[Disqualification of Directors] 2014 and 2018 amendments to Companies Act are prospective: Calcutta High Court

"Such an amendment (if retrospective) would, without fail, be anomalous and absurd, outlying the “reasonableness” envisaged in Article 19(6) of the Constitution", the Court said.
[Disqualification of Directors] 2014 and 2018 amendments to Companies Act are prospective: Calcutta High Court
Calcutta High Court

The Calcutta High Court recently ruled that the 2014 amendment to Section 164(2) and the 2018 amendment to proviso to Section 167(1)(a) of the Companies Act, 2013 are prospective in nature opining that their retrospective application would be anomalous, absurd, unreasonable and could potentially ruin the economy (Naresh Kumar Poddar v. Union of India, through Secretary, Ministry of Corporate Affairs and another).

These provisions deal with the disqualification of the director of a company for not filing financial statements for a continuous period of three years and/or balance sheet within thirty days of the date of the Annual General Meeting. On account of such failure, the director would be disqualified for a five year period.

On Tuesday, Justice Sabyasachi Bhattacharyya ruled that these provisions can be applied only prospectively.

The judgment was rendered on a petition moved by the director of a private limited company who had been disqualified by a 2017 notification for the period between November 1, 2016 and October 3, 2021.

The Court opined that it cannot but be held that the operation of the 2014 and 2018 Amendments to the Companies Act are prospective, given the punitive consequences these provisions entail, the ground-level impact and the practical impossibility of giving them retrospective effect.

"The relevant test here is not a mere lip-service to public good but of the ground-level impact of the amendment. Such an amendment (if retrospective) would, without fail, be anomalous and absurd, outlying the “reasonableness” envisaged in Article 19(6) of the Constitution," the Court found.

Therefore, it accepted the petitioner's contention that he could not have been disqualified through the retrospective application of the above provisions.

The Court clarified:

  • The amendment to Section 164(2), introduced on April 1, 2014, has to be applied prospectively. The first possible three-year default contemplated has to commence from the financial year 2014- 2015 (April 1, 2014 - March 31, 2015) and end in the financial year 2016-2017 (ending on March 31, 2017).

  • As far as the amended proviso to Section 167(1)(a) of the 2013 Act is concerned, the operation of such proviso also has to be construed prospectively by applying it to companies in default of Sections 92 and 137 of the Companies Act only after May 7, 2018.

The petition was allowed and the deactivation of the petitioner's Director Identification Number (DIN) by the challenged 2017 notification was set aside.

Advocates Palash Tiwari and Prasoon Agrawal appeared for the petitioner. Advocate Avinash Kankani appeared for the respondent side.

What the Legal Provisions say

Section 164 (2)(a) deals with the disqualification of the Director of a company for failure to file financial statements or annual returns for a continuous period of three financial years. Section 167 (1) (a) calls for directors to vacate their office in a company upon incurring disqualification as per Section 164 of the Companies Act, 2013.

The proviso to Section 167 (1) (a) states that when a director is disqualified on account of the company failing to file its financial statements or it defaults on other dues prescribed under Section 164 (2), such person would have to vacate director’s office in all other companies (in which he is director) but not the company that committed the default.

Questions before the Court

  1. Whether Section 164(2)(a), as introduced by the 2014 Amendment and the proviso to Section 167(1)(a), as introduced by the 2018 Amendment, are prospective, retrospective or retroactive in nature?

  2. Whether there is any scope for giving opportunity to the defaulting company or its directors to represent against the disqualification under Section 164, read with Section 167 of the 2013 Act?

Contentions made before the Court

The petitioner argued that Section 164 (2) of the Companies Act came into force only from April 1, 2014. It can only be applied prospectively, he contended and the first time liability that can be fixed under this provision would be for the financial years 2014- 2015, 2015-2016 and 2016-2017. The disqualification of a director with effect from November 1, 2016 was, therefore, patently illegal. Similarly, the 2018 amendment to the proviso to Section 167 (1)(a) only kicked in during May 2018. The proviso would be applicable to companies whose names are struck off only after the introduction of the 2018 Amendment, that is, after May 7, 2018. It could not be invoked in the case of the petitioner. The impugned notice disqualifying the petitioner for five years from November 1, 2016 to October 31, 2021 is premature and untenable at law.

