With the growth of corporate activities in India coupled with the stringent enforcement of laws, liability of directors has become a hot-bed for discussions. The Companies Act, 2013 (CA 2013) and the erstwhile Companies Act, 1956 (CA 1956) (collectively Companies Act) both expressly provide for the concept of “officer who is in default”. Simply put, certain persons inter alia, whole-time directors, key managerial persons or every director who is aware of a contravention under the Companies Act, by virtue of the receipt by the concerned director of any proceedings of the board or participation in such proceedings without objecting the same, or where such contravention takes place with his consent or connivance, will be held liable for contraventions under the CA 2013.

In this context, the Securities and Exchange Board of India (SEBI) has in its recent order dated 20 June 2017 in respect of Zylog Systems Limited, sought to provide respite to independent directors for contraventions under the Companies Act, involving actions to be taken by the company’s management. In its order, SEBI has acknowledged that the role of independent directors does not extend to the day-to-day management of the Company. Further, it has upheld that as long as independent directors discharge their duties using “best efforts”, they cannot be held liable for non-compliances attributable to the company’s management.

The SEBI order has been discussed below.

Background

Zylog Systems Limited (Zylog), a listed company had declared certain dividends to be distributed to its shareholders in its annual general meeting of 25 September 2012. Subsequently, SEBI received multiple complaints from Zylog’s investors that no dividend had been distributed by Zylog, pursuant to which SEBI issued a notice to Zylog demanding inter alia, the reasons for default. Zylog reasoned with SEBI that due to liquidity constraints, dividend could not be distributed.

SEBI issued show cause notices to all the directors of Zylog, who were directors of the company on the date of declaration of the dividend in 2012. Two independent directors, namely Mr S Rajagopal and Mr V K Ramani, responded to SEBI’s notices stating that (a) they were not responsible for the day-to-day management of the affairs of the company; and (b) the issue relating to the failure of the company to distribute the dividends was brought to Mr V K Ramani ‘s notice only at the board meeting held on 14 November 2012, while Mr S Rajagopal learnt of such non-compliance based on the certificate issued by the company secretary and the managing director, confirming that the declared dividend had not been distributed for the year 2011-2012. To corroborate the reasoning provided by the two independent directors, the minutes of the meeting of the board of directors of 14 November 2012 was submitted to SEBI.

The minutes recorded that both the independent directors had raised a concern regarding the contravention by the company to pay the statutory dues and had demanded immediate action by the management to meet its commitments in this regard. It was noted that both the independent directors had resigned from the company, within 2 (two) months of the board meeting being held. While SEBI took cognizance of the role of independent directors in the management of the company, it concurred that the independent directors had used their “best efforts” to demand action by the management of the company in relation to the contraventions.

Law regarding distribution of dividends

Declaration of dividends: Under Section 205(1A) of the erstwhile CA 1956, if a company declares dividends, it is mandated to deposit the declared amount in a separate bank account, within 5 (five) days from the date of such declaration. Further, as per section 207 of CA 1956, Zylog and its directors were under an obligation to disburse the dividend declared to shareholders entitled to the payment of the dividend within 30 (thirty) days from the date of declaration of dividend. Separately, a violation of Section 205 of CA 1956 will result in the company and every officer of the company who is in default being punished with a fine for every day during which the contravention continues. Further, a contravention section 207 of the CA 1956 attracts a punishment of imprisonment of up to 3 (three) years and fine for every director of the company who is knowingly a party to the default, and the company will be liable to pay interest on the amount. Similar provisions have been prescribed under Sections 123 (4) (corresponds to Section 205 (1A) of CA 1956) and 127 (corresponds to Section 206 of CA 1956) of CA 2013.

Comment

In light of the foregoing order, it may be worthwhile for directors of companies (listed and unlisted) to pro-actively deal with the affairs of the company. It remains to be seen if standards similar to those applied by SEBI to listed companies are applied to for directors, independent or otherwise of a private company under CA 2013.

The SEBI (Listing Obligations and Disclosure Requirements), 2015 and CA 2013 have endowed directors with enhanced duties and liabilities, to make them more accountable, including being personally liable in case of wrongs committed by them. Considering that stringent penal actions are imposed even for not-such-grave non-compliances, it is necessary that directors, whether nominee, independent, or otherwise, adopt an extra cautious approach whilst exercising their duties to limit their exposure to possible penal action in case of contravention by the company.

While directors must always act in the best interests of the company, abundant caution must also be observed in their actions, such as attending as many board meetings as possible, to ensure that they are fully aware of the company’s business. As a step further, directors must read all necessary papers and relevant background information made available to them for meetings to enable their meaningful participation and contribution. Directors must ensure that any questions raised by them in a board meeting or any dissent expressed is properly recorded in the minutes of the meeting so as to provide prima facie evidence, in the event the actions of a director are questioned.