PublicationsA CRITICAL ANALYSIS OF THE PROVISIONS RELATING TO DISQUALIFICATION AND SUBSEQUENT VACATION OF OFFICE OF DIRECTORS UNDER THE COMPANIES ACT, 2013

July 23, 20210
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ABSTRACT

A director is defined under Section 2(34) of the Companies Act, 2013 (Herewith referred to as ‘the Act’) as an individual appointed to the Board of a company. Accordingly, the Board is collectively responsible for the supervision and control of the company’s affairs and must act in due compliance with the law and its Articles of Association. Ever since corporate frauds like that of Satyam, Kingfisher, 2G Spectrum inter alia came to light, the Union Government has enacted various amendments to the Act to ensure a more robust system of corporate governance. These frauds revealed that the directors of these companies withheld vital information from shareholders. In this regard, the Union Government had enacted and implemented specific stringent compliance-based provisions regarding directors of a company.

The paper aims to analyse the following research questions:

  1. Whether the existing domestic framework regarding disqualification and vacation of office of directors leads to a trade-off between transparency of company affairs and a more significant statutory burden levied on directors of a company?
  2. Whether this domestic framework can be improved to carry out the Union Government’s goals without compromising the position of directors in the corporate set-up?
INTRODUCTION

Section 164(2) of the Act, which deals with disqualification of a director, reads as follows,

“No person who is or has been a director of a company which (a) has not filed financial statements or annual returns for any continuous period of three financial years; or (b) has failed to repay the deposits accepted by it or pay interest thereon or to redeem any debentures on the due date or pay the interest due thereon or pay any dividend declared and such failure to pay or redeem continues for one year or more, shall be eligible to be re-appointed as a director of that company or appointed in other company for a period of five years from the date on which the said company fails to do so. Provided that 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.”[1]

Under this subsection, the purpose of disqualification is to penalise directors for company defaults if a company is non-compliant with the above-mentioned provision, thereby ensuring that the directors bear the burden of compliance with the requirements under the Act on behalf of a company. Typically, when a director is disqualified, his office is also liable to vacate under the Act. This is where several absurdities arise. Section 167(1)(a) of the Act and its proviso states as follows,

“The office of a director shall become vacant in case (a) he incurs any of the disqualifications specified in section 164.

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.”[2]

Take the hypothetical case where an individual is a director in ten different companies. If a default, the likes of which is mentioned under section 164(2) arises, the individual would, on a joint interpretation of Section 164(2) and the proviso to Section 167(1)(a) of the Act, be disqualified from the appointment in any company or re-appointment in the defaulting company for five years. Further, his office of directorship would also be vacated in all the other nine companies in which he held the position of director. Through this hypothetical, it can be highlighted that the Act imposes severe far-fetching civil consequences on directors due to their role in the corporate setup. The complexities within this framework are elaborated further in parts of this paper. The first part of this paper analyses the process of disqualification and subsequent vacation of office under the Act and the drawbacks, or issues, both practical and constitutional, that arise with it. The second part compares the Indian framework regarding disqualification and vacation of office of directors with the U.K. and suggests potential recommendations to improve the existing framework in India.

