By Team Vinod Kothari & Company (firstname.lastname@example.org)
This version is dated October 3, 2017
Continuing the crackdown on shell companies, MCA in its Press Release issued on September 6, 2017, expressed that the government will soon take steps against the directors of the shell companies which have not filed returns for three or more years. Post this, the Registrar of Companies of the respective states started issuing the list of disqualified directors u/s 164 (2) (a) of the Companies Act, 2013.
Therefore, in this regard, the work below endeavours to answer the nagging questions relating to the law about directors’ disqualifications and the impact of such disqualification thereon.
We submit that our work is academic piece; it contains our opinions some of which may not find favour with the MCA or with some of the rulings of the NCLT. However, we do give basis for our views. Our work is not a professional advice; please do consult your professional adviser for your queries.
- Is there any difference in the provision of disqualification of directors as per Act 1956 and Act 2013?
Section 274 (1) (g) of Act 1956, the corresponding provision to Section 164 (2) of the Act 2013, which deals with disqualification of directors, was not applicable to private companies. Therefore, the ambit of Act 2013 is wider than the erstwhile Act. Further, the disqualification under Section 274 (1) (g) did not result in vacation of office under Section 283 of Act 1956, which is not the case as in Section 167 of the Act, 2013.
In the 1956 Act, the disqualifications referred to in sec. 274 were, where appropriate, repeated in sec. 283. For example, the disqualifications in sec. 274 (1) (a) to ( e) were repeated in sec. 283 (1). The disqualification in sec. 274 (1) (g) was not a ground for vacation of office in sec. 283.
As against this, sec. 167 of the 2013 Act merely makes a reference to the disqualifications referred to in sec. 164, as if covering, in one single sweep, all the disqualifications referred to in sec. 164.
- Are the Sections 164 (2) and 167 of the Act 2013 co-linked?
Act 2013 has linked Section 164 to Section 167 leading to an impression that disqualification under Section 164 leads to automatic vacation. This may seem logical if one were to be disqualified under Section 164(1), e.g., become an undischarged insolvent or is declared as being of unsound mind by a Court. Most certainly such a person cannot continue as a director. These are, what we may refer to as personal disqualifications, because each of these relate to the person assuming or holding office as a director. However, Section 164(2) is on a different footing than Section 164(1). The failure to file financial statements or inability to redeem debentures are the failures of the company. There are corporate failures; many of these may be due to circumstances beyond the control of the Company. Section 164 (1) specifies disqualification due to personal default while Section 164 (2) specifies about disqualification arising due to corporate default.
Hence, other than by the doctrine of attribution, whereby the offences done by a company can be attributed to the director(s), the failures referred to in sec. 164 (2) do not indicate personal disqualifications.
Section 164 (1) starts with the language “person shall not be eligible for appointment as a director” implying that the disqualifications apply at the time of appointment itself. Sec. 164 (2), on the other hand, uses the language, “shall be eligible to be re-appointed as a director of that company or appointed in other
Company”, implying that the disqualifications, at least for the particular company where the person is a director, will be applicable only at the time of reappointment. However, if we compare this language with that of sec. 167 (1) (a), there is a clear mismatch in the language, as sec. 167 (1) (a) provides that the person attracting any of the disqualifications as in sec. 164 will immediately vacate his office. If the person immediately vacates his office, then the question of the disqualification arising at the time of reappointment does not arise. On account of this mismatch in the language, we are of the view that the provisions of sec. 167 (1) (a) pertain to sec. 164 (1), and not to sec. 164 (2).
This discrepancy is sought to be corrected by the changes proposed in Companies Amendment (Bill), 2017, pursuant to the recommendation of Company Law Committee, by inserting the following proviso in sec. 167 (i)(a):
“Provided that where he incurs disqualification under sub-section (2) of section 164, the office of the director shall become vacant in all the companies, other than the company which is in default under that sub-section.”
