Directors, Deadlocks And Disqualifications Under The Companies Act, 2013
Directors, Deadlocks And Disqualifications Under The Companies Act, 2013
Imagine a world where companies possess their own unique identities, are capable of acquiring property, taking legal actions, and existing indefinitely regardless of the people working within them. Welcome to the fascinating world of corporate law, where companies are conferred with a separate legal personality. The members of a company may come and go, but the company goes on forever until it is wound up or dissolved. Being an artificial person, a company has no mind of its own and has to be managed by natural persons, i.e., human beings, who make decisions on its behalf. The directors have been bestowed with the power and responsibility of managing, administering and controlling the affairs of a company. However, such individuals should be cautious and beware of compliances under the Companies Act, 2013, as certain non-compliances may lead to their disqualification from becoming directors, which may further lead to the vacation of their offices of directors from all the other companies.
Statutory provisions
Considering the crucial role played by a director in a company, the Companies Act sets out the criteria which an individual has to meet to qualify as a director. The Act further enumerates the duties and responsibilities which a director needs to comply with, the breach of which can render the person disqualified from being a director.
Section 164 of the Companies Act cites the grounds for a person's disqualification from being a director. These disqualifications can broadly be classified into two categories. On one hand, are the disqualifications pertaining to the non-satisfaction of eligibility conditions for becoming a director, while on the other hand are the ones which can be triggered on account of non-compliances of the company in which a person is a director. The first category relates to a person alone, while the latter category has its roots in a person being a director of a company. Section 164(1) deals with the disqualification of the former category, which makes a person disqualified if he is declared to be of unsound mind, insolvent, convicted by court of any offence for a certain period, and not having a Director Identification Number ('DIN'), amongst other things.
While on the other hand, Section 164(2) lists down grounds for disqualification of a director which are not due to personal disqualifications but because of default in compliances by any company in which such person is a director. Section 164(2) restraints a person from being re-appointed as a director in that company or appointed as director in another company, where the company continuously fails to file financial statements or annual returns, repay deposits, redeem any debentures, or pay any dividend declared for specified period. It is noteworthy that this sub-section casts disqualification on a director for a period of 5 (five) years from the date of default.
Section 164(2) disqualifies a director in case of non-filing of financial statements or annual returns for a continuous period of 3 financial years. It is worthwhile to note that the financial statements of a company are to be filed within 30 days of the holding of the Annual General Meeting ('AGM') of a company. The last date for holding AGM for a financial year is 30th September of next financial year and consequently the last date for filing of financial statements will be 30th October. Hence, a director will become disqualified only after 30th October following the 3rd (third) continuous financial year of non-filing.
Disqualification leading to vacation of office
Bare perusal of the two categories of disqualifications makes it evident that the latter category pertaining to corporate defaults is a vicious one since such defaults can be attributed to many other factors which are not even in the direct control of a director. There may be situations in which a director is fully cooperative and taking steps to fulfil all the compliances, however, is restrained from doing so because of other directors of his company. Furthermore, the disqualifications under Section 164 become all the more detrimental owing to Section 167 of the Companies Act, which states that the office of a director will become vacant in case such person incurs any of the disqualifications specified in Section 164 of the Companies Act, 2013. The conjoint reading of both sections makes it clear that the moment a person incurs disqualification from becoming a director under Section 164 and is declared as such, his office as a director will be vacated in all the other companies in which he is holding a position as a director. Thus, the disqualification resonates a domino effect initiating a chain reaction potentially causing chaos in the corporate landscape.
Situation of Deadlock
Such disqualification, as specified in Section 164(2), is more prevalent in companies which are incorporated as joint ventures and where a deadlock exists in the management. Imagine a situation where a person 'A' enters into an agreement with another person 'B' to start a joint venture by the name of Company 'XYZ Pvt. Ltd.', having equal shareholding and equal representation on the Board of Directors amongst 'A' and 'B'. Now, suppose with the passage of time, certain differences start building between both directors which aggravates to such an extent that they are at loggerheads and have no consonance in running the affairs of the company. Such a situation will make it practically impossible to fulfil compliance requirements of the company. In case such deadlock remains unresolved, the company suffers from non-compliances and consequently its directors get subjected to disqualifications due to defaults mentioned in Section 164(2) above.
In this situation, even if 'A' wishes to comply with provisions of law and file financial statements or annual returns, he may not be able to do so since even after sending due notice for convening Board Meeting to 'B', 'B' may not attend the Board Meeting for giving authorisations and not provide required information with respect to the 'XYZ Pvt. Ltd.'. Further, by virtue of Section 167 in this situation of deadlock, 'A' will lose control of his office from all the other companies in which 'A' is a director, despite the fact that there may be no default in the compliances in such other companies. This scenario poses a grave threat in the form of disqualification for directors and creates issues in management of affairs of companies they serve, for no fault of their own.