ANALYSIS OF DOMESTIC FRAMEWORK AND THE ISSUES THAT ARISE

Section 164 of the Act provides for two types of disqualifications. Namely, disqualification in an individual capacity as envisaged under subsection one and disqualification due to the defaulting company’s failure to file its annual returns, financial statements for three years, or failure to repay deposits and redeem debentures under subsection two for one year or more.[3] If any of these conditions are met, the individual is disqualified from re-appointment in the defaulting company or appointment in any other company for five years.[4] For the purposes of this paper, only the second type of disqualification will be discussed and analysed. The implications of disqualification under Section 164(2) are mentioned in Section 167(1)(a) of the Act, which states that the individual disqualified must vacate their office of directorship in all companies other than the defaulting company.[5] The paradox these provisions created was that if an individual was appointed as a director in a non-compliant company under Section 164(2) of the Act, his office would automatically be vacated through the operation of Section 167(1)(a) of the Act resulting in a situation where if the company was non-compliant with the conditions specified in Section 164(2) of the Act, no director could be appointed to that company in perpetuity. Thus, the Union government amended the Act in 2017 to include the proviso within Section 164(2) of the Act, which states that incoming directors are provided with a cool-down period of 6 months after they are appointed to make the company compliant within the 6 months the statute provides. The far-fetching civil consequences envisaged by the Act with regards to disqualification and vacation of office of directors leads to an absurd situation where even compliant companies would bear the brunt of these provisions due to the automatic operation of Section 164 (2) read with 167 (1) (a) of the Act which results in disqualification and vacation of directors in companies other than the company in default under Section 164 (2) of the Act. Other companies in which such individuals hold directorships may be fully compliant with the aforementioned provisions but may yet suffer if the compliant company consists of a director/s who holds an additional directorship in a non-compliant company. In doing so, the Act may affect third-party companies and transactions entered by the disqualified director on behalf of the compliant companies.[6] This consequence could have a spiraling effect on a substantial number of companies’ business activities if directors of defaulting companies hold multiple positions of directors in various other companies as well. This issue is compounded given the wide scope of Section 164(2) of the Act as on a bare reading; it appears to apply to even those individuals who had been directors in companies that had defaulted under Section 164(2) the Act.[7] As a result, due to the language used in the provision, various ambiguities present themselves regarding its application in this respect. If the statute envisages the defaulting company’s responsibility and the consequences of non-compliance with Section 164(2) of the Act to even those directors that already left the company, the provision may be severe.[8] Further, unlike Section 274(1)(g) of the 1956 Act, Section 164(2) of the Act applies to private companies as well[9] but not Government companies. By including private companies within the ambit of the Section, the scope to carry out the Government’s desired goal, i.e., cracking down shell companies and reducing black money in the economy, is increased.[10] However, by excluding its own companies from the purview of Section 164(2) of the Act, the Government highlights non-conformity with the law on its part, which adds weight to the argument that these provisions bring with them significant consequences on directors as well as third party companies. Another ambiguity that arises when Section 164(2) read with Section 167(1)(a) of the Act is applied to cases is whether prior notice and an opportunity of hearing should be granted to the concerned directors? This issue came up before the Allahabad Division Bench in Jai Shankar Agrahari v. Union of India[11] in that case, the Registrar of Companies disqualified certain individuals from directorship in all companies except the defaulting company via Sections 164(2) read with 167(1)(a) of the Act. The petitioners claimed that no prior notice was served on to them, and neither were they given an opportunity to be heard; therefore, the rule of Audi alteram partem was compromised, and thus the actions of the Registrar of Companies were against the principles of natural justice. However, the Court held that the conditions for disqualification are laid down in the statute itself. Thus, no executive body ought to make a declaration stating the same. It further opined that disqualification and vacation were automatic through the operation of law on the happening of certain events mentioned in the Act, and thus other than the establishments of facts where the same had not been established clearly, there was no need to serve prior or show-cause notices to the individuals disqualified. This judgment appears to conform with judgments across various High courts in India, such as the Delhi High court in Mukut Pathak v. Union of India[12] and the Karnataka High court in Yashodhara Shroff v. Union of India &Anr.[13] However, the Madras Division bench in MeethelaveetilKaitheriMuralidharan v. Union of India &Anr has adopted a contrary stance.[14] The facts of the case are similar to the Jai Shankar case, i.e., the Registrar of Companies disqualified various individuals from directorship in pursuance of Section 164(2) read with Section 167(1)(a) of the Act. However, unlike the Jai Shankar case, the Court was of the opinion that a prior enquiry and notice were required before the Registrar took action due to the consequences the provision stipulates, which could have a serious impact on the livelihood of such directors. It also held that the exceptions to natural justice principles, i.e., a non-biasedness and the likelihood of only one conclusion was not applicable in this case.[15] The judgment of the Madras Division, in my opinion, is the correct interpretation of the law due to the far-fetching civil consequences the Act specifies on directors. Thus, it is essential to ensure that the correct decision is arrived at by the executive authority for which prior enquiry and notice are required. This judgment of the Madras Division bench also appears to be in accordance with the apex court’s judgment in Mohinder Singh Gill Vs. Chief Election Commission[16] stated that the rules of natural justice ought to be complied with when administrative action results in civil consequences. It also held that “everything that affects a citizen in his civil life inflicts a civil consequence.”[17] There can be no doubt that the provisions mentioned above entail civil consequences on the lives of the individuals concerned, being that a director is compelled to vacate his office in all companies other than the defaulting company; hence executive bodies ought to ensure that due process of the law is followed when applying these Sections.