Therefore, by virtue of the proposed amendment, a disqualification under Section 164(2) will trigger automatic vacation of office of directors in other companies only and not in the company in respect of which such disqualification has incurred.
- When does Section 164 (2) of the Act 2013 lead to an ipso facto vacation?
Assuming, as seems to be the MCA’s view, that sec. 164 (2) leads to an immediate vacation of office in all companies where there the person, holding office of a director of a company attracting the offence of sec. 164 (2), the question is, when exactly does the disqualification arise? The section refers to a period of 3 years, in respect of annual filing, from the date on which the company fails to do so. So, the issue is, what is that date from which the failure commence?
Annual filings by companies are connected with date of holding of the AGM, which, in turn, is related to the financial year. Since the RoC’s action is obviously taken in absence of any filings done by the company, the RoC would not have information about the date of holding of the AGM, the presumption will have to relate to the last date on which AGM could have been held. If the financial year of a company ended on 31st March 2014, the AGM ought to have been held by 30th Sept., and accordingly, the annual filings ought to have been done by end October 2014.
There is an option, vide sec 403 (the section is due for amendment vide the 2017 Amendment Bill), to file documents within a time of 270 days. However, that option is available only if the company chooses to pay the additional fees for the delay. If the company in question has not filed at all, the failure may run from the last day on which the filing in question would have been done, that is, 3 years from end-October, 2017.
- Will an independent director/non-executive director be saved from the implications of sec. 164 (2) by virtue of sec. 149 (12)?
Section 164 (2) paints every director with the same brush – as if the payment delays/filing failure is attributable to every director.
However, it is important to note the provisions of sec. 149 (12), which starts with a non-obstante clause. An independent director or non-executive director shall be “liable” only for such lapses which “occurred with his knowledge, attributable through Board processes, and with his consent or connivance or where he had not acted diligently.”
There are two issues that arise here – first, if the independent/non-executive director is immune from a liability arising from lapses, will this immunity extend to the implications of sec. 164 (2) as well? It is pertinent to emphasise, as we mentioned earlier, that the lapses in sec. 164 (2) are corporate lapses on the part of the company – they percolate down to the director only because of his culpability for the same. It is trite to say that no one can be condemned to suffer consequences for something that one was not responsible. Therefore, there is little doubt that the serious consequence of being banished from corporate boards for a period of 5 years is no less a condemnation than being prosecuted under the law, and therefore, if the intent of sec. 149 (12) is to hold the director safe, the immunity must extend to sec. 164 (2) as well.
Second question – if the director wants to take advantage of sec. 149 (12), how does he do so? The process of automatic and forced notices by the RoC does not give any opportunity to the concerned director to make his case. The current MCA action seems to have proceeded on the ground that there is no scope for the directors in question for any opportunity to be given. While opportunity was given, by way of at least 2 notices, to the companies whose names were struck off, there was, arguably, none to the affected directors. Applying the well-settled principles of natural justice, it may be contended that an independent/non-executive director may feel aggrieved on account of lack of natural justice in the process of disqualification.
- Whether the Section 164 (2) (a) of the Act 2013 has prospective or retrospective effect?
It is settled position with several Supreme Court rulings that a law affecting substantive rights of parties is presumably prospective in applicability and effect, unless the intent to make it retrospective is clearly spelt out in the law. There is no doubt that sec. 164 (2) does affect the right of a director to continue as such, not only in the company committing the lapse, but other companies as well. Hence, this provision affects substantive right – that is, the right to serve as a director.
However, if the case is one of continuous failure to file financial statements, the period of 3 years would have been over even if the provision was to be prospective. It is pertinent to note that the companies had a period of three continuous years to comply with the requirement of the Section, post the Section is effective i.e., April 1, 2014 in the following way:
|Financial Year||Filing requirement post April 1, 2014|
Therefore, the time span of three years, post the applicability of the Section is well provided to the Companies and hence, the question of retrospective application of the Section does not arises at all in those cases where the disqualification is from November 2016.