Judicial Approach on issues revolving around disqualification
On account of ramifications of such provisions relating to disqualification, many interrelated issues have time and again surfaced before the courts for their adjudication. Majority of the litigations arose in 2017, when lists of disqualified directors and defaulting companies were published by the Registrar of Companies. There being no provision under Companies Act providing relief to such disqualified directors, they approached High Courts invoking its writ jurisdiction seeking remedy by raising the following issues:
- Enforceability of disqualification provisions: One of the most landmark judgment covering nearly all of the issues pertaining to disqualification is that of High Court of Delhi in Mukut Pathak and Others vs. Union of India and Another[1]. The most germane issue challenging the disqualification list was regarding the date of applicability of disqualification provisions. The Delhi High Court held that Section 164(2), which came into effect on 01.04.2014, operates prospectively, however, such nature does not restrict it to take into consideration defaults like non-filing of financial statements for the financial year ending on 31.03.2014, which are prior to 01.04.2014. The High Court was of the opinion that taking such prior defaults into account does not amount to a retrospective application of these provisions.
However, Karnataka High Court in Yashodhara Shroff vs. Union of India[2], Madras High Court in Bhagavan Das Dhananjaya Das vs. Union of India[3] and Gujarat High Court in Gaurang Balvantlal Shah vs. Union of India[4] had divergent views with respect to the applicability of Section 164(2). These High Courts have held that Section 164(2) applies prospectively in a strict sense wherein no default prior to coming into effect of this provision is to be considered. The High Courts observed the disqualification provision being incorporated for the first time in the Companies Act, 2013 as the reason behind its prospective operation.
- Applicability of principles of Natural Justice: Another important issue which arose in Mukut Pathak (supra), was with respect to the applicability of principles of natural justice in case of disqualifications. It was to be decided whether a prior notice and opportunity of being heard is required before conferring such disqualification. Answering the question in negative, the Delhi High Court stated that Section 164 merely lists the conditions, non-compliance of which would render a director disqualified. It was further observed that there is no decision making process involved or discretion to be exercised by any Authority for disqualifying a director, which is fairly an automatic process. Hence, it was held that the rule of audi alteram partem would not be applicable in operation of Section 164. Majority of the High Courts have a similar view like that of Delhi High Court with respect to applicability of principles of natural justice in disqualifications. Recently also similar view was taken in Satya Narayan Banik and Others vs. Union of India and Others,[5] wherein Calcutta High Court[6] held that since the language of sections 164 and 167 is quite unambiguous and provides for automatic consequences, hence, rules of natural justice are inapplicable in this scenario.
- Deactivation of DIN or DSC: The Delhi High Court, in Mukut Pathak (supra), was further posed with the issue of deactivation of DINs as well as Digital Signature Certificates (“DSCs”) of the disqualified directors. The High Court while referring to Companies Act and Companies (Appointment and Qualification of Directors) Rules, 2014, stated that there exists no provision enabling cancellation or deactivation of DIN on account of a director suffering disqualification under Section 164(2) of the Act. It was further observed that although a DIN is necessary for a person to act as a director, it is not necessary that a person who has DIN be appointed as a director. The High Court stated that since Section 164(2) levies only temporary disqualification for a period of 5 (five) years, hence, it is not necessary that the DIN of such a person be deactivated. Similarly, it was observed that there is no provision for cancellation of DSC either. The Court directed the government to reactivate the DINs and DSCs of the disqualified directors. Recently also, the Delhi High Court in Maha Nand Sharma and Another vs. Union of India and Others[7], following the decisions in Mukut Pathak (supra) and Anjali Bhargava and Another vs. Union of India and Another[8], has directed the reactivation of DINs/DSCs of the disqualified directors enabling them to file requisite documents in compliance of applicable provisions of Companies Act, 2013. Certain other High Courts are also in consonance with Delhi High Court's view on this aspect.
It is crucial to note that the government has from time to time notified various settlement and fresh start schemes enabling inactive / defaulting companies to fulfil their past compliances and file all the documents / statements / returns relating to past defaulting years. These schemes also allow inactive companies to get themselves declared as 'dormant companies'. To avail benefits of such schemes, the Courts were of the view that DINs or DSCs of disqualified directors need to remain active.
Viable Solution
Considering the difficulties and the series of litigations one would have to undergo for resolving disqualification issues, it is of paramount importance that the directors comply with applicable laws and compliances to ensure that there is no default by the company. Further, the directors should also conduct extensive due diligence by way of background check to see for any possible red flags in their prospective business partner. The directors should also have proper documentation and worded agreements explicitly specifying roles and responsibilities of both parties in the joint venture. It is also necessary for directors to align their goals and vision with their prospective partners before jumping into a joint venture so that no situation of deadlock is created in the future. This will reduce the chances of incurring disqualifications under Section 164(2) and consequent vacation of offices from other companies. If still, a company defaults and the director is rendered disqualified, then such a director should be on the lookout for revival schemes launched by the government and apply under them to do belated filings and start afresh. However, such filings are only possible if the reason behind non-compliance, like the example of deadlock, is not in effect anymore and the company is in a position to prepare and file its statutory financial documents.
Authors: Ms Pankhuri Jain is a Partner and Mr. Anmol Chawla is an Associate in ZEUS Law Associates. Views are personal.
2019 SCC Online Del 10868 ↑
W.P. No. 52911/2017 ↑
W.P. Nos. 25455/2018 ↑
(2019) 214 Comp Cas 199 ↑
2022 SCC OnLine Cal 259 ↑
Relying upon Naresh Kumar Poddar vs. Union of India, 2021 SCC OnLine Cal 669 and Gautam Mehra vs. Union of India 2020 SCC OnLine Cal 3264 ↑
2022 SCC OnLine Del 4409 ↑
2021 SCC OnLine Del 195 ↑