Disqualification, Personal Liability and Other Penal Consequences for Directors of a Company

Disqualification of Directors as per Companies Act

Ineligibility Of Being Appointed As A Director

Section 164 of the Companies Act, 2013 prescribes certain conditions which make a person ineligible for appointment as a Director in any company. As per Sub-section (1) of this provision, a person cannot be appointed as a Director if:

a. He is of unsound mind and stands so declared by a competent court;

b. He is an undischarged insolvent;

c. He has applied to be adjudicated as an insolvent and his application is pending;

d. An order disqualifying him for appointment as a director has been passed by a court or Tribunal and the order is in force;

e. He has not paid any calls in respect of any shares of the company held by him, whether alone or jointly with others, and six months have elapsed from the last day fixed for the payment of the call;

f. He has been convicted of the offence dealing with related party transactions at any time during the last preceding five years;

g. He has not complied with provisions pertaining to allotment of Director Identification Number; or

h. Due to a criminal conviction (as explained separately in detail below).

Further, as per Companies (Amendment) Act, 2017, vide a proviso, it is provided that the disqualifications relating to conviction or disqualification order of the court shall continue to apply even if the appeal or petition has been filed against the order of conviction or disqualification.

Disqualification Due To Criminal Conviction – Section 164(1)(D)

1. If a person has been convicted of any criminal offence by a court, whether it involves moral turpitude or otherwise, and has been sentenced for:

a. at least six months, then until a period of five years has elapsed from the date of expiry of the sentence he will not be eligible for appointment.

b. for a period of seven years or more, then under these circumstances, he will not be eligible to be appointed as a Director in any company, i.e., leads to permanent disqualification.

2. Section 167 of the Companies Act, 2013, provides for situations under which the office of a Director is liable to be vacated. The situations are same as set out in Section 164(1) mentioned above. Further, this section clarifies that the office of the Director shall be vacated even if he has filed an appeal against the order of the court.

3. Vide Companies (Amendment) Act, 2017, a proviso has been added to Section 167 to provide that the office shall not be vacated by the Director for 30 days from the date of conviction or order of disqualification:

a. Where an appeal or petition is preferred within 30 days against the conviction, resulting in sentence or order, until the expiry of seven days from the date of such appeal or petition is disposed of; or

b. Where any further appeal or petition is preferred against the order or sentence within seven days, until such further appeal or petition is disposed of.

4. The term ‘moral turpitude’ has nowhere been defined in the Act or under the Rules. Through a catena of judgments, the expression is understood to mean anything done contrary to justice, honesty, modesty or good morals. It can be defined as an act of biasness, vileness, or depravity in private and social duties owing to fellow men in general, contrary to accepted and customary rules. For instance, offences related to sexual harassment at workplace and gross ethical violations would constitute moral turpitude.

5. One of the most common instances pertaining to conviction of directors is the dishonour of cheque which is a criminal offence as per Section 138 of the Negotiable Instruments Act, 1881.

Ineligibility Of Being Re-Appointed As A Director

Sub-section (2) of Section 164 states that no person who is or has been a Director of a Company which has done the following, shall not 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 company fails to do so:

a. Has not filed Financial Statements or Annual Returns for any continuous period of three Financial Years; or

b. Has failed to repay its Deposits accepted from public including interest or redeem its Debentures on due date including interest, pay any Dividend and such failure continues for a period of one year or more.

Further, as per the Companies (Amendment) Act, 2017, a person who is appointed as a Director of a company which is already in default of the above mentioned two conditions, shall not incur the disqualification for a period of six months from the date of his appointment.

Other References With Respect To Disqualification Of Directors

1. Under Section 143(3), the Auditor has to state whether any Director is disqualified from being appointed as a director under Sub-section (2) of section 164.

2. Under Section 152(4), every person proposed to be appointed as a Director by the company in general meeting or otherwise, shall furnish a declaration that he is not disqualified to become a Director under this Act.

Reporting Of Disqualification

Rule 14 of the Companies (Appointment and Qualification of Directors) Rules, 2014 provides obligation of the Director to intimate the disqualification to the Company and thereafter, the Company has to inform the Registrar of Companies.

