Madras High Court grants relief to disqualified directors of private companies

Introduction

1. The Central Government initiated campaign against black money, wilful defaulters and erring directors. After demonetisation, the Registrar of Companies identified 2.97 lakh companies during financial year 2017 – 2018 which were not filing their Financial Statements or Annual Returns for a continuous period of 2 or more financial years and, prima facie, were not conducting any business or were in operation. Out of such identified companies, the Registrar of Companies removed the names of 2,26,166 companies from the register of companies under section 248 of the Companies Act, 2013 ('the Act'). The Government identified 3,09,619 directors as disqualified directors under section 164(2)(a) of the Act pertaining to the deregistered companies for which Financial Statements or Annual Returns had not been filed for a continuous period of 3 Financial Years('FYs'). In the recent times, India Inc. and corporate law professionals are addressing two issues – Revival of deregistered company and disqualification of directors of the company. In Bhagavan Das Dhananjay Das v. Union of India [2018] 96 taxmann.com 189 (Madras), the Madras High Court granted reprieve to such disqualified directors. In the judgment, the Madras High Court addressed some pertinent issues relating to revival of deregistered companies, powers of Registrar of Companies, disqualification of directors, it's retrospective or prospective application, etc. The High Court considered a large group of writ petitions that various disqualified directors had filed before it. In doing so, the High Court interpreted the provisions of the Act and found that the actions of the Registrar of Companies were inconsistent with the statutory provisions of the law.

This article gives an analysis of the relevant facts of the case, key observations of the Madras High Court and conclusion drawn by the High Court. The observations made by the High Court about the contentious issues are quite interesting. 

2. Case of Bhagavan Das Dhananjay Das v. UOI

2.1 Facts of the case - Petitioner was a director in a private company (incorporated under the Companies Act, 1956). Petitioner was also a director of a few other private companies. One of the private companies had no operations till 2012 and the directors prepared a plan to revive the company. The board of directors of the company was reconstituted. The new management infused additional capital into the company. Inspite of the change in management, the proposed revival plan did not fructify and, as a result the company was unable to commence its business activities. During this time the company did not file annual returns with the Registrar of Companies, i.e., from Financial Year 2012-13. On March 18, 2017, the Registrar of Companies issued a show cause notice under Section 248(1) of the Companies Act to the company for striking off its name from the Register of Companies for non-filing of the annual returns for a continuous period of 3 Financial Years. On receipt of the show cause notice, the company conveyed it's no objection for striking off the name, as there were no intentions to revive the company. Subsequently, the petitioner also came to know that the name of the company was struck off under Section 248 of the Companies Act, 2013 by the Registrar of Companies by the issue of a gazette notification. The Registrar of Companies released a list of directors disqualified under Section 164(2)(a) of the Companies Act with effect from November 11, 2016. In the list, the name of the petitioner was mentioned. In view of the consequential disqualification resulting from the striking off the company, the petitioner was prohibited to be appointed or re-appointed as a director in any other company for a period of 5 years until October 31, 2021 (5 years with effect from November 11, 2016). The petitioner (and many other directors of different company) filed a writ petition challenging the order passed by the Registrar of Companies.

2.2 High Court's key observations on disqualification of directors of private companies, interpretation of 'financial year', powers of Registrar of Companies & Principles of natural justice - Before concluding on the contentious matters relating to disqualification of directors and deregistration of companies, the High Court relied on some important principles and precedents. The important points covered by the High Court are calculation of Financial Year, notices issued by the Registrar of Companies w.r.t. Directors disqualification, General Principles concerning retrospective application of law and the principles of natural justice. Following five points will give us some background of the conclusion drawn by the High Court:

(i) High Court compared the provisions of Section 164(2)(a) of the Companies Act, 2013 with the provisions of Section 274(1)(g) of the Companies Act, 1956. The High Court noted that Section 274(1)(g) of the Companies Act, 1956, which came into effect from December 13, 2000, clearly states that '3 financial years commencing on and after the first day of April, 1999', whereas the Section 164(2)(a) of the Companies Act, 2013 uses the expression 'for any continuous period of 3 financial years'. Based on this, the High Court observed that Section 164(2)(a) of the Companies Act, 2013 was made effective from April 1, 2014 as per Section 2(41) of the Companies Act, 2013, the first financial year for the purpose of Section 164 of the Companies Act, 2013 would be March 31, 2015 i.e. April 1, 2014 to March 31, 2015;

