Companies Act, 2013 under section 164  provides for various strategies when a person would be disqualified for appointment as a director. Section 164(1) sets out eight personal grounds for the qualifications of an individual director like being of unsound mind, insolvency, non-payment of call money, etc. On the other hand, Section 164(2) is wider in scope and a directorship. The corresponding provision under the Companies Act, 1956 was Section 274(1)(g). However, this provision had applied only to directors who held directorship in Public Limited Companies. Unlike, Section 164(2) which all companies, specified defaults by Private Limited Companies did not attract the sword of disqualification.

The disqualification of directors as a result of default the filing of annual returns and financial statements for three consecutive years has been the endless contentious issue under the Companies Act, 2013. The issue surfaced in 2017 when various Registrar of Companies(ROCs) started publishing the list of defaulting companies and the disqualified directors.

In compiling the list of defaulting companies and disqualified directors the ROCS considered the companies that had defaulted in filing annual returns and financial statements for Financial Years 2013-14, 2014-15, and 2015-16. Since the Companies Act, 2013 had come into effect only from 01/04/2014 a controversy arose as to which Financial Year should be considered as part of the three consecutive years, 2013-14 or 2014-15. On this issue, several High Court(1), including the Madras High Court, held Section 164(2) can only operate prospectively, and three consecutive years should be reckoned from Financial Year 2014-15. Thus, the issue of prospective applicability of Section 164(2) is fairly settled.

The Madras High court in Bhagavan Das case has clenched that the regulations of natural justice should have been adhered to by issuing a proper notice to all the directors concerned. ROCS continued publishing the list of disqualified directors year on year, without issuing any prior notice. The list published by ROC Chennai and Coimbatore on 18/13/2018 was unsuccessfully challenged on this ground in a Writ Petition before the Madras High Court. However, the decision of the Signal judge was reversed by this Division Bench of the Madras High court in Meethelaveetil Kaitheri Muralidharan vs. Union of India and Anr.

Issues before the division bench of the Madras High Court –

In the new digital environment where a businessman can suddenly be discovered denial of access or a person can discover that he had been disqualified to be a director by a backend exercise reflected in the portal or website, two key issues were identified by the Court.

  • Whether a prior notice is required before disqualifying a director under Section 164(2).
  • Whether the ROC is empowered by the Companies Act, 2013 to deactivate the DIN of disqualified directors.

Section 164 is a basket of disqualifications. While a majority of them are personal in nature and there is justification for consequences, Section 164(2)(a) is in the context of a compliance breach in the procedure by the defaulting company. Section 164(2)(b) is a serious requirement as it deals with a company defaulting in replacement of deposits or payment of interest or redemption of debentures on the due date. The matter is likely to reach the Supreme Court at some point in time and the seriousness of disqualification or the nature of disqualification would have a bearing on the decision. When one looks at the issue dispassionately there are four aspects that come into play. Section 164 which identify disqualifications of a director regarding appointment or reappointment; Section 167 refers to the vacation of office of directors in certain cases and the act of the ROC in publishing the names of disqualified directors and the DIN deactivation that was done.

Section 164 is a statutory provision that enumerated disqualification and there be no quarrel against a provision that seeks to ensure compliance with provisions of the Act; Section 167 deals with vacation of office by operation of law and these provisions are equally important in the general scheme of things. The third and fourth aspects are however acts of the executive and such acts are not valid unless power has been conferred by statute. The object of publishing names is to ensure that companies would be in a decent position to verify the profile of an individual who is being contemplated for appointment as a director. From that perspective the objective is laudable. However, given the wide scope of Section 164(2), there is no distinction within the list. For example, a director could have resigned from the defaulting company even before the default occurred, and the defaulting company would have equally defaulted in intimating the resignation of the director. There could be cases where an individual could be a director in a private company that was not active and a default by the said company is filing the annual return and financial statements could endanger important and prestigious directorships in other companies where there is no issue in compliance. Ideally, Section 167(1)(a) should be amended or read down to the effect that only if the defaulting company is a public limited company or public interest is involved in the form of loan taken from financial institutions, vacation of office of director in other company should apply.

The HC was of the prima facie opinion that, regarding the reappointment of a director of a company that “has not filed financial statements or annual returns for any continuous period of three financial year’s, would mean that the person can continue till the end of the extant term, but would not be eligible for reappointment for another five years, thereafter there is sufficient opportunity to enable him to correct the affairs of that company.” So if the company in which the person is or has been a director has not filed financial statements or annual returns for any continuous period of three financial years on the date on which the company fails to do so, a disqualification is incurred. It is a ministerial or administrative act of filing that is to be performed by the company. Therefore, if such financial statements or annual returns for any continuous period of three financial years have not been filed, then the action is triggered, said the HC bench of Justices S C Dharmadhikari and Riyaz Chagla in a February 7 order, uploaded recently.

The directors who had moved court relied on judgments passed by the high courts of Gujarat, Delhi, Telangana, Madras and Allahabad to argue that the list of September 2017 cannot have a retrospective effect or could not have been implemented prior to October 2017 as was sought to be done. But the Centre said that if returns are not filed continuously for three years, then disqualification is invited. The HC said after having also heard Cyrus Ardeshir, Zal Andhyarujina, and some other counsels for the directors, an earlier order it had passed in October 2019 raising legal queries “sufficiently protects the interest of both sides”. The matters will be finally heard to decide particularly the Constitutional challenge raised against the law.

Conclusion: The Union Government has amended the Companies Act, 2013 to make major changes to provisions pertaining to Directors’ disqualifications. These amendments are expected to usher in greater accountability in corporate governance. The Government’s new scheme to enable companies to comply with the return filing provisions in the event of pending delays/defaults in return filing would likely enable the formation of a robust culture of litigation free compliance. At the same time High Courts, Company Law Boards, and National Company Law Tribunals have passed several major decisions in recent years which have a significant impact on the aforesaid matters. These rulings should be able to give rise to new jurisprudence in company law which is consistent with the development needs of India. Adjusting to the new developments in the law presents new challenges for India Inc.

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March 2021