Disqualification of Directors: Construing Retrospectivity

[Aditya Singh Chauhan is a B.A. LL.B (Hons.) student at the National Law University, Jodhpur]

The Companies Act, 2013 (“Act”), under section 164(2)(a), provides for the disqualification of directors of a company in case they fail to file financial statements and annual returns for a period of at least three (3) consecutive financial years. The provision reads as follows:

 “No person who is or has been a director of a company which […] has not filed financial statements or annual returns for any continuous period of three financial years […] shall be eligible to be re-appointed as a director[.]”

Section 167(1)(a) of the Act provides that the office of the person, who is the director of a company and suffers from any disqualifications that are stipulated under section 164(2), becomes vacant in all other companies. In other words, even if a person is director in multiple other companies that have not defaulted in filing financial statements and annual returns, such a director will be disqualified from all of them, and will also not be eligible for any (re-) appointment for a period of five (5) years. In such a case, the promoter (or, in their absence, the Central Government) appoints the appropriate number of interim directors to hold office until the company makes the required appointments in a general meeting. If the directors who were disqualified are found to have knowledge of their potential disqualification under section 164(2) of the Act, they face imprisonment of up to one (1) year, which may also be accompanied with a fine of an amount more than one (1) lakh Rupees, and less than five (5) lakh Rupees by virtue of section 167(2).

In 2017, on the directions of the Ministry of Corporate Affairs (MCA), the Registrar of Companies (ROC) all over the country began identifying and releasing the lists of disqualified directors under section 164(2) of the Act in pursuance of the initiative to curb shell companies and money-laundering. In Mukut Pathak v. Union of India (discussed here on this Blog), the Delhi High Court had clarified the position regarding section 164(2) by stating that it can be applied in cases where there is a failure to file financial statements and annual returns for the financial year (FY) prior to 1 April 2014, i.e., the date on which the aforesaid provision entered into force. It held that such an application will not be retrospective (by virtue of notification 26 March 2014). In Jai Shankar Agrahari v. Union of India (decided 16 January 2020), the Allahabad High Court disagreed with the Delhi High Court and held that it will apply for the FYs post 2014-15. The above-mentioned judgments are discussed below.

Revisiting the Mukut Pathak Case

On 4 November 2019, the Delhi High Court pronounced its judgment in Mukut Pathak. The petitioners therein challenged three (3) lists released by the Ministry in September 2017, disqualifying directors under section 164(2)(a) for default in filing financial statements and annual returns, pertaining to the FYs 2012-14, 2013-15 and 2014-16. Their digital signature certificates (DSCs) and director identification numbers (DINs) were also blocked. The Court considered the following issues:

  • whether disqualification could be made for defaults pertaining to the FY prior to  1 April 2014, as penal provisions cannot be applied retrospectively;
  • whether the non-service of notice (and merely releasing the names in the list of disqualified directors) violated the principle of audi alteram partem;
  • whether they were disqualified from being (re-)appointed in the non-defaulting companies; and
  • whether the DSCs and DINs of the disqualified directors could be cancelled.
First, the Court in observed that there is no doubt as regards the prospective application of section 164(2). Previously, the Companies Act, 1956 contained a similar provision, i.e., section 274(1)(g), which applied to public companies only. Since section 164(2) of the Act applies to private companies as well, a retrospective application would affect the right of the directors of private companies under the 1956 legislation. This position is consistent with the decisions of the Karnataka High Court (Yashodhara Shroff v. Union of India) and the Gujarat High Court (Bhagavan Das Dhananjaya Das v. Union of India, Gaurang Balvantlal Shah v. Union of India.

The Court in Mukut Pathak, however, disagreed with the above-mentioned High Courts by stating that the application of section 164(2) of the Act to defaults in filings that pertain to FYs before 1 April 2014 does not amount to retrospective application. The annual general meeting (AGM) has to be held by the company within six (6) months from the end of the FY 2013-14, i.e., from 31 March 2014. Even though the FY ended prior to the date on which section 164(2) entered into force, its AGM was required to be scheduled before 30 September 2014. Thus, the financial statements and annual returns of the company for that FY had to be filed within thirty (30) and sixty (60) days respectively from the last date of the AGM. Any default in filing the above under section 164(2) will, consequently, attract penal consequences and disqualification.

