Law of Disqualifications for Appointment of Directors: Analysis

Amitav Ganguly

Background

The Board of Directors {Board} of a company is its highest decision making organ. However the shareholders’ jurisdictions always exist as per the scheme of the Company jurisprudence. The directors constituting the Board act collectively, as well as individually, depending upon the position they hold and the authorities granted to them by the Board/ shareholders and the statute.

There exist well established judicial precedents as well laws that the directors have fiduciary obligations and also duties to act reasonably and honestly in the best interests of the companies where they hold such positions. Their duties emanate due to their holding positions which may be synonymous to agents as well as trustees of their companies.

In view of such important position of directors it is essential that their eligibilities for appointment are strictly regulated and disqualifications are not permitted.

Section 164 of the Companies Act 2013 {Act} which corresponds to sections 274 of the erstwhile Companies Act 1956 {erstwhile Act} has provided for disqualifications for appointment of directors.

SECTION 164 OF THE COMPANIES ACT 2013

Eligibility for appointment as director

LAW

Section 164(1): A person shall not be eligible for appointment as a director of a company, 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) he has been convicted by a court of any offence, whether involving moral turpitude or otherwise, and sentenced in respect thereof to imprisonment for not less than six months and a period of five years has not elapsed from the date of expiry of the sentence:

Provided that if a person has been convicted of any offence and sentenced in respect thereof to imprisonment for a period of seven years or more, he shall not be eligible to be appointed as a director in any company;

(e) an order disqualifying him for appointment as a director has been passed by a court or Tribunal and the order is in force;

(f) 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;

(g) he has been convicted of the offence dealing with related party transactions under section 188 at any time during the last preceding five years; or

(h) he has not complied with sub-section (3) of section 152.

ANALYSIS

This sub section {1} lays down the disqualifications whereby a person shall not be eligible for appointment as a director of any company, whether public or a private company. Thus if any one or more of the disqualifications, as laid down in the section, applies/apply to him at the time of his appointment as director of the company, he cannot be so appointed.

It was held by the Court in the case of Cricket Club of India v. Madhav L Apte {1975} 45 Comp Cas. 574 {Bom} that the word “disqualified” in section 274 {3} of the Companies Act 1956 {erstwhile} must be understood in its plain natural meaning and not in a limited sense.

It was held in the case of B R Kundra v. Motion Pictures Association {1976} 46 Co Cases 339, Delhi that these provisions in the Companies Act {erstwhile} do not apply to retirement of directors.

Unsound mind

The first disqualification is that the person concerned is of “unsound mind” and he stands so declared by a competent court. Under the Black’s Law Dictionary, a person of unsound mind is an adult who from infirmity of mind is incapable of managing himself or his affairs. The term, therefore, includes insane persons, idiots, and imbeciles.

He, therefore, cannot be appointed as a director. Significantly, it is of relevance that he is declared as unsound mind by the court having the requisite jurisdiction and that such declaration is in force at the time of consideration of his appointment.

Undischarged insolvent

• The second disqualification is that he is an undischarged insolvent. Here, the term ‘undischarged insolvent’ may have to be understood as per the Presidency Towns Insolvency Act, 1909 and the Provincial Insolvency Act, 1920, although these the laws have not been referred in the section. It was held in the case of James v. Rockwood Colliery Co., [1912] WN 263 that a director will be held as insolvent where he asks his creditors to accept composition since he has become financially insolvent. Composition would mean a contract made by an insolvent with more than one creditor in which they agree to accept revised payment of the total amount of their claims.
• The third disqualification is that the person concerned has applied to be adjudicated as insolvent and his application is pending. It is worthwhile to note that in contrast to the disqualification of being unsound mind where the person has to be declared as such by court, it is not necessary here that the person should be adjudicated as insolvent, and even where his application is pending, he becomes ineligible.

