In Part I of this series, we had discussed the ambiguities surrounding the rectification of non-compliances under the Companies Act, 2013 (“Act”). In Part II, we seek to address another critical aspect of the Act – the imposition of liability on a company’s officer for offences and non-compliances by the Company.[1]
Evolution of officer’s liability for corporate offences/ non-compliances
A company, being a juristic entity, operates through certain individuals who are at the helm of its affairs. When a company contravenes any law, including the Act, the board of directors –considered the “mind” of the company[2] –is often held accountable along with the company. The concept of attributing liability to directors and other officers for corporate offences/ non-compliances has existed for a long time. However, the scope of “who” can be made liable has evolved over time. Starting from the Companies Act, 1913, the liability for lapses/ non-compliances was placed on the officers of a company. It wasn’t until the Companies Act, 1956 that the concept of an “officer who is in default” was introduced, marking a shift towards limiting liability to the officer directly responsible for offence/ non-compliance under the Act.
Understanding ‘who’ qualifies as an ‘officer who is in default’ under the Act
The term “officer who is in default” has been defined under Section 2(60) of the Act as “an officer of the company who is in default shall be liable to any penalty or punishment by way of imprisonment, fine or otherwise ….”. Further, Section 2(59) of the Act defines an officer to include “any director, manager or key managerial personnel or any person in accordance with whose directions or instructions the Board of Directors or any one or more of the Directors is or are accustomed to act”. This inclusive definition for an “‘officer”’ under the Act makes it ambiguous, leaving room for interpretation.
The Act attempts to provide some clarity on the intended regulatory net by giving an indicative list of individuals who would qualify as being an officer who is in default, namely:
“(i) whole-time director; (ii) key managerial personnel; (iii) where there is no key managerial personnel, such director or Directors as specified by the Board in this behalf and who has or have given his or their consent in writing to the Board to such specification, or all the Directors, if no director is so specified; (iv) any person who, under the immediate authority of the Board or any key managerial personnel, is charged with any responsibility including maintenance, filing or distribution of accounts or records, authorises, actively participates in, knowingly permits, or knowingly fails to take active steps to prevent, any default; (v) any person in accordance with whose advice, directions or instructions the Board of Directors of the company is accustomed to act, other than a person who gives advice to the Board in a professional capacity; (vi) every director, in respect of a contravention of any of the provisions of this Act, who is aware of such contravention by virtue of the receipt by him of any proceedings of the Board or participation in such proceedings without objecting to the same, or where such contravention had taken place with his consent or connivance; (vii) in respect of the issue or transfer of any shares of a company, the share transfer agents, registrars and merchant bankers to the issue or transfer”.[3]
Understanding the regulatory threshold governing ‘shadow directors’
Under the Act, directors can be broadly categorised as executive and non-executive. Non-executive directors, including independent directors and nominee directors, are members of the Board of Directors but are not responsible for the company’s day-to-day affairs. While the Act does not expressly define “shadow directors”, [4], they can be deemed to be included within the ambit of the term’s “officer” and “officer who is in default”. This is so because of the Act’s inclusion of “any person in accordance with whose directions or instructions the Board of Directors or any one or more of the Directors is or are accustomed to act”[5] and “any person in accordance with whose advice, directions or instructions the Board of Directors of the company is accustomed to act, other than a person who gives advice to the Board in a professional capacity”[6] as an “officer” and “officer who is in default,” respectively. Interestingly, this understanding is in line with the definition of “shadow directors” under the UK Companies Act 2006, which define them as follows “(1) In the Companies Acts “shadow director”, in relation to a company, means a person in accordance with whose directions or instructions the directors of the company are accustomed to act. (2) A person is not to be regarded as a shadow director by reason only that the directors act on advice given by him in a professional capacity (3) A body corporate is not to be regarded as a shadow director of any of its subsidiary companies for the purposes of— Chapter 2 (general duties of directors), Chapter 4 (transactions requiring members’ approval), or Chapter 6 (contract with sole member who is also a director), by reason only that the directors of the subsidiary are accustomed to act in accordance with its directions or instructions”[7]. The concept of “shadow directors” was discussed and considered from an Indian company’s law perspective by the Expert Committee on Company Law (the “JJ Irani Committee”) which submitted their report on May 31, 2005. The JJ Irani committee recommended inter alia that “the law should also seek to discourage ‘shadow directors’ who tend to operate from behind the scenes by adopting a framework of ‘attributability’ of directions to such persons, if the Board is accustomed to act on their instructions in any or all matters”.[8]
Does the anticipatory and ex post facto relief afforded to ‘officers’ adequately shield them from unnecessary litigation risk?
