Disqualification of Directors under Section 164(2) Companies Act: What the Delhi HC held
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Disqualification of Directors under Section 164(2) Companies Act: What the Delhi HC held

Aditi Singh

The Delhi High Court has held that the disqualification of directors under Section 164(2) of the Companies Act cannot be applied retrospectively.

The Single Judge Bench of Justice Vibhu Bakhru held,

“Concededly, 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. This Court is of the view that the taking into account such default does not amount to a retrospective application of Section 164 of the Act.”

It was also held that a director would not demit office in terms of Section 167(1) of the Companies Act, 2013 on account of a disqualification incurred under Section 164(2) for conduct prior to the amendments to the Act introduced from May 7, 2018.

However, if a director suffers any of the disqualifications under Section 164(2) on or after May 7, 2018, he would demit the office of director in all companies other than the defaulting company by virtue of the provisos to Section 164(2) and 167(1)(a).

The Court has also held that under the Companies Act or its Rules, the Central government has no power to cancel or deactivate the Director Identification Number (DIN) on account of a director suffering a disqualification under Section 164(2) of the Act.

The judgment was passed in a batch of petitions challenging the disqualification of the petitioners as directors of their respective companies.

The petitioners were disqualified under Section 164(2) for default on the part of concerned companies in filing the annual returns and financial statements for the financial years 2014-2016. Similarly, two more lists of disqualified directors were published for defaults pertaining to the financial years 2012-2014 and 2013-2015.

As relief, the petitioners had also sought a direction to the Central government to allow them to use their Digital Signature Certificates (DSC) and Director Identification Numbers (DIN).

The petitioners broadly contended that the action of the Centre in disqualifying them was arbitrary inasmuch as they were not afforded an opportunity to be heard. Secondly, it was stated that since Section 164 was penal in nature, it could not be applied retrospectively.

Further, the petitioners argued that a plain interpretation of Section 164(2)(a) suggested that they could not 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.

The petitioners lastly contended that the defaults under Section 164(2) of the Act resulted in the directors being disqualified from being appointed/re-appointed as directors, but did not result in their demitting office as directors.

After hearing the parties, the Court noted that the case was limited to the interpretation of Section 164(2) and Section 167(1)(a) of the Act, and not their constitutional validity.

The Court went on to frame a number of issues on the provisions relating to the disqualification of directors.

  1. Whether the provisions of Section 164(2)(a) are retrospective and what is its scope?

 he Court stated that there could be no dispute that the provisions of Section 164(2) were prospective in nature.

However, the controversy pertained to whether the defaults in relation to the financial year ending March 31, 2014, would be taken into account for the purposes of the section, which came into force on April 1, 2014.

Answering the issue in affirmative, the Court opined that in view of the scheme of the Act, even though the financial year ending March 31, 2014 had ended before Section 164 came into force, the Annual General Meeting in respect of that financial year under Section 92(4) of the Act was required to be held by September 20, 2014 i.e. after the Section had come into force.

.. the failure of a company/its directors to file annual returns (for three financial years) thereafter would result in the directors incurring the disqualification as specified under Section 164(2) of the Act. It is of little consequence that such defaults relate to filing annual returns that pertain to a period prior to 01.04.2014..Merely, because the returns to be filed pertain to a period prior to 01.04.2014, is of no relevance considering that the default in doing so (after the AGM) has occurred after the provisions of section 164 of the act had become applicable.”

In view of the above, the Court concluded that disqualification of directors premised on the defaults committed prior to Section 164 come into force could not be sustained.

The default in filing the financial statements/annual returns for the financial year ending 31.03.2013 had occurred on the failure of the concerned companies to file the same by 31.10.2013. This was prior to Section 164(2) of the Act coming into force. Similarly, the third list is also premised on the failure to file financial statements / annual returns pertaining to FY 2011-12 and FY 20120-13. These were to filed latest by 31.10.2012 and 31.10.2013.”

2. Whether a prior notice and an opportunity of being heard was required to be afforded to the petitioners before including their names in the impugned list and whether the impugned list is void as being violative of principles of natural justice?

The Court observed that Section 164 (2) of the Act merely set out the conditions, which if not complied with, would disqualify an individual from being re-appointed or appointed as a director.

The provision entails no decision-making process on the part of the authorities and no authority is required to exercise any discretion or take any judicial or quasi-judicial decision regarding the disqualification of directors, it said.

The Court therefore, held that in these circumstances, the rule of audi alteram partem would be inapplicable.

