Companies (Amendment) Act, 2017: New grounds for Directors’ disqualification and opportunities for correction under CODS, 2018

The last 15 months have been quite revolutionary in terms of an attempt to make India a transparent and global business hub as far as corporate governance is concerned. The Government has struck off more than 2,00,000 defunct companies and disqualified 3,00,000 individuals who were holding directorships in such companies. Further, the Government of India has amended the Companies Act, 2013 to make major changes to provisions pertaining to Directors’ disqualifications and launched a new scheme to enable companies to comply with the return filing provisions in the event of pending delays/defaults in return filing.

While the Union Government seeks to make Directors’ appointments/disqualifications a means to usher in much needed transparency in the operation of companies, its Condonation of Delay Scheme, 2018 also allows Directors having any disqualifications owing to the defaults in a previous company to act within time to correct such defaults and cure their own disqualification. This article analyses these developments to enable a nuanced understanding of these legal developments.

Changes in provisions on Directors’ disqualification

It is pertinent that Sections 164(1) and (2) of the Companies Act, 2013 read as follows:

164. Disqualifications for appointment of director.— (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:

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(e) on 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.

(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 reappointed 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.

The aforesaid provision has been amended by the Companies (Amendment) Act, 2017, adding the following proviso to sub-section (2):

Provided that where a person is appointed as a director of a company which is in default of clause (a) or clause (b), he shall not incur the disqualification for a period of six months from the date of his appointment.

Thus, the new amendment has granted a time window to Directors to correct the position of the prior company in which he was appointed. So long as such corrections are done to alleviate the disqualifications mentioned under sub-section (2), the appointee can continue as a Director. Thus, candidates for directorship would need to be vigilant enough to ensure that no defaults either in filing statutory returns or defaults on deposits/debentures/dividends exist on the part of a prior company in which they are or were a Director. On the other hand, the inability/failure to make such corrections would render such Director disqualified even if such failure is unintentional. Clearly, by requiring appointed Directors to be responsible for companies they have left already the statute might be a case of overkill. Directors are faced with a new challenge in terms of compliance and the time window is most welcome in that regard.

It is pertinent that the Uday Kotak Committee on Corporate Governance in its chapter on Disclosures & Transparency Disclosures Pertaining to Disqualification of Directors has made a significant recommendation. The recommendation is that disclosures under the SEBI Listing Obligations and Disclosure Requirements (LODR) must also include a company secretarial certificate in the annual report that none of the Directors on the board of the company have been debarred or disqualified from being appointed or continuing as Directors of the companies by SEBI/MCA or any “such statutory authority”.

This goes out as a clear indication of where business regulation is headed as far as major companies are concerned. The Committee felt that investors are often unaware whether the Directors of the company have been debarred from acting as Directors of a company. The recommended changes in the Fifth Schedule to LODR have been suggested to resolve this anomaly. It is noteworthy that the recommended amendment also contains other “statutory authorities” within its ambit. It could mean NCLT as an example, thus indicating that even adverse orders by the same which invalidate or bar a Director would have to be adequately acted upon by listed companies as they must obtain the bona fide certificate from the company secretary concerned.

Changes with respect to the vacation of office of Director

It is clear from Section 167 of the Companies Act, 2013 that:

167. Vacation of office of Director.— (1) The office of a director shall become vacant in case—

(a) he incurs any of the disqualifications specified in Section 164:

Provided that where he incurs disqualification under sub-section (2) of Section 164, the office of the director shall become vacant in all the companies, other than the company which is in default under that sub-section.

This provision has been subjected to the following additions under the Companies (Amendment) Act, 2017:

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(b) he absents himself from all the meetings of the Board of Directors held during a period of twelve months with or without seeking leave of absence of the Board;

(c) he acts in contravention of the provisions of Section 184 relating to entering into contracts or arrangements in which he is directly or indirectly interested;

(d) he fails to disclose his interest in any contract or arrangement in which he is directly or indirectly interested, in contravention of the provisions of Section 184;

(e) he becomes disqualified by an order of a court or the tribunal;

(f) he is convicted by court of any offence, whether involving moral turpitude or otherwise and sentenced in respect thereof to imprisonment for not less than six months:

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(g) he is removed in pursuance of the provisions of this Act;

(h) he, having been appointed a director by virtue of his holding any office or other employment in the holding, subsidiary or associate company, ceases to hold such office or other employment in that company.

