Madras High Court Grants Reprieve to Disqualified Directors

The Madras High Court in Bhagavan Das Dhananjay Das v. Union of India (decided on 3 August 2018 and accessible via Judis) struck down the order of the Registrar of Companies, Chennai (“RoC) which had disqualified a number of directors from their position in various companies. The Court was considering a large group of writ petitions that various disqualified directors had filed before it. In doing so, the Court interpreted the provisions of the Companies Act, 2013 (the “2013 Act”) and found that the actions of the RoC were inconsistent with the statutory provisions and were considered to be bad in law.

The facts pertaining to one company typify the scenario involving the disqualification. Birdies and Eagles Sports Technology Private Limited was unable to commence the business activities for which it was incorporated. Hence, it did not file its annual returns with the RoC since the year 2011-2012. Accordingly, by way of a gazette notification dated 5 July 2017 the RoC struck off the name of the company from the register for not filing annual returns for a continuous period of three years in terms of section 248 of the 2013 Act. Thereafter, on 8 September 2017, the RoC released a list disqualifying several directors under section 164(2)(a) of the 2013 Act for the reason that the companies had failed to file financial statements for the financial years 2013-14, 2014-15 and 2015-16. Consequently, the directors are prohibited from being appointed or reappointed as directors in any other company for a period of five years.

The directors mounted a legal challenge against the RoC’s actions by filing a writ petition before the Madras High Court under article 226 of the Constitution. The principal questions for consideration were whether the “three year period” of non-filing of financial statements or annual returns as a condition of disqualification of directors began to run only after the commencement of the 2013 Act or whether the period can be counted retrospectively; and whether the RoC had complied with the principles of natural justice before effecting the disqualifications.

After hearing the parties, the Court essentially delved into the timing question. Section 164(2)(a) of the 2013 Act disqualifies a person who is a director of a company (whether public or private) if such company “has not filed financial statements or annual returns for any continuous period of three financial years”. The disqualification will prevent the director not only from acting in that position in the company that failed to make the requisite filings in a timely manner but also in other companies in which the person is a director. The key question was whether the three-year period can commence in the financial year 2013-14 when the 2013 Act itself came into force only on 1 April 2014. In other words, can there be a retrospective computation of the three-year period that extends before the effectiveness of the 2013 Act? The Court emphatically answered in the negative.

The Court placed reliance on the definition of the expression “financial year” in section 2(41) of the 2013 Act, under which the first financial year under the legislation commences only on 1 April 2014. Therefore, to consider the period commencing from 1 April 2013 (as the RoC has done) is to misconstrue the provisions of the law in a manner that impinges upon the fundamental rights of the affected directors. The disqualification cannot be given effect to retrospectively.

Moreover, there was no similar disqualification under the erstwhile Companies Act, 1956 (the “1956 Act”) because section 274(1)(g) of that legislation applied explicitly only to public companies. When there is no ground for disqualification under the previous regime, the financial year 2013-14 (when that 1956 Act was in force) cannot be considered to disqualify the directors. This was supported by the Government’s own view in the Ministry of Corporate Affairs General Circular No. 08/14 dated 14 April 2014 which categorically stated that financial statements in respect of periods prior to 1 April 2014 will be governed by the 1956 Act and that the provisions of the 2013 Act shall apply only thereafter. The Court considered this Circular to be a significant piece of evidence to clear the air on the matter.

Although the affected directors did not challenge the constitutionality of section 164 of the 2013 Act, they sought to invalidate the executive action on the part of the RoC. This included a challenge on the ground of violation of the principles of natural justice. Although the RoC issued a notice calling upon the recipient to explain as to why the company should not be struck off from the register, no such notice was issued in relation to disqualification of directors. The two are separate actions and ought to have been treated as such in terms of issue of notice. In arriving at this conclusion, the Court reviewed (albeit briefly) the jurisprudence on the issue.

Hence, the Madras High Court found that the RoC had erroneously disqualified the directors concerned by taking into account the period comprising the financial year 2013-14, which was prior to the date on which the 2013 Act came into effect. Although there are no specific notice provisions regarding disqualification of directors, the Court found that the general principles regarding natural justice should nevertheless have been followed. It observed:

“… extinguishing the corporate life of the directors to the extent of disqualifying them to hold the directorship in the other companies, the said provision is liable to be read down, hence, Section 164(2)(a) is read down to the extent it disqualifies the directors in other companies which are scrupulously following the requirements of law, making it clear that no directors in other companies can be disqualified without prior notice.

The Court therefore set aside the disqualification orders.

This has effectively put paid to the Government’s efforts in pursuing action against shell companies. Given the magnitude of the case and the number of directors involved, one can expect the Government to appeal against this decision. At the same time, the principles laid down by the Court have somewhat narrow as well as broad application. They are narrow because in terms of timing they relate to the overlap of the three-year period (for non-filing of financial statements or annual returns) between the 1956 Act and the 2013 Act. In that sense, this is a transitory problem afflicting the current batch of disqualified directors and may not carry long-lasting implications for future cases. The Court’s guidance is, however, broad when it comes to application of the principles of natural justice, which is the more sustaining element of the ruling.