Disqualification of Directors: A Legal Farce?

Ministry of Corporate Affairs has struck off more than 2 lakh companies and disqualified 3 lakh directors as part of an ongoing exercise of cleaning up corporate India and a crackdown on shell companies out of which approximately more than 1 lakh directors have been disqualified due to non-filing of financial statements under provisions of Companies Act, 2013 ("Act"). This article tends to demystify the applicable provisions of disqualification of directors and remedy available to such directors.

Dissecting the disqualifications of directors under the Act

Section 164 of the Act provides for various disqualifications for appointment of a director. The said section is divided in three sub-sections. Sub-section (1) provides basic disqualifications (like person of unsound mind, undischarged insolvent etc.) possessing which a person shall not be eligible for appointment as a director of a company. Sub-section (2) states disqualifications on account of default i.e. if a company has either failed to file the financial statements or annual returns for any continuous period of three financial years or 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, any person who is or has been a director of such company 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 said company fails to do so. Sub-section (3) gives an additional discretion to a private company to provide for any disqualifications in its articles of association for appointment as a director in addition to those specified in section 164(1) & (2) of the Act. In view of the disqualification under section 164(2) of the Act, Rule 14 of the Companies (Appointment and Qualification of Directors) Rules, 2014 states that every director shall inform to the company concerned about the disqualification in Form DIR-8 before he is appointed or re-appointed.

Section 167 of the Act provides for the vacation of office of director and states that the office of a director shall become vacant in case he incurs any of the disqualifications specified in section 164 of the Act. The said section 164 further states that if a person, functions as a director even when he knows that the office of director held by him has become vacant on account of any of the disqualifications specified in subsection 167(1), he shall be punishable with imprisonment for a term which may extend to one year or with fine which shall not be less than one lakh rupees but which may extend to five lakh rupees, or with both. Sub-section (3) states that where all the directors of a company vacates their offices under any of the disqualifications specified in sub-section(1), the promoter or, in his absence, the Central Government shall appoint the required number of directors who shall hold office till the directors are appointed by the company in the general meeting. Therefore, upon vacation of the office by the Board of Directors of a company under section 164 of the Act, an interim Board of Directors can only be appointed under the terms of section 167(3) of the Act, either by the Promoters or the Central Government

Upon a conjoint reading of section 164 and 167 of the Act, it appears that the legislative intent on section 164 of the Act is to disqualify a director for appointment and re-appointment from the date of default for a period of five years. The said section, does not operate to interrupt the appointment of any director made prior to the coming into such default and there is no mid-tenure cessation of any director as a result of section 164(2) of the Act. Therefore, where a director of a company attains the disqualification under section 164(2) of the Act, it has to be looked into at the time of appointment or re-appointment and not requiring immediate vacation of office.

Applicability of Section 164 of the Act

The provision of section 164 of the Act came into effect on 1st April 2014 and disqualification as stated therein, if any, have to accrue prospectively upon coming into effect of the said provision by failure to file financial statements of the Company for three consecutive financial years post coming into effect of the said provision. Further, the existence of a pari material provision section 274 of the Companies Act, 1956 ("Old Act") is of no relevance since the consequences of the disqualification under section 274 of the Old Act, as provided for in section 283 of the Old Act are distinct from the consequences of the disqualification under section 164 of the Act as provided in section 167 of the Act. It is noteworthy that disqualification under section 274 of the Old Act does not result in vacation of the board of directors under section 283 of the Old Act. As such, the provision for vacation of the board of directors under section 167 of the Act consequent upon attracting any of the disqualification under section 164 of the Act is a new consequence effective only upon coming into effect of the said provision on 1st April 2014.

The case of non-filing of financial statements before the enactment would not tantamount to disqualification to become director or to continue as director, new enactment made non-filing of financial statements for three consecutive years as disqualification and amounts to an offence only to the Act after 1st April 2014. If this disqualification is construed as applicable to the past acts, it is obviously unfair to the people conducted the affairs of the company under the impression that non-filing of financial statements for three years is not a default and not an offence. Therefore, this provision has to be read as applicable to the situations where non-filing has started, at the most in the past and continuing while this enactment has come to into existence and also to future non-filing but not to be considered as applicable to the past acts for it is an established proposition that an Act has to be considered retroactive only when it has been explicitly mentioned in the Act.

Compounding of offence under Section 164(2) of the Act

The Ministry of Corporate Affairs introduced General Circular No. 34/2014 dated 12th August 2014 a Company Law Settlement Scheme 2014 ("Scheme") wherein an opportunity is given to the defaulting companies to make their default good by filing belated documents and Central Government condoning the delay in filing by granting immunity for prosecution and charging a reduced additional fee of 25% of the actual additional fees payable under section 403 of the Act read with Companies (Registration Offices and Fees) Rules, 2014. The said Scheme was initially valid till 15th October 2014 later extended General Circular No. 44/2014 dated 14th November 2014 till 31st December 2014. Upon expiry of the said Scheme, in absence of any provision there was lot of uncertainty on compounding of offences under Section 164(2) of the Act.

The National Company Law Appellate Tribunal while compounding the offence under section 164(2)(a) of the Act stated that there is a wide scope and power vested in the Tribunal to compound an offence of the nature provided in the section 441 of the Act either before or after the institution of any prosecution. Therefore, the Tribunal has jurisdiction to compound the offence of the nature provided for before institution of any prosecution, as also after the institution of any prosecution. In view thereof, before compounding any offence, for violation of any provisions of the Act, it is not only the gravity of the offence required to be looked into but also the punishment as prescribed under the law and held that:

"22. In the present case as admittedly, the default in filing the Annual Return is more than two years and continued during the subsequent financial years, therefore, we are not inclined to compound the amount to the extent of Rs. 25,000/- each, as ordered by Company Law Board in the other case. It is also noted that non-filing of Annual Returns for any continuous period of three Financial Years is also a disqualification for appointment as Director under Section 164(2)(a) of Companies Act 2013, thus making it a serious offence. However, to be consistent with the orders passed by Tribunal in analogous case, which is approximately 1/5th of the maximum fine, we modify the impugned order of Tribunal dated 6th October 2016 passed in Company Petition No. 16/128/16 and to compound the offence on payment of Rs. 2 lacs by each of the appellants i.e. the Company and the two Directors, Mr. Sandeep Kapoor and Mr. Atul Prabhakar Kulkarni. That means total six lacs to be paid by them.

The amount, as compounded be deposited with the Tribunal within three weeks, after adjusting the amount, if any already deposited by appellants. Subject to the remittance of the fine as ordered above, the offence stand compounded. The Registrar of Companies will ensure compliance of the order. This appeal stands disposed of with aforesaid observations."

In view thereof, the offences under section 164(2) can be compounded by the National Company Law Tribunal by virtue of its inherent jurisdiction even after the expiry of the Scheme issued by the Ministry of Corporate Affairs.

Conclusion

In view of the above, in the opinion of the author, section 164(2) of the Act simply enables a disqualification to be imposed on or after 1st April, 2014, thus non filing of annual return of a company prior to 1st April 2014 will not be considered for the purpose of determining the non-filing of financial statements for a period of three years. Therefore, a company whose directors have been disqualified under section 164(2) of the Act, can file an application/petition with the National Company Law Tribunal seeking discharge from such disqualifications and for compounding of offence under section 164(2) of the Act.

This article was first published by Taxmann ([2017] 86 taxmann.com 209 (Article)).The view and opinion expressed in this article is solely that of the author and do not necessarily reflect the official view or position of the firm.