The far-fetching severe civil consequences of Section 167(1)(a) of the Act on directors’ lives led to a constitutional challenge to the provision in G Vasudevan v. Union of India[18] before the Madras Division Bench. The petitioner claimed that the provision violated Article 14 and Article 19(1)(g) of India’s Constitution. Firstly, the petitioner contended that the provision led to unequal treatment between those directors who held multiple positions in other companies and the defaulting company and those directors who solely held directorship in a defaulting company. Further, that this classification was not based on an intelligible differentia and had no nexus with the object sought to be achieved by the Act; therefore, it failed the reasonable classification test laid down by Article 14. Secondly, the petitioner argued that the provision resulted in the violation of their right to carry on trade and business guaranteed by Article 19(1)(g) of India’s Constitution and hence was liable to be struck down. The petitioner also made other ancillary claims regarding compliance with the rules of natural justice inter alia; the law regarding the same has already been discussed and analysed above. The Apex Court in the case of Dale and Carrington Invt. P. Ltd v. P.K. Prathapan&Ors[19] held that directors owed an obligation of transparency to the public and must conduct their duties and responsibilities in a bonafide manner. In this context, the Court stated that Section 167(1)(a) of the 2013 Act and Section 274(1)(g) of the 1956 Act which was enacted with the intention of good governance, protection of stakeholder’s interests and transparency in the corporate sector. As a result, the Court held that the Act classified between those directors who carried out their statutory duties and those who did not, with regards to filing of statements returns for three years or repayment of deposits or redeeming debentures for one year or more and hence the differentia was capable of being understood. Further, since the differentia, i.e., statutory compliance, had a direct nexus to the object of the provision, which is good governance, investor protection inter alia, thus the provision passed the muster of Article 14. Regarding Article 19, the Court held that the provision in no way placed any restrictions on carrying on business or trading of the company as the directors who were disqualified could be replaced. Further, disqualification of a director/s cannot be construed to imply that the company’s business activities are in any way being restricted; hence, Article 19 had not been violated either. For these reasons, the Court rejected the petitioner’s claims and upheld the constitutional validity of Section 167(1)(a) of the Act. A similar challenge was made in the Jai Shankar case as well. However, similar to the G. Vasudevan case, the Allahabad Division bench refuted the petitioner’s claims, stating that the provision correctly distinguished between tainted and untainted directors. In my opinion, the decision made by the Madras Division Bench in the G. Vasudevan case was well reasoned and in accordance with the structure of the reasonable classification test as the classification created by the provisions was based on an intelligible differentia which bore a direct nexus a with the object that sought to be achieved by the Act. However, it is also my humble belief that the object, i.e., transparency of company affairs, investor protection and good governance, could have been achieved in a better and more practical manner which is elaborated on further.

COMPARISON WITH U.K. FRAMEWORK AND SUGGESTIONS TO IMPROVE DOMESTIC FRAMEWORK

Unlike India, where there is no separate legislation enacted for the governance of disqualification of directors, the U.K. legislature drafted the Company Directors Disqualification Act, 1986 (Herewith referred to as ‘CCDA’) for the specific purpose of governing disqualification of individuals as directors of companies and to exclude such individuals from the management of company affairs. Disqualifications under the CCDA range from fraud to competition infringements. The procedure followed under the CCDA is clear and practical. Any person, if they have the locus standi to make the necessary application, may by application to the relevant Court seek the disqualification of an individual as a director on the grounds specified in that application. If the appropriate court determines the case against the director, he would be disqualified from being a director in all companies in which he/she held that position or all companies in which the Court seems fit or would even be disqualified from management, promotion, or formation of the company whether directly or indirectly inter alia and would only be able to participate in the corporate set-up regarding the above-mentioned roles with the leave of the Court.[20] Thus, it can be observed that the power granted to the relevant courts through the CCDA in the U.K. regarding disqualification orders is far greater than that the Companies Act, 2013 grants on Courts in India as under the latter Act, disqualification is limited to the role of the director only and does not account for disqualification from management or promotion or any other role in the corporate set-up.