Accordingly, the Court reasoned that neither the effect of section 164(2) of the Act on the existing right of the directors of private companies, nor the fact that “a part of the requisites for its action is drawn from a time antecedent to its passing” is enough to render the section retrospective. In other words, it operates prospectively, but takes into account the defaults in filing financial statements and annual returns that were committed in the previous FY. In that regard, the Court observed as follows:

 “[A] director cannot be heard to contend that he had acquired a vested right not to be penalised for this default since it pertains to filing returns for a financial year that had closed prior to Section 164 of the Act coming into force. […] Merely, because the returns to be filed pertain 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.”

Second, the Court adopted the view that the principles of natural justice cannot be applied in a dogmatic fashion, and it depends upon the requirements stipulated in the relevant statutory provision. It found that, under section 164(2) of the Act, there is no decision-making process on the part of any authority that requires the exercise of any discretion to determine whether an individual is to be disqualified. In that sense, in terms of the jargon set out earlier, such a disqualification is automatic. Hence, the Court concluded that the exclusion of the audi alteram partem rule does not result in any procedural unfairness. The requirement of a hearing cannot be readily inferred from section 164(2).

Third, the Court held that the rule of literal interpretation could not be applied for interpreting the provisions of section 167(1)(a) of the Act. Therefore, the Court, while relying on the decision of the Bombay High Court in Kaynet Finance Ltd. v. Verona Capital Ltd., read down the provisions of section 167 of the Act to apply only to cases of disqualification falling under section 164(1) of the Act and not section 164(2) of the Act. Accordingly, the Court held that the petitioners would be disqualified from acting as directors of the defaulting company, but would not demit their office in other (non-defaulting) companies where they are directors. However, in view of the proviso to clause (a) of section 167(1) of the Act inserted by the Companies (Amendment) Act, 2018, which became effective from 7 May 2018, if the directors suffer any of the disqualifications it entered into force, such directors would have to demit their office in all companies and not just the defaulting company.

Fourth, the Court observed that, under section 153 of the Act, an application for DIN can be made by any person “intending to be appointed as director of a company,” and its purpose is to provide a unique identity for efficient administration of the Act. It follows that temporary disqualification from being (re-)appointed as a director under section 164(2) of the Act does not, by itself, warrant deactivation or cancellation of the DINs. Additionally, there is no statutory provision that supports such an action by the Central Government. Similarly, the action to deactivate or cancel the DSCs will also be unsustainable.

Take-away from the Jai Shankar Case

While Mukut Pathak only addressed the questions of interpretation, the vires of section 164(2) of the Act was considered by the Allahabad High Court in Jai Shankar. The petitioners challenged the aforesaid section as contrary to articles 14 and 19(1)(g) of the Constitution of India, 1950, i.e., the right to equality and freedom of trade and business respectively. Both of the aforesaid challenges to constitutionality of section 164(2) of the Act were rejected by the Court. Further, it was also observed that the principle of audi alteram partem does not apply in such cases (except for the purpose of determination of facts), as the disqualification under section 164(2) was automatic by the operation of law. As regards the retrospective application of section 164(2) of the Act, the Court disagreed with the Delhi High Court on the retrospective application in Mukut Pathak, and observed the following:

 “[F]or a provision, which came into force on 01.04.2014, [FY] which ended on 31.03.2014 will not be relevant, inasmuch as, disqualification under Section 164(2)(a) of [the Act] is failure of submission of Financial Statements or Annual Returns for any continuous period of three [FYs] and this provision, which is adverse and penal in nature, cannot be made applicable to a [FY] which had already lapsed and when there was no such condition attracting any disqualification on an event as provided under Section 164(2)(a) of [the Act.]”

On the final issue of whether respondents were right in deactivating the DIN of the directors, the Court observed that neither any of the provisions of the Act nor the rules framed thereunder stipulate cancellation or deactivation of DIN or DSC on account of a director suffering a disqualification under section 164(2) of the Act. Therefore, the Court held the same to be unsustainable in law and directed the respondents to reactivate the DIN and DSC of the petitioner directors, while clarifying that such directors would still be liable to pay applicable penalties under the Act.

Conclusion

There exists a lot of divergence of opinion between the High Courts of the country on correct interpretation of the prospective application of section 164(2) of the Act. As such, the issue is clearly one which has scope for widespread implications, and it seems that the final onus is likely to fall upon the Supreme Court to determine it with finality.

Aditya Singh Chauhan

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