Directors’ responsibility for “All” applicable laws to Company

Directors’ responsibility for “All” applicable laws to Company– an open ended responsibility

Section 134(3)(c) of the Companies Act, 2013 provides that there shall be attached to statements laid before a company in general meeting, a report by its Board of Directors, which shall include “Directors’ Responsibility Statement”.

Section 134(5) of the Companies Act, 2013 further provides that the Directors’ Responsibility Statement referred to in clause (c) of sub-section (3) shall state that the directors had devised proper systems to ensure compliance with the provisions of “all” applicable laws and that such systems were adequate and operating effectively.

The word “all” used in Section 134(5) supra has left the directors of the companies with a question as to whether their responsibility is made open ended under the Companies Act, 2013, since prima facie the word “all” seems to provide an inclusive sense rather than an exhaustive sense. In the present article, an attempt has been made to understand the directors’ responsibility(s) in respect of the requirement under section 134(5) of the Act.

The understanding about the implications of Section 134(5) becomes all the more vital considering the definitions of “officer” and “officer who is in default” contained respectively in Section 2(59) and Section 2(60) of the Companies Act, 2013, as follows:

“officer” includes any director, manager or key managerial personnel or any person in accordance with whose directions or instructions the Board of Directors or any one or more of the directors is or are accustomed to act;

“officer who is in default”, for the purpose of any provision in this Act which enacts that an officer of the company who is in default shall be liable to any penalty or punishment by way of imprisonment, fine or otherwise, means any of the following officers of a company, namely:—

(i) whole-time director;

(ii) key managerial personnel;

(iii) where there is no key managerial personnel, such director or directors as specified by the Board in this behalf and who has or have given his or their consent in writing to the Board to such specification, or all the directors, if no director is so specified;

(iv) any person who, under the immediate authority of the Board or any key managerial personnel, is charged with any responsibility including maintenance, filing or distribution of accounts or records, authorises, actively participates in, knowingly permits, or knowingly fails to take active steps to prevent, any default;

(v) any person in accordance with whose advice, directions or instructions the Board of Directors of the company is accustomed to act, other than a person who gives advice to the Board in a professional capacity;

(vi) every director, in respect of a contravention of any of the provisions of this Act, who is aware of such contravention by virtue of the receipt by him of any proceedings of the Board or participation in such proceedings without objecting to the same, or where such contravention had taken place with his consent or connivance;

(vii) in respect of the issue or transfer of any shares of a company, the share transfer agents, registrars and merchant bankers to the issue or transfer.

Words presumed to be correctly and exactly used and interpreted contextually – The word used in the Act by the Legislature must be considered to have been correctly and exactly used and not loosely or inexactly, in ascertaining the meaning. Mere reference to the ordinary dictionary meaning will be of no use and the construction divorced from the context in which it has been used and the object of the legislation may often lead to injustice, absurdity, contradiction or stultification of the very statutory objective and, consequently, the language must be so modifidely read as to give effect to all provisions of the Act. Further, when the language used is possible of bearing more than one construction, an endeavour to place the correct or true meaning must be made having due regard to the consequences resulting from adopting the alternative constructions and the one which results in hardship, serious inconvenience, injustice or absurdity or anomaly or which leads to inconsistency or uncertainty or friction in the very system, which the State purports to regulate, has to be rejected and the construction, which would avoid such results should always be preferred – H.P. Tourism Development Corpn. v. Union of India [1999] 238 ITR 38 (HP).

To apply words literally may defeat the obvious intention of the Legislature and produce a wholly unreasonable result. To achieve the obvious intention and to produce a reasonable result, some violence to the words has to be done. The proper course is to adopt the sense of the words which harmonises best with the context and promotes in fullest manner, the apparent policy and objects of the Legislature. The ‘Golden rule’ could, thus, be explained as follows:—

1. It is the duty of the Court to give effect to the meaning of an Act when the meaning can be fairly gathered from the words used, that is to say, if one construction would lead to an absurdity while another will give effect to what common sense would show, as obviously intended, the construction which would defeat the ends of the Act must be rejected even if the same words used in the same section, and even the same sentence, have to be construed differently. Indeed, the law goes so far as to require the courts sometimes even to modify the grammatical and ordinary sense of the words, if by doing so absurdity and inconsistency can be avoided.
2. The Court should not be astute to defeat the provision of the Act whose meaning is, on the face of it, reasonably plain. Of course, this does not mean that an Act or any part of it, can be recast. It must be possible to spell the meaning contended for, out of the words actually used.
3. Unless the words are without meaning or absurd, it would be safe to give words their natural meaning because the framer is presumed to use the language which conveys the intention and it would not be in accord with any sound principle of construction to refuse to give effect to the provisions of a statute on the very elusive ground that to give them their ordinary meaning leads to consequences which are not in accord with the notions of propriety or justice entertained by the Court.