Further, unlike Section 164 of the Act, the CCDA does not stipulate a blanket ban of 5 years from being appointed as a director; instead, it takes into account the grounds for disqualification and lays down maximum periods of disqualification for different grounds based on its nature and seriousness of the statutory non-compliance or violation of the law. Using the term maximum period, the CCDA grants certain discretion to the relevant courts, which is not the case under the Act. For example, under the CCDA, the maximum period of disqualification of a director for persistent breaches of company legislation is five years, but for fraud, it is fifteen years since fraud involves public deception, the nature of the breach of law is put in higher regard as compared to repeated compliance breaches. Thus, the CCDA takes into account a normative assessment of disqualification of directors to more severely penalise those directors that had unlawful intentions and provide relative relief to those who did not have such intent. Lastly, unlike the Act, which vacates a director’s office in all companies other than the defaulting one through Section 164(2) read with Section 167(1)(a) of the Act, the CCDA disqualifies individuals based on the Court’s discretion.

After a perusal of the provisions enshrined in the CCDA and analysing the issues that arise regarding the provisions of the Act, there are undoubtedly certain changes that can be enacted and implemented by the Union Government to strengthen the existing corporate framework regarding disqualification of individuals as directors and vacation of their office. Firstly, the Union Government ought to amend Section 164(2) of the Act by adding the phrase “during the period of the relevant default” after “No person who is or has been a director of a company.”[21]Doing so would ensure that exiting directors of a company when the company was compliant do not fall within the scope of the Section since they had complied with the law, thereby clarifying this ambiguity in the language used in the provision. Secondly, Section 167(1)(a) of the Act ought to be amended so that vacation of office of director in all other companies be limited to those instances where public interest is involved, thus ensuring that the objective of the Government, i.e., reduction of potential corporate fraud, can be carried out without compromising numerous directors and third-party companies and transactions.[22] Thirdly, to bring clarity regarding disqualification and vacation of office of directors, the Government ought to consolidate the provisions regarding the same and enact legislation on similar lines with the CCDA in the U.K. Lastly, necessary guidelines be enacted to govern executive bodies while disqualifying directors. Although the Act provides almost no scope of discretion to the executive bodies while assessing these claims since the statute makes the distinctions itself, it is essential that the administrative bodies correctly determine the individuals concerned due to the civil consequences the provisions entail.

CONCLUSION 

The role directors play in governing a company is significant. Hence, due to their position in the corporate set-up, the Act casts a significant burden on directors to be compliant with the law and carry out their duties diligently. The phrase, with greater power, comes greater responsibility, is an apt depiction of the treatment delved out to directors of a company under the Act. It can be observed that the Government, through the above-mentioned provisions of the Act, has taken a conservative stance holding directors to a higher obligation than it previously did to ensure good governance and hence this effort of the Union Government is commendable. However, the downside of creating such a sizeable statutory burden on directors is that it may not be the most practical solution to carry out good governance intention as it may result in a range of issues, as discussed above. To briefly summarise my answers regarding the questions laid down at the start of the research paper, the existing domestic framework does, in my opinion, lead to a trade-off between good governance, transparency of company affairs and a significant statutory burden cast on directors of companies. However, given the backdrop of corporate frauds committed in India, the trade-off may not necessarily be at a high cost despite the severe consequences that could be borne by directors, as the only ones who would suffer would be those who are non-compliant with the statutory requirements in place.

Further, the existing framework can be bettered to reduce this trade-off, thus ensuring an adequate balance without compromising the Union Government’s desired goals. The method to affect such balance has been discussed in the second part of this paper. One thing that can conclusively be arrived at, however, is that directors or individuals hoping to become directors ought to be vigilant about the company’s affairs they are already part of and the companies they desire to be part of in the future. They must also always comply with the necessary statutory provisions and Act in good faith.

REFERENCES

[1]The Companies Act, 2013, s 164(2).

[2]The Companies Act, 2013, s 167(1).

[3]The Companies Act, 2013, s.164.

[4]Ibid.

[5](n 2).

[6]Ankur Khandelwal, ‘The recent tale of disqualification of directors and Myriad legal issues’, (2014) Lexology, https://www.lexology.com/library/detail.aspx?g=3a1487cf-b78c-4af5-a45a-dad301437fea , (Dec. 03, 2020, 11:17 PM).

