Liability for Fraudulent Conduct of Business: S. 339

Liability for fraudulent conduct of business is the point in an Indian winding up where the company's limited liability stops protecting the people who ran it. Section 339 of the Companies Act, 2013 lets the Tribunal declare a person personally responsible, without any limitation of liability, for the company's debts. Sections 340 and 341 extend the reach. This page reads all three as printed.

What is liability for fraudulent conduct of business, and when does it arise?

In the course of the winding up, on an appearance rather than a conviction. Section 339(1) applies If in the course of the winding up of a company, it appears that any business of the company has been carried on with intent to defraud creditors of the company or any other persons or for any fraudulent purpose.

Two alternatives are in that test. Intent to defraud is one, and any fraudulent purpose is the other, and the persons protected are not limited to creditors: the section names creditors or any other persons.

Four applicants can bring it: the Official Liquidator, or the Company Liquidator or any creditor or contributory of the company. A single creditor can therefore move without the liquidator, and section 340(1) names the same four applicants for its own remedy. Who the two liquidators are is covered in the Company Liquidator and the powers of an Official Liquidator.

The Tribunal may, if it thinks it proper so to do, declare that any person, who is or has been a director, manager, or officer of the company or any persons who were knowingly parties to the carrying on of the business in the manner aforesaid shall be personally responsible, without any limitation of liability, for all or any of the debts or other liabilities of the company as the Tribunal may direct.

The second limb of that sentence is the widest part of the section. Any persons who were knowingly parties to the carrying on of the business need hold no office at all. The proviso then lets the liquidator prove it himself: on the hearing, the Official Liquidator or the Company Liquidator may himself give evidence or call witnesses.

What can the Tribunal do to enforce the declaration?

Turn it into security. Section 339(2) lets the Tribunal give further directions, and particularises two. Clause (a) lets it make provision for making the liability of any such person under the declaration a charge on any debt or obligation due from the company to him, or on any mortgage or charge or any interest in any mortgage or charge on any assets of the company held by or vested in him, or any person on his behalf, or any person claiming as assignee from or through the person liable or any person acting on his behalf. Clause (b) allows such further order as may be necessary for the purpose of enforcing any charge imposed under this sub-section.

So a director who is himself owed money by the company, or holds security over its assets, can have that very entitlement charged with his personal liability.

Section 339(3) adds the criminal consequence: every person who was knowingly a party to the carrying on of the business in the manner aforesaid, shall be liable for action under section 447, the general fraud provision covered in fraud under section 447. Section 339(4) makes the section apply notwithstanding that the person concerned may be punishable under any other law for the time being in force in respect of the matters on the ground of which the declaration is to be made. The tail is the limit: the other law has to bear on the same matters.

The Explanation defines two words. Assignee includes any person to whom or in whose favour, by the directions of the person liable, the debt, obligation, mortgage or charge was created, issued or transferred or the interest was created, but does not include an assignee for valuable consideration, not including consideration by way of marriage, given in good faith and without notice of the matters grounding the declaration. Officer includes any person in accordance with whose directions or instructions the directors of the company have been accustomed to act, the same formula used in section 336.

How does section 340 differ?

It does not need fraud at all. Section 340(1) applies where it appears that a person who has taken part in the promotion or formation of the company, or is or has been a director, manager, Company Liquidator or officer, either has misapplied, or retained, or become liable or accountable for, any money or property of the company, or has been guilty of any misfeasance or breach of trust in relation to the company.

The remedy is restitution rather than a debt guarantee. The Tribunal may inquire into the conduct and order him to repay or restore the money or property or any part thereof respectively, with interest at such rate as the Tribunal considers just and proper, or to contribute such sum to the assets of the company by way of compensation in respect of the misapplication, retainer, misfeasance or breach of trust, as the Tribunal considers just and proper.

Section 340(2) is the limitation: an application shall be made within five years from the date of the winding up order, or of the first appointment of the Company Liquidator in the winding up, or of the misapplication, retainer, misfeasance or breach of trust, as the case may be, whichever is longer. The three dates are not alternatives to choose between; the longest governs. Section 340(3) applies the section notwithstanding that the matter is one for which the person concerned may be criminally liable.

Do the sections reach a corporate wrongdoer's own people?

Yes, and section 341 is the whole of that rule. Where a declaration under section 339 or an order under section 340 is made in respect of a firm or body corporate, the Tribunal shall also have power to make a declaration under section 339, or pass an order under section 340, as the case may be, in respect of any person who was at the relevant time a partner in that firm or a director of that body corporate.

The test is status at the relevant time, not at the date of the order, so a partner or director who has since left is not outside it.

How does the Tribunal get to these sections?

Often through the liquidator's own report. Section 282(3) requires the Tribunal, on a report that a fraud has been committed, to order an investigation under section 210, and then lets it pass order and give directions under sections 339 to 342. That route is covered in the Company Liquidator's report, and the questioning that usually precedes it in the examination of promoters in winding up.

Liability for fraudulent conduct of business is therefore the civil counterpart to the criminal sections beside it: section 336 punishes the officer, and section 339 makes him pay the company's creditors, without the limit that the corporate form would otherwise supply.

Flock reports the filings themselves, each stamped with its date and linked back to the exchange or regulator that published it. What any of it means for you is your call to make.