Serious Fraud Investigation

1. Section 212(8) which became effective form August 24, 2017, read with the Companies (Arrests in Connection with Investigation by Serious Fraud Investigation Office) Rules, 2017 provides that if the Officers of SFIO (Director, Additional Director or Assistant Director), has on the basis of material possession reason to believe (and the reason for such belief is recorded in writing) that any person is guilty of any of the following offences, he may arrest such person and shall inform him of the grounds for such arrest:

  1. Incorporation of company;
  2. Criminal liability for mis-statements in prospectus;
  3. Punishment for fraudulently inducing persons to invest money;
  4. Punishment for personation for acquisition of securities;
  5. Certificate of shares;
  6. Transfer and transmission of securities;
  7. Reduction of share capital;
  8. Removal, resignation of auditor and giving of special notice;
  9. Power to call for information, inspect books and conduct inquiries;
  10. Investigation into company’s affairs in other cases;
  11. Penalty for furnishing false statement, mutilation, destruction of documents;
  12. Fraudulent application for removal of name;
  13. Liability for fraudulent conduct of business.

2. Section 447 of the Companies Act, 2013, defines fraud as:

Fraud in relation to affairs of a company or any body corporate, includes any act, omission, concealment of any fact or abuse of position committed by any person or any other person with the connivance in any manner, with intent to deceive, to gain undue advantage from, or to injure the interests of, the company or its shareholders or its creditors or any other person, whether or not there is any wrongful gain or wrongful loss;

In the definition above,

wrongful gain means the gain by unlawful means of property to which the person gaining is not legally entitled; and

wrongful loss means the loss by unlawful means of property to which the person losing is legally entitled.

Section 447 provides the penal consequence of fraud as under:

  • Where the offence of fraud involves an amount of at least Rupees Ten Lakh or one per cent. of the turnover of the company, whichever is lower:
    1. Punishable with imprisonment for a term which shall not be less than six months but which may extend to ten years; and
    2. Liable to fine which shall not be less than the amount involved in the fraud, but which may extend to three times the amount involved in the fraud.
    3. Where the fraud in question involves public interest, the term of imprisonment shall not be less than three years.
  • Where the fraud involves an amount less than Rupees Ten Lakh or one per cent. of the turnover of the company, whichever is lower and does not involve public interest:
    1. Punishable with imprisonment for a term which may extend to five years; or
    2. With fine which may extend to Rupees Fifty Lakh; or
    3. With both

3. It is pertinent to note that the Special Court shall not take cognizance of any offence as mentioned above except upon a complaint in writing made by:

a. The Director of Serious Fraud Investigation Office; or

b. Any officer of the Central Government authorised, by a general or special order, in writing in this behalf by that Government.

Complaint Of Fraud Against The Company

1. The government, in order to encourage better compliance of the law, has introduced the Form SCP (Serious Complaint Form) for reporting the serious complaints relating to the companies. This is an e-form and can be filed on the website of the Ministry of Corporate Affairs. There is no fee for filing Serious Complaint Form.

2. Following category of persons can file this complaint:

  1. Shareholder
  2. Investor
  3. Creditors
  4. Employee
  5. Deposit Holder
  6. Others

3. Nature of the Complaint:

  1. Cessation of director
  2. Management Dispute
  3. Financial Mismanagement
  4. Removal of Director
  5. Corporate Fraud
  6. Accounting Fraud
  7. Oppression of Minority Shareholders
  8. Others

Liability Of The Directors Where The Name Of The Company Has Been Struck Off From The Register Of Companies

Section 248 of the Companies Act, 2013 provides for situations where the name of the company has been struck off from the Register of Companies and the company continues to carry out its operations/ business, then the directors/management and such other officers of the company will be held personally liable.