It is difficult to understand as to how such principles would assist in the administrative procedure where an authority is not required to take any qualitative decision. The question whether a person fulfils the stipulated qualifications leaves little room for debate.”

3. Whether the directors incurring a disqualification under Section 164(2) of the Act would demit their office as a director in all companies or only in the defaulting company in terms of Section 167(1)(a) of the Act?

The Court held that a director would not demit office by virtue of Section 167(1)(a) on account of disqualifications incurred under Section 164 (2) of the Act prior to the amendments introduced from May 7, 2018.

However, if they suffer any of the disqualifications under Section 164(2) on or after May 7, 2018, the clear implication of the provisos to Section 164(2) and 167(1)(a) is that they would demit their office in all companies other than the defaulting company, the Court added.

The Court observed that Section 164(2) stipulates a default committed by a defaulting company, which results in the directors of that company incurring the disqualification being vicariously responsible for such defaults.

For such default, the director may not be directly responsible but he nonetheless, is disqualified to act as a director on account of being responsible for the affairs of the defaulting company by virtue of his holding the office of a director.

A plain reading of Sub-Section (2) of Section 164 indicates that his functioning as a director in companies, in which he holds such office at the time of incurring the disqualification, is not affected. Such disqualification triggers in respect of appointment in the future after he has incurred the disqualification.”

The Court noted that where a person is disqualified from being appointed/reappointed as a director under Section 164(1), the import of Section 167(1)(a) is that such a director demits his office immediately on incurring such disqualification.

However, importing the same consequence to disqualification under Section 164(2) would result in an absurd situation where a defaulting company can never appoint a director, the Court remarked.

In view of the above, the Court opined that there was a compelling reason for limiting the scope of Section 167(1)(a) to the disqualification incurred under Section 164(1) of the Act.

..t.he disqualifications under Section 164(1) of the Act are directly attributable to the individuals incurring such disqualifications. These include an individual being declared insolvent, of being unsound mind, and being convicted of an offence involving moral turpitude. Clearly, such persons cannot continue to hold the office of a director on incurring such disqualifications.

It would be irrational to await for the reappointment of a director for Section 164 to trigger in respect of companies in which such individuals stand appointed as directors. Thus, the Parliament in its wisdom has enacted clause (a) of section 167(1) of the Act to provide for such directors to immediately vacate their office as a director, on incurring the disqualifications under section 164(1) of the Act…”

The Court then went on to examine the impact of the provisos to Section 167 (a) and Section 164(2) which were introduced by the Companies (Amendment) Act, 2018.

Holding that the provisos were not clarificatory but substantive, the Court stated that by virtue of the amendment, a person appointed as a director of a defaulting company would not incur such disqualification for a period of six months and would consequently also not cease to be a director of any company by application of Section 167(1)(a) of the Act.

Extending the punitive measure under section 167(1)(a) to such directors would expose the said section to a challenge on the ground of being manifestly unreasonable and arbitrary, the Court remarked.

However, if they suffer any of the disqualifications under Section 164(2) 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.

4.  Whether the act of the respondents in deactivating the DIN of the directors is sustainable?

The Court observed that there is no impediment for a person who has been temporarily disqualified from acting as a director, to apply for a DIN.

It stated that the rationale behind DIN is only to ensure that any person acting as a director has a unique identity to identify him and there was no obligation on him give up this identification number only because he is temporarily disqualified for being appointed as a director.

The Court further noted that neither any of the provisions of the Companies Act nor its Rules stipulate “cancellation or deactivation of DIN” on account of a director suffering a disqualification under Section 164(2) of the Act.

It is important to note that whereas a DIN is necessary for a person to act as a director; it is not necessary that a person who has a DIN be appointed as a director. Section 164(2) only provides for temporary disqualification for a period of five years for a person to be appointed/re-appointed as a director. Thus, it is not necessary that the DIN of such person to be deactivated.”

In view of the above findings, the petitions were accordingly disposed of.

The Centre was represented by Central Government Standing Counsel Shiva Lakshmi, Vikram Jetley, and Bharathi Raju with Advocates Siddharth Singh, Sriram Krishna, Maya Narula, Ruchir Mishra, Sanjiv Kumar Saxena, MK Tiwari,  Ramneek Mishra, and Abhishek Rana.

The petitioners were represented by Advocates Indraneel Ghosh, Vinita Sahaitya, Kaushik Mandal, Aseem Malhotra, Vaibhav Dang.

[Read the Judgment]

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