Director Liability: Nexus with Role and not Position

[Pammy Jaiswal is a Partner at Vinod Kothari and Company, and can be reached at [email protected]]

While there have been an increasing number of rulings on the liability of directors, the question that mostly came up for examination related to their involvement in the day-to-day operations of the company. The liability of non-executive directors has mostly been scanned to evaluate their role in the subject matter of default. An important fact for enabling courts to conclude on the liability of directors is the precise role played by them in the company, while at the same time disregarding the stated position held by them in the same company. The Securities Appellate Tribunal (SAT), in two very recent cases, has clearly laid down that it is not the designation but the function or role played by a director that is instrumental in affixing liability on such person.

The SAT has penned the clear reasons for adopting this view and, as such, provides a landmark yet again. This post briefly covers a summary of the cases recently decided by the SAT on the liability of directors and, at the same, refers to other relevant cases decided in the similar context.

Function, not designation, is relevant for liability

In Sayanti Sen v. SEBI, the Securities and Exchange Board of India (SEBI) issued directions to Silicon Projects India Limited (SPIL) and its directors for contravening the provisions of the Companies Act, 1956, the SEBI Act, 1992 and certain SEBI regulations in relation to the issuance of non-convertible debentures (NCDs) in certain years. Accordingly, SEBI initiated recovery proceedings against them and debarred the directors from accessing the securities market and from issuing prospectus for soliciting money from the public for the issue of securities.

One of the directors, Ms. Sayanti Sen, filed her reply to the interim order by stating that she was initially appointed as a receptionist and was subsequently appointed as one of the directors on the board of SPIL. Ms. Sen, being the appellant, contended that she tendered her resignation and the same was duly communicated to the Registrar of Companies in Form 32. She further submitted that she had nothing to do with the issuance of NCDs since she never attended any board meeting nor signed any documents in relation to such issuance. She also submitted that she was never involved in any activities of the company, which was also proven by one of the investigation reports conducted by the Central Bureau of Intelligence (CBI) in 2016, where the key person of SPIL was found to be Mr. Shib Narayan Das, one of the directors of SPIL.

While the whole time member (WTM) of SEBI held Ms. Sen liable after considering the position held by her in SPIL, in terms of provisions of sections 5, 56 and 73  of the Companies Act, 1956, the SAT clearly mentioned that the approach of the WTM in the said case was erroneous and, therefore, illegal and unsustainable.

Analysis of the reasoning given by SAT for allowing the appeal of Ms. Sen

On numerous occasions, it has been held that a managing director, if any, appointed in a company will be regarded an officer in default. The same becomes explicit by referring to section 5 (g) of the Companies Act, 1956. A reference may be drawn to Agritech Hatcheries & Food Ltd. vs Valuable Steels India Pvt. Ltd., wherein the Court held that where there is a managing or whole time director or a manager, it would be an abuse of the process of the court if proceedings are launched against the ordinary directors without examining their role in default. Further, the Ministry of Corporate Affairs (MCA) issued a circular dated 25 March 2011 on prosecution of directors and clarified that the prosecution should be filed primarily against the managing director and against such directors who were in charge and responsible for the affairs of the company. Another matter for reference to the liability of a managing director can be Ravindra Narayan vs ROC, Jaipur.

Similarly, in Smt. G. Vijaylakshmi & Ors. v. SEBI, (2000) 100 Comp Cases 726 (AP), it was held that it is not necessary that every director is required to be penalized merely because he is a director on the ground that he is responsible for the affairs of the company. It is imperative to note that the judiciary has time and again stressed on the fact that if the director can explain that he had no role to play in the alleged default or that he did not perform his duties assigned to him under the agreement of his appointment, the presumption of guilt and thereafter penalty cannot be fastened upon him.

Further, the Supreme Court in Sunil Bharti Mittal vs. Central Bureau of Investigation & Ors held that a director can only be prosecuted if there was sufficient evidence of his active role or where the statutory regime attracts the doctrine of vicarious liability. Also, a reference may be drawn to Municipal Corporation of Delhi v. Ram Kishan Rohtagi and Ors.

While section 27 of the SEBI Act, 1992 states that a person is deemed to be guilty of an offence on condition that he was in charge and responsible to the company, the proviso mentions as follows:

Provided that nothing contained in this sub-section shall render any such person liable to any punishment provided in this Act, 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.

[emphasis added]

In Manoj Agarwal vs. SEBI as well as Yogesh G. Gemawat vs. SEBI, the SAT discharged the directors where their role could not be found with the alleged default.

Accordingly, it was found that the WTM has given a categorical finding that Shri Shib Narayan Das was responsible for the affairs of the company. Hence, it was not open for the WTM to pass further orders on the other directors, namely the appellant, especially when there is no finding or even a shred of any evidence to indicate that the appellant was also responsible for the affairs of the company. Following the aforesaid arguments and submissions, the impugned order of the adjudicating officer to the extent of refund liability by the appellant was rejected and quashed.

Director appointed after the initiation of a defaulting event not liable

In Dr. Uppal Devinder Kumar v. SEBI, the facts are that PACL Limited, a real estate company, mobilised funds under a collective investment scheme (CIS) without obtaining registration from SEBI. While a penalty of INR 7269.49 crore was imposed on PACL and its directors, Dr. Uppal Devinder, the appellant, was not a party to the proceedings. However, a separate show cause notice was issued to the appellant wherein it was clearly mentioned that he was a director of PACL for a period of 50 days. Being aggrieved by the order of the adjudicating officer wherein penalty was levied, the appellant preferred an appeal to the SAT.

The SAT referred to the meaning of ‘sponsor’ under various dictionaries which clearly states that one who promises or takes the responsibility for another is known as surety. It also discussed that, according to the provisions of the SEBI regulations governing CIS, any person who sponsors a CIS without registration will attract liability.

Based on the aforesaid background, SAT held that the appellant has not given surety for another, nor is there any evidence to show that any money has been pledged in advance or contribution has been made to bear with the expenses of the scheme. Further, there is no evidence to show that the appellant attended any board meetings in connection with CIS nor has he played any role in this regard. It is rather clear that the scheme was approved by the board even before the appellant was appointed as a director.

Against this backdrop, SAT held that liability depends on the role one plays in the affairs of a company and not on designation or status and concluded that the AO has already penalised the PACL and its directors. Accordingly, the appeal was allowed.

Connection of liability with role

While section 166 of the Companies Act, 2013 imposes onerous duties on directors, the same should not be read in isolation. Courts have time and again settled that affixing liability should not be automatic, rather it should be attributed to the role of the director. Further, section 149 (12) of the 2013 legislation reiterates the fact that independent directors and non-executive directors can be held liable only in respect of items of omission and commission which had occurred with their knowledge or attributable through board processes, and with their consent or connivance or where they had not acted diligently.

Even if the director in question is an executive of the company, still the role and function of such director must be evaluated before concluding on his liability in case of default. Merely holding a position of director will not certainly be enough to fix liabilities for non-compliances.

Conclusion

Looking at the reasoning given by the SAT, the picture is clearer on the circumstances where a director can be said to be liable for wrongful actions and evasions. Thus, situations where the person is made a part of board for reasons other than the requirement of law, it is most likely that such person remains unaware of events taking place in the company; however, the same cannot be used as a shield for evading liability in case of default. It is obvious that the facts surrounding the case will have to be evaluated in detail before coming to a conclusion.

Pammy Jaiswal

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