Disqualification of directors - Delhi High Court clarifies the legal position

Introduction

The Government of India ("Government") has initiated a slew of measures through which it wants to restrict the menace of shell companies and non-filing of financial returns of companies. In this regard, the Government through ROC applying Section 164(2) of the Companies Act, 2013 ("Companies Act") started disqualifying the Directors who had not filed the financial statements or annual returns for a continuous period of three (3) financial years of their respective companies[i].

Recently, the aforesaid provision was challenged by numerous disqualified Directors of different companies before the Hon'ble Delhi High Court ("Court"). The Court tagged all the similar matter and vide a common judgment pronounced in the case of Mukut Pathak & Ors, vs. Union of India & Anr[ii] decided the issue in question. Apart from other issues, the main aspect being challenged by the Petitioners was whether, in computing the consecutive three-year period for purposes of section 164(2) of the Companies Act, the financial year 2013-14 ending on 31st March, 2014 can be taken into account when the provision itself came into effect only on 1st April, 2014. The three-year period in question was 2013-14, 2014-15 and 2015-16.

Whether the disqualification of directors was done by retrospective application of the provision?

The main contentious issue raised by the Petitioners was whether the directors can be disqualified prior to the date the statutory provision coming into force by retrospectively applying the provision. The Court came to the conclusion that section 164(2) of the Companies Act was prospective in nature. The Court further went on to review the question as to the whether financial year 2013-14 should be consider for disqualifying the Directors of defaulting companies as such that date/period of default was prior to date of enforceability of the provision itself.

Court's observation

The Court rejected the claim of the Petitioners that the financial year could not be considered for the purpose of disqualifying directors u/S. 164(2) of the Companies Act. The Court stated that companies by law were mandatorily required to file financial returns even prior to the provision coming into effect. Therefore, in the event of existing requirement to file financial returns and thus, non-compliance of the same would lead to disqualification of director as envisaged under section 164 of the Companies Act.

The Court stated as follows -

"46. The penal consequences of not filing returns for three consecutive financial years would be attracted on section 164 of the Act coming into force. Section 164 of the Act came into force on 01.04.2014 and thus, 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. Undisputedly, the concerned companies (and vicariously the petitioners) were obliged to file the financial statements for the financial year 2013-14 after 01.04.2014. As noticed above, the failure to do so would be in violation of Section 137(2) of the Act and this Court finds no reason why such defaults should not be considered for the purposes of Section 164 of the Act. 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 has occurred after the provisions of section 164 of the act had become applicable.
........

52. 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....

As per the Court, Section 164 (2) of the Companies Act sets out the conditions, on which directors of the defaulting company could be disqualified from being appointed or reappointed as a director in other company for a period of five years. The court clarified that disqualification of the Directors under Section 164(2) of the Companies Act occurred post May 7, 2018. Therefore, as per section 164(2) and 167(1) (a) of the Companies Act a Director is terminated from his office in all companies other than the defaulting company.

Conclusion

Evidently, the Court in this Case has tried to address the endeavor of the Government in eradicating shell companies. One hopes that the ultimately, the issues relating to disqualification of Directors is settled once and for all by this judgment in the Case. Of course, as a most likely step, the ball will fall into the Supreme Court when the Petitioners appeal against this judgment.

[i]The disqualification of directors is prescribed under section 164(2)(a) of the Companies Act, 2013
[ii] W.P. (C) 9088/2018
[iii]167. Vacation of office of director
(1) The office of a director shall become vacant in case—
(a) he incurs any of the disqualifications specified in section 164

This update is by Rohitaashv Sinha, Advocate & Associate Partner at Agarwal Jetley & Co., Advocates & Solicitors. Contact: Email: rohitaashv.sinha@agarwaljetley.com or Mob: (+91) - 9999565393