Responsibility by rod: MCA adjudication orders deal punches of penalty for CSR breaches

– Vinod Kothari | corplaw@vinodkothari.com

If the intent of CSR provisions coded in the law was to promote socially responsible conduct on the part of companies, that lesson of responsibility is being taught the very hard, indiscriminately harsh way – by imposing penalties of 2X of the amount involved in CSR breaches, even if the breach was a pure timing mismatch. By now, there are several such adjudication orders – purely as an example, is  where the order clearly notes that there has been no failure on the part of the company to spend the failed amount of Rs 14.50 lacs. The amount was indeed spent, as intended for “ongoing projects”, but there mere segregation of this money into a separate bank account, required to be done within 30 days, was missing. Applying the provisions of sec. 135 (7) which provides for a “penalty of twice the amount” which failed the segregation requirement, though it did not fail the spending requirement.

There are several points that arise here: segregation of the amounts meant to be spent for ongoing projects is merely a ring-fencing requirement, such that companies are aware of the purpose for parking the money, and such money is indeed not commingled with the company’s own funds. If the funds are indeed spent for the purpose for which they are to be segregated, the failure to segregate is, at the most, the failure of the method and not the ultimate result. The failure was transient, and only a timing issue, and not a substantive failure. Therefore, even if punishable, the punishment could not have been the maximum amount provided by the law.

The adjudicating officers seem to have gone by the language of the law which talks about “penalty of twice the amount” as compared to a usual language in most laws which provides for a “penalty upto” or “penalty not exceeding”.

The following points need to be noted:

• If the penalty was indiscriminate, and was 2X no matter whether the failure was a timing failure or ultimate failure, that is, not spending the money at all or not transferring the money to CG funds, then the very intent and purpose of adjudication will be lost. Adjudication, as the word implies, is judiciously computing the amount of the penalty. The principles of adjudication and the factors to be considered are laid in Rule 3 (9) of the Adjudication of Penalties Rules. Those factors will become redundant if the penalty would always have to be 2X.
• If the penalty for a failure to segregate the unspent money is the same as the failure to eventually spend the money or transfer the money to CG funds, then a company which truly meets the spirit of CSR ends up spending 3X of its obligation, whereas the one who does not spend at all as required, or fails transfer the money to CG funds,  is only paying a penalty, and therefore, suffers only 2X. Usually, we say, देर आयद दुरुस्त आयद, and therefore, mere delays should not be put at par with a substantive, non-remediable failure. If someone actually spends the money, the offence stands remedied. Even if there is a penalty, it can only be a token, because the commingling of funds and failure to segregate did not prevent the entity from spending.
• If the penalty was always 2X, someone who delayed the segregation of funds for, say, a day, will stand on the same footing as someone who did not spend at all. Once again, there always has to be a sense of proportionality between the wrong and the implications of the wrong. Weighing all wrongs as equal is the surest indicator of अंधेर नगरी चौपट राजा.

The power to impose a penalty never implies a compulsion to do so. Penalty is a sum charged, in a civil process, essentially for deterring. It is not punishment for an offence, as in case of a fine or imprisonment. It is a penal provision, but completely monetary. The monetary implications of a penalty cannot be disproportional to the wrong involved. There have been various rulings of courts on this issue. In Superintendent and Legal Remembrancer of Legal Affairs Vs. Abani Maity, the SC held that even where the law uses the words “shall be liable”, it does not import an obligation to impose penalty.

In its landmark judgement in the matter of Adjudicating Officer vs. Bhavesh Pabari, the SC while evaluating the scope of Section 15J of the SEBI Act, which provides for the factors to be analysed by the adjudicating officer (AO) for determining the quantum of the penalty to be imposed, held that the AO has the power to determine the penalty and not limiting it only to the factors mentioned in Section 15J. In this ruling, SC elaborated that the AO will not be restricted by the minimum penalty rule and can impose the penalty which is proportional to the gravity of the offense, thereby giving the liberty to the AO to impose lesser penalty than the minimum prescribed in the Section or completely waive it off, after comprehending the nature of the offense.^[1]

The above ruling of the Apex court goes to the extent of saying that there is no concept of minimum penalty, as any such minimisation disregards the gravity of the wrong, and therefore, will be in breach of fundamental principles of justice. The adjudicating officers have been led to believe that they are required to impose 2X as the minimum penalty – which is a wrong interpretation.

The act of imposing a penalty is not a revenue raising exercise: hence, penalties can never be automatic. This is different from a time-based payment –for example, a delay in doing something is penalised with a penalty which runs on a daily basis. But an absolute penalty can never be mechanical, automatic or the same irrespective.

In any case, CSR provisions have travelled from being a benign “comply or explain” case of a innate, self-inspired sense of responsibility, for a mandatory spend. Currently, companies spend huge time and compliance cost, not for being socially responsible, but for literally staying within the language of the law. This is, clearly, neither the intent of the law, nor does the conduct of adjudicating officers fit the provisions of the section.

^[1] Read our detailed article analysing the ruling at: https://vinodkothari.com/2019/04/adjudication-of-penalties-under-sebi-sc-ruling-gives-controlled-discretion/