Vacating Directorship in Companies: Examining a Fallacy

[Paras Ahuja is a third year law under-graduate at National law University, Jodhpur]

Section 167(1) of the Companies Act, 2013 provides for several grounds that mandate directors of companies to vacate their office. Section 167(1)(a) provides for one such ground, wherein the office of the director shall become vacant if he is disqualified to be a director under section 164 of the Act. Under section 164(2), a person is disqualified from the directorship of a company which has not filed financial statements or annual returns for any continuous period of three financial years, or which has failed to undertake specified financial obligations and such a failure continues for one year.

This assumes pertinence in light of the Companies (Amendment) Act, 2017, by which a proviso was inserted to Section 167(1)(a). It provides that, where the director has been disqualified under section 164(2), his office shall become vacant in all companies where he is a director, and not merely the defaulting company. In others words, if a person holds the post of a director in three companies at the same time, one of which becomes a defaulting company for the purposes of section 164(2), he shall have to vacate office in all the three companies. The introduction of the proviso had the impact of enormously expanding the scope for application of section 167(1)(a). Several non-defaulting companies would also now be impacted as there would be creation of a vacancy in such companies as well.

The constitutional validity of the proviso to section 167(1)(a) of the Companies Act, 2013 was challenged and upheld in the Madras High Court judgement of G. Vasudevan v. Union of India. The petitioners contented that the proviso metes out unequal treatment to directors of a defaulting company and therefore violates article 14 of the Constitution of India. They contended that such a provision is arbitrary and unreasonable.

The Court upheld the validity of the proviso and observed that it will ensure the preservation of transparency and probity in governance. The Court held that the legislative intent behind the inclusion of the proviso to section 167(1)(a) was to ensure good governance and inculcate a sense of security in investors through transparent disclosures and control over erring directors, and the same stands fulfilled by such insertion.

A Critical Perspective

The introduction of the proviso to section 167(1)(a) of the Companies Act, 2013 raises a plethora of questions and challenges, some of which were not even raised or address in G. Vasudevan. A detailed perusal and comparative understanding of sections 164(1) and 164(2) would lead us to a conclusion that the former attributes disqualification to a “particular director” by singularly identifying him; the latter attributes it to the entire “body of directors”, which is then disqualified as a collective for the dysfunction relating to the company. This is because grounds for disqualification of a person under section 164(2) are attributable to the functioning of the company in which he has served as director. However, section 164(1) attributes disqualification of a director to his personal conduct independent of the functioning of the company, such as declaration of a person to be of an unsound mind by a competent court, failure to make payment when called upon to pay, or being convicted for an offence for not less than six months.  Under section 164(2), there is default on part of the company, attributable to a collective unit and not an individual in particular. The grounds of disqualification under section 164(2) such as non-performance of activities such as non-filing of annual returns or financial statements, non-payment of declared dividend cannot and have not been attributed to a singular director but to a body of directors. Disqualification for a default under section 164(2) is therefore imposed on the director as a part of a collective body and not in his individual capacity.

Now, the introduction of the proviso to Section 167(1)(a) mandates the removal of a director from companies, other than the defaulting company. This has the impact of identifying a director singularly and mandating his removal from a post occupied in a company other than the defaulting company, even though he has been successfully fulfilling his duties vis-à-vis the other companies. This is rooted in attributing liability to a director in his personal capacity and not as a member of a collective body and is therefore logically inconsistent.

It is pertinent to note that the disqualification under section 164(2) is very peculiar to functioning of a particular company unlike section 164(1) under which an independent act by the director makes him eligible for disqualification. Therefore, although the extension of disqualification of a director of a particular company to other companies for a default under section 164(1) is comprehensible, the same cannot be said for disqualification under section 164(2) as that is intimately connected with a dysfunction or default by the board of directors in a particular context, i.e., the defaulting company itself. Mandating the director to vacate his post in other companies is fallible and does not serve any purpose.

The Madras High Court in G. Vasudevan pointed out that the reason for disqualification of a director under section 164(2) is not to punish the individual director but to protect companies and observe the proper dispensation of principles of corporate governance. However, one can see that the effect of the proviso is to disqualify a company’s director even though he has been presumably performing his duties properly vis-a-vis other non-defaulting companies, where he holds the position of directorship alongside the defaulting companies. Therefore, although a particular company has been functioning smoothly, yet liability is attributed to the director, requiring him to vacate his office for that company as well.

The impact of the proviso is that dysfunctional observance in one company would percolate to create a vacancy for the post of a director in another company. This is unwarranted and fatal to the smooth functioning of the other companies. The provision has an undesirable impact of introducing a linkage between the functioning of different companies and therefore makes unnecessary space for hindrances in carrying out of functions of a particular company.

Conclusion

The introduction of the proviso to Section 167(1)(a), Companies Act, 2013 is a mis-directed amendment and should be rectified. It wrongfully mandates for the removal of a person from a post in which he has been properly discharging his duties. The provision massively impacts the functioning of the companies, even in situations when such was not required.  The provision falls short of logical consistency and legal postulates, and is unfair to both the director and the other companies, apart from the defaulting company.

Paras Ahuja

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