Prosecution of company directors for day-to-day operational issues: SC ruling provides relief

By Dibisha Mishra (dibisha@vinodkothari.com; corplaw@vinodkothari.com)

Introduction:

While directors are the brain and neural control center of companies, but it is evident that the day to day affairs of  companies are not run by the board of directors , or even the executive directors of companies. Under circumstances can directors be prosecuted, merely because they hold board positions, for something as operational as the lack of safety measures in a smoking zone in a hotel? The SC in a recent ruling[1] of Shiv Kumar Jatia vs. State of NCT of Delhi has taken forward its earlier rulings in the case of Maksud Saiyed vs. State of Gujarat & Ors[2] and Sunil Bharti Mittal vs. CBI[3], and has held the doctrine of vicarious liability cannot be applied to offences under the IPC unless specifically provided for.

The concept of a corporate structure is based on the very premise of a business idea brought into by a group of persons [also known as promoters], backed up with funds from shareholders and creditors and set to implementation by directors who are elected by the shareholders. While shareholders continue to hold certain decision making powers, the directors are broadly responsible for the functioning and performance of the company. Having said so, it is also to be understood that a director of a company is not always in charge of everyday affairs. It depends upon the respective role assigned to different officers in a company.

Liability of officers for offences under Companies Act

The Companies Act, 2013 (‘the Act’), has explicitly identified officers who are in default for the purpose of the Act which includes directors and KMP.

Further, Section 149(12)(ii) of the Companies Act 2013 provides that liability of a NEDs arises only with respect to such acts of omission or commission by a company which had occurred with his knowledge, attributable through Board processes, and with his consent or connivance or where he had not acted diligently. Hence, obligation is on the ROC to verify relevant information and records before initiating prosecution against independent or nominee directors.

However, it is to be noted that the above provisions are to be considered only where there has been any contravention with the provisions of the Companies Act while in case of other statutes, respective provisions is to be seen.

Liability for criminal felonies

When a Corporate gets accused of a criminal offence, the individual to be prosecuted for the same remains a matter of consideration. The extent of liability of Non-Executive Directors in case of offences has been discussed in our earlier article[4]. The present article discusses the Supreme Court’s judgment[5] on the case of Shiv Kumar Jatia vs. State of NCT of Delhi which quashed the impugned order of the High Court and freed the Managing Director from the criminal liability imposed on the basis of doctrine of ‘vicarious liability’.

Facts of the case:

Shiv Kumar Jatia is the Managing Director of M/s. Asian Hotels which looks after Hyatt Regency Hotel. He had authorized Mr. PR. Subramanian to apply for lodging license of the hotel.

There was a contravention the condition of the lodging license which led to a hotel guest enter into a semi lit under-construction terrace for smoking. The guest fell from the terrace of 6th floor to the 4th floor and got injured. Case was brought before the High Court which ordered for prosecution the Managing director along with the other three accused by relying on the case of Sushil Ansal vs. State through CBI[6].

Shiv Kumar Jatia appealed before the Apex Court against such impugned order of the High Court where the case was decided in his favour vide judgment dated 23rd August, 2019.

Provisions of law considered:

Alleged offences under Section 336 and 338 of the Indian Penal Code

Section 336:

“Whoever does any act so rashly or negligently as to endanger human life or the personal safety of others, shall be punished with impris­onment of either description for a term which may extend to three months, or with fine which may extend to two hundred and fifty rupees, or with both.”

Section 338:

“Whoever causes grievous hurt to any person by doing any act so rashly or negligently as to endanger human life, or the personal safety of others, shall be punished with imprisonment of either description for a term which may extend to two years, or with fine which may extend to one thousand rupees, or with both.”

Apex court stated that the essential elements to prove an alleged offence under section 336 are:

  • an act
  • done rashly or negligently
  • to endanger human life or personal safety

while for section 338, the condition of grievous hurt is to be met in additional to elements in section 336.

Doctrine of vicarious liability

Under the doctrine of vicarious liability, one person is held responsible for the wrong doing of the other. Such liability arises only when both persons are somehow connected to each other like employee-employer relationship or principal-agent relationship. In case of corporates, the applicability of the said doctrine is to be determined on the basis of provisions of statute dealt with.

There is no vicarious liability unless the statute specifically provides so.

  • The court referred to the judgment[7] of Maksud Saiyed vs. State of Gujarat & Ors, where the Court held that the Penal Code does not contain any provision of vicarious liability on the part of the Managing Director/ Director of the company where the accused is a company.
  • Further, the case of Sunil Bharti Mittal vs. CBI[8] was also referred to wherein it was held that:

“a corporate entity is an artificial person which acts through its officers, directors, managing director, chairman etc. If such a company commits an offence involving mens rea, it would normally be the intent and action of that individual who would act on behalf of the company. It would be more so, when the criminal act is that of conspiracy. However, at the same time, it is the cardinal principle of criminal jurisprudence that there is no vicarious liability unless the statute specifically provides so.”