However, some RoCs have applied the law in a retrospective way and have disqualified directors from November 2014.
With due respect to the NCLT ruling in Vikram Ahuja Vs. Greenstone Investments Pvt. Ltd. and ors., before the NCLT, Mumbai Bench, decided on November 11, 2016” our view, based on the principles of prospective applicability of the law, is, respectfully, different. What section 164 (2) does, in case of private companies, is to create a new disability, or take away substantive rights. A prolonged failure of 3 years is required to have such a serious impact. A director was entitled to know that there is such a consequence, if the failure to file financial statements prolongs. If the law itself came into effect on 1st April, 2014, the period of failure cannot extend before the applicable date of the law. Assuming that the law may apply to a continuing failure, a director of a defaulter company got barely 6 months time for rectifying what may well have been a chronic failure. A director cannot be taken unawares of the dire consequences of his filing defaults.
Further, MCA vide General Circular No. 34/2014 dated 12th August, 2014 was benevolent enough to introduce Company Law Settlement Scheme, 2014, in exercise of powers conferred under Section 403 and 460 of Act, 2013, in view of the stricter regime prescribed under Act 2013 for defaulting companies thereby condoning the delay in filing the statutory documents, granting immunity for prosecution and charging a reduced additional fee. The Scheme was valid till 15th October, 2014, extended till 15th November, 2014 and thereafter extended till 31st December, 2014.
The CLSS scheme is admittedly a Departmental initiative to clear pending defaults. However, when it comes to applicability of the law, the Department cannot take a different view in case of companies opting for the CLSS and those who do not.
- Will disqualification u/s 164 (2) also apply to the newly appointed director of a company?
Section 164 (2) beings with the words “No person who is or has been a director of a company which……”. The expression “is or has been” seems to suggest that the disqualification will fasten to a director, if the director assumes office in a company which is already running a default. However, this view will be both counter-intuitive and patently unfair. First, the doctrine of attribution can attach the offences of a company to a director only if the director in question was responsible for the same. Secondly, if a person earns a disqualification as soon as he joins the company, there is no reason for a person to join the company at all.
Section 167 (3) seems to provide for replacement directors for a company which has become headless due to the filing offence; however, that provision will also become meaningless as every director appointed either by the Central Govt or by the promoters will also lose his office, as soon as he/she is appointed, if the word “is” in the provision is intended to attach to a director who just enters the board. Obviously, there is no way to make good the filing lapse unless there is a board, and there may be no board if the filing offence is like a venom which kills the person immediately upon touch.
In our view, both the filing default, as well as the directorship, have to be for a period of 3 years. As we noted earlier, the filing default is incurred by the company – the only reason it fastens with the director is due to the director’s prolonged failure in making good the flaw. Therefore, the provision cannot be interpreted to apply to a director who has been on the board for a part of the period of lapse.
The Companies Amendment (Bill), 2017, tries to correct this very anomaly by providing the following insertion in Section 164 (2)-
“where a person is appointed as a director of a company which is in default of clause (a) or clause (b), he shall not incur the disqualification for a period of six months from the date of his appointment”
The amendment provides a time period of six months for an incoming director to correct the filing defaults committed by the company.
Further, as per the proposed changes in Section 167 (1) by the Companies Amendment (Bill), 2017-
“Provided that where he incurs disqualification under sub-section (2) of section 164, the office of the director shall become vacant in all the companies, other than the company which is in default under that sub-section.”;
By virtue of the proposed amendment, a disqualification under Section 164(2) will trigger automatic vacation of office of directors in other companies only and not in the company in respect of which such disqualification has incurred. This will partly remove the anomalies in the current provisions which otherwise may have suggested a situation of vacation of office by all the directors.
- Is there any compliance requirement to be done by the company and the director in case of non – compliance of Section 164 (2)?
