Demonetization version 2.0: the frozen accounts fiction

While the wire reports claimed that the government has “frozen” the bank accounts of all the 2.09 lakh companies, the PIB press release did not use the word “frozen” even once.
PRASHANT R THIKKAVARAPU does a fact check on what the press put out

 

On September 5th and 6th several newspapers and wires published similar stories about the government reportedly “freezing” bank accounts of 2.09 lakh companies as a part of Modi’s fight against black money and shell companies that are used to launder such black money. In order to understand the magnitude of the move it is necessary to understand that per the government’s figures there are approximately 15 lakh companies registered in India and of those, the government has turned off the tap on 2.09 lakh companies i.e. approximately 13% of all registered companies have their accounts frozen over the last 3 months. From a purely business perspective, this is truly stunning and can be placed in the category of demonetization for its ‘shock and awe’ effect. But how much of this is actually true?

For the sake of a fact check let’s compare the original press release put out by PIB with the reports published by Reuters, PTI (republished by Business Standard),  and Economic Times to determine how the story was “spun”.

 

1.  Not a mention of black money or tax evasion or shell companies: The Reuters story starts with the sentence “India has frozen the bank accounts of 209,032 suspected shell companies as part of a crackdown on illegal transactions and tax evasion, the finance ministry said on Tuesday”, while the PTI story starts with the line “ In a major clampdown against black money, the government on Tuesday directed freezing bank accounts of more than 2.09 lakh companies whose names have been struck off from the records and said action would be taken against more such firms”. Similarly, the Economic Times pitched the move as targeted against “black money” and “shell companies”

In reality, the press release put out by the government does not once use the words “black money”, “shell companies” or “tax evasion”. Rather the entire exercise has been carried out under Section 248 of the Companies Act, 2013 under provisions that allow the Registrar of Companies to strike off from the register, companies which aren’t doing business after being incorporated or which are not filing their returns. 

 

2.  On the point of bank accounts being frozen: While the reports in ET, Reuters and PTI claim that the government has “frozen” the bank accounts of all the 2.09 companies, the PIB press release does not use the word “frozen” even once. Rather the press release presumes that the Directors and Authorized Signatories lack the authority to access to the companies’ bank accounts because the companies themselves have been struck off the register. This appears to be not true from a reading of the law. Section 248(6) of the Companies Act, 2013 clearly allows companies to continue using their assets even after the company is struck off the register of companies.

"In reality, the press release put out by the government does not once use the words "frozen" or “black money”, “shell companies” or “tax evasion”. "

 

The closest the press release comes to freezing bank accounts is this sentence which states “The Department of Financial Services has, through the Indian Banks Association, advised all Banks that they should take immediate steps to put restrictions on bank accounts of such struck off companies. A list of such companies, Registrar of Companies wise, has been published on the website of the Ministry of Corporate Affairs.” (emphasis mine)

Please note the use of the word “advise” the banks – there are no orders to this effect and a bank cannot without authority of law restrict a person from accessing an account that he is otherwise authorized to access. In fact, there is an earlier press release, from June, where the government has in fact conceded that the RBI has refused to order banks to freeze accounts for violations of company law. The relevant extract reads as follows:

“The Government had requested the Reserve Bank of India (RBI) for freezing of accounts of the defaulting companies who have long exceeded the stipulated time limit, for filing of Financials Statements and returns, under the Companies Act. The RBI has informed that, at present, it has no powers to freeze such accounts. Moreover, freezing orders issued by the Government as per the provisions of the relevant statutes such as Unlawful Activities Prevention Act or Foreign Contribution Regulation Act, are communicated by the RBI to the banks.” 

 

3.  Have legally ‘dormant’ companies been struck of the register illegally? The biggest mystery of the government’s claim of striking off 2 lakhs companies is whether the process was actually done per the statute book. From what little research I have managed, it appears that a bulk of the companies appear to be “dormant” companies. Under Section 455 of the Companies Act, some companies can seek a “dormant” status, which if granted allows the company to not file returns etc. subject to some conditions. If those conditions aren’t fulfilled, the company can be struck off the register but it appears that those orders will have to be issued under S. 455 and not S. 248 (under which the present orders were issued).

I sampled a few companies from this list released by the RoC, Ahmedabad – for example, Gayatri Agro Products Pvt. Ltd. This company was listed as dormant long before the notification published in August.

The second list from the same RoC strikes off those companies which have not been carrying on any financial business for a period of two preceding financial years and have not made any application to obtain dormant company status under Section 455. Such companies can be struck off the register but after following a due process, which starts off with a requirement on the Registrar of Companies to issue notice to each company and all of the directors of each company being struck off, asking them to show cause. Further a public notice should be published in the gazette and the Registrar of Companies is required to assess the financial situation of the company and ensure that it is in a position to discharge its liabilities and obligations. Given that this exercise appears to have commenced in April, 2017 with the first set of companies struck off the register from May, 2017 and the second set in August, 2017 the entire process has been wrapped up in less than 4 months. 

I find it rather implausible that all the different RoCs in the country have the resources required to complete such a gargantuan exercise in a period of 4 months flat. An additional point to be noted is that the Registrars of Companies are actually required to pass reasoned orders in all of these cases and not merely publish a consolidated list of companies without providing individual reasons for each company’s demise. Indian law doesn’t allow for mass punishment of the sort that Modi seems to love be it through demonetization or the current exercise targeted at alleged shell companies.

 

Changing the narrative

My guess is that the Modi government, which is reeling from the very public failure of demonetization post the publication of the RBI report on how most of the currency came back, is seeking to change the narrative on the fight against black money. The additional point that may be noted is that Modi’s PMO in February, a few months after demonetization, setup a high profile “Taskforce” to “review the functioning of ‘Shell Companies’ (companies which do not conduct any operations and indulge in money laundering) in India, so as to prevent their misuse for money laundering and tax-evasion, especially in the context of unearthing black money post demonetization.”

"Indian law doesn’t allow for mass punishment of the sort that Modi seems to love, be it through demonetization or the current exercise targeted at alleged shell companies."

 

This taskforce is headed by the Revenue Secretary and is yet to announce any major victories in the fight against  the black money bug. In fact, the government faced a major embarrassment when SEBI banned 331 active companies from trading on the suspicion that they were shell companies and was then reprimanded by the Securities Appellate Tribunal (SAT) for not following due process.

When SEBI originally announced the ban, anonymous sources from the government were quoted as follows: “These companies were identified by a panel formed by government of India post-demonetization. The 331 companies saw high investments through layering and fund flows from non-listed shell companies,” said a ministry official on condition of anonymity.” The “panel” is most likely a reference to the “Taskforce”. When the move backfired and came under criticism from both SAT and the private sector, the Indian Express had reported how the ‘Taskforce on Shell Companies’ was seeking an explanation from SEBI. The same report also mentions how Modi had boasted at an ICAI event that “one lakh companies were struck off the list by the stroke of a pen. The names of those companies have been removed from the register of companies”.

While publicly traded companies are high profile, dormant companies are typically low profile since they aren’t in operation – hence most of them are unlikely to run to the courts for relief, bringing publicity to the process or lack of process followed by the government.

The government stepping in to strike off a private company from the Register is a big event. When a government decides to strike off  over 2 lakh company, it is a legal and regulatory earthquake that will shake the faith of the private sector in the government. It is in times like this that business journalism should stand up for the rule of law and tell us the truth.  

 

The author is an Asst. Professor at NALSAR.  

 

 

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