The Ministry of Corporate Affairs, last month, disqualified around 200,000 directors, under Section 164(2)(a) of the Companies Act, 2013 (2013 Act). Section 164(2)(a) of the 2013 Act provides for disqualification of directors if the company has not filed financial statements or annual returns for a continuous period of three financial years (non-compliance ground). These disqualifications were carried out with the likely intent of cracking the whip on black money and as part of the Government’s crackdown on shell companies. Resultantly, Director Identification Number (DIN) of the disqualified directors have been suspended. Suspension of a director’s DIN is perhaps, on the understanding that disqualification under Section 164(2)(a) results in automatic vacation of the office of the disqualified director, under Section 167. Pertinently, such automatic vacation upon disqualification was not envisaged under corresponding provisions of the Companies Act, 1956 (i.e. Sections 274 and 283 of the 1956 Act). In petitions filed by various disqualified directors, the Madras High Court, the Kerala High Court and the Delhi High Court, have stayed the operation of the disqualification of the directors before them.

The disqualification of directors and the consequent suspension of their DIN has raised multiple legal questions, including the following, which could very well mean that the disqualifications are contrary to law:

1. Retrospective application of Section 164:

(i) Section 164 was notified on 1 April 2014 and therefore, could be made applicable only to future financial years (FY), i.e. the FY beginning 1 April 2014 and not to prior FYs.

(ii) Under the 1956 Act, disqualification on the non-compliance ground was only for public companies. Even for public companies, automatic vacation of the disqualified director’s office was not provided for under the 1956 Act. Therefore, the application of Section 164 of the 2013 Act is retrospective, even for public companies. Pertinently, the automatic vacation of the office of the director happens, not just for the defaulting company, but for all companies that the person is a director of.

(iii) The Hon’ble Supreme Court in Pyare Lal Sharma v Managing Director and Ors (1989) clarified that, the principles of natural justice demand that no person be penalised for any conduct which was not penal on the day it was committed.

(iv) However, apparently, the disqualifications are on the assumption that since the obligation to file financial statements triggered only after 1 April 2014, Section 164(2)(a) has not been applied retrospectively.

 

2. Disqualification made effective from an earlier date (from 1 November 2015/ 1 November 2016):

(i) Disqualifications have been effected from 1 November 2016 and in some case, even from 1 November 2015. As a general principle of law, such disqualification, being penal in nature, cannot apply from an earlier date.

(ii) Moreover, the automatic vacation of a director’s office comes with the necessary implication that any decision taken by the person, as the director, of any third company also will also become a nullity. This may potentially unsettle concluded transactions and have a spiralling effect on the rights created by such transactions.

 

3. No opportunity of being heard granted to the disqualified director

(i) Principles of natural justice demand that a hearing be accorded to any person whose rights are being curtailed by administrative action. The Hon’ble Supreme Court in Nawabkhan v State of Gujarat (1974) held “...an order is null and void if the statute clothing the administrative tribunal with power conditions it with the obligation to hear, expressly or by implication.”

(ii) Further, it is a possibility that the disqualified director may have taken due care in ensuring compliance but the non-filing was a result of a lapse on the part of some official of the company.

 

4. Rights of third party companies affected for no default of theirs and without hearing

(i) (If Section 167 is deemed to apply to Section 164(2)(a), disqualification of directors will result in the automatic vacation of the office of the directors from other companies – impacting the rights of such third-party companies without any non-compliance on their part. Further, this would be done without giving any notice or opportunity of hearing even to such third-party companies;

(ii) Additionally, where the disqualification is effected from 1 November 2015/ 2016, the decisions/ actions taken by the disqualified directors, as members of the Board of such third parties, between 1 November 2015/2016 and the actual disqualification, will also be rendered inoperative, as a direct consequence of such vacation.

 

5. No remedy to the disqualified directors

(i) Interestingly, the 2013 Act does not contain any provision permitting the disqualified director to challenge his disqualification. However, Rule 14(5) of the Companies (Appointment and Qualification) Rules, 2014 reads “Any application for removal of disqualification of directors shall be made in Form DIR-10”. However, the Rules, being delegated legislation, cannot provide any remedy.

(ii) Moreover, Rule 14(5) requires the Application to be made to the Registrar of Companies, and is therefore, contrary to the principles of natural justice – an appeal against disqualification cannot be made against the disqualifying authority.

 

6. Vicarious liability provisions cannot be invoked without action against the principal offender

(i) Disqualification of the directors is invocation of vicarious liability for the non-compliance of the company. Ordinarily, vicarious liability is not invoked, unless the principal offender is also proceeded against. Therefore, where the company’s name has not been struck off, disqualification of the director could well be wrongful invocation of the provision of vicarious liability;

(ii) In the context of criminal liability, the Supreme Court, in Aneeta Hada v M/s. Godfather Travels & Tours Private Limited (2012), held that “…Applying the doctrine of strict construction, we are of the considered opinion that commission of offence by the company is an express condition precedent to attract the vicarious liability of others…”

Further, disqualification may perhaps, not result in automatic vacation of the office of the director, given the language of Section 164(2)(a) – “No person who is or has been a director of a company which…has not filed financial statements ……shall be eligible to be re-appointed as a director of that company or appointed in other company …”. Therefore, Section 164(2)(a) does not, on its plain reading, suggest that disqualification is a bar on continuing as a director. Also, Section 167 may be read only as including disqualification under sub-section (1) within its ambit and not sub-section (2) of Section 164, since the latter deals only with vicarious liability of directors.

In this regard, the order of the Delhi High Court staying the disqualification also records that prima facie, it appears that the said provision does not provide for immediate disqualification of Directors. Whether the disqualifications will stand judicial scrutiny or not is for time to tell. While an interim order is, by no standard, a yardstick, it appears that prima facie, the courts are noticing the fault lines in the disqualification drive of the Ministry of Corporate Affairs.