The following observations in this regard of Venkatarama Ayyar, J. in Tirath Singh v. Bachittar Singh clearly underscore the desirability of the above indicated course of action in the given situation of textual inadequacy of a given provision:—

“It is argued that if the language of the enactment is interpreted in its literal and grammatical sense, there could be no escape from the conclusion that parties to the petition are also entitled to the notice under the proviso. But it is a rule of interpretation well-established that ‘where the language of a statute’ in its ordinary meaning and grammatical construction leads to a manifest contraction of the apparent purpose of the enactment, or to some inconvenience or absurdity, hardship or injustice, presumably not intended, a construction may be put upon which modifies the meaning of the words, and even the structure of the sentence.”

It is also well-recognised principle of construction that while construing a statute, the courts have to so read the provision of the Act as to steer clear of the vice of unconstitutionality.

Contextual interpretation of words – Words are meant to serve and not to govern – Plain words are delusion. Since the words must have spoken as clearly to legislators as to judges, it may be safely presumed that the Legislature intended what the words plainly say. This is the real basis of the so-called literal rule of construction that where the words of statutes are plain and unambiguous, effect must be given to them. Where words used are unambiguous, interpretative aids such as objects of statute would not be relevant [Kailash Nath Agarwal v. Pradeshiya Indl. & Invt. Corpn. of U.P. Ltd. [2003] 114 Comp. Cas. 4 (SC)]. While it is permissible to refer to dictionaries to find out the meaning in which a word is capable of being used or understood in common parlance, the well-known canon of construction should not even for a minute be overlooked that the meanings of the words and expressions used in a statute ordinarily take their colour from the context in which they appear. Words take colour from the context in which they are used (Jasbir Singh v. Vipin Kumar Jaggi [2001] 8 SCC 289).

Interpretation of word “all”: The word(s) “all” or “every” as well as “some” or “one” and its meaning in a given statute depends upon the context and subject of the statute (Lucknow Development Authority v. M. K. Gupta AIR 1994 SC 787)

Context under the Companies Act, 2013: The context of “all” the applicable laws should be understood with the harmonious assessment of the following twin factors:

(a) Industry or sector in which the company is operating;

(b) Object clause of the Memorandum of Association;

Further, there are many laws and regulations, relating principally to the operating aspects of an entity that typically do not affect the financial statements and are not captured by the entity’s information systems relevant to financial reporting. Non-compliance may even involve any conduct designed to conceal it, such as collusion, forgery, deliberate failure to record transactions, management override of controls or intentional misrepresentations being made to the entity. Whether an act constitutes non-compliance is ultimately a matter for legal determination by a court of law.

Indicators of non-compliance of the applicable laws: The following can be the indicators of non compliance of the applicable laws:

(a) Investigations by regulatory organisations and government departments or payment of fines or penalties.

(b) Payments for unspecified services or loans to consultants, related parties, employees or government employees.

(c) Sales commissions or agent’s fees that appear excessive in relation to those ordinarily paid by the entity or in its industry or to the services actually received. Purchasing at prices significantly above or below market price.

(d) Unusual payments in cash, purchases in the form of cashiers’ cheques payable to bearer or transfers to numbered bank accounts.

(e) Unusual payments towards legal and retainership fees.

(f) Unusual transactions with companies registered in tax havens.

(g) Payments for goods or services made other than to the country from which the goods or services originated.

(h) Payments without proper exchange control documentation.

(i) Existence of an information system which fails, whether by design or by accident, to provide an adequate audit trail or sufficient evidence.

(j) Unauthorised transactions or improperly recorded transactions.

(k) Adverse media comment.

Devising proper systems to ensure compliance with the provisions of “all” applicable laws: The system as aforesaid or the control environment in a more technical sense, can be designed:

• either as an in house function; or
• may even be outsourced as a separate independent function.

Some elements of an entity’s control environment have a pervasive effect on assessing the risks of non-compliance. The effectiveness of the design of the control environment in relation to participation by those charged with governance is therefore influenced by such matters as:

1. Their independence from management and their ability to evaluate the actions of management.
2. Whether they understand the entity’s business transactions.
3. The extent to which they evaluate whether the financial statements are prepared and entity is operating in accordance with the applicable financial reporting framework.
4. Control activities to ensure that management directives are carried out

An active and independent board of directors may influence the philosophy and operating style of senior management. However, other elements may be more limited in their effect. For example, although human resource policies and practices directed toward hiring competent financial, accounting, and IT personnel may reduce the risk of errors in processing financial information, they may not mitigate a strong bias by top management to overstate earnings.

Control activities are the policies and procedures that help ensure that management directives are carried out. Control activities, whether within IT or manual systems, have various objectives and are applied at various organisational and functional levels. Examples of specific control activities include those relating to the following:

(a) Authorization.

(b) Performance reviews.

(c) Information processing.

(d) Physical controls.

(e) Segregation of duties

The above article is contributed by CA Kamal Garg. For any queries and suggestions he may be approached at cakamalgarg@gmail.com

Bibliography: 1. www.mca.gov.in 2. www.taxmann.com 3. www.icsi.edu 4. www.bharatlaws.com

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