White Collar Crimes Investigations

The last quarter saw several sanctions imposed by multilateral development banks against corrupt and fraudulent activities by companies. Domestically, High Courts rendered important judgments on the classification of accounts as ‘fraud account’ by lenders post forensic audits, and on the jurisdiction of the Enforcement Directorate over money-laundering offences committed by a company undergoing insolvency proceedings.

Kunal GuptaPartner

Shreya KunduSenior Associate

The Year 2021 closed with a number of lengthy debarments by the integrity offices of various Multilateral Development Banks (MDBs), bringing an interesting close to what was an active enforcement year. The practices that violated MDB procurement guidelines ranged from corrupt acts (paying bribes to influential ex-government officials); to various shades of fraudulent practices involving subcontractors; and representations made in bidding documents. Meanwhile in India, certain High Courts delivered important judgments for borrowers, clarifying how lenders could interpret forensic audit reports on borrowers, as well as the interplay of the Insolvency and Bankruptcy Code, 2016 (IBC) with money-laundering investigations.

Key Developments

  • Important judgments

    • Scope of 'fraud accounts' widened

      In Shree Saraiwwalaa Agri Refineries Limited v Union of India, the High Court of Telangana upheld the lenders’ classification of a borrower's account as a ‘fraud account’ under the Reserve Bank of India’s Master Circular on Frauds (Circular), although the forensic audit commissioned by the lenders found 'no diversion of funds or fraud' intentionally perpetrated by the borrower’s management. In arriving at this conclusion, the High Court gave considerable weightage to certain unusual indicators noted by the forensic auditors, including devolvement of several concurrent letters of credit, diversion of loans to other business verticals of the borrower and a qualified audit opinion issued by the borrower’s new statutory auditors. A key takeaway here is that lenders need not be constrained by the conclusions of forensic auditors on fraud or malintent on the part of the management – if the forensic audit uncovers sufficient evidence of fraudulent or suspicious transactions in the borrower’s account, the lender is entitled to classify it as a 'fraud account'.

      The borrower also contended that the lender classified its account as 'fraud' without giving it an opportunity of hearing and hence violated the principles of natural justice. The High Court did not rule on this point and instead observed that the Supreme Court is already slated to determine whether principles of natural justice, including the right to receive a hearing, should be read into the Circular. Regardless, the High Court observed that the forensic audit report containing adverse observations had been prepared with the borrower’s full participation and therefore was not a unilateral exercise. In the event that the Supreme Court reads the right to receive a hearing into the procedures for fraud classification set out in the Circular, a key question that may then need answering is whether engaging with forensic auditors in the course of defending such an audit amounts to substantive fulfilment of the hearing requirement, or whether the borrowers will be entitled to a separate hearing opportunity vis-à-vis the lender, apart from making their case to the forensic auditor.

    • Position on money-laundering investigations during insolvency proceedings clarified

      In Nitin Jain, Liquidator PSL Limited v Enforcement Directorate, the High Court of Delhi considered if jurisdiction under the Prevention of Money Laundering Act, 2002 (PMLA) could be exercised against a corporate debtor’s property once an order of liquidation is passed by the National Company Law Tribunal (NCLT) under the IBC. In this case, the liquidation of the debtor ordered by the NCLT was already underway when the liquidator received summons from the Directorate of Enforcement (ED). At the time of issuing the summons, the ED’s investigation was still ongoing and no proceedings (including attachments) had been initiated by it.

      The ED’s summons were stayed and the debtor’s properties were successfully auctioned with the NCLT approving the liquidation sale of INR 4,250 million. However, the ED issued a provisional attachment order (PAO) after the NCLT’s approval of the sale, attaching certain auctioned properties (amounting to INR 2,750 million) on the ground that these were proceeds of crime. The liquidator approached the Delhi High Court seeking to disburse the sale proceeds and to have the PAO quashed.

      Section 32A of the IBC was argued by both sides. It essentially provides a ‘clean slate’ to the successful resolution applicant and states that action cannot be taken against a debtor’s property for offences committed before initiation of the corporate insolvency resolution process when the property in question is subject to a resolution plan or 'sale of liquidation assets'. The ED contended that sale of liquidation assets is completed only when a sale certificate is issued certifying the receipt of proceeds.

      The High Court considered the legislative objectives behind both, the PMLA and the IBC, and held that once the decision/plan of liquidation or resolution with respect to the debtor receives the NCLT’s approval, the bar under Section 32A kicks in, and consequently any jurisdiction under the PMLA abates. The Court also noted that individuals who were previously in charge of the debtor continue to remain liable for prosecution. Further, since under the IBC the liquidator steps into the shoes of the erstwhile management, the liquidator has an obligation to cooperate with the ED and provide it with any materials and documents which it may require for its investigation.

  • Multilateral Development Bank sanctions

    • The Inter-American Development Bank (IDB) debarred the Belgian engineering company, Tractebel Engineering S.A. (Tractebel), for 3 years and 10 months for corrupt and fraudulent practices in a public works contract being executed in Haiti. The corrupt practices at the heart of this sanction were that Tractebel offered (through its subcontractors) paid positions to former colleagues of government officials at the Haitian government body responsible for the public works contract in question. The fraudulent practices sanctioned were that Tractebel did not disclose the fees it paid to certain agents in connection with the contract and also misrepresented the availability (for the actual execution of the project) of an individual designated as 'key personnel' in contract documents. This sanction serves as another reminder that MDBs look beyond just corrupt practices when trying to ensure integrity in funded projects, and that subcontracting and the use of intermediaries continue to be high-risk areas when participating in development institution-financed projects. Companies bidding for such financed projects should take care to monitor all ongoing or planned subcontracting activity for compliance with the institution’s procurement guidelines.

      During the debarment period, Tractebel will not be eligible to participate in any projects financed by the IDB. The company has entered into a negotiated settlement agreement with the IDB, and during the period the agreement was under negotiation, voluntarily restrained from bidding in any IDB-financed projects, thus effectively extending the period of Tractebel's exclusion from participating in IDB-financed projects.

      Under the terms of the settlement, Tractebel must retain an independent consultant to evaluate its compliance program for gaps and recommend improvements, and continue cooperating with the IDB, including conducting internal investigations related to IDB-financed activities. Non-compliance with the terms of the settlement may result in the period of debarment being extended to nine years.

    • The African Development Bank has also been active, debarring the China-based Weihai Construction Group for fraudulent practices in connection with certain highways, rivers and sanitation contracts in Kenya. While details of the fraudulent practices in question do not appear to have been made publicly available, the debarment is in effect for 2 years and 11 months during which period the company and its affiliates are ineligible for participating in contracts financed by the Bank.

Both sanctions are eligible for cross-debarment by other MDBs under their Agreement for Mutual Enforcement of Debarment Decisions, extending to the Asian Development Bank, the European Bank for Reconstruction and Development and the World Bank.

The deployment of funding from MDBs has always been important for infrastructure development and has grown more crucial for its role in global recovery from pandemic-induced economic and social crises. In the next quarter and beyond, we expect the integrity offices of major MDBs to continue the enforcement momentum from 2021.

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