the meaning of ‘offence to be cognizable and non-bailable’. It reads as follows:

‘Explanation. – For the removal of doubts, it is clarified that the expression “Offences to be cognizable and non-bailable” shall mean and shall be deemed to have always meant that all offences under this Act shall be cognizable offences and non-bailable offences notwithstanding anything to the contrary contained in the Code of Criminal Procedure, 1973 (2 of 1974), and accordingly the officers authorised under this Act are empowered to arrest an accused without warrant, subject to the fulfilment of conditions under section 19 and subject to the conditions enshrined under this section’.

Thanks to this clarification, the controversies faced by the Courts in the above-mentioned decisions have been put to rest.

COGNIZANCE OF THE OFFENCE OF MONEY-LAUNDERING – PRECONDITION

There are two provisions which refer to the precondition to take cognizance of the offence of money-laundering.

Section 44(1)(b) of the Prevention of Money-Laundering Act, 2002 (PMLA) provides that, notwithstanding anything contained in the CrPC, a Special Court may take cognizance of the offence of money-laundering upon a complaint made by an authority authorised in this behalf under the Act, without the accused being committed to it for trial.

The second Proviso to section 45(1) lays down the basic precondition for taking cognizance of an offence punishable u/s 4. It categorically provides that the Special Court cannot take such cognizance except upon a written complaint by the Director or any officer of the Central or State Government authorised by a general or special order.

‘Taking cognizance of’ – connotation of
The expression ‘taking cognizance of’ is not defined or explained in the PMLA. In section 44, too, there is no clarification as regards the meaning of this expression. However, its meaning has been examined by the Supreme Court and the High Courts in various decisions. The propositions laid down by the Courts may be reviewed as follows:

• Whether a Magistrate has taken cognizance of an offence depends on the facts and circumstances of each case and no rule of universal application can be laid down on this issue1.
• Taking cognizance means cognizance of an offence and not of an offender. ‘Cognizance’ indicates the point of time when a Magistrate takes judicial notice of an offence. It is different from initiating a proceeding. Rather, it is a condition for initiating a proceeding2.
• Taking cognizance does not involve any formal action but occurs as soon as a Magistrate applies his mind to the suspected commission of an offence and takes first judicial notice of an offence on a complaint or police report or on his own information.3
• The Magistrate takes cognizance once he makes himself fully conscious and aware of the allegations made in the complaint and decides to examine or test the validity of the said allegation4.
• At the stage of taking cognizance, only the prima facie case is to be seen. It is not open to the Court to appreciate the evidence at this stage with reference to the material5.
• For taking cognizance of an offence, the Court has to merely see whether prima facie there are reasons for issuing process and whether the ingredients of an offence are on record6.
• ‘Taking cognizance of offence’ means taking notice of an offence which would include the intention of initiating judicial proceedings. It is not the same thing as issuance of process. It is entirely different from initiation of judicial proceedings; rather, it is a condition precedent to the initiation of proceedings by the Magistrate7.

Private complainant has no locus standi
Having regard to the provisions of section 44(1)(b) and section 45 of the PMLA dealing with a complaint to the Special Court to take cognizance of an offence punishable under the PMLA, an important question that frequently arises is whether a complaint filed by a private complainant can be entertained by the Special Court.

This question was addressed by the Delhi High Court in the Raman Sharma case8. While answering it in the negative, the High Court made the following observations:

‘The question before the learned Trial Court was whether the Trial Court can entertain a complaint filed by a private party for the offence committed under the Prevention of Money-Laundering Act. On this issue, section 44(b) of the Act clearly stipulates that the Special Court may, upon a complaint made by an authorised person in this behalf under this Act, take cognizance of an offence under section 3. Further, the second Proviso to section 45 makes it clear that the Special Court shall not take cognizance of offence except upon a complaint in writing made by the Director, or any officer of the Central Government or State Government authorised in writing in this behalf by the Central Government.

