Reclassification of Non-Compoundable Offences under the Companies Act, 2013: Impact on Section 203

[Radhika Parthasarathy is a 4th Year B.A. LL.B. (Business Law Honours) Student at National Law University, Jodhpur]

Introduction

The Committee to Review Offences under the Companies Act, 2013, was set up by the Ministry of Company Affairs in July 2018 to recommend the recategorization of acts that have been, for so long, cognizable offences under the Companies Act, 2013 [the “Act”]. The Report of the Committee to Review Offences under the Companies Act, 2013 [the “Committee Report”] was released on August 14, 2018. It lays down eight categories of offences that are compoundable under the Act. Of these, the Committee has proposed that the offences falling under Categories IV and V be dealt with by means of in-house adjudication. This Report seeks to make recommendations that aid in improving corporate compliance by leaps and bounds.[1]

Under the Committee Report, Category IV deals exclusively with defaults related to corporate governance norms, while category V pertains to technical defaults committed by companies while conveying certain information in forms to the Registrar of Companies or sending notices to stakeholders. Under category IV of these compoundable offences, the Committee has proposed in house adjudication of these penal provisions due to the presence of sufficient safeguards within the Act.[2] The Committee has proposed such changes in sections 53(3) [Prohibition on Issue of shares at discount], 165(6) [accepting directorship beyond a specified limit], 191(5) [payment to director not to be made in case of loss of office except under certain circumstances], 197(15) [overall maximum managerial remuneration and managerial remuneration in case of loss of profit] and 203(5) [appointment of key managerial personnel in certain class of companies].[3] Over the course of this post, I shall be assessing the current position, the related proposal, and the impact of the proposal on section 203(5).

Is a Key Managerial Person Truly Key to a Company?

Introduction

The term “key managerial person” is defined under section 2(51) of the Act. Further, section 203 of the Act mandates the appointment of key managerial persons [“KMP”] in companies as prescribed under rule 8 of the Companies (Appointment and Remuneration of Managerial Personnel) Rules, 2014 promulgated under the Act. These KMPs must be whole-time personnel and are the:[4]

  1. managing director, or chief executive director or manager, and in their absence, a whole-time director
  2. company secretary, and
  3. chief financial officer.

Under section 203(5), a company contravening this provision would be liable to pay a fine ranging from a minimum of Rs. 1 Lakhs to a maximum of Rs. 5 Lakhs. Further, every defaulting director and KMP of the company would be punishable with a fine which could extend to Rs. 50,000.[5] Additionally, if this default continues, a further fine of Rs. 1000 may be levied for every continuing day of the default.[6] This provision, thus, makes the non-appointment of a KMP a compoundable offence.

Legislative History underscoring Section 203

The need for key managerial persons was highlighted in the J.J. Irani Committee Report [“Irani Report”], which was issued in May, 2005. It stated that KMPs are required for the formulation of polices and execution of policies, and thus are responsible for the fulfilment of the needs of the shareholders and the board of directors.[7] These KMPs, according to the Irani Report, have a “significant role to play in the conduct of the affairs of the company”, thereby determining the quality of governance of the company.[8]

Additionally, the need for KMPs was highlighted in the 2009 Standing Committee Report on the Companies Act, which reviewed the Companies Bill of 2009. The need for KMPs was recognised to ensure a check on “corporate delinquencies”.[9] It also recommended that whole-time directors be recognised as KMPs, irrespective of whether the company has any other managing director or directors.[10] Further, it suggested giving statutory recognition to the chief financial officer and the company secretary as KMPs.[11] Over the course of the Report, this Committee also laid down the various obligations and duties that must be fulfilled by a KMP. The recommendations on the appointment of KMPs were partially accepted and included as clause 2(51) in the Companies Bill, 2011.[12]

On a perusal of these Committee Reports, it seems appropriate to draw the conclusion that the need for KMPs was borne out of a need to ensure strong corporate governance practices. These KMPs have a high level of responsibility and obligations attached to their position, such that there can be no waiving from them.

