Disqualification Of Directors Under Sec.164(2)(a) Companies Act 2013 For Default Before April 1, 2014 Is Illegal : Karnataka HC [Read Judgment]

Disposing of a batch of nearly three hundred writ petitions, the High Court of Karnataka has declared that period prior to April 1, 2014 cannot be taken into consideration for disqualification under Section 164(2)(a) of the Companies Act.

The petitions challenged the list published by the Ministry of Commercial Affairs in September 2017, disqualifying nearly three lakh directors under Section 164(2)(a) and Section 167(1)(a) for failing to file annual returns and statements for a period of three consecutive years.

The petitioners pointed that at the time of disqualification notified by the MCA, the period for filing annual returns and statements had not got over after April 1, 2014, the date when Companies Act 2013 came into force. The Annual General Meeting has to be held within six months of the closing of the financial year. The annual returns could be filed within 60 days of the AGM and financial statements could be filed within 30 days of the date of AGM. Hence, for filing annual returns and financial statements, the directors had time till November 30, 2017 and October 30, 2017,respectively. However, the list of disqualified directors was published on September 12, 2017.

Accepting this plea, Justice B V Nagarathna observed 

"The continuous period of three financial years must commence with effect from 01.04.2014 onwards. No period prior to 01.04.2014 can be taken into consideration to be a part of the continuous period of three financial years and thereby impact a director of a defaulting private limited company"

The Court noted that under the earlier law - Companies Act 1956 - such default did not lead to disqualification of directors of a private company. 

"As far as directors of private companies are concerned, a provision like Section 164(2) is applicable for the first time. Thus, no period antecedent 01.04.2014 could be taken into consideration when there has been a efault in the filing of the annual returns or the statements by such a private company. This is because, prior to the enforcement of the Act, such a disqualification was not imposed on a director of a private company under Section 274(1)(g) of the 1956 Act. Therefore, as far as private companies are concerned, Section 164(2) being made applicable to them for the first time under the Act, no period prior to 01.04.2014 could be taken into consideration for the purpose of reckoning three continuous financial years under Section 164(2) of the Act", observed the 614 pages judgment.

The Court however repelled the challenge to the constitutionality of Sections 164 and 167. It was also held that no prior hearing was required before imposing disqualification, as it took place by automatic operation of law.

Disqualification Of Directors : Companies Act 2013 Takes Effect Only From FY 2014-15; Gujarat HC Quashes MCA List [Read Judgment]

Public companies.

As far as public companies are concerned, though a disqualification as stated under Section 274(1)(g) of the 1956 Act applied to the directors of a public company, which was in default, nevertheless, the consequence was not to the extent stipulated under the  2013 Act.

Under 1956 Act such a director became ineligible to be appointed as a director in any other company, but he could be re-appointed as a director in the defaulting company. Moreover, under Section 283 of the 1956 Act, there was no vacation of the office of such a director.

But under the Act, a director of a defaulting company becomes ineligible to be re-appointed as a director of the defaulting company as well as any other company. Moreover, in terms of the proviso to Section 167(1)(a) of the Act, such a director would have to vacate office as a director in all companies where he is a director other than the defaulting company.

Since the cumulative effect of the consequences in respect of directors of public companies are greater in 2013 Act than the 1956 Act, the Court held that while reckoning three financial years during which annual returns or financial statements have not been filed, no period prior to 01.04.2014 could be considered.

"there has been an arbitrary exercise of power by the respondent authority in disqualifying the petitioners as directors of public companies by taking into consideration the period prior to 01.04.2014 as well as subsequent thereto for the purpose of reckoning the continuous period of three financial years. It is observed that even in respect of public companies,  having regard to the nature of the consequences envisaged under Section 164(2) of the Act as compared to Section 274(1)(g) of the 1956 Act, the period prior to 01.04.2014 and subsequent thereto could not have been considered for reckoning three continuous financial years for disqualifying the directors of public companies. Such disqualification is hence quashed"

The Court however added that a disqualification already sustained by a director of public company under 1956 Act will have a bearing  while applying Section 164(2) of 2013 the Act when a director has to be re-appointed in a defaulting company or in any other company.

"if any disqualification of directors of public companies has occurred under the 1956 Act, i.e., prior to 01.04.2014, the same would result in an ineligibility under Section 164(2) of the Act on account of the retro-active operation of the Section".

This is because a new law can be applied to an act or transaction which has been completed before it is enforced. In such a case, the provision is not retrospective because a part of the requisite for its action is drawn from a time antecedent to its passing. The new law imposes consequences in respect of past events, with effect from 01.04.2014 which is prospective, said the Court.

Proviso to Section 167(1)(a) prospective

The Court said that the proviso to Section 167(1)(a) has only a prospective effect and cannot have a retrospective operation. Thus, in respect of the petitioners who were disqualified prior to the date of enforcement of the amended provision, that portion of the proviso namely "office of the director shall become vacant in all the companies" is not applicable to those petitioners.  

It was held : 

"It is clarified that the operation of the proviso under Section 167(1)(a) of the Act being prospective in nature, any disqualification of any director of a public company or a private company prior to 07th May 2018, would not result in such director vacating the office of the director in all other companies in which the disqualified director is a director. However, the director of the company in default would continue to hold office as a director even in respect of the defaulting company. The proviso to the above extent only is by way of a clarification so as to avoid an absurdity as otherwise, all the directors of the defaulting company would have to vacate office which would result in the company being bereft of directors and have a cascading effect and there would be no compliance of Section 164(2)(a) by such a company. Hence, the expression "other than the company which is in default" in the proviso to Section 167(1)(a) would imply that the director of a defaulting company who has suffered disqualification need not vacate his office of the director in the defaulting company. 

Consequently, proviso to Section 167(1)(a) of the Act having a prospective operation would affect only those directors who are disqualified on or after 07 th May 2018 insofar as vacating office of director other than the defaulting company is concerned". 

Striking off by itself will not lead to disqualification

The Court held that striking off of a company under Section 248 of the Companies Act will not lead by itself lead to disqualification.

"It is held that the directors of the struck off companies under Section 248 of the Act do not per se get disqualified. But, if the said company has also not complied with Section 164(2)(a) of the Act, then the said company being a defaulting company, the directors of such a company get disqualified in terms of the discussion made above". 

Judgments of Gujarat and Madras HCs referred

The Kartnataka HC referred to the judgments of Gujarat and Madras High Courts which had reached similar conclusions.

Last August, the Madras HC had quashed the list of disqualified directors on the ground that the Act will take effect only from the financial year 2014-15.

In December, the Gujarat High Court quashed the list of disqualified directors published by the Ministry of Corporate Affairs (MCA) on September 12, 2017. The Court held that Section 164(2) of the Companies Act is prospective in nature and will take effect only from its date of notification, viz, April 1, 2014.

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