Interpretation on Section 164(2) of The Companies Act

-NISHTHA SINGH

Background (Section 164(2) of Companies Act)

Companies Act 2013 is an Act of the Indian Parliament that regulates the incorporation of a company, responsibilities of a company, directors, dissolution of a company. The Companies Act is divided into 29 chapters, containing 470 clauses as against 658 Sections in the Companies Act, 1956 and has 7 schedules. The Act has replaced The Companies Act, 1956 (partially) after receiving the assent of the President of India on 29 August 2013. The Act came into force on 12 September 2013 with only certain provisions of the Act notified. Section 164(2) of Companies Act, 2013 deals with the disqualifications for the appointment of directors. A person is disqualified by law for being appointed as a director if,

  • he has been declared by the court of possessing an unsound mind
  • is an undischarged insolvent
  • also is adjudicated insolvent and his application is pending
  • he has been convicted by a court and given punishment for more than six months
  • he has been ordered disqualified by a court or tribunal.

Under section 164(2) of the Companies Act, a person who is a director, cannot be re-appointed in that or any other company, for the next five years if,

  • the company has not filed financial statements and/or Annual Returns for 3 years in continuation
  • the company has failed to pay depositors or shareholders their dues; defaulted for more than a year.

ALSO READ: Need to install mobile iPad in police control vans- Delhi HC

Interpretation on Section 164(2) of The Companies Act

Current Issues (Delhi HC on Section 164(2) of Companies Act)

Delhi High Court has clarified the position of law in disqualification of directors under section 164(2) of the Companies Act. Under the said section, directors of companies that have defaulted on filing financial returns for three consecutive years are disqualified from being appointed as directors for 5 years.

While ruling upon the retrospective applicability of section 164(2), Justice Vibhu Bakhru held that the said section can apply to failure in filing returns for financial years prior to 2014, the year in which the said section came into force.

While acknowledging the judgments passed by the High Courts of Gujarat, Madras, and Karnataka, which had held section 164(2) as having prospective applicability, the court went on to note that the operation of the said section in the present case, doesn’t amount to retrospective application of a penal provision. The court said:

‘Merely because an enactment draws on events that are antecedent to its coming in force does not render the said enactment retrospective’.

The present batch of petitions were filed by the directