Amendment to the Companies Act 2020: Is Fixed Penalty Sufficient enough to deter Companies?

Gunjan Shrivastav[i]

In 2020, the Parliament approved certain amendments to the Companies Act 2013, called as Companies (Amendment) Act 2020. These amendments were based on the recommendations of the Company Law Committee 2019 (hereinafter “CLC”), headed by Injeti Srinivas. The committee was formed to look at the provisions of the act that could be decriminalized and to strike a balance between civil and criminal liabilities for corporates. The committee realized that it was important to decriminalize certain provision so as to provide ease of doing business to the companies in India. Moreover, corporate criminal liability was considered to be inefficient as it was time-consuming, cost-intensive and the chances of a successful prosecution were limited.


Accordingly, to lessen the burden of the National Company Law Tribunal (“NCLT”) by reducing the number of cases concerning minor offences, these amendments were brought. Essentially there are two main changes in the Amendment Act, firstly, it allows for in house adjudication mechanism (“IAM”) presided over by Adjudicating Officers (AOs) which is appealable to the Regional Director and secondly, the amendments allow a fixed penalty for certain offences instead of fines or imprisonment. While a penalty is imposed by any authority not necessarily the court, whenever there is a violation of any law, rule or regulation, whereas a penalty is imposed when a petition s filed.


This blog focuses on the second proposition of the Amendment Act 2020. It is argued that imposition of fixed penalty by the Regional Directors is biased towards the companies with large turnover, and fails to provide effective deterrence to the companies. The amendment seems to provide an easy escape to companies with large turnovers to contravene the compliance requirement under the Act.


Fixed Penalties are biased towards companies with large turnover

Under the recent amendments based on the recommendations CLC Report, certain offences for which their were criminal sanctions in form of fine or imprisonment have now been brought under civil wrong and a fixed penalty has been imposed. For instance under Section 243 (2) of the Act, in case of default in complying with the directions of the NCLT with respect to termination or modification of certain agreements, the punishment has been restricted to fine only. The rationale for this was that such offences require a subjective interpretation based on facts and circumstances, and a prosecuting court would be in the best position to determine the punishment. Similarly, violation of offence under Section 56 of the Act does not involve detailed adjudication and accordingly has been shifted to a civil penalty of fifty thousand. The purpose of the removal of criminal liability was to ensure that the work of a company was not obstructed because of mere procedural non-compliance.


Companies are economic entities whose goal is to maximize profits and have executives and managers whose main task is to analyze the costs and benefits from a possible course of conduct and choose the course that is most profitable for the company, which even includes transgressing the law if committing the offence maximizes corporate profit. Different companies have different turnovers which can range from fifty thousand to fifty thousand crores and all company strive to increase their turnover. In such a case imposing a fixed penalty for all companies is problematic as it works unfairly against different companies. For some companies, a penalty may cost them their annual earnings while for companies with large turnover it will only serve as a cost incurred in achieving the desired profit.


Fixed Penalty fails to deter Companies from violation

Penalties were imposed as a form of punishment for corporate offences so that it acts as deterrence for the companies but, when a fixed penalty is imposed it might not always be effective in deterring the companies. This can further be explained with the help of Learned Hand Formula B<PL, here B refers to the cost of compliance and taking precautions to not commit an offence, P refers to the probability of committing the wrong and being caught and L refers to the cost incurred in form of penalty. According to this formula if the cost of taking precautions or measure to avoid an offence is less than the probability of being caught and the cost of the penalty imposed, then such rules would deter companies and they would not break these rules of compliance, however, if the cost of compliance is higher than the probability of being caught and the cost of penalty being imposed, then in such a case the penalty would fail to deter a company from non-compliance. Since companies run on an approach of rational profit maximization, they will commit the offence as the expected benefits from the offence would exceed the expected costs.


Thus, in the case of big companies that have a big turnover, such penalties might not always deter them from committing the offence as they could afford to pay the fixed penalty but it might affect the companies with low turnover. In addition to this, big companies are better equipped with resources and tactful counsels and experts which makes it easier for them to circumvent the law as compared to other companies. It defers from the actual goal of decriminalization and makes it at ease for big companies to violate the law and shift the burden of compliance on companies that don’t have a big turnover.


Before decriminalization, when fines were imposed, there used to be a range of fine that could be imposed on the company based on its turnover, size, nature of business etc. For example under the pre-amended Act, failure of compliance with the procedural requirements for the transfer of securities would result in a fine ranging from twenty-five thousand to five lakh, but under the amended provision, a fixed penalty of fifty thousand has been imposed. Since such procedural compliance requires a lot of legal assistance and other resources, it would not be fair to consider all the companies at one pedestal while imposing a penalty. Therefore, by having a fixed penalty, the government has adopted the approach of one size fits for all, where irrespective of how high or low the turnover of the company is, it has to pay a fixed penalty.


How can Penalty act as efficient deterrence?

In order to resolve this issue, it is suggested that companies should be penalized according to their turnovers. For instance, companies that have a turnover ranging from one lakh to ten lakh can be subjected to lesser penalty as compared to companies with high turnover ranging from ten lakh to twenty lakh and this can further extend till the maximum penalty that is allowed. Such categorization of companies to determine the penalty based on their turnover will ensure that the amended provisions are fair for all companies irrespective of their profit and size. Although under section 446B of the Amended Act the penalty for non-compliance in case of One Person Company, start-up company, a small company or producer company has been reduced to one half of the specified penalty and it shall not exceed two lakh. While this provision is definitely needed as it aims to protect a certain category of companies that cannot afford to pay a heavy penalty, we cannot ignore the fact that the provision is very restrictive. There should be a general categorization of companies so that the fixed penalty is effective in deterring the companies.


Conclusion

It is concluded that the amendment to the Act needs certain revisions for otherwise, it will create more obstacles in conducting business in India instead of facilitating the same. The ease of doing business includes the protection of minority investors as one of its parameter. Fixed penalties on companies imposed by recent amendments contravene this condition as the burden of high penalties has to be borne by them. Initially, the rationale for decriminalization was to improve the ease of doing business in India and remove criminal prosecution which caused a major hurdle for companies, however, the way the provisions are amended seems to provide an easy escape for big companies for non-compliance.


[i] Gunjan Shrivastav is a 3rd Year B.A.LL.B (Hons.) student at National Law School of India University, Bangalore. Her interests lie in corporate law, constitutional law and data protection law. For any discussion related to the article, she can be contacted via mail gunjan10shrivastav@gmail.com