2020 (1) TMI 169 - HC - Companies Law

Vires of the proviso to Section 167(1)(a) of the Companies Act - Disqualification for appointment of Director - case of petitioner is that petitioner's rights have not been in any manner affected by the insertion of the proviso in as much as the petitioner is not a Director in any company and has not had to vacate his office by virtue of the proviso inserted in Section 167(1)(a) of the Companies Act by the Companies (Amendment) Act 2017 - HELD THAT - As per Section 167(1)(a) of the 2013 Act, the office of the Director is to become vacant if a Director incurs any disqualification as provided for under Section 164. However, such all-encompassing provision existed in the 1956 Act with each of the grounds for vacation being listed individually. It is important to note that liability under Section 274(1)(g) was not a ground for a Director to vacate his post in any company. Before the impugned proviso was inserted in the Companies Act 2013, Directors of a company who had defaulted under Section 164(2) would have to vacate their post as Director of the defaulting company only. This was leading to a situation where any person who became a Director of a company which had defaulted under Section 164(2) automatically attracted Section 167(1). Thus, no person could be appointed as a Director in those companies which had defaulted under Section 164(2). Section 274(1)(g) of the Companies Act 1956 was made to protect investors rights and to ensure that Directors of companies act vigilantly in preventing any misfeasance or discrepancy which may affect investors and the public. It is thus held that the underlying object of Section 274(1)(g) is facilitating good corporate governance and it cannot be declared unconstitutional without considering the purpose that the provision serves - the legislative intent behind the inclusion of the proviso to Section 167(1)(a) is also to ensure good governance and inculcate a sense of security in investors through transparent disclosures and control over erring Directors. The filing of returns and disclosures regarding the finances of the company are vital to ensure greater transparency and accountability to the public which is the need of the hour in today's corporate set up. These measures are extremely necessary in the interest of fair trade and ensuring justice. Additionally, a great deal of responsibility is borne by the Directors of a company to ensure that the company acts in accordance with laws and upholds the principles of transparency and probity - A Director must not derelict his duties as a Director and must exercise all due diligence necessarily to ensure that the company abides by laws and regulations. A Director, irrespective of the nature of Directorship, by virtue of the fact that he holds the position of Directorship cannot claim immunity for the defaults of the company in the filing of returns or the business of the company, and therefore cannot be made to vacate his post in other companies. This Court can take judicial notice of the fact that people invest their hard earned money in companies in which there are persons of repute holding the position of a Director. The Director therefore cannot absolve himself of the misdeeds of the company after holding a position in the company - There is thus a rational nexus between the amendment and the object for which the amendment was brought about in the Companies Act 2013. The contention of the petitioner that the proviso to Section 167(1)(a) is irrational, manifestly arbitrary and unreasonable, and thus must be declared as ultra vires Article 14 of the Constitution of India cannot be accepted. The exclusion of Directors from vacating their posts in the defaulting company while doing so in all other companies where they hold Directorship has been done in order to prevent the anomalous situation wherein the post of Director in a company remains vacant in perpetuity owing to automatic application of Section 167(1)(a) to all newly appointed Directors. Secondly, the underlying object behind the proviso to Section 167(1)(a) is seen to be the same as that of Section 164(2) both of which exist in the interest of transparency and probity in governance. Owing to these justifications, the Court thus holds that the proviso to Section 167(1)(a) is neither manifestly arbitrary nor does it offend any of the fundamental rights guaranteed under Part III of the Constitution of India. Petition dismissed.

Summary

Issues Involved
1. Vires of the proviso to Section 167(1)(a) of the Companies Act, as inserted by the Companies (Amendment) Act 2017.
2. Locus standi of the petitioner.
3. Constitutionality and arbitrariness of the proviso to Section 167(1)(a) under Article 14 of the Constitution of India.

Detailed Analysis

1. Vires of the Proviso to Section 167(1)(a)
The central issue in the writ petition is the challenge to the vires of the proviso to Section 167(1)(a) of the Companies Act, 2013, which states: "Provided that where he incurs disqualification under sub-section (2) of section 164, the office of the director shall become vacant in all the companies, other than the company which is in default under that sub-section."

The petitioner contends that this proviso leads to unequal treatment of Directors based on whether they hold positions in multiple companies. The petitioner argues that this differential classification lacks intelligible differentia and is arbitrary, thus violating Article 14 of the Constitution. The petitioner also claims that the provision irrationally affects non-defaulting companies and punishes individual Directors for the defaults of a company even when fault cannot be directly attributed to them.

2. Locus Standi of the Petitioner
The petitioner, a Company Secretary, previously challenged the impugned proviso through another writ petition, which was withdrawn. The court noted that the petitioner was not granted liberty to file a fresh petition for the same relief. The petitioner’s rights were not affected by the proviso as he is not a Director in any company and has not had to vacate his office. Therefore, the petitioner lacks locus to institute the present writ petition. Despite this, the court chose to address the substance of the challenge rather than dismissing the petition solely based on locus standi.

3. Constitutionality and Arbitrariness of the Proviso
The court examined the constitutionality of the proviso in light of Article 14. It was noted that prior to the 2017 amendment, Directors of a defaulting company would have to vacate their post only in the defaulting company, leading to a situation where no person could be appointed as a Director in such companies. The amendment aimed to rectify this by ensuring that a Director of a defaulting company does not vacate his post in the defaulting company but must vacate his post in all other companies.

The court referred to the legislative intent and the Company Law Committee’s recommendations, which aimed to prevent a paradoxical situation where the office of all Directors in a defaulting company would become vacant, leaving no one to manage the company. The amendment was intended to ensure good governance and transparency, protecting investors and ensuring compliance with statutory requirements.

The court also referenced judgments from the Gujarat High Court in Saurashtra Cement Ltd. and the Bombay High Court in Snowcem India Ltd., which upheld similar provisions in the Companies Act 1956, emphasizing the importance of good corporate governance and protection of investors.

The court concluded that the proviso to Section 167(1)(a) has a rational nexus with the object it seeks to achieve, which is to ensure transparency, probity, and accountability in corporate governance. The proviso was found to be neither manifestly arbitrary nor violative of Article 14. The court upheld the validity of the proviso, dismissing the writ petition.

Conclusion
The court dismissed the writ petition, holding that the proviso to Section 167(1)(a) of the Companies Act is constitutionally valid and does not violate Article 14. The proviso serves the purpose of ensuring good corporate governance and protecting investors by mandating that Directors of defaulting companies vacate their posts in other companies, thereby preventing the perpetuation of mismanagement and ensuring accountability.