Lifting Of The Corporate Veil

1. The Companies Act, 2013, points out the person liable for any improper/illegal activity as officer who is in default under Section 2(60) of the Act, and also includes people holding the positions of directors and key-managerial personnel. A few instances when a Court may consider the lifting of the corporate veil of a company include:

  1. Economic offences
  2. Fraudulent conduct
  3. Non-payment of statutory welfare payments

2. On lifting of the corporate veil, the Court determines the directing mind / real agency behind the corporate façade and accordingly the liabilities/ penalties may ensue. The jurisprudence of piercing of corporate veil is derived from the landmark judgements of the Supreme Court of India, in:

a. Life Insurance Corporation of India v. Escorts Ltd. & Ors, 1986

    • A non-resident portfolio investment scheme which existed under the Foreign Exchange Regulation Act, 1973. The scheme allowed non-resident companies, which were owned by or in which the beneficial interest vested in non-resident individuals of Indian nationality or origin was at least sixty per cent., to invest in the shares of Indian companies. Investment was allowed to the extent of one per cent. of the paid-up equity capital of such Indian companies and could not exceed a ceiling of five per cent.
    • Under the scheme, 13 companies, all owned by Caparo Group Limited, invested in Escorts Limited which is an Indian company. Importantly, sixty per cent. of the shares of Caparo Group Limited were held by a trust, whose beneficiaries were Mr. Swraj Paul and members of his family, who were all non-resident individuals of Indian origin.
    • The investment by the 13 Caparo Group companies was challenged on the ground that it was an attempt at circumventing the prescribed ceiling of investment of 1% under the Scheme.
    • The Hon’ble Supreme Court ruled that only for the purposes of ascertaining the ownership in the investment, lifting of the veil would be necessary to a limited extent, i.e. to ascertain the nationality or origin of the shareholders. It was not necessary to ascertain the individual identity of each of them. It could not deny these companies. The Apex Court ignored that the identity of the shareholders may be common, thus recognising that each company was an independent juristic entity, looking only at nationality for compliance with the requirements of the scheme.
    • Thus, it was held that corporate veil should be lifted where associated companies are inextricably connected as to be in reality, part of one concern.

b. State of Uttar Pradesh v. Renusagar Power Company, 1988

    • Renusagar was a hundred per cent. subsidiary of Hindalco thus wholly owned and controlled by Hindalco.
    • The agreement between Renusagar and Hindalco indicated that there was a normal Sale-Purchase Agreement between two independent juridical persons at arm’s length. The price of electricity was determined according to the cash needs of Renusagar.
    • The State of U.P. contended that Renusagar must be treated as alter ego of Hindalco.
    • Following the decision of LIC v. Escorts, the Hon’ble Supreme Court held that Hindalco and Renusagar were inextricably linked together. Renusagar had, in reality, no separated and independent existence. The person generating and consuming energy were the same and the corporate veil should be lifted.

i. Liability of Directors under Prevention of Corruption Act, 1988

a. The Prevention of Corruption Act, 1988 was amended in 2018 to bring it in line with the United Nations Convention against Corruption 2005, which was ratified by India in 2011. The amendment provided to prevent corruption in Government departments and to prosecute and punish public servants involved in corrupt practices.

b. It also introduced implication of offering bribes by a Corporate

  1. Where an offence has been committed by a commercial organisation and such an offence is proved in the court to have been committed with the consent or connivance of any director of the commercial organisation, such director shall also be held guilty of the offence and shall be liable to be proceeded against.
  2. The director will be imprisoned for a term which shall not be less than three years but which may extend to seven years and shall also be liable to fine.

c. Iridium India Telecom Limited v. Motorola Incorporated & Ors 2011.

  • The question of punishing a corporation came up in the Hon’ble Supreme Court in a criminal case filed by Iridium against Motorola Inc. for cheating and criminal conspiracy.
  • The allegation by Iridium was that Motorala Inc., the primary contractor for the Iridium project, floated a Private Placement Memorandum to obtain funds/investments to finance the Iridium project. The project was represented as being the world’s first commercial system designed to provide global digital hand held telephone data and it was intended to be a wireless communication system through a constellation of sixty-sex satellites in low orbit to provide digital service to mobile phones and other subscriber equipment locally. Several financial institutions invested in the project based on the information contained in the Private Placement Memorandum. However, it was alleged that the representations were false and that the project turned out to be commercially unviable resulting in significant loss to the investors.
  • The Hon’ble Supreme Court held that a corporate body can be prosecuted for cheating and conspiracy under the Indian Penal Code. The offences for which companies can be criminally prosecuted are not limited only to the specific provisions made in the Income Tax Act, the Essential Commodities Act, and the Prevention of Food Adulteration Act. Several other statutes also make a company liable for prosecution, conviction and sentence.
  • The Apex Court noted that companies and corporate houses can no longer claim immunity from criminal prosecution on the ground that they are incapable of possessing the necessary means rea for the commission of criminal offences.
  • Thus, the mens rea of the ‘alter ego’ of the company, i.e. the person or group of people that guide the business of the company will be imputed to the company.

