Establishing Good Governance: Efficient Whistleblowing Adjudication within the Real-Estate Sector

~By Tvisha Zatakia, BITS Law School

Introduction

According to Section 177(9) of the Companies Act, every listed company in, addition to a class of prescribed companies, must establish a vigil mechanism which could be leveraged by directors and employees to report concerns, subsequently supervised by an audit committee. The essence remains the assurance of freedom, transparency and independence, since financial ombudsmen such as the audit committees are deemed to be entities ensuring independence within financial reporting.

However, when contextualized in reference to the real-estate sector, the independence seems to be curtailed owing to the centralization of power within the Board as witnessed within the sector. In the real-estate sector, the Board, as opposed to representing competitive interests, is not an independent body consisting of professionals, but rather consisting of individuals which not only engage in promoter control, dominance in sector through interconnected real-party transactions, and concentration of decision making herein financing the acquisitions, but also remain the key individuals which tend to be the target of the whistleblower allegations. Thus, the individuals  who remain integral to whistleblowers’ allegations, actually constitute, influence or control the audit committee which adjudicates upon these allegations. Although these issues might sound theoretical in nature, real estate frauds concentrate within areas which remain driven by the Board, such as aggressive land banking based on internal or insider valuations, diversion of funds to group entities which were ideally meant for projects and remain in escrow accounts, and concealment of risk and non-compliance  with Real Estate (Regulation and Development) Authority during decision making within the Board.

Hence, whistleblowing in the real-estate sector is ideally contextualized in reference to ratified Board decisions, and the pertinence of Section 177 of the Companies Act despite these structural and procedural conflicts results in a critical consequence, wherein the oversight body or the ombudsmen adjudicating upon these allegations is not independent of the alleged wrongdoer. Whistleblowing about these issues inherently means blowing the whistle on board decisions or at least on matters that the board has ratified. Yet Section 177 routes the complaint to a mechanism supervised by the same board committee. The consequence is a structural conflict of interest: the oversight body is not institutionally independent of the alleged wrongdoer. Thus, in such situations, Section 177 does not assure genuine adjudication but rather serves as a filtration mechanism wherein disclosures and concerns tend to be buried before being raised before the right for a, and although the company might have policies, and channels enabling such concerns being adjudicated upon, there is little incentive for these mechanisms to be actually disruptive in nature

Why the Real-Estate Sector?

It can be argued that the aforementioned structural conflicts persist within all sectors, since the possibility of the Board dominating the adjudication of such allegations prevails in reference to multiple sectors, and thus, the question remains as to why should the real-estate sector remain especially vulnerable to the mechanisms under Section 177, resulting in its applicability within the sector being a structural façade.

The real estate sector is unique owing to the multiplicity of factors, one of them being the opacity and localism of the transactions, since the key governance risks arise from transactions involving benami holdings, informal cash being used in land deals, collusive deals with local governance authorities for approval, and coercive agreements with brokers – and these transactions and actions are under-documented in nature. Hence, whistleblowers are mostly individuals who coordinate at the mid-level as employees, or individuals who are well aware as of what remains undocumented in nature, and thus, if these internal mechanisms are weak or merely procedural in nature, there remains no alternative means to ensure documentation of these critical documents for future adjudication of whistleblower complaints.

Furthermore, the real estate sector remains infused with multiplicity of complicated group structures and project financing enabled through Special Purpose Vehicles (SPV). Real-estate projects are designed in a specific method wherein each project is a separate SPV with interlocked shareholding and cross-collateralization, since the funds flow through a multiplicity of forums, including joint ventures, limited liability partnerships and group entities. Thus, a whistleblower allegation flagging a single transaction might be alleging a systemic fraud pattern across a group however the application of Section 177 may remain constrained in nature owing to the scope being company centric and excluding other formalised structures existing within practice such as group structures pertaining in the real estate sector. In terms of governance, this centralization remains critical, since although the architecture of the complaint might pertain to the wrongdoing across a group, the architecture of the whistleblowing mechanism, as enabled through the statutory provisions, remains siloed in nature.