[7](n 1)

[8]Bhumesh Verma &Somashish, ‘Companies (Amendment) Act 2017: New Grounds for Director’s Disqualification and opportunities for correction under CODS, 2018, (2018) Scc Online, https://www.scconline.com/blog/post/2018/03/22/companies-amendment-Act-2017-new-grounds-for-directors-disqualification-and-opportunities-for-correction-under-cods-2018, (Dec. 03, 2020, 11:52 PM).

[9]K. Vaitheeswaran& C.J. Yeshwanthram, ‘Disqualification of Directors & Principles of Natural Justice’, (2020) LawStreetIndia, http://www.lawstreetindia.com/experts/column?sid=478, (Dec. 04, 2020, 10:06 PM)

[10](n 6).

[11]2020 S.C.C. OnLine All 24 (India).

[12]W.P.(C) No. 9088 of 2018 (India).

[13]2019 SCC OnLine Kar 682 (India).

[14]2020 S.C.C. OnLine Mad 2958 (India).

[15](n 9).

[16]A.I.R 1978 S.C. 851 (India).

[17]Ibid at 440, para 66.

[18]W.P. No. 32763 of 2019 (India).

[19](2005) 1 S.C.C. 212 (India).

[20]Company Directors Disqualification Act, 1986, (Eng.).

[21](n 1).

[22](n 9).

CITE THIS WORK

Legal Maxim (October 26, 2021) A CRITICAL ANALYSIS OF THE PROVISIONS RELATING TO DISQUALIFICATION AND SUBSEQUENT VACATION OF OFFICE OF DIRECTORS UNDER THE COMPANIES ACT, 2013. Retrieved from https://www.legalmaxim.in/a-critical-analysis-of-the-provisions-relating-to-disqualification-and-subsequent-vacation-of-office-of-directors-under-the-companies-act-2013/.
A CRITICAL ANALYSIS OF THE PROVISIONS RELATING TO DISQUALIFICATION AND SUBSEQUENT VACATION OF OFFICE OF DIRECTORS UNDER THE COMPANIES ACT, 2013.” Legal Maxim – October 26, 2021, https://www.legalmaxim.in/a-critical-analysis-of-the-provisions-relating-to-disqualification-and-subsequent-vacation-of-office-of-directors-under-the-companies-act-2013/
Legal Maxim July 23, 2021 A CRITICAL ANALYSIS OF THE PROVISIONS RELATING TO DISQUALIFICATION AND SUBSEQUENT VACATION OF OFFICE OF DIRECTORS UNDER THE COMPANIES ACT, 2013., viewed October 26, 2021,<https://www.legalmaxim.in/a-critical-analysis-of-the-provisions-relating-to-disqualification-and-subsequent-vacation-of-office-of-directors-under-the-companies-act-2013/>
Legal Maxim – A CRITICAL ANALYSIS OF THE PROVISIONS RELATING TO DISQUALIFICATION AND SUBSEQUENT VACATION OF OFFICE OF DIRECTORS UNDER THE COMPANIES ACT, 2013. [Internet]. [Accessed October 26, 2021]. Available from: https://www.legalmaxim.in/a-critical-analysis-of-the-provisions-relating-to-disqualification-and-subsequent-vacation-of-office-of-directors-under-the-companies-act-2013/
A CRITICAL ANALYSIS OF THE PROVISIONS RELATING TO DISQUALIFICATION AND SUBSEQUENT VACATION OF OFFICE OF DIRECTORS UNDER THE COMPANIES ACT, 2013.” Legal Maxim – Accessed October 26, 2021. https://www.legalmaxim.in/a-critical-analysis-of-the-provisions-relating-to-disqualification-and-subsequent-vacation-of-office-of-directors-under-the-companies-act-2013/
A CRITICAL ANALYSIS OF THE PROVISIONS RELATING TO DISQUALIFICATION AND SUBSEQUENT VACATION OF OFFICE OF DIRECTORS UNDER THE COMPANIES ACT, 2013.” Legal Maxim [Online]. Available: https://www.legalmaxim.in/a-critical-analysis-of-the-provisions-relating-to-disqualification-and-subsequent-vacation-of-office-of-directors-under-the-companies-act-2013/. [Accessed: October 26, 2021]
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Author: Jay Vora

Designation: Student,3rd Year

University: O P Jindal Global Law School

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