The amendment significantly clarifies the effect of disqualification of a Director due to other reasons of grave non-compliance with the law. Now, no shadow of doubt remains regarding the effect of such disqualification. The office of the Director shall stand vacated when, for example the Director fails to comply with interest disclosure norms under Section 184 of the Companies Act, 2013. Another major takeaway is guidance as to the course best taken in situations of the kind witnessed in the Cyrus Mistry-Tata group litigation. Now onwards, it shall be far difficult for an ousted Director to seek a contrary order of reinstatement from the relevant tribunal. This is because the statute is straightforward in declaring that the office remains vacated the moment the removal of a Director is effectuated “in pursuance of the provisions of this Act”.

Shareholders of company can oppose a disqualified Director

In Nabendu Dutta v. Arindam Mukherjee[1] the Calcutta High Court adjudicated on the issue of locus standi of shareholders to seek declaration against the appointment of a disqualified Director. It was affirmed by the learned High Court that shareholders are vitally interested in proper and lawful management of company, inasmuch as they are represented by Directors, and obviously they must see that Company is managed and controlled by competent and untainted person to protect their interest. Thus, a shareholder has locus standi to challenge appointment of disqualified Directors. If a company mans the office of Director with disqualified persons, it certainly brings disrepute to the company itself and it may have adverse effect in the business of the company. It is significant that the judgment found the disqualifications to be a punitive measure for the benefit and protection of the deposit holders against failure, either wilful or otherwise in repayment of deposits on due date.

The judgment further affirmed that apart from the shareholder of a particular company in which tainted Directors are sought to be appointed from a defaulting company, any member of the public who is interested in terms of transactions with the limited company can also seek to set aside the appointment of the tainted Directors. The judgment rationalises the provision as being intended to identify those Directors under whose management the defaults were committed by any company.

Sections 164 and 167 of the Companies Act, 2013 apply retrospectively

The Kolkata Bench of Company Law Board in Raj Shekhar Agrawal v. Pragati 47 Development Ltd.[2] adjudged a case of oppression and mismanagement in which the issue of prospective application of Sections 164 and 167, Companies Act, 2013 was decided. The respondents filed an application praying for an order of injunction restraining/declaring as non est appointment of any advocate-on-record/counsel under claimed authorisation of erstwhile Directors of respondent Company, as they had vacated their offices in terms of Section 167(1). Further, the respondent submitted that all Directors vacated their offices in terms of Section 167(1) read with Section 164(2), due to default committed by erstwhile Directors in filing, the financial statements of the respondent company and its subsidiary companies for three consecutive years.

CLB held that provisions of Sections 164 and 167 have been notified with effect of 1-4-2014 and, hence, consequential action under Section 167(3) accrues on non-filing of financial statements for 3 years commencing from 1-4-2014. Therefore, based on the prospective application of notification of Sections 164 and 167, erstwhile Directors were held to continue to be validly and legally appointed Directors and hence, the said Board of Directors was competent to appoint the advocate by following the provisions of law. Thus, the timeline of obligations under Sections 164 and 167 of the Companies Act, 2013 would have to be calculated post-notification of the aforesaid sections.

In this regard, it is crucial to understand the difference between Section 196(3)(a) and Section 164 of the Companies Act, 2013. Section 196(3)(a) of the Companies Act, 2013 reads as follows:

196(3).— No company shall appoint or continue the employment of any person as managing director, wholetime director or manager who—

(a) is below the age of twenty-one years or has attained age of seventy years:

Provided that appointment of a person who has attained the age of seventy years may be made by  passing a special resolution in which case the explanatory statement annexed to the notice for  such motion shall indicate the justification for appointing such person.

In Sridhar Sundararajan v. Ultramarine & Pigments Ltd.[3] (‘SS’ & ‘RS’) a Single Judge of the Bombay High Court gave a significant judgment on whether the interpretation of aforesaid section could be applicable with respect to Section 164. The judgment held that a Director turning seventy years did not attract automatic “mid-stream” disqualification from appointment. In this case, RS was appointed as CMD of listed company on 13-8-1990. On 21-5-1998, SS was appointed as Director.

On 1-8-2012, RS was reappointed as CMD for term of five years till 2017. On same day, SS was also appointed as Joint-MD. The Companies Act, 2013 was enforced with effect from April 1, 2014. RS attained the age of seventy years on 11-11-2014. SS contended that on the 70th birthday of RS, he earned himself statutory disqualification.

The judgment held that Section 196(3) does not operate to interrupt appointment of any Director made prior to coming into force of the 2013 Act. It also does not interrupt the appointment of MD appointed after 1-4-2014 where at the date of MD‘s appointment/reappointment was below the age of seventy years but crossed that age during his tenure. It was held that there ought to be a contextual reading of the words in Section 196(3).