Shaping Board Control

Section 177, when viewed in reference to the design of multiple vigil mechanisms, enables the effective control of the Board over three levers, these primarily being the intake and triage, the reach of investigation, and the consequences post disclosures. This design remains critical to be deconstructed, specifically the first two levers, since individuals may argue that independent directors form the audit committees and despite the nature of the real-estate sector, independence and transparency within adjudication can be ensured.

Delving into the first lever, which remains intake and triage, it remains critical to understand that most complaints or allegations are reported through internal mechanisms such as portals or email-IDs, and these concerns ultimately are received either by the Company Secretary or the Chief Compliance Officer, employees which remain structurally subordinate to the Board of the company, and the audit committee delves into allegations or complaints which are escalated by the aforementioned individuals enabling a two-tier filtration mechanism being indirectly constituted. This mechanism allows the employees subordinate to the Board to re-characterize allegations as grievances faced by employees or as better resolved by the HR herein eliminating these concerns being raised as “governance breakdowns”, in addition to raising allegations which encompass a lower-risk of serious adjudication or allegations with reference to structural and governance matters already known. Finally, these complaints, which are raised further to the audit committee are reframed in anodyne terminologies without any context, resulting in them being treated as systemic complaints as opposed to allegations in reference to governance issues. Furthermore, an allegation stating the deviation of deployment of funds meant for Project X to Project B through a SPV, can be reduced to a query in reference to “inter-project advances”, therein using anodyne terms inviting clarification from management as opposed to an intricate investigation into the allegation.

Secondly, although Section 177 requires establishment of a mechanism adjudicating upon the allegations raised by employees or directors, it fails to infuse the essence of an independent investigative reach, and thus, pertinent issues are raised such as the appointment of the investigator, defining the mandate as to the quantitative and qualitative reach of the investigation and the extent of control of access being granted. However, in real-estate sectors, the Board and the senior management control the key decisions being made, including the extent of investigation being allowed, in addition to the definition of the scope encompassing which email communications and complaints remain pertinent to be investigated, thereby stripping off the independence, and freedom of the investigative reach for accurate adjudication. The infusion of such dominance over the investigative reach, which should ideally be independent and transparent in nature, allows for subtle sanitization, that is, although an investigation be conducted, and an audit committee might adjudicate upon the findings, the intricate and pertinent allegations can be buried or bypassed by narrowing the scope of the investigative reach resulting into sabotization of complaints and allegations.

Conclusion

To resolve these aforementioned issues and ensure a transparent and independent procedure in reference to the adjudication of whistleblowing allegations in real-estate, whistleblowers complaints exceeding a defined threshold or falling under certain class of activities must mandatorily be reported to external authorities such as Real Estate (Regulation and Development) Authority/Securities and Exchange Board of India /Ministry of Corporate Affairs, and in case these complaints are dealt internally, these adjudicatory procedures must be supervised by external authorities or must remain open to external authoritarian review.

Secondly, the independence and flexibility of individuals serving on the audit committee must be regulated, that is limit on the time period a director can serve on the audit committee of the same real estate company, in addition to the inclusion of one member possessing adequate demonstrated experience in forensic accounting and investigation. Moreover, measures ensuring the prevention of victimization of whistleblowers must be substantial, ensuring the prevention of personal retaliation against a whistleblower making an adequate disclosure once the same is adjudicated upon, complemented with personal liability upon individuals enabling personal retaliation, such as adverse employment consequences. Lastly, statutory remedies such as reinstatement and compensation can be enabled, thereby ensuring a real-estate specific integration to construct “good governance” within whistleblowing mechanisms in the real-estate sector, which could be amplified through material disclosures and alignment of measures strategically to ensure creation of efficient adjudication of whistleblowing allegations.