Yes. Such company will have to inform the Registrar in Form DIR-9 within a period of thirty days of the failure that would attract the disqualification under sub-section (2) of Section 164, furnishing therein the names and addresses of all the directors of the company during the relevant financial years, otherwise the officers of the company as specified in Section 2 (60) of the Act shall be the officers in default.
In case of other companies where the person is a director, he will inform the company concerned about the disqualification incurred in Form DIR-8 before he is appointed/ reappointed. Further, as per Section 167 (2) — if a person, functions as a director even when he knows that the office of director held by him has become vacant on account of any of the disqualifications specified in sub-section (1), he shall be punishable with imprisonment for a term which may extend to one year or with fine which shall not be less than one lakh rupees but which may extend to five lakh rupees, or with both.
- How will a company function if all the directors of a company will need to vacate their offices?
As per Section 167 (3), where all the directors of a company vacate their offices under any of the disqualifications specified 167 (1), then –
- the promoter or, in his absence,
- the Central Government (i.e., MCA Delhi)
shall appoint the required number of directors who shall hold office till the directors are appointed by the company in the general meeting.
- How can the promoters of a private company be identified?
The word “promoter” has to take its meaning from sec. 2 (69). Promoters are required to be identified in the annual return or in the prospectus. The question of identification in the prospectus will not arise in case of companies which did not file one at the time of formation. Hence, identification in the annual return will be required.
the company in question has been a persistent defaulter in filing, it will be hard to expect the company to have filed an annual return. Also, it is important to note that the contents of the annual return under the 1956 law did not require identification of promoter.
It is a wrong notion that the subscribers to memorandum are the promoters – they may be presumed to be the promoters; but they are not necessarily the promoters. They can be promoters only if they fit into the definition in sec. 2 (69).
10. How can the director remove his/her name from the list of disqualified directors post serving the punishment of 5 years bar on appointment/ re-appointment?
As per Rule 14 (5) of the Companies (Appointment and Qualification of Directors) Rules, 2014, the director shall make an application in form DIR – 10 to the RoC for removal of disqualification and the said application can be made only at the end of the tenure of five years post his disqualification.
- The PIB press release says the following relating to the role of professionals:
“The Professionals, Chartered Accountants/Company Secretaries/Cost Accountants associated with such defaulting Companies and involved in illegal activities have been identified in certain cases and the action by Professional Institutes such as ICAI, ICSI and ICoAI is also being monitored.” What is the intent of the MCA as far as role of professionals is concerned?
The plausible meaning of the MCA is to say that where professionals have been involved either as masterminds or as conduits or in abetting the formation/trading/proliferation of shell companies, will also be proceeded against.
Obviously, professionals may be involved in doing any of the following:
(a) Filing of documents in case of companies who are likely to be regarded as dormant;
(b) Filing of applications/petitions before NCLT for revival of companies;
(c) Taking up of litigation/action on behalf of directors who have been disqualified;
(d) Rendering professional advice.
Professionals are admittedly in the business of rendering professional advice. Even a criminal gets a lawyer to defend himself. There is a presumption of innocence, unless pleaded or proven guilty. There can be absolutely nothing wrong in professionals getting involved in their role as professionals. However, if professionals get involved in abetting an offence in law, in formation or proliferation of companies which get indulged into ulterior activities, they may face the flak of the regulators.
12. Is there any remedy available to such disqualified directors if the director contends that his name has wrongly been removed?
At present, since there seems to be no remedy available as per the Companies Act, 2013, a Writ Petition can be made by the aggrieved director under Article 226 of the Constitution of India in the absence of any alternate remedy available.
On September 21, 2017, the Madras High Court has passed an interim order staying the RoC Chennai’s order of disqualification of Bhagavan Das Dhananjaya Das as the director of Birdies and Eagles Sports Technology, a private company. It is expected that in sometime from now, there will be several court rulings on the issue whether the removal of the name of a person was/was not right.
[We will continue to develop this write-up. Hence, please do check back on the same link for a renewed version of this write up]