Section 164(2) Companies Act Not Retrospective; Default Before 2014-15 FY Can't Be Considered : Kerala High Court

This came after approximately 250 writ petitions were filed before the Court raising common questions of law. All the petitioners were disqualified u/s 164(2) for failure of their respective companies to file Financial Statements/Annual Returns. The petitions therefore challenged Sections 164 and 167, and actions of the respondents pursuant thereto. These petitions were consequently heard together and disposed of by a common judgment.

The litigations were initiated contending that Section 164 of the 2013 Act brought about a sweeping change in the disqualifications for being appointed as Directors of Companies as compared to Section 274 of the repealed 1956 Act. It was alleged that incidents leading to disqualifications u/s 164(2) are not directly attributable to Directors, and yet bore grave consequences on them.

Several counsels appeared for the petitioners, including Adv Navod Prasannan Pattali, Adv Shameem Ahmed, Adv Mohan Pulickkal, Adv Sukumar Nainan Oommen, Adv Sherry Samuel Oommen, and Adv Ramola Nayanpalli.

A Single Judge Bench of Justice N. Nagaresh disposed of the writ petitions with the following declarations and directions:

• S.164(2) and 167(1) not ultra vires Art. 14 or 19(1)(g)

The petitioners argued that circumstances like pandemic, prolonged lockdowns, shutting down of internet facilities etc. could be reasons for failure to file Annual Returns / Financial Statements. The Court observed that such disqualification would arise only after three years, and that said eventualities cannot last continuously for three years. Hence, it was held that Sections 164 and 167 do not offend Article 14.

It was further submitted that Directors disqualified under these provisions were debarred from acting as Directors in other companies for five years. The Court observed that the purpose of such disqualification was to incorporate accountability, avoid mismanagement, and lift the standards of corporate governance. Hence, Sections 164 and 167 fall within the exceptions under Article 19(6).

• Disqualification u/s 164(2) is by operation of law: Audi Alteram Partem Not Applicable

It was contended that when the consequences of disqualification are so grave, principles of natural justice should necessarily be read into Section 164. This implied that before effecting disqualification, the affected Directors should be extended an opportunity of hearing.

The Court observed that ineligibility of Directors u/s 164 is for a period of five years, and not perpetual. Moreover, ineligibility under the provision arises by operation of law. Therefore the requirement of hearing does not arise, and principles of natural justice do not have to be read into the Sections.

• Disqualification based on default prior to 01.04.2014 bad in law and set aside

The petitioners argued that the 2013 Act has only prospective operation, implying that Directors cannot be disqualified u/s 164(2) till 2017. Agreeing with the petitioners that only the defaults made by Companies in filing Financial Statements / Annual Returns in the financial year 2014-15 and subsequent financial years can be taken into account for disqualifying a Director, the Court held thus:

"It is a settled proposition of law that no statute shall be construed to have retrospective operation unless such a construction appears very clearly in the terms of the Act or arises by necessary implication. Directors of private Companies cannot be disqualified for appointment / re-appointment as mandated under Section 164(2) if any of such three consecutive defaults in filing Annual Returns/Financial Statements, is before the financial year 2014-'15.

• Provisos to Section 164(2) & 167(1)(a) to have retrospective effect

While discarding the argument of illegality and unconstitutionality of the provisos, the Court observed that they intended to enable the defaulting Companies to file Financial Statements / Annual Returns for defaulted years, and to vacate them from the office of Directors in all other Companies.

Taking into consideration the purpose of incorporating the proviso, it was held thus:

"The provisos inserted below Section 164(2) and Section 167(1)(a) of the Act, 2013 by the Companies (Amendment) Act, 2017 with effect from 07.05.2018 are constitutionally valid and the same being clarificatory in nature, would apply retrospectively. However, the words 'in all the companies' appearing in the proviso to Section 167(1)(a) will have only prospective operation. "

• The DINs of petitioners to be re-activated

The petitions mentioned that their Director Identification Numbers were cancelled following their disqualification. The Court observed that Rule 11 does not empower any authority to cancel or deactivate DIN upon disqualification under Section 164(2).

Cancellation or deactivation is contemplated only where it is duplicated or obtained through fraudulent means as mentioned in Rule 11. Moreover, DIN is an Identification Number and disqualification under Section 164(2) is temporary. Hence, there is no justification for cancelling/ deactivating DINs of Directors consequent on their disqualification.

The Court observed thus:

"the DIN of the petitioners allotted under Rule 10 of the Companies (Appointments and Qualifications of Directors) Rules, 2014 ,are not liable to be deactivated or cancelled solely for the reason that the petitioners stand disqualified for appointment / reappointment as Directors of Companies by operation of Section 164(2)."

However, the respondents were given the liberty to cancel/ deactivate the DINs of the petitioners for any reasons laid down in Rule 11.

The following are the directions/declarations issued by the Court :

The observations made by the Kerala High Court are similar to decisions of Gujarat, Madras, Karnataka, Allahabad and Madhya Pradesh High Courts on the position of law in disqualification of directors under Section 164(2) of the Companies Act.

The Delhi High Court has taken a contrary view in Mukut Pathak & Ors. v. Union of India & Anr., WP (C) No. 9088/2018, which 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.

Title: Zacharia Maramkandathil Mohan and Ors v. Union Of India