Disqualification Of Directors Under Section 164(2) Of The Companies Act: Delhi HC Interprets The Law [Read Judgment]

While ruling upon the retrospective applicability of section 164(2), Justice Vibhu Bakhru held that the said section can apply to failure in filing returns for financial years prior to 2014, the year in which the said section came into force.

While acknowledging the judgements passed by the High Courts of Gujarat, Madras and Karnataka, which had held section 164(2) as having prospective applicability, the court went on to note that the operation of the said section in the present case, doesn't amount to retrospective application of a penal provision. The court said:

'Merely because an enactment draws on events that are antecedent to its coming in force does not render the said enactment retrospective'.

The present batch of petitions were filed by the directors of various companies who were disqualified from being appointed / reappointed as directors for a period of five years, under Section 164(2)(a) of the Companies Act, by virtue of their companies failing to file financial returns in the past 3 consecutive years.

Further, the names of some of the companies, in which the petitioners were holding the office of directors, were also struck off from the Register of Companies.

Therefore, the Petitioners had sought directions to be issued to the Ministry of Corporate Affairs to allow them to use their Digital Signature Certificates (DSC) and Director Identification Number (DIN).

In the pursuance of their case, the Petitioners had made the following submissions before the court:

1. The action of the respondents in disqualifying the Petitioners is arbitrary inasmuch as the petitioners were not afforded an opportunity to be heard. They contended that the said action is in violation of principles of natural justice.
2. Section 164 of the Act, which mandates the disqualification of directors, being penal in nature, could not be applied retrospectively.
3. On the plain interpretation of Section 164(2)(a) of the Act, the petitioners cannot be disqualified to act as directors of the companies, which have not defaulted in filing their annual returns and financial statements for a period of three consecutive years
4. Defaults under Section 164(2) of the Act result in the directors being disqualified from being appointed/re-appointed as directors but does not result in them demitting office as directors.

The Respondents, on the other hand, argued that sufficient opportunity had been provided to the petitioners to correct the default of not filing the statutory documents.

1. Retrospective Applicability of Section 164

While dealing with the issue regarding retrospective applicability of section 164(2), the court faced with a significant question as to whether the default as contemplated in clause (a) of Section 164(2) of the Act, in respect of a financial year prior to the said provision coming into force, could be considered for the purposes of the said Section.

The court rejected the claim of the Petitioners by opining that non-filing of financial returns was already prohibited under the Companies Act. Therefore, when the same prohibition was envisaged under section 164, the retrospective application of the same has no significantly adverse effect of the rights of the defaulting companies.

Therefore, the court held that Section 164(2) of the Act operates prospectively. However, such prospective operation would entail taking into account failure to file the financial statements pertaining to the financial year ending 31.03.2014 on or before 30.10.2014.

However, the penalty under section 164(2) would not extend to defaults committed prior to 01.04.2014

Justice Vibhu Bakhru highlighted that:

'merely because it also takes into account an event that had occurred prior to the Act coming into force, the same would not render the said enactment as retrospective. Such a law would not suffer from the vice of being ex post facto. This is so because it neither impairs any vested or accrued right nor imposes any new disabilities in respect of events that had occurred earlier'.

1. Whether a prior notice and an opportunity of being heard was required

The court opined that Section 164 (2) of the Act merely sets out the conditions, which if not complied with would disqualify an individual a person from being reappointed or appointed as a director.

This provision does not entail any decision-making process on the part of the Authorities administering the Act. No Authority is required to exercise any discretion or take any judicial or quasi-judicial decision regarding disqualification of a director.

Therefore, the rule of audi alteram partem is incapable to section 164(2).

The court also provided the following reason for the same:

'Undisputedly, in a large number of cases, withholding of information was willful as the information pertained to shell companies, which were incorporated to serve a limited purpose. The purpose of debarring such directors from

participating in any corporate entity as a direction is to ensure that persons who take up the mantle of becoming directors of companies are conscious of their responsibility of ensuring that the companies comply with the statutory requirement'.

1. Interpretation of Section 164(2)

The court denied the interpretation put forward by the Petitioners, and went on to hold that the disqualification under section 164(2) would also apply to 'reappointments'.

The court also clarified that directors disqualified under Section 164(2), that happened on or after 07.05.2018, the clear implication of the provisos to

Section 164(2) and 167(1)(a) of the Act are that they would demit their office in all companies other than the defaulting company.

The court also directed the Respondents to to reactivate the DIN and DSC of the petitioners. While doing so, the court noted that the Central Government having framed the rules specifying the conditions in which a DIN may be cancelled, cannot cancel the same on any other ground and without reference to such rules.