d. Mr. Sunil Mittal, CMD, Bharati Cellular Limited v. Central Bureau of Investigation, 2015

  • In the year 2008, Unified Access Services Licenses (“UASL”) were granted by the Ministry of Telecommunications. After sometime, an information was disclosed to the Central Bureau of Investigation (CBI) alleging various forms of irregularities committed in connection with the grant of the said UASL which resulted in huge losses to the public exchequer.
  • The Prevention of Corruption Act, 1988 does not provide for the vicarious liability of directors. This issue came up for consideration in this case wherein the Hon’ble Supreme Court quashed the criminal charge against Sunil Bharati Mittal, Chairman-cum-Managing Director of Bharti Cellular Limited, since there was no vicarious liability of director provision in POCA.
  • The issue at hand before the Hon’ble Supreme Court was when a director or a person in charge of the affairs of the company can be prosecuted for an offence committed by the company.
  • The Apex Court relying upon the law laid down in Iridium v. Motorala Inc. (as above) stated that the ‘principle of attribution’ is applied to impute criminal intention to the company on account of the criminal intention of its ‘alter ego’ and cannot be applied in a reverse scenario to make the directors liable for offences committed by the company.

ii. Personal/Vicarious Liability Under Tax Statutes

1. Lifting Of The Corporate Veil

a. Section 179 of the Income Tax Act, 1961 imposes a vicarious liability on a director and such liability can be imposed by the Assessing Officer without adjudication by a court.

b. Where any tax due from a private company cannot be recovered, then every person who was a director at any time during the relevant previous year shall be jointly and severally liable for the payment of such tax unless he proves that the non-recovery cannot be attributed to any gross neglect, misfeasance or breach of duty on his part in relation to the affairs of the company.

c. The onus will be on the director to prove his innocence.

2. Under The Goods And Service Tax Regime

a. If a private company does not pay its dues then the directors of the company will become jointly and severally liable for the dues. In this case, only the directors who were in office during the period when the tax was due will be held liable.

b. If a director can prove to the Commissioner that the non-payment was not due to any negligence or breach of duty due to his part, then he will not be held liable.

iii. Personal Liability under Insolvency and Bankruptcy Code, 2016

1. Personal Liability of The Director For Wrongful Trading: A director of the company can be held liable to contribute to assets of the corporate debtor if such director knew that the company has no prospect of avoiding commencement of insolvency process and he did not exercise any due diligence in minimising potential loss to creditors.

2. Personal Liability of The Director for Fraudulent Trading: Any person who is a party to any business of the debtor carried on with the intent to defraud creditors or any other fraudulent purposes may be liable to contribute to the assets of the company as determined by the National Company Law Tribunal.

3. Chapter VII of the Code prescribes certain acts which constitute an offence and the officers in default/ directors are held liable.

These offences include the following:

  1. Concealment of property
  2. Transactions defrauding creditors
  3. Misconduct in course of corporate insolvency resolution process
  4. Falsification of books of corporate debtor
  5. Wilful and material omissions from statements relating to affairs of corporate debtor
  6. False representations to creditors
  7. Non-disclosure of dispute or repayment of debt by operational creditor

iv. Personal / Individual Liability under Competition Act, 2002

1. Section 48(1) of the Competition Act, 2002 states that, if a company is found to have contravened the provisions of the Act, then, every person who is in charge of and responsible for the company’s conduct shall be deemed to be guilty of the contravention, and shall be liable to punishment according to the provisions of the Act.

2. Further, the proviso to Section 48(1) provides that nothing contained in Section 48(1) shall apply, if the relevant individual can prove that the company’s contravention was without his/her knowledge or that he/she had exercised due diligence to prevent the commission of such contravention.

This Article is written under the guidance of Ms. Attreyi Mukherjee, Senior Corporate Counsel and Ms. Deepika Bhagwagar, Deputy Company Secretary.

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