In ruling thus, the judgment drew parallels to Section 269 of the Companies Act, 1956 under which “there was no discontinuance” of existing Managing Director at the age of seventy years and the section applied only to his appointment (including re-appointment). The learned Single Judge relied on SC ruling in P. Suseela v. University Grants Commission[4] (2015) wherein it was held that “it is relevant to distinguish between an existing right and vested right. Where a statute operates in future it cannot be said to be retrospective merely because within the sweep of its operation, all existing rights are included.”

The aforesaid matter went on an appeal to the Division Bench of the Bombay High Court and an opposite judgment was rendered.[5] It was held that a Managing Director attaining seventy years would immediately stand disqualified whether or not the Managing Director was appointed before or after the enactment/commencement of the Companies Act, 2013.  The Division Bench held that disqualification for MD appointment on ground of age-limit would act automatically. RS was disqualified from continuing as MD, unless he fulfilled the requirements of the proviso i.e. company has to continue his appointment by a special resolution and, secondly, that resolution must state the reason why the continuation is necessary.

The judgment affirmed that parliamentary intention was to change earlier position by providing that person who has been appointed as MD before he was seventy years old is prohibited from continuing as MD once he has attained the age of seventy. It reasoned that the language of Section 196(3)(a) is plain, simple and unambiguous. The Division Bench rejected RS’s contention that Section 196(3)(a) is not applicable to MD’s  appointment before 1-4-2014. There is no distinction in the section between MD who have been appointed before 1-4-2014 and those after 1-4-2014. The Division Bench also rejected reliance on an old MCA Circular that clarified conditions specified in erstwhile Schedule XIII Part 1 of the old Companies. Act, 1956 which required satisfaction of the age requirement only at the time of appointment.

Thus, the problems which could arise because of prospective applicability such as the exclusion of most pre-existing MDs from the operation of the mandate under the aforesaid section, have been permanently resolved by the judgment’s conceptual clarity.

Directors’ qualifications under the articles of association

In the judgment of the Madras High Court in Saraswathi Vilasam Shanmugha Nandha Nidhi Ltd. v. V.S. Daiva Sigamami Mudaliar[6] it was held that there is nothing in any provisions of the Companies Act which precludes a company from prescribing additional qualifications for directorship, if the articles so provide. There is nothing unreasonable in having a non-statutory minimum age-limit for Directors with a view to justify confidence in mature judgment.

Recent trends in disqualification of Directors

In a recent Madras High Court judgment in Bhagvan Das Dhananjaya Das v. Union of India[7] granted an interim stay against disqualification from directorship. The interim stay was granted in writ petitions filed challenging MCA order disqualifying petitioner from directorship, under Section 164(2) of the Companies Act. While the writ petition also seeks directions to MCA & ROC to permit petitioner to get appointed or reappointed as Director of any Company without any hindrance, the order has only granted an interim stay on the MCA order and final judgment is still awaited.

In another order by the High Court of Andhra Pradesh in Dr Reddy’s Research Foundation v. Ministry of Corporate Affairs[8] MCA directed DIN restoration of defaulting Directors in lieu of annual-filing completion. Thus, the order enabled directors to submit annual returns for Financial Years 2011-2012 to 2015-2016 and financial statements for 2012-2013 to 2015-2016. The order noted, “It appears that there is a lacuna in the procedure that is required to be followed by the companies, which are defaulted in filing their annual returns and the consequent disqualification of the Directors to rectify the defect.” The High Court noted that Rule 14 of Companies (Appointment and Qualification of Directors) Rules, 2014 prima facie provides for rectifying the defect by enabling defaulting companies to file returns.

The order stated, “The said Rule does not provide what is required to be done by the respective authorities.” In light of the fact that a defaulting company is allowed to rectify the defect by filing the returns which have not been filed earlier, the natural corollary of the same would be that the competent authority is required to take the same into consideration. As the filing has to be done through e-platform, the same cannot be done unless access is provided to it.

It is noteworthy that the order referred to the Report of Companies Law Committee that disclosed the anomaly in respect of disqualification earned by an individual not only with respect to a defaulting company but also with respect to other companies. The order states that rectification ought to be made restricting the scope of disqualification to defaulting company.

Condonation of Delay Scheme, 2018 as a cure for disqualifications of a Director

The Condonation of Delay Scheme, 2018 is a scheme of the Union Government under Sections 403, 459 and 460 of the Companies Act, 2013 which gives an opportunity to non-compliant companies to comply with the return filing provisions of the Companies Act. While on the one hand, the amendments encourage the appointment of only such Directors whose previous companies did not suffer from any defaults under the law, the CODS, 2018 offers Directors with disqualifications to correct affairs in their previous companies to be able to cure themselves of their disqualifications.