_________________________________________________________________________________

1   Nupur Talwar vs. CBI [2012] 1 SCC (Cr) 711

2   Ajit Kumar vs. State of WB; AIR 1963 SC 765

3   Anil Sawant vs. State of Bihar (1995) 6 SCC 142; R.R. Chari vs.
State of
UP 1951 CrLJ 775(SC); Darshan Singh Ram Kishan vs. State of Maharashtra 1971
CrLJ 1697 (SC)

4   Narayandas Bhagwandas Madhavdas vs. State of WB; 1959 CrLJ
1368(SC)

5   Kishan Singh vs. State of Bihar 1993 CrLJ 1700 SC

6   Chief Enforcement Officer vs. Videocon International Ltd.
[2008] 2 SCC 492

7   State of Karnataka vs. Pastor P. Raju: AIR 2006 SC 2825; State
of WB vs. Mohd Khalid AIR 1995 SC 785

8   Raman Sharma vs. Director, Directorate of Enforcement (2020)
113
taxmann.com 114 (Del)

Accordingly, the learned Trial Court opined that the aforesaid two provisions make it clear that the Court cannot entertain a complaint filed by a private complainant for the offence committed under the Act’.

Cognizance of supplementary complaint
In the context of a supplementary complaint, a question arises whether cognizance is required to be taken again on the filing of a supplementary complaint? This question has been addressed by the Delhi High Court in Yogesh Mittal vs. Enforcement Directorate (2019) 105 taxmann.com 336 (Del). While answering it in the negative, the Delhi High Court made the following observations:

‘It is thus trite law that cognizance is taken of the offence and not the offender. It is also well settled that cognizance of an offence / offences once taken cannot be taken again for the second time. Since this Court has already taken a view that a supplementary complaint on additional evidence qua the same accused or additional accused who are part of same larger transactions / conspiracy is maintainable, however, with the leave of the Court and cognizance is taken of the offence / offences, not the offender and in case no new offence is made out from the additional material collected during further investigation, supporting an earlier offence on which cognizance has already been taken or additional accused are arrayed, no further cognizance is required to be taken’.

Procedural aspect of the cognizance of the offence of money-laundering
Apart from the above-mentioned substantive aspects of cognizance of the offence of money-laundering, it is equally necessary to be aware of procedural aspects relating to the same. Such procedural aspects are not specified in the PMLA.

Section 65 of the PMLA provides that the provisions of the CrPC shall apply, insofar as they are not inconsistent with the provisions of the PMLA, for search and seizure, attachment, confiscation, investigation, prosecution and all other proceedings under the PMLA.

Hence, a reference may be made to Chapter XII of the CrPC [Information to the Police and their Powers to Investigate]. This Chapter lays down the procedure to be followed for investigation of cognizable or non-cognizable offences.

A reference may be made to the following provisions relating to a cognizable offence:
• Section 154 – Information in case of cognizable offence,
• Section 157 – Procedure for investigation of cognizable offence,
• Section 158 – Report to Magistrate, how submitted,
• Section 159 – Power to hold investigation or preliminary inquiry,
• Section 160 – Police officer’s power to require attendance of witnesses,
• Section 161 – Examination of witnesses by Police,
• Section 167 – Procedure when investigation cannot be completed in twenty-four hours,
• Section 172 – Diary of proceedings in investigation,
• Section 173 – Report of police officer on completion of investigation.

A review of the above-mentioned provisions of the CrPC in the context of certain provisions of the PMLA would show that the PMLA does contain the following provisions which are analogous to corresponding provisions of the CrPC:
• Section 19 of the PMLA empowers the ED to arrest a person u/s 19 if, on the basis of material in its possession, it has reason to believe that a person is guilty of an offence punishable under the PMLA.
• Proviso to section 44(1)(b) of the PMLA (inserted w.e.f. 1st August, 2019) requires that upon completion of investigation where it is found that no offence of money-laundering was committed, just like section 173 of the CrPC, the ED is required to submit a closure report to the Special Court.
• However, in respect of the other provisions of Chapter XII of the CrPC, such as filing of FIR, maintaining a case diary, etc., the PMLA does not contain analogous provisions.

CONCLUSION
Often, clients approach their chartered accountants with the show cause notice received by them from an Enforcement Officer alleging that an offence under the PMLA has been committed. The clients seek advice on the manner of giving a reply. That apart, a number of questions are raised by clients in respect of the consequences of various actions under the PMLA, such as provisional attachment of property, arrest, search and seizure, etc.

To advise clients on the proper course of action it is necessary for us to familiarise ourselves with basic knowledge of the main provisions of the PMLA. This will facilitate proper steps to be taken by the client during adjudication and other proceedings under the PMLA and briefing the arguing Counsel engaged by the client for representation before the Special Court.