The Role of and Need for Key Managerial Persons

KMPs, and the persons defined as such, are those who are responsible to the company for the conduct of its business.[13] On a perusal of the Act, it seems as though the Act mandates the appointment of three distinct individuals as key managerial persons.[14] Further, paragraph 10 of Accounting Standard 18 defines KMPs as those persons who have the authority and responsibility of planning, directing and controlling the activities of an enterprise. This position has further been analysed in DLF Limited and ors. v. Securities Exchange Board of India, where a KMP has been defined as one who can exert significant influence over the affairs of the company, and under whose orders a company is accustomed to act.[15]

In the matter regarding Top Telemedia Ltd. And Ors., the Securities and Exchange Board of India observed that a managing director [“MD”] is one who has knowledge of the affairs of the company.[16] This observation led to the conclusion that MDs and whole time directors, who have been identified as KMPs under the Act and whose labilities and roles have been prescribed by the Act, owe a high level of responsibility and duty of care to the company, while carrying out its day-to-day affairs.[17] It has also been held in N. Rangachari v. BSNL, that the duty to show that there is no liability on the part of the directors is, in fact, on the directors or the officers in charge of the company.[18]

However, not all these directors may be in-charge of the day-to-day functioning of the business, and thus will have a lower burden to prove.[19] It becomes clear as day here, again, that KMPs are of great importance to a company. They hold a position that comes with great power and greater responsibilities, and are thus integral to the functioning of their company. In this scenario, it also seems likely that the non-appointment of the KMP would not only be harmful to the interest of shareholders, but it will also be deleterious to the company.

Proposal related to Section 203(5) under the Committee Report

According to the Committee Report, non-appointment of KMPs by companies under section 203 can be found easily on the MCA21 system, which provides a sufficient safeguard for such defaults by initiating summary adjudication proceedings.[20] The MCA21, which was implemented by the MCA in March 2006,[21] is an IT-driven project under the Government’s National e-Governance Plan.[22] The MCA21 is essentially a repository of information related to the company and its assets,[23] which digitalises the memorandum of association, articles of association and certificate of incorporation of the company.[24] Thus, the Committee Report suggests that any non-compliance with Section 203(5) may be subject to in-house adjudication and levying of penalties.[25]

Conclusion: Will the Proposal Truly Ensure Better Corporate Governance Practices?

On the culmination of this post, the author believes that the mandate under section 203 for the appointment of KMPs is one that seeks to improve and enforce corporate governance norms and ensure more efficient corporate practices. Based on the judgments of Indian courts and tribunals, and reports of various committees that have been analysed, it is evident that the KMP holds a position of great value and importance in the corporate structure. The KMPs, being three distinct personnel, i.e. the Company Secretary, Chief Financial Officer, the Managing Director/ Chief Executive Officer/ Manager of the Company, perform various functions, inter alia, related to maintaining the books of accounts kept by the company,[26] handling substantial affairs of the company,[27] administering the investor education and protection fund.[28] These are evidence of the high level of responsibility bestowed upon the KMPs.

The Committee Report seeks to, however, make the non-appointment of such KMPs a non-compoundable offence subject to in-house proceedings, as the Committee believed that such non-appointment would not be a heinous offence, and could easily be redressed by means of the MCA21 system. A similar belief was also put forth by the National Company Law Tribunal [“NCLT”] in Krishna Institute of Medical Sciences Ltd and Ors v. the Registrar of Companies, Andhra Pradesh and Telangana,[29] where the NCLT observed that the non-appointment of a company secretary is not, in fact, an offence of such a serious nature, that would have any impact on the public and shareholders of the company. 

This author, however, disagrees with these opinions. This is due to a composite analysis of the opinions given in reports preceding the Committee Report and the cases cited above. By enforcing in-house adjudication for offences under section 203, the author believes that the need and the importance of the said provision may get diluted. Under the Companies Act, 1956, there was no provision pertaining to the appointment of KMPs. However, from 2005, with the Irani Report, and the Companies Bill of 2009, KMPs were introduced as mandatory officers to be appointed by the company to ensure that corporate governance was enforced and “corporate delinquency” was done away with. In permitting companies to settle governance matters internally, it could lead to a situation coloured with prejudice or ambiguity in redressal. Companies may also start avoiding the mandate under section 203 by appointing a single KMP, to reduce management costs or flout compliance norms, and simply choose to pay a fine levied by the in-house adjudicator that may be much lower than what the NCLT may prescribe.

