Disqualification of Directors under Section 164(2)(a) of The Companies Act, 2013: Madras High Court clears the Air
[Devina Srivasatava]

 

Devina is a 4th year BBA LL.B. (Hons.) student at Symbiosis Law School, Pune.

Introduction

In the recent case of Bhagavan Das Dhananjaya Das v. Union of India[1], decided on 3rd August, 2018, the Madras High Court has set a significant precedent for matters concerning disqualification of directors under Section 164(2) of the Companies Act, 2013 (“2013 Act”).

Various petitions were clubbed by the Madras High Court in this matter and the facts in all pertained to disqualification of directors on the ground of failure of the company to file annual returns or financial statements for 3 consecutive financial years. For instance, in the petition filed by Mr. Bhagavan Das Dhananjaya Das, the director of a private company called Birdies and Eagles Sports Technology, the company had been unable to commence business activities and had not filed annual returns since 2011-12. Accordingly, the Registrar of Companies, Chennai (“ROC”), struck off the company’s name from the Register of Companies under Section 248 of the 2013 Act after giving due notice. Various other companies were also struck off as part of the nationwide crackdown of over 2 lakh shell companies and their directors disqualified from being appointed or re-appointed as directors for the next 5 years.[2]

Grounds for Challenge

The writ petitions challenged the disqualification on two major grounds: Firstly, the 3 year period for disqualification under Section 164(2)(a) can only commence for private companies post the enactment of the 2013 Act. Hence, the year 2013-14 cannot be included in the 3 year period of default. Secondly, the principles of natural justice were violated as no opportunity to be heard was provided to directors before their disqualification.

Analysis of Issues Involved

Since there was no alternative remedy for challenging the disqualification and a statutory body like the ROC had allegedly misconstrued provisions of law, infringing on the fundamental rights of the petitioners, the writ petition was held to be maintainable.

In deliberating upon the first issue of scope of the period of 3 financial years under Section 164, the court considered that the 2013 Act came into force only on 1st April, 2014 and as per the definition of ‘Financial Year’ contained in Section 2(41) of the Act, the first financial year under the Act commences on 1st April, 2014. Hence, if the three year period is considered to commence from 1st April, 2013, as done by the ROC, it would be inconsistent with the 2013 Act. In addition to this, no provision for disqualification of directors for failing to file annual returns existed under the Companies Act, 1956 (“1956 Act”) for private companies. Section 274(1)(g) of the 1956 Act, which provided for such disqualification applied only to public companies. Hence, to consider the year 2013-14 for disqualification of a director would be in contravention of law as the then applicable law did not attach any liability for default in filing annual returns or financial statements in case of a private company. This is also supported by the General Circular No. 08/14 by the Ministry of Corporate Affairs[3] which clearly states that financial statements in respect of periods prior to 1 April 2014 will be governed by the 1956 Act and that the provisions of the 2013 Act shall apply only thereafter.

Moreover, the provisions of the Companies Act, 2013 ought to be read prospectively and cannot relate to occasions prior to its coming into force, failing which the said provision would become unconstitutional under Article 20(3) of the Constitution of India. Thus, the court held the disqualification of directors to be invalid and bad in law.

As far as the second issue was concerned, the court noted that though the ROC had called upon the companies to explain as to why they should not be struck off, no notice was given for disqualification of their directors. The Court opined that these were two distinct and independent actions and a fair opportunity to be heard should have been provided to the disqualified directors. Thus, the Court thus read down Section 164(2) of the Act to the extent that a fair opportunity to be heard must be given to directors of a company before disqualification. Resultantly, the challenged orders of disqualification were set aside.

Conclusion

Scholars are of the opinion that the principles laid down by the Court have somewhat narrow as well as broad application.[4] Narrow because the decision as to the 3 year period will apply only to the current batch of disqualified directors and broad because the decision on reading down of Section 164 will have sustained implications. This aptly demonstrates the impact of the judgment. However, a question that arises is that even if the ROC gives a notice of disqualification and an opportunity to be heard to a director, what will be the grounds which will be considered as sufficient justifications for non-compliance with the statutory mandate of filing annual returns or financial statements? Section 164 provides no proviso to disqualification of a director for such a default and hence, it will be worthwhile to see if a notice of disqualification will only prove to be a mere legal requirement or actually serve a useful purpose.

In August this year, the Supreme Court stayed another order of the Bombay High Court granting relief to disqualified directors[5] on different grounds. If the present matter is appealed against, whether the Supreme Court will adopt a pro-director stance or support the government in its endeavours– time will only tell. In any case, the decision is a landmark one as it not only provides clarity about the calculation of period of default by directors, but also upholds the principles of natural justice.

 

 

 

[1] 1967 SCC OnLine Mad 307.

[2] https://www.livemint.com/Companies/1Y2Eru7mxnNgHoKkqXicHP/Over-2-lakh-shell-companies-to-be-struck-off-from-records-in.html.

[3] General Circular No. 08/ 2014 dated 4th April, 2014, Ministry of Corporate Affairs, Government of India. Available at: http://www.mca.gov.in/Ministry/pdf/General_Circular_8_2014.pdf.

[4] Umakanth Varottil, Madras High Court Grants Reprieve to Disqualified Directors, IndiaCorpLaw. Available at: https://indiacorplaw.in/2018/08/madras-high-court-grants-reprieve-disqualified-directors.html.

[5] https://www.moneycontrol.com/news/business/supreme-court-stays-bombay-hc-order-granting-relief-to-disqualified-directors-2815121.html.

 

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