On the other hand, the respondents argued that the Sections 164(2)(a) and 167(1)(a) of the Companies Act could not be read in isolation. The nature of Section 164(2) was disqualifying as opposed to penal in nature. Penal consequences for failure to file statements/returns are provided for separately. As such, the provision was retrospective in nature. As far as Section 167(1)(a) was concerned, it was argued that the 2018 amendment was introduced to remedy a paradoxical situation where no new person could be appointed to a Board that became vacant owing to the disqualification of its directors. The provision was curative and declaratory in nature. Since it was aimed to remedy unintended consequences and make Section 167(1)(a) workable, it had to be treated as retrospective in operation.

What the Court held

Disqualification is penal in nature

Justice Bhattacharyya dismissed the contention that Section 164 (2) did not entail penal consequences. He noted that the other provisions of the Companies Act only provided for the imposition of pecuniary fines.

On the other hand, the 2014 amendment to this Section introduced a new consequence of the directors of a defaulting company being disqualified and ineligible for re-appointment as a director for five years. The judge opined that such a consequence was penal, stating:

"Although the aforesaid provisions “disqualify” the directors for a span of five years, the effect of such disqualification is patently penal in nature", reads the judgment.

He went on to explain that such a consequence would also affect the Director's Constitutional rights, if not prospectively applied.

"The concerned director misses out on participation in company affairs for five crucial years and might lose relevance in the cut-throat rat-race of the corporate world. This directly affects the fundamental right of the director, enshrined in Article 19(g) of the Constitution of India, that is, the right to practice any profession, or to carry on any occupation, trade or business", reads the judgment.

Given its penal nature of disqualification, the Court opined that both the provisions must be applied prospectively. Otherwise, it would not have been possible for the director of a company to foresee "that the rigours of the 2014 or the 2018 Amendment would be breathing down their neck soon" when the default takes place.

"If retroactive effect is given thereto, and would entail the directors suffering a grievous violation of their fundamental right under Article 19(1)(g) of the Constitution without any possibility of the directors, or anyone for that matter, having been able to predict such consequence on the relevant date, that is, the date of such default. In such a factual scenario, it cannot be argued by reasonable prudence that a retroactive effect ought to be given to the amendment-in-question. This is an irreconcilable anomaly that would befall the directors if retrospective/retroactive effect is given to the amendments-in-question, not justiciable even by applying Article 19(6) of the Constitution", the Court said.

Retrospective operation could ruin economy

The Court proceeded to take stock of the potential implications on the economy if a retrospective application is given to the two amendments, opining that "the fall-out of retrospective operation of the amendments is fatal to small and medium businesses, which still comprise the backbone of the economy."

The Court added that there may be situations where larger operators may remain affected while the credibility and goodwill of small companies may take a hit.

"... there might be ‘Black Swan’ situations, for example, economic recession and debilitating pandemics, which would throw off business and commerce out of gear for considerable periods of time, having little or no effect on robust or anti- fragile (Courtesy: Nassim Nicholas Taleb for the terms ‘Black Swan’ and ‘anti-fragile’) large operators but ruining the credibility and goodwill of small companies, completely veering them off course … This, coupled with the automatic disqualification envisaged in the 2014 and 2018 amendments to the 2013 Act, is sufficient to ruin the economy as a whole which, somewhat counter-intuitively, is detrimental to the growth of the economy. Thus, attributing retrospective/retroactive effect to the said amendments would run contradictory to the purpose of public good. The simplistic approach of merely identifying non-performers in an attempt to provide a fillip to commerce, by a pseudo-streamlining of the economy, loses teeth in the broader perspective discussed above," the judgment said.

No scope application of natural justice when it comes to Sections 164 (2) and 167(1)(1)

Insofar as the second question was concerned, the Bench agreed with the respondents that there is no discretion vested with the authorities when it comes to disqualification of directors for the defaults laid out in Sections 164 and 167.

As such, there would be little point in given the defaulter an opportunity to be heard. In other words, there would be no scope for the application of natural justice principles in such matters.

"It is well-settled that the rules of natural justice can only be applied if an opportunity of hearing/representation is of relevance and affects the outcome of the procedure. In the absence of any discretion of the authorities, since the disqualification under the said sections is automatic on the perpetration of the defaults contemplated therein, an opportunity of representation/hearing to the defaulter would merely be an exercise in futility," the Court said.

[Read Judgment]

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