It is the author’s opinion that section 203(5) remain untouched, instead of being dealt with by means of an in-house adjudicator. Amending Section 203(5) would most certainly require amendments in the entirety of Section 203. The author suggests that the Ministry of Corporate Affairs [“The Ministry”] give due thought to the redressal mechanism that would follow, the probable dilution of the powers of the NCLT, and the probable conflict between the roles of the NCLT and the in-house adjudicator in this regard. In any case, if this proposal is enforced, the author hopes that the Ministry suggests a minimum prescribed threshold for the fine that may be levied by the in-house adjudicator and lays down the qualifications of such adjudicators.

Radhika Parthasarathy

[1] Committee Report, page 5.

[2] Committee Report, page 24, paragraph 1.4.D.3.

[3] Committee Report, page 24, at paragraph 1.4.D.4.

[4] Section 203(1), Companies Act, 2013.

[5] Section 203(5), Companies Act, 2013.

[6] Id.

[7] Ministry of Company Affairs, Report of the Expert Committee on Company Law under Dr. Jamshed J Irani, page 52, at paragraph 34.2 (2005).

[8] Id, at paragraph 34.1.

[9] Overview of Committee’s Examination of Companies Bill, 2009, at paragraph K.54, Companies Bill, 2009.

[10] Part II, at paragraph 17, Companies Bill, 2009.

[11] Ministry of Corporate Affairs, Report of the Standing Committee on Finance, The Companies Bill, 2009, paragraph 10(viii) (2010) [Hereinafter, Companies Bill, 2009].

[12] Ministry of Corporate Affairs, Report of the Standing Committee on Finance, The Companies Bill, 2011, 3 at paragraph 1.7 (2012).

[13] Manish Pharwani v. The National Capital Territory of Delhi and Ors., (2010) ILR 5 Delhi 262.

[14] Ramaiya on Companies Act, 2013, 3527 (2014).

[15] DLF Limited and Ors. v. Securities Exchange Board of India, The Securities Appellate Tribunal, Mumbai, March 13, 2015.

[16] In Re: Top Telemedia Ltd. And Ors., A.O. No. RS/JP/50-57/2016, the Securities and Exchange Board of India, Mumbai, June 06, 2016.

[17] Id.

[18] N Rangachari v. BSNL, AIR 2007 SC 1682.

[19] S.M.S. Pharmaceuticals Limited v. Neeta Bhalla and Anr., (2005) 8 SCC 89.

[20] Committee Report, page 24, at paragraph 1.4.D.2.

[21] Ministry of Company Affairs, MCA21 Programme Launched by Hon’ble Prime Minister of India (Mar. 18, 2006), at http://www.mca.gov.in/Ministry/latestnews/MCA21ProgrammeLaunch.pdf.

[22] National Institute of Smart Governance, MCA 21 – The first Mission Mode Project to be launched under NeGP (July 11, 2013), at https://www.nisg.org/project/41.

[23] Government of India, Press Information Bureau, MCA 21 Second Cycle to Benefit all the Companies and LLPs Registered in India: Dr. M.Veerappa Moily (Sept. 26, 2012) http://pib.nic.in/newsite/mbErel.aspx?relid=87984.

[24] Government of India, Ministry of Company Affairs, MCA 21 Newsletter, No. HQ/ 59/ 2005 (2005). 

[25] Committee Report, page 25, at paragraph 1.4.D, Recommendations.

[26] Section 128, Companies Act, 2013.

[27] Section 2(54), Companies Act, 2013.

[28] Section 125, Companies Act, 2013.

[29] Krishna Institute of Medical Sciences Ltd and Ors. v. the Registrar of Companies, Andhra Pradesh and Telangana, 2017 SCC Online NCLT 2271.

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