Del HC | Scheme of Ss. 164(2) and 167(1)(a) of Companies Act explained in respect to disqualification of directors on default of filing returns

Delhi High Court: Vibhu Bakhru, J. while addressing the petitions filed in respect to the impugned list of directors stated to have been disqualified under clause (a) of Section 164(2) of the Companies Act, 2013, explained with reasons and logic, the scheme of Section 164(2) and Section 167(1)(a) of the Act that was materially amended by the Companies (Amendment) Act, 2018.

Facts of the case

The present petitions were filed, inter alia, impugning the list of directors that were disqualified for default on the part of companies concerned in filing the annual returns and financial statements for the Financial Years 2014-2016, under Section 164(2)(a) of the Companies Act, 2013.

Adding to the above challenge, another challenge placed by the petitioner was to the list of disqualified directors published subsequently for defaults pertaining to the FYs 2012-2014 and 2013-2015.

The above-mentioned lists represent the disqualification of petitioners from being appointed/re-appointed as directors for a period of 5 years under Section 164(2)(a) of the Act. Names of the companies in which the petitioners were holding office have also been struck off from the Register of Companies.

Following are the 4 grounds on which the impugned list has been challenged:

  • Action of the respondents in disqualifying the petitioner is arbitrary as the petitioners were not afforded an opportunity to be heard, which is in violation of principles of natural justice.
  • Section 164 which mandates the disqualification of directors, being penal in nature, could not be applied retrospectively.
  • On the interpretation of Section 164(2)(a), it is noted that the petitioners cannot be disqualified to be directors of the companies, which have not defaulted in filing their annual returns and financial statements for a period of 3 consecutive years.
  • Defaults under Section 164(2) results in directors being disqualified from being appointed/re-appointed as directors but does not result in them demitting office as directors.

In addition, the petitioners also impugn the action of the respondents in deactivating their DINs and DSCs.

Conclusion

Court concluded its decision by providing relevant reasoning for the same in respect to the provisions of Sections 164(2) and 167(1)(a) of the Act.

To clarify the subject of controversy in the present petition, Court stated that it is limited to interpreting the provisions of Sections 164(2) and 167(1) (a) of the Act and no challenge to the constitutional vires of the aforesaid sections have been placed.

Following are the questions that the Court addressed in the present petition:

1.Whether the provisions of Section 164(2)(a) are retrospective?

Controversy arises in the context of the submissions advanced on behalf of the petitioners that considering the defaults in filing financial statements and annual returns for the financial year ending 31.3.2014 (FY 2013-14) and prior years for the purposes of imposing the disqualification under Section 164(2) of the Act, tantamount to applying the said provisions retrospectively. This, according to the petitioners, is impermissible.

None of the counsel appearing for the respondents canvassed the proposition that the provisions of Section 164(2) of the Act would relate back to a period prior to its enactment. Thus, concededly, the said Section is applicable prospectively.

  • Controversy, essentially, relates to whether the default as contemplated in clause (a) of Section 164(2) of the Act, in respect of a financial year prior to the said provision coming into force, could be considered for the purposes of the said Section.

Thus in view of the Court’s opinion, Section 164(2) of the Act operates prospectively. Such prospective operation would entail taking into account failure to file the financial statements pertaining to the financial year ending 31.03.2014 on or before 30.10.2014

“Court finds no reason why such defaults should not be considered for the purposes of Section 164 of the Act. Merely, because the returns to be filed pertaining to a period prior to 01.04.2014, is of no relevance considering that the default in doing so has occurred after the provisions of Section 164 of the Act had become applicable.”

2. Whether a prior notice and an opportunity of being heard were required to be afforded to the petitioners before including their names in the impugned list and whether the impugned list is void as being violative of principles of natural justice?

 Principles of natural justice admit a considerable degree of flexibility and said rules can be suitably modified where it is expedient to do so. Principles of natural justice are not inflexible.

Court proceeded to examine the statutory provisions and applicability of the audi alteram partem rule. Section 164 (2) of the Act merely sets out the conditions which if not complied with would disqualify an individual a person from being reappointed or appointed as a director.

 This process does not entail any decision-making process on the part of the Authorities administering the Act. Authority is not required to pass any order disqualifying an individual. Thus, in the said circumstances, audi alteram partem rule would be inapplicable.

Hence the Court is of the view that the principles of audi alteram partem are not applicable given the nature of the provisions of Section 164(2) of the Act. However, even if it is assumed that disqualifying a director entails an administrative decision, there is a qualitative decision required to be taken by the authorities, the rule of affording a prior hearing cannot be readily inferred as a part of Section 164(2) of the Act.

 3.Interpretation of provisions of Section 164(2) of the Act.

Court noted the contention of the petitioners that the petitioners may be disqualified to act as directors of the concerned companies that had committed defaults as contemplated under Section 164(2)(a) of the Act – that is, had failed to file financial statements or annual returns for a continuous period of three financial years – but they are not disqualified to act as a directors of companies that are not in default.

High Court noted that no person who is or has been a director of company shall be eligible to be re-appointed as a director of ‘that company’ or appointed in any ‘other company’.

“Clause (a) of Section 167 (1) of the Act indicates that a Director would demit office if he incurs the disqualification under Section 164 of the Act. The proviso to Clause (a) of Section 167(1) of the Act was introduced with effect from 07.05.2018, by virtue of the Companies (Amendment) Act, 2018.”

 Whereas Section 164 disqualifies a person from being appointed/reappointed as a director, the import of Section 167(1)(a) is that such a director demits his office immediately on incurring such disqualification.

Proviso to Section 167(a) as introduced by the Companies (Amendment) Act, 2018 with effect from 07.05.2018, cannot be read in isolation and without reference to the proviso to Section 164(2), which was introduced by the same amending enactment.

Court further added to its decisions that, the petitioners would not demit their office on account of disqualifications incurred under Section 164(2) of the Act by virtue of Section 167(1)(a) of the Act prior to the statutory amendments introduced with effect from 07.05.2018. If they suffer any of the disqualifications under Section 164(2) on or after 07.05.2018, the clear implication of the provisos to Section 164(2) and 167(1)(a) of the Act are that they would demit their office in all companies other than the defaulting company.

Thus, in view of the above observations, Court found no infirmity with the impugned list to the extent it includes the names of the petitioners as directors disqualified under Section 164(2) of the Act. Court also rejects the contention that the impugned list is void as having been drawn up in violation of the principles of natural justice.

Court finds merit in the contention that the petitioners cannot be stated to have demitted their office as directors by virtue of Section 167(1) of the Act.

The Scheme of Section 164(2) and Section 167(1)(a) of the Act was materially amended by the Companies Amendment Act, 2018 by the introduction of the provisos to Section 164(2) and Section 167(1)(a) of the Act with effect from 07.05.2018.

Directors who incur disqualification under Section 164(2) of the Act after the said date, would also cease to be directors in other companies on incurring such disqualification.

Respondents were directed to reactivate the DIN and DSC of the petitioners. Court also clarified that petitioners would continue to be liable to pay penalties as prescribed under the Act. [Mukut Pathak v. Union of India, WP (C) 9088 of 2018 & CM Appln. No. 35006 of 2018, decided on 04-11-2019]

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