Conviction by court

Fourthly, a person is disqualified where he is convicted of any offence and sentenced to imprisonment by a competent court for minimum six months and five years have not elapsed from the date of expiry of the sentence. The offence should involve “moral turpitude or otherwise”.

The words “moral turpitude” although not defined, has been held by courts in various cases as intentional actions on the part of the concerned person which are against good morality, justice, honesty, modesty, and, shows depravity, base and wickedness of character. {Ref: American Encyclopaedia of Law}. { Also ref cases: Baleshwar Singh v. Distt. Magistrate & Collector AIR 1959 All 71 and Durga Singh v. State of Punjab AIR 1957 Punj 97}.

Moreover the words “ or otherwise” appearing after the words “moral turpitude” were not there in sections 274 & 283 of the erstwhile Companies Act which only covered “moral turpitude”. This has extended the coverage and as per the Companies {Specification of Defintion Details} Rules 2014 means “any offence in respect of which he has been convicted by a Court under this Act or the Companies Act 1956”

Furthermore, where a person has been convicted of any offence and sentenced in respect thereof to imprisonment for a period of seven years or more, he shall not be eligible to be appointed as a director in any company. This is an all encompassing disqualification covering all offences and companies.

Order of Court/Tribunal

Fifthly, a person is ineligible for appointment as director, where a court or Tribunal has passed an order disqualifying the person for appointment as director. It is essential that such order should be subsisting and in force.

Non payment of calls

Sixthly, the person concerned is ineligible where has not paid any calls in respect of any shares, whether equity or preference, of the company held by him, whether singly or jointly and such failure has continued for more than six months from the last day fixed for the payment of the call.

It is the legal position that the calls on shares should be validly made by a company in terms of the law and articles of association of the company. It is interesting to note that to constitute a valid call, inter alia, there should be a resolution of the board, the amount and time of payment should be specific, it should be made bonafide and on an uniform basis. The power of making a call is in the nature of trust and is to be exercised in the interest and benefit of the company. {Ref case: European Central Railway Co., Re., {1872} LR 13 Eq. 255}. In case it is proved that there was defect in making the call by the company, any failure to pay such calls by the concerned person making him ineligible to be appointed as director can be disputed by him.

Offence of related party transactions

Seventhly, the person concerned has been convicted of the offence dealing with related party transactions covered under section 188 of the Companies Act 2013 at any time during last preceding five years. Although not clearly stated, the conviction has to be done by a competent court/ tribunal. This is a new provision as compared to erswhile Companies Act. The conviction shall make the concerned person ineligible for appointment as director.

The above provision arises from the well-established legal position that the directors hold the position of trust and are agents of the company and therefore transactions with them, their relatives, or with their entities need to regulated. This will ensure that such transactions are proper commercial dealings, in the best interest of a company, at an arm’s length, with no conflict of interest. Otherwise, these transactions could end up favouring and benefitting the related party at the detriment of the company.

DIN

Lastly the person who has not obtained the Director Identification Number {DIN} in terms of section 152(3) of the Companies Act 2013 will not be eligible to be appointed as a director.

As per the provisions every person is required to obtain DIN from the Central Government before he acts as a director in any company. Every proposed director shall furnish his DIN, a declaration that he is not disqualified to become a director and gives consent to hold office as director.

NOT ELIGIBLE TO BE RE-APPOINTED/APPOINTED AS A DIRECTOR

LAW

Section 164(2): 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 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.

ANALYSIS

The applicable Rules here is Companies {Appointment and Qualification of Directors} Rules 2014.

The provision in this sub section {2} is in line with section 274{1} {g} of the erstwhile Companies Act validity of which has been upheld in the case of Saurashtra Cement v. UOI (2007) 75 SCL 375 (Guj HC DB). The sub section however, covered public companies only, whereas the new law here, covers a “company” which includes a public or a private company.