Para 2 of the said Scheme[9] lays down certain basic concepts underlying it. These concepts are as follows:

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(ii) “overdue documents” means the financial statements or the annual returns or other associated documents, as applicable, in the case of a defaulting company and refer to documents mentioned in Para 5 of the Scheme.

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(iv) “Defaulting company” means a company which has not filed its financial statements or annual returns as required under the Companies Act, 1956 or the Companies Act, 2013, as the case may be, and the Rules made thereunder for a continuous period of three years.

(v) “Designated authority” means the Registrar of Companies having jurisdiction over the registered office of the company.

The beneficiaries of the Scheme would be defaulting companies which have not been deregistered i.e. removed from Register of Companies by the Registrar of Companies Such defaulting companies can file annual accounts or annual return which are overdue for filing till 30-6-2017. Companies which have been deregistered/removed from Register of Companies by Registrar of Companies are ineligible to avail this scheme.

The procedure for availing the Scheme involves the temporary reactivation of deactivated DINs of defaulting Directors. Defaulting companies shall complete pending filing by payment of additional fees as prescribed. Defaulting company shall file an e-Form “e-CODS along with a fees of Rs  30,000. If defaulting company does not file the requisite documents/e-Forms, the DIN of the Directors will be deactivated. Where a company has been restored after an application to NCLT, the DIN of such Directors would be reactivated, subject to company filing all overdue documents. Annual return, annual accounts/financial statements, submission of compliance certificate, appointment of auditors can be filed as part of the Scheme.

Registrar of Companies shall withdraw the pending prosecution, if any, before the court concerned in lieu of documents filed under the Scheme. However, this Scheme does not affect any action under Section 167(2) of the Act. This Scheme also does not affect civil and criminal liabilities as may be applicable on such disqualified Directors during the period of such disqualification.

The Scheme requires beneficiaries to disclose whether any appeal was filed against any notice issued or complaint filed before competent court for violating provisions of the Act. Disclosure about prosecution pending before any court against the company and its officers in respect of belated documents is also required.

The e-form also requires disclosure about any Director who is declared as proclaimed offender or facing criminal case for economic offences. It also requires a declaration that company has withdrawn existing appeals/writs before any court of law.

The significance of the CODS, 2018 is also understood in light of a Press Information Bureau (PIB) Press Release of 5 September 2017 which has introduced a number of restrictions on bank accounts of deregistered companies. The press release reads as follows:

“Department of Financial Services advises all banks to take immediate steps to put restrictions on bank accounts of over two lakh deregistered companies…Banks have also been advised to go in for enhanced diligence while dealing with companies in general. A company even having an active status on the website of the Ministry of Corporate Affairs but defaulting in filing of its due financial statement(s) or annual return(s) of particular of charges on its assets on the secured loan should be seen with suspicion as, prima facie, the company is not complying with its mandatory statutory obligations to file this vital information for availability to its stakeholders.”

Conclusion

The Union Government has amended the Companies Act, 2013 to make major changes to provisions pertaining to Directors’ disqualifications. These amendments are expected to usher in greater accountability in corporate governance. The Government’s new scheme to enable companies to comply with the return filing provisions in the event of pending delays/defaults in return filing would likely enable the formation of a robust culture of litigation free compliance. At the same time High Courts, Company Law Boards and National Company Law Tribunals have passed several major decisions in recent years which have significant impact on the aforesaid matters. These rulings should be able to give rise to new jurisprudence in company law which is consistent with the development needs of India. Adjusting to the new developments in the law presents new challenges for India Inc.

 

Bhumesh Verma is Managing Partner at Corp Comm Legal and can be contacted at bhumeshverma@corpcommlegal.com and Somashish, Fifth Year B.A. LL.B. (Hons.) student, School of Law, Christ (Deemed to be University), Bangalore.

[1]    2003 SCC OnLine Cal 635 : (2004) 55 SCL 146.

[2]    LSI-985-CLB-2015-(KOL), decided on 17-9-2015 (Calcutta High Court).

[3]    2015 SCC OnLine Bom 3817.

[4]    (2015) 8 SCC 129.

[5]    Sridhar Sundararajan v. Ultramarine and Pigments Ltd., 2016 SCC OnLine Bom 10591 : (2016) 2 TMI 583.

[6]    1950 SCC OnLine Mad 116 : (1951) 21 Comp Cas 85.

[7]    WPs Nos. 25455 & 25456 of 2017, decided on 21-9-2017 (Madras High Court).

[8]    [2017] 144 SCL 571, decided on 24-10-2017 (High Court of Andhra Pradesh and Telangana).

[9]    Condonation of Delay Scheme, 2018, General Circular No. 16 of 2017.

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