Actions against Independent Directors for Dishonour of Cheques

The question of liability of independent directors is a sensitive one given such directors carry substantial risk without having an influence in the day-to-day management of the company. Hence, the Companies Act, 2013 introduced a specific carve out in section 149(12) by which an independent director cannot be made liable for acts pertaining to the company except in limited circumstances “which had occurred with his knowledge, attributable through Board processes, and with his consent or connivance or where he had not acted diligently”. As far as I am aware, the courts have yet to obtain the opportunity to interpret the scope and extent of this exonerative provision.

In terms of criminal liability for directors, a key threat relates to offences under section 138 of the Negotiable Instruments Act, 1881 for dishonour of cheques issued by companies. Where a company commits such an offence, the concept of vicarious liability is triggered and under section 141 of that legislation “every person who, at the time the offence was committed, was in charge of, and was responsible to the company for the conduct of the business of the company, as well as the company, shall be deemed to be guilty of the offence and shall be liable to be proceeded against and punished accordingly”. Similar to section 149(12) of the Companies Act, it is possible to exonerate a director if “he proves that the offence was committed without his knowledge, or that he had exercised all due diligence to prevent the commission of such offence”.

It is quite customary in complaints under section 138 of the Negotiable Instruments Act to arraign all directors of a company whose cheque has been dishonoured. This can indeed cause significant inconvenience to non-executive directors and, in particular, independent directors, as they will have to face prosecution under the Indian criminal legal system and that too irrespective of the ultimate outcome of such an action. Courts have generally been cautious in interpreting section 141 of the Negotiable Instruments Act to ensure that prosecution can continue only against directors who were in charge of the day-to-day affairs of the company or those who had in fact signed the cheque that was dishonoured.

These issues arose in two cases before the Delhi High Court last month. Non-executive and independent directors of a company challenged the criminal actions initiated against them under the Negotiable Instruments Act, and approached the High Court to quash such actions. Surprisingly, the two cases witnessed rather contrasting outcomes. One was the predictable outcome wherein the Court concluded that action cannot continue against a non-executive director who was not involved in the management of the company. But, the other involved a rather intriguing conclusion in that the Court arrived at a paradoxical conclusion that an independent director was involved in the day-to-day management of the company, and hence action must continue against him. This decision is likely to cause considerable consternation among independent directors and the corporate governance community in general and must be set right.

In Bhardwaj Thirvenkata Venkatavaraghavan v PVR Ltd, the Delhi High Court was concerned with a non-executive nominee director of a company that had issued a cheque. The Court reiterated the position that in order to be prosecuted under section 141 of the Negotiable Instruments Act the person must be in charge of the day-to-day activities and responsible for the conduct of business of the company. The Court also cautioned that it is insufficient for a complainant to arraign directors merely on the basis of a statement that they are responsible for the conduct of the company without anything more. Consequently, the Court found it appropriate to quash the complaint against the director in that case.

However, in Sh Somendra Khosla v State, the Delhi High Court was concerned with a complaint against an independent director of a company. Curiously enough, even though the relevant director was an independent director, the complainant argued that such a director was responsible for the day-to-day functioning of the business, which the Court accepted. Consequently, it refused to quash the complaint against the independent director.

With respect, the Sh Somendra Khosla case entirely overlooks the position of an independent director. By their very nature, independent directors ought not to be involved in the management of the company or in any executive capacity. For example, section 149(6)(e)(i) clarifies that a person who hold the position of a key managerial personnel cannot be treated as an independent director. The Court arrived at its conclusion based on the submission of the parties without considering the position of an independent director. In doing so, it has also gone against the grain of judicial reasoning on the topic that the prosecution of such a complaint against a director cannot be continued merely upon the statement of the complainant.

In arriving at its conclusion in the Sh Somendra Khosla case, the Delhi High Court relied on the Supreme Court’s decision in Standard Chartered Bank v State of Maharashtra. In that case, the Supreme Court had permitted summoning directors who are in charge of the day-to-day business of the company. However, that case involved the chairman, managing director, executive director, wholetime director and authorized signatories of the accused company, and hence the conclusion therein was understandable. To apply that principle to deal with a completely different category of directors such as independent directors who are in a non-executive capacity is somewhat perplexing.

Given the amount of attention that independent directors receive in the context of corporate governance, the fact that they could prosecuted for offence involving dishonour of cheques, a matter on which they have little control, could act as a significant deterrent. This position needs further examination and modification.

About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.

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