The Act provides certain avenues for allowing an ‘officer’ who may have /anticipate proceedings against them under the Act to seek relief. Section 463(1) of the Act stipulates that: “If in any proceeding for negligence, default, breach of duty, misfeasance or breach of trust against an officer of a company, it appears to the court hearing the case that he is or may be liable in respect of the negligence, default, breach of duty, misfeasance or breach of trust, but that he has acted honestly and reasonably, and that having regard to all the circumstances of the case, including those connected with his appointment, he ought fairly to be excused, the court may relieve him, either wholly or partly, from his liability on such term, as it may think fit”. While this grants courts the discretion to excuse an officer who has “acted honestly and reasonably”, the relief is ex post facto, meaning it applies after the fact and the officer still has to bear the onus of proving that he/she deserves to be excused from liability. This discretionary relief, however, does not extend to cases where the proceedings against the officer are criminal in nature.[9]
Interestingly, the Act also provides an officer to seek anticipatory relief, it stipulates under Section 463(2) of the Act, that “Where any such officer has reason to apprehend that any proceeding will or might be brought against him in respect of any negligence, default, breach of duty, misfeasance or breach of trust, he may apply to the High Court for relief and the High Court on such application shall have the same power to relieve him as it would have had if it had been a court before which a proceedings against that officer for negligence, default, breach of duty, misfeasance or breach of trust had been brought under sub-section (1)”.
Regulatory Ambiguity in Liability Threshold of Certain Classes of Directors
It must be noted that the directors are also included in the “officer in default” category, given its broad definition of under Sections 2(59) and 2(60) of the Act. The key question here is whether independent directors, appointed under Sections 2(46) and 149(6) of the Act, and non-executive directors fall within the ambit of “officers in default”. Their involvement spanning control and oversight over the day-to-day affairs is arguably much lower than those included within the ambit of “officer” and hence the concern if they should be held liable to the same extent.
To this end, Section 149(12) of the Act carves out a safe harbour for independent directors (“IDs”); and non-executive directors who do not qualify as promoters or key managerial personnel of the company (“NEDs”). It stipulates that they shall only be held liable “in respect of such acts of omission or commission by a company which had occurred with his knowledge, attributable through Board processes, and with his consent or connivance or where he had not acted diligently”. This immunity while limited in scope, is similar to the ‘business judgement rule’.[10]
The Ministry of Corporate Affairs (“MCA”) has further clarified the intent behind Section 149(12) vide its General Circular dated March 2, 2020, titled “Clarification on prosecutions filed or internal adjudication proceedings initiated against Independent Directors, non-promoters and non-KMP non-executive directors – reg” (“Circular”)[11]. The Circular makes it clear that the MCA intends to exclude the liability of IDs and NEDs. It also creates a rebuttable presumption in favour of NEDs and IDs, stating that civil or criminal proceedings should not be initiated against them unless there is sufficient evidence to suggest that the defaults/lapses are directly attributable to them. Notably, the National Company Law Tribunal (“NCLT”) applied the directions issued in the Circular and waived off fines payable by non-executive directors.[12]
Although, attempts are made to safeguard IDs, it is not clear whether these protections are enough. Pertinently there are no safeguards in place at the summons stage, which would leave the IDs vulnerable to reputational damage and unnecessary litigation[13] in the event that they are summoned for lapses/defaults. This is exacerbated by the fact that the differential status of IDs is not specifically recognised under such legislations as the Contract Labour (Regulation and Abolition) Act, 1970, the Environment (Protection) Act, 1986, the Prevention of Money Laundering Act, 2002 etc., which significantly reduces the utility of the safeguard under Section 149(12) of the Act.
Increasing Regulatory Vigilance: Need for reform
On the one hand, there is increased regulatory vigilance, which is advantageous since it showcases the regulatory intent to protect the stakeholders’ interests. On the other hand, over-regulation can have the opposite effect, especially in cases when both the company and its directors are held liable for compliance offences/ non-compliances under the Act. This becomes more concerning in light of the recent increase in the imposition of penalties on a company’s officers for both mundane and technical non-compliances, such as incorrect pagination, etc.[14] Further, the net for “who” might be held liable for a company’s offences/ non-compliances is cast too wide due to the inherent ambiguities in the regulatory thresholds (as was also seen in the ROCs order in relation to LinkedIn India)[15] which can potentially become a deterrent for the ease of doing business in India.
Conclusion
Against this backdrop, it has become increasingly important for companies to put in place robust internal regimes that ensure compliance with the necessary processes and procedures under the Act. Given the ambiguity surrounding the persons who can be made liable for any default/lapse on part of the company, it would be advisable for companies to err on the side of caution whenever in doubt in relation to any compliances under the Act and push for over compliance as opposed to minimal or dotted line compliance.
For further information, please contact:1
Ankoosh Mehta, Partner, Cyril Amarchand Mangaldas
ankoosh.mehta@cyrilshroff.com
[1] You can read part I of this series here – Ambiguities in Regulatory Thresholds for Rectifying Breaches under the Companies Act, 2013 | Dispute Resolution Blog (cyrilamarchandblogs.com)
[2] Section 179 of the Act.
[3] Section 2(60) of the Act.
[4] Section 2(34) of the Act defines ‘director’ as “a director appointed to the Board of a company” which automatically excludes a ‘shadow director’ from its scope.
[5] Section 2(59) of the Act.
[6] Section 2(60)(v) of the Act.
[7] Section 251 of UK Companies Act 2006.
[8] May 2005, J. J. Irani Report of the Expert Committee on Company Law.pdf (ibbi.gov.in), Chapter 12 – Offences and Penalties, paragraph 10.
[9] Proviso to Section 463(1) of the Act.
[10] You can read more about this rule here – The Business Judgment Rule: The Indian context | India Corporate Law (cyrilamarchandblogs.com); Vicarious Liability of Non-Executive Directors: A Case for Reform of Law | India Corporate Law (cyrilamarchandblogs.com)
[11] The Circular is accessible here – Circular_03032020.pdf (mca.gov.in).
[12] In the matter of North East Regional Agricultural Marketing Corporation Limited, NCLT, Guwahati Bench, CP/13/441(1)/GB/2023 order dated November 9, 2023
[13] You can read a critique on the same here – Vicarious Liability of Non-Executive Directors: A Case for Reform of Law | India Corporate Law (cyrilamarchandblogs.com)
[14] Adjudication order passed by the Registrar of Companies of Mumbai on August 9, 2024 in relation to Landt Welfare Company Limited accessible here, and L&T Employees Welfare Foundation Private Limited accessible here; and by the Registrar of Companies of the NCR of Delhi and Haryana on August 9, 2024 in relation to Blue Sapphire Healthcares Private Limited accessible here.
[15] Please read our detailed critique on the ROC order in relation to LinkedIn India here – Ambiguities in Regulatory Thresholds for Rectifying Breaches under the Companies Act, 2013 | Dispute Resolution Blog (cyrilamarchandblogs.com)