• In terms of clause {a} of this sub section {2}, the default relates to the failure of the company of not filing for any continuous period of three financial years, its financial statements or annual returns, which makes the director disqualified. The term ”financial statements” has been defined in section 2(40) of the Companies Act 2013 and covers not only balance sheet and profit and loss/ income and expenditure account of the company but also its cash flow statements, statement of change in equity and any explanatory note annexed to or forming part of the aforesaid financial statements. Preparation and filing of annual return, each year has been mandated in terms of section 92 of the Companies Act 2013.
• In terms of clause (b) of this sub section, the disqualification of a director will get invoked where the company has failed to repay the deposits accepted by it or pay interest thereon. Acceptance of deposits and payment of interest thereon are regulated under section 73 to 76A and the related Rules of the Companies Act 2013. Disqualification will also get invoked where the company has failed to redeem any of its debentures on the due date or pay interest due thereon as regulated in section 71 and related Rules of the Companies Act 2013. Moreover, failure to pay any dividend declared by the company is also covered; declaration and payment of dividend is regulated under PART VIII of the Companies Act 2013 (Sections 123 to 127 and related Rules). Significantly, such failure to pay or redeem by the company should continue for one year or more.

These failures on the part of the company shall make the person concerned, who is or has been a director of such company, ineligible to be re-appointed as a director of not only that company but also ineligible to be appointed in any other company, whether public or private. This disqualification shall continue for a period of five years from the date on which the said company has failed to do as stipulated aforesaid. It has been held in the case of Nabendu Dutta v Arindam Mukherjee , 2003 CLC 1249 that an application for declaration of disqualification of a director can be filed by the shareholders as they have the locus standi.

FURTHER DISQUALIFICATIONS

LAW

Section 164(3): A private company may by its articles provide for any disqualifications for appointment as a director in addition to those specified in sub-sections (1) and (2):

Provided that the disqualifications referred to in sections (d), (e) and (g) of sub-section (1) shall not take effect—

(i) for thirty days from the date of conviction or order of disqualification;

(ii) where an appeal or petition is preferred within thirty days as aforesaid against the conviction resulting in sentence or order, until expiry of seven days from the date on which such appeal or petition is disposed of; or

(iii) where any further appeal or petition is preferred against order or sentence within seven days, until such further appeal or petition is disposed of.

ANALYSIS

This sub section {3} permits a private company to add further disqualifications for appointment of a person as its director, through its articles of association. There is no limit or restriction for such additions. Significantly the company cannot amend or delete any of the statutory disqualifications laid down herein through its articles of association. It was held in terms of the erstwhile Companies Act that in the case of Cricket Club of India Ltd v Madhav L. Apte, {1975} 45 Com Cases 574{ Bom} that public companies and their subsidiary private companies are not permitted to adopt additional disqualifications. However in the case of Ketan Harkishan Marvadi v. Saurashtra – Kutch Stock Exchange Ltd {2002} 109 Comp. Cas. 269 {Guj} it was held that section 274 of the ertswhile Companies Act do not contain any express prohibition against additional disqualifications by a public company.

Taking effect of disqualifications

The proviso has the effect of laying down when the disqualifications referred in clauses (d), (e) and (g) of sub section (1) herein shall take effect.

Thus it will be effective after thirty days from the date of conviction or order of disqualification.

Moreover, where an appeal or petition has been preferred by the person concerned and/or the company within thirty days as aforesaid against the conviction resulting in sentence or order, the disqualifications will take effect after seven days from the date on which such appeal or petition has been disposed of.

Where any further appeal or petition has been preferred against the order or sentence within seven days, the disqualifications will not take effect until such further appeal or petition has been disposed of.

CONCLUSION

Although the provisions in section 164 of the new Companies Act 2013 are somewhat in line with the laws which were laid down in the ertswhile Companies Act 1956, there is definitely an improvement in these new provisions in tune with the modern corporate scenario and practices.

Click here to read other articles of Amitav Ganguly