(ii) The High Court observed that Section 164(2)(a) of the Companies Act, 2013 either expressly or by implication had not contemplated that the financial year would be from April 1, 2013. The High Court opined that "The Registrar of Companies, being a statutory body, cannot be allowed to misconstrue the provisions of a statute which infringes the fundamental rights of the petitioners. Hence, the writ petitions filed under Article 226 of the Constitution of India, which is the only remedy available to the petitioners, are maintainable and the wrong interpretation of Section 164(2)(a) of the 2013 Act for wrongly disqualifying the petitioners to be eligible to be appointed as director of that company or to be appointed in any other company for a period of five years by taking into account the default in filing of annual returns or financial statements even before the provision came into force by the second respondent, is bad in law";

(iii) The High Court perused the provisions relating to Annual Return and Financial Year, observed that last date for filing the Annual Return for the third FY. (i.e., March 31, 2017) is October 29, 2017. Based on this background, the High Court stated that "When this is the legal position, as per Section 164 of the 2013 Act, the disqualification of directors of a private company can get triggered only on or after October 30, 2017, hence, the list of disqualified directors published on the website of the first respondent in September, 2017 has no legal legs to stand up to the scrutiny of the Court under Article 226 of the Constitution of India";

(iv) On the General Principles concerning retrospectivity, the Madras High Court relied on the ratio laid down by the Constitution Bench of the Apex Court in Commissioner of Income Tax (Central)-I, New Delhi v. Vatika Township Private Limited, [2015] 1 SCC 1, wherein it has been observed that "…. Of the various rules guiding how a legislation has to be interpreted, one established rule is that unless a contrary intention appears, a legislation is presumed not to be intended to have a retrospective operation. The idea behind the rule is that a current law should govern current activities. Law passed today cannot apply to the events of the past. If we do something today, we do it keeping in view the law of today and in force and not tomorrow's backward adjustment of it. Our belief in the nature of the law is founded on the bed rock that every human being is entitled to arrange his affairs by relying on the existing law and should not find that his plans have been retrospectively upset. This principle of law is known as lex prospicit non respicit: Law looks forward not backward. As was observed in Phillips v. Eyre [1870] LR 6 QB 1, a retrospective legislation is contrary to the general principle that legislation by which the conduct of mankind is to be regulated when introduced for the first time to deal with future acts ought not to change the character of past transactions carried on upon the faith of the then existing law."

(v) The High Court referred to the judgment passed by the Constitution Bench of the Apex Court in A.K. Kraipak v. Union of India, AIR 1970 SC 150, wherein the rule of the principles of natural justice was reiterated as "The aim of the rules of natural justice is to secure justice or to put it negatively to prevent miscarriage of justice. These rules can operate only in areas not covered by any law validly made. In other words, they do not supplant the law of the land but supplement it. The concept of natural justice has undergone a great deal of change in recent years. In the past it was thought that it included just two rules, namely, (1) no one shall be a judge in his own cause (Nemo debet esse jndex propria cause), and (2) no decision shall be given against a party without affording him a reasonable hearing (Audi alter partem). Very soon thereafter a third rule was envisaged and that is that quasi-judicial enquiries must be held in good faith without bias and not arbitrarily or unreasonably. But in the course of years many more subsidiary rules came to be added to the rules of natural justice. Till very recently it was the opinion of the courts that unless the authority concerned was required by the law under which it functioned to act judicially there was no room for the application of the rules of natural justice…. An unjust decision in an administrative enquiry may have more far reaching effect than a decision in a quasi-judicial enquiry".

Analysis of the conclusion drawn by the High Court

3. This part of the article is the summary of conclusions drawn by the High Court. The important and relevant points covered are retrospective effective of director's disqualification, interpretation of the 'financial year', effective date of director's disqualification, principles of natural justice and most importantly, whether the provisions relating to disqualification of directors of private companies is applicable with retrospective effect? The High Court's observations have far-reaching effects on the contentious issues relating to directors disqualification and deregistration of companies.

(i) Retrospective effect of director's disqualification was erroneous: The High Court noted that the Companies Act, 2013 came into effect from April 1, 2014 and the ROC has wrongly given retrospective effect and erroneously disqualified the petitioner-directors from November 1, 2016 itself before the deadline commenced wrongly fixing the first financial year from April 1, 2013 to March 31, 2014,

(ii) Interpretation of 'financial year' under section 164(2) of the Act with reference to MCA Circular: By virtue of the Section 164(2)(a) of the Act using the expression 'for any continuous period of three financial years' and in the light of Section 2(41) of the Act defining 'Financial Year' as well as MCA Circular, the first FY. would be from April 1, 2014 to March 31, 2015, the second FY would be from April 1, 2015 to March 31, 2016 and the third FY. would be from April 1, 2016 to March 31, 2017. Whereas the ROC clearly admitted that the default of filing statutory returns for the FYs commenced from Financial Years 2013-14, 2014-15 and 2015-16 i.e., one year before Companies Act, 2013 came into force. High Court stated that "This is the basic incurable legal infirmity that vitiates the entire impugned proceedings";