This means where the statutory provision itself does not specifically attract the doctrine of vicarious liability, an individual cannot be implicated under the same.

Existence of Active Role and Criminal Intent

It was stressed that in the absence of any statutory provision incorporating vicarious liability, an individual cannot be made accused, unless there is a sufficient evidence of his ‘active role coupled with criminal intent’. Further such criminal intent must have direct nexus with the accused.

In the given case, the Managing Director was outside the country on the day of the accident. Moreover, mere authorizing an official for obtaining license cannot be construed to his active role with criminal intent. Hence, the same was also failed to be established before the Court.

Judgment

The Apex Court held that there is no specific provision of applicability of doctrine of vicarious liability in the Indian Penal Code. Further, the allegations made on the Managing Director could not establish any active role coupled with criminal intent having direct nexus with the accused.

Concluding the same, the Court passed the judgment that the allegations made on the Managing Director was vague in nature and the criminal proceedings against Shiv Kumar Jatia as passed by the High Court were quashed.

Time and again the court have taken the view that merely because of holding the position as a director/managing director, a person cannot be vicariously held liable for offence committed by Companies. It has to be proved how he was responsible for, or in control of, or negligent in conducting the affairs of the company. In the absence of definite averments, a director cannot be deemed to be liable.

 

[1] https://sci.gov.in/supremecourt/2018/31728/31728_2018_6_1502_16190_Judgement_23-Aug-2019.pdf

[2] https://indiankanoon.org/doc/159121041/

[3] https://indiankanoon.org/doc/159121041/

[4] http://vinodkothari.com/wp-content/uploads/2017/03/Umesh_K_-Modi_vs_Deputy_Directorate_of_Enforcement.pdf

[5] https://sci.gov.in/supremecourt/2018/31728/31728_2018_6_1502_16190_Judgement_23-Aug-2019.pdf

[6] https://indiankanoon.org/doc/152261427/

[7] https://indiankanoon.org/doc/159121041/

[8] https://indiankanoon.org/doc/159121041/

Injeti Srinivas’s Committee: Changes recommended in provisions of Corporate Social Responsibility

Provisions relating to DVR & DRR- stands amended

Amendments introduced in Companies (Share Capital and Debentures) Amendment Rules, 2019

by Smriti Wadehra (smriti@vinodkothari.c0m)

The recent Notification of Ministry dated 16th August, 2019 has amended the provisions of Companies (Share Capital and Debentures) Rules, 2014 with respect to quantum of holding of equity shares with differential voting rights by a Company and provisions pertaining to creation of debenture redemption reserve. The amended provisions are applicable from the date of notification in the e-gazette i.e. 16th August, 2019.

Differential Voting Rights

SEBI in its Board Meeting dated 27th June, 2019 proposed insertion of the provisions of DVRs in SEBI ICDR Regulations. The proposal was w.r.t inter alia to cap the total voting rights of superior rights shareholders (including ordinary shares) at 74% of the total voting power. The respective amendments are still awaited. Meanwhile, the Ministry vide the aforesaid Notification amended the provisions under CA, 13 related to DVRs. The Notification has escalated the limit of DVR shares in the Company from 26% of total post-issue paid up equity capital of the Company to 74% of the total voting power.

The erstwhile provisions of the Companies (Share Capital and Debentures) Rules, 2014 permitted issuance of equity shares with differential rights subject to compliance of conditions mentioned in Rule 4(1) of the said Rules. One of criterion for issuance of equity shares with differential rights by a Company was that shares with differential rights should not exceed 26% of total post-issue paid up equity capital of the Company at any point of time. However, the amendment has increased this limit to 74% of the total voting power at any point of time. Notably, this is another significant highlight of the amendment  that the erstwhile cap of 26% was based on the post-issue paid up equity capital which has now been changed to 74% of the voting power.

Further, in this regard, condition on companies issuing shares with differential rights having consistent track record of distributable profits for the last three years have been done away with.

Debenture Redemption Reserve

The erstwhile provisions of Section 71(4) read with Rule 18(1)(c) of the Companies (Share Capital and Debentures) Rules, 2014 required every company issuing redeemable debentures to create a debenture redemption reserve (“DRR”) of at least 25% of outstanding value of debentures for the purpose of redemption of such debentures. Apart from creation of DRR, such companies were required to either deposit, before April 30th each year, in a scheduled bank account, a sum of at least 15% of the amount of its debentures maturing during the year ending on 31st March of next year or invest in one or more securities enlisted in Rule 18(1)(c) of Debenture Rules.

Under the erstwhile framework, the following classes of companies were required to comply with the provisions relating to DRR:

  1. NBFCs registered with RBI under section 45-IA of RBI Act, 1934 issuing debentures through public issue;
  2. Other listed companies coming up with public issue or private placement;
  3. Unlisted companies issuing debentures on private placement basis.

With a view to liberalise the legal framework surrounding issuance of debentures by NBFCs, the FinMin proposed Union Budget of 2019-20 proposed to scrap off the requirement of creation of DRR for publicly issued debentures also so as to motivate NBFCs.  Subsequently, the MCA came out with notification to amend the Companies (Share Capital and Debentures) Rules, 2014.

The amended provisions has exempted NBFCs registered with RBI and HFCs registered with National Housing Bank from creation of DRR in case of public issue of debentures. Further, the requirement of listed companies to create DRR has been done away with. The amended Rules have also lowered down the quantum of funds to be transferred to DRR by unlisted companies. However, as a flipside to the exemptions granted, the MCA has knowingly or unknowingly, unsettled an otherwise settled matter on creation of debenture redemption fund as per Rule 18(7).

Under the erstwhile provisions required creation of debenture redemption fund only by those companies on which DRR was applicable. However, under the current set of rules, the requirement to create DRF will apply to all listed companies, other than AIFIs or other FIs as per the clause of section 2(72). This new rule applies even to NBFCs.

It is pertinent to note that until now, NBFCs were required to create debenture redemption reserve only for publicly issued debt securities. However, under the new rule, all listed NBFCs will have to create a DRF even in case of private placement of debentures. This change in the rules seems to be contradicting the intention of proposal in the Union Budget.

The intention of the proposal was to promote NBFCs to explore Bond markets more often for fund raising, however, the language of the new rule has jeopardised the existing cases of debenture issuances, let alone be new debenture issuances. Considering the ongoing liquidity crisis, the entire financial system is going through, the implications of this requirement could be severe.

Creation of DRR is somewhat a liberal requirement then creation of DRF, this is because, where the former is merely an accounting entry, the latter is investing of money out of the Company and the fact the new rule casts an exemption from the first and not from the second makes the situation a bit awkward. Therefore, where there is no requirement even for annually conserving a part of their profits, the requirement of creating a fund out of the same becomes completely illogical.

Hence, in our view, the amendments have actually slashed the expectation to relax issuance of debentures by NBFCs and on the other hand has also taken away the available exemption to the NBFCs for not creating DRF in case of issuance of debt securities through private placement. The actual intent of the amendment would have been to reduce the requirement of DRR from somewhat say 25% to 10%, however, in a completely unexpected move, the requirement for parking liquid funds, in form of a debenture redemption fund (DRF) has been extended to all bond issuers except unlisted NBFCs (which are hardly any in India), irrespective of whether they are covered by the requirement of DRR or not.

In this regard, the notification also fails to clarify the basic question that is whether the requirement will be applicable to debentures/bonds already issued, before the date of the notification or only after the date of notification. Though, the language suggest that the same shall be applicable on debentures due for redemption after the date of notification, i.e. for debentures maturing during the year ending on 31st March, 2020. However, in our view, one should try to create a DRF for the debentures maturing within 31st March, 2020 itself. Lastly needless to say, the MCA notification needs to be considered immediately.

A brief analysis of the amendments are discussed below:

Applicability of DRR and Debenture Redemption Fund

a)    All India Financial Institutions and Banking Companies

b)   NBFCs registered with RBI under section 45-IA of RBI Act, 1934 and Housing Finance Companies registered with National Housing Bank

  1. Other companies

Synopsis of amendments in DRR provisions

Sl. No. Particulars Type of Issuance DRR as per erstwhile provisions DRR as per amended provisions DRF as per erstwhile provisions DRF as per amended provisions
1. All India Financial Institutions Public issue/private placement

 

× × × ×
2. Banking Companies Public issue/private placement

 

× × × ×
3.

 

Listed NBFCs registered with RBI under section 45-IA of the RBI Act, 1934 and HFC registered with National Housing Bank

 

Public issue

 

25% of value of outstanding debentures

×
Private Placement

 

× × ×
4. Unlisted NBFCs registered with RBI under section 45-IA of the RBI Act, 1934 and HFC registered with National Housing Bank

 

 

Private Placement

 

 

×

 

×

 

×

 

×

5.

 

Other listed companies

 

Public Issue

 

 

25% of value of outstanding debentures

 

×
Private Placement

 

 

25% of value of outstanding debentures

 

×
6. Other unlisted companies Private Placement

 

25% of value of outstanding debentures

 

 

10% of the value of outstanding debentures