2019 (6) TMI 1076 - HC - Companies Law

Disqualification of Directors. - Vires of Section 164(2)(a) of the Companies Act, 2013 as well as Section 54 of the Companies (Amendment) Act, 2017 - proviso has been inserted to clause (a) of sub-section (1) of Section 167 of the Act as well as Section 167(1)(a) itself. Whether Section 164(2)(a) of the Act is ultra vires Articles 14 and/or 19(1)(g) of the Constitution being manifestly arbitrary or on the principle of proportionality? - HELD THAT - On perusal of Section 164(2) of the Act, in light of the above references, it is noted that a twofold consequence is prescribed if there is an infraction of either Section 164(2)(a) or (b), or both. The first is that a director of the defaulting company cannot be re-appointed as a director of the said company. Secondly, such a director cannot also be appointed as a director of any other company for a period of five years. The Parliament in its wisdom has prescribed the two-fold consequence under the Act though as per Section 274(1)(g) of 1956 Act, there was only one consequence viz., that a director of a defaulting company could not be appointed as director of any other company for a period of five years. But under Section 164(2) of the Act, a director of a defaulting company cannot be re-appointed as a director of a defaulting company for a period of five years. The prescription of a two-fold consequence cannot be held to be manifestly arbitrary as the Parliament in its wisdom has prescribed the same having regard to the objects sought to be achieved which have been elaborately stated by the Bombay High Court as well as Gujarat High Court and which are reiterated. The only aspect that requires further consideration is the expression is or has been a director of a company . On a reading of Section 164(2)(a) of the Act, it is clear that a person who is a director of the company when the default occurs i.e., when for any continuous period of three financial years, financial statements or annual returns are not filed would be faced with the consequences mentioned under the Section. But there has been a debate at the Bar over the expression has been a director of a company . Petitioners counsel contended that the expression has been cannot extend to a person who is a director of a defaulting company prior to the three material years. There is force in the said contention. The expression has been is not equivalent to the expression was . The phrase has to be interpreted to mean a person was a director during the period of three years i.e., continuous period of three financial years during which financial statements or annual returns were not filed and who may have since ceased to be a director. Even if such a director has subsequently ceased to be a director after the default has occurred, he would be disqualified. The vires of Section 274(1)(g) of the 1956 Act upheld - the said provision did not violate any fundamental right under Article 19(1)(g) of the Constitution. The ineligibility to be re-appointed as a director of the defaulting company under Section 164(2) of the Act is significant for, when juxtaposed with the fact that such a director cannot be re-appointed in any other company for a period of five years, (although any other company may not be in default), it is logical that such a director is also ineligible to be re-appointed as a director of the company in default. The ineligibility to be re-appointed as a director of a defaulting company stems from the fact that a director, being a member of the governing body of a company, must ensure that the company does not default either under Section 164(2)(a) or (b), as the case may be. Further, the ineligibility to be reappointed is not in the nature of a disqualification as under Section 164(1) of the Act, but only results in a temporary suspension for a period of five years which is in order to ensure compliances as stipulated under Section 164(2) of the Act. Moreover, under Section 164(1) of the Act, the material period resulting in the ineligibility is three years and not immediate which, in my view, is a reasonable period. Thus, Section 164(2)(a) of the Act resulting in an ineligibility for a director after a lapse of three consecutive financial years cannot be held to be capricious or a disproportionate repercussion, lacking in reasonableness or any rationale. Whether Section 164(2)(a) of the Act is in violation of principles of natural justice and hence ultra vires Article 14 of the Constitution as it does not envisage any hearing prior to disqualification or post-disqualification? - HELD THAT - It becomes clear that there would be no dispute with regard to the fact that financial statements or annual returns are not filed by a company for three continuous financial years. Similarly, when there is a failure to repay the debentures accepted by a company or to pay interest thereon or to redeem debentures on the due date or to pay interest due thereon or to pay any dividend declared and such failure to pay or redeem continues for one year or more the ineligibility for re-appointment applies. When such facts are apparent and show a failure by the company, for whatsoever reason or cause, the director of such a company sustains a disqualification in the form of an ineligibility - But it is only concerned with there being violation of Section 164(2)(a) or (b) of the Act, as the Act considers the same to be a serious lapse on the part of the company and it affects the directors of such a company. The disqualification is by operation of law on an emerging and coming into existence of a set of facts. There is no legal infirmity in the said provision as there is no violation of principles of natural justice and Article 14 of the Constitution is not violated. Accordingly, point No.2 is answered against the petitioners. Whether Section 164(2)(a) of the Act has retrospective operation and therefore, is unreasonable and/or arbitrary as per Article 14 of the Constitution? - Whether there has been any illegal exercise of power by the concerned respondent-authority in publishing the List of Directors, including the names of petitioners as disqualified directors, under Section 164(2)(a) of the Act? - HELD THAT - The consequences that would visit a director of a defaulting company as per Section 164(2) of the Act being distinct from what was envisaged under the 1956 Act, it is held that no period commencing prior to 01.04.2014 and ending after the said date can be the basis for reckoning the continuous period of three financial years during which financial statements or annual returns are not filed by any company. Thus, point No.4 is answered by holding that the List of directors disqualifying the petitioners herein with effect from 01.11.2016 till 31.10.2021 could not have published by taking into consideration a period prior to 01.04.2014 as well subsequent thereto while computing continuous period of three financial years under Section 164(2)(a) of the Act. Whether Section 167(1)(a) of the Act is ultra vires Article 14 and/or Article 19(1)(g) of the Constitution as being manifestly arbitrary? - Whether proviso to Section 167(1)(a) of the Act is ultra vires Articles 14 and/or 19(1)(g) of the Constitution as being manifestly arbitrary? - HELD THAT - I find much force in the argument of learned ASG that the proviso is only clarificatory in nature as Section 167(1)(a) of the Act categorically states that the office of the director shall become vacant in case he incurs any of the disqualification specified in Section 164 of the Act . The aforesaid expression cannot be read down to refer only to those disqualifications under Section 164(1)(a) to (h) of the Act. It even incorporates a disqualification incurred under Section 164(2) as well as (3) of the Act. Thus, the object of introducing Section 167(1)(a) of the Actwhen such a provision was conspicuous by its absence in 1956 Act-is to bring in higher degree of transparency and accountability in corporate governance so as to ensure control over the companies in the interest of share-holders and the public in general and in the interest of Indian economy - I do not think that it could be contended by the petitioners that Section 167(1)(a) of the Act did not envisage vacation of office of a director under Section 164(2) of the Act. Under the proviso to Section 167(1)(a) of the Act, the director of a defaulting company continues to hold the office of Director despite disqualification, his DIN cannot be cancelled. On the issue of cancellation of DIN, reference was made to Companies (Appointment and Qualification of Directors) Rules, 2014. Under Rule 14, the consequences of disqualification of directors under Section 164(2) of the Act are mentioned. That every director shall inform to the company concerned about his disqualification under sub-section (2) of Section 164 of the Act in Form DIR-8 before he is appointed or re-appointed. Further, whenever a company fails to file the financial statements or annual returns, or fails to repay any deposit, interest, dividend, or fails to redeem its debentures, as specified in sub-section (2) of section 164, the company shall immediately file Form DIR-9, to the Registrar furnishing therein the names and address of all the directors of the Company during the relevant financial year. That cancellation or surrender or deactivation of DIN is stipulated in Rule 11. It is contended that Rule 11 does not permit cancellation of or deactivation of DIN on account of disqualification of a director under Section 164(2) of the Act at all. That DIN could be cancelled on account of the death of a director or a director being declared as a person of unsound mind by a competent Court or being adjudicated as a insolvent or for other reasons, but, not for suffering a disqualification under Section 164(2) of the Act.

Summary

Here are the key points from the judgment:

Issues Involved:
1. Whether Section 164(2)(a) of the Companies Act, 2013 is ultra vires Articles 14 and 19(1)(g) of the Constitution for being manifestly arbitrary or disproportionate?
2. Whether Section 164(2)(a) violates principles of natural justice by not providing hearing before disqualification?
3. Whether Section 164(2)(a) has retrospective operation making it unreasonable/arbitrary?
4. Whether there was illegal exercise of power in publishing list of disqualified directors under Section 164(2)(a)?
5. Whether Section 167(1)(a) is ultra vires Articles 14 and 19(1)(g)?
6. Whether proviso to Section 167(1)(a) is ultra vires Articles 14 and 19(1)(g)?

Conclusions:

1. Section 164(2)(a) is not ultra vires Articles 14 or 19(1)(g). It is not manifestly arbitrary or disproportionate.

2. Section 164(2)(a) does not violate natural justice by not providing hearing as the disqualification operates by law.

3. Section 164(2)(a) does not have retrospective operation as interpreted by the Court.

4. There was arbitrary exercise of power in disqualifying directors by considering period prior to 1.4.2014 for reckoning 3 financial years under Section 164(2)(a). Such disqualification is quashed.

5. Section 167(1)(a) is not ultra vires Articles 14 or 19(1)(g).

6. Proviso to Section 167(1)(a) is partly prospective - it applies prospectively for vacating office in other companies, but clarificatory and retrospective for not vacating in defaulting company.

7. Directors of struck off companies under Section 248 don't automatically get disqualified under Section 164(2)(a).

The Court has provided a detailed interpretation of Sections 164(2)(a) and 167(1)(a) along with the proviso, keeping in mind principles against retrospective operation of law.