(iii) Effective date of triggering of director's disqualification: The High Court rightly observed that the disqualification could get triggered only on or after October 30, 2017, if any company fails to file annual forms for 3 Financial Years. Interestingly, the High Court stated that "It is to be borne in mind that even beyond that time limit, additional time limit of 270 days was available by virtue of the then first proviso to Section 403 (of the Act)";

(iv) Principles of natural justice against disqualification of directors: The High Court also observed that, although there is no statute or provision expressly spelling out the observance of the principles of natural justice against disqualification of directors, as the legal right of the petitioners to continue as director in other company or reappointed in any other company, which are scrupulously following the provisions of the Companies Act, have been deprived of the principles of natural justice should have been adhered to by issuing proper notice to all the directors;

(v) Whether Section 164(2)(a) of the Act has retrospective application for private companies: With respect to the retrospective application of the Companies Act, 2013 for private companies, the High Court has made some significant observations. The High Court has referred to the corresponding provisions of the Companies Act, 1956 (Section 274(1)(g) of the Companies Act, 1956) and stated that when the disqualification clause was not attracted to the directors of private companies under the Companies Act, 1956, the same cannot be allowed to take a retrospective effect under the Companies Act, 2013, i.e., when the provision of Section 164(2)(a) of the Companies Act, 2013 came into force only from April 1, 2014. The High Court stated that this is also for one more reason that the failure to file the annual returns has been adequately taken care of by the penal provision under Section 92 of the Act, making it clear that every officer of the company who is in default shall be punishable with imprisonment for a term which may extend to 6 months or with fine which shall not be less than Rs. 50,000 but which may extend to Rs. 5,00,000, or with both. The High Court further stated that under section 137 of the Act, the failure to file the financial statement visits punishment with imprisonment for a term which may extend to 6 months or with fine which shall not be less than Rs. 1 lakh but which may extend to Rs. 5 lakhs, or with both. The High Court has further stated that under section 441(4) of the Companies Act, 2013, the default in filing returns or accounts compoundable by the National Company Law Tribunal or the Regional Director or by any officer authorized by the Central Government;

(vi) Compoundable Offence – Non-filing vis-à-vis director's disqualification: The High Court observed that when the default in filing the accounts or returns are made as compoundable offence, Section 164(2)(a) of the Act providing the disqualification of director of private company not only in the defaulting company, but also from other company in which the petitioner is a director, diligently and meticulously following every provision of law, is certainly disproportionate to the lapse, as it is only regulatory in nature;

(vii) Strike off notice by the Registrar of Companies vis-à-vis Notice for directors disqualification in relation to FY: The High Court stated that the notice to be sent under Section 248(1) of the Act by the Registrar of Companies on the premise that the company has not been carrying on any business for a period of 2 FYs, is different from the disqualification u/s 164(2)(a) of the Act, inasmuch as a company can be struck off, if the company has not been carrying on any business for a period of 2 FYs, whereas for disqualification, the criteria is 3 FYs. The High Court opined that "…. although the petitioners have not challenged the provision of Section 164(2)(a) of the Act, as ROC have not followed the principles of natural justice, extinguishing the corporate life of the directors to the extent of disqualifying them to hold the directorship in the other companies, the said provision is liable to be read down, hence, Section 164(2)(a) of the Act is read down to the extent it disqualifies the directors in other companies which are scrupulously following the requirements of law, making it clear that no directors in other companies can be disqualified without prior notice";

(viii) Mischief of removal of the names of the companies by the Registrar of Companies: With reference to the deregistered company and directors disqualification the High Court stated that "It is made clear beyond any pale of doubt that the mischief of removal of the names of the companies by the Registrar of Companies and the disqualification of the directors in the defaulting company will go together, as it is inseparable, and the Registrar of Companies need not give fresh notice to the directors for their disqualification from the dormant company, if there is a failure to file the financial statement or annual return for any continuous period of 3 FYs as per Section 164(2)(a) of the Act."

Concluding Remarks

4. In a very recent development, the Supreme Court has admitted a Special Leave Petition of the Ministry of Corporate Affairs. The Supreme Court has stayed the Bombay High Court's order, which gave relief to directors of the deregistered companies. The Bombay High Court had directed the Registrar of Companies to accept physical documents of such deregistered companies and treat them as applications for voluntary striking off. This means that the directors of such deregistered companies, who are disqualified by the notice of the Registrar of Companies, would no longer be considered disqualified 

Refer:[2018] 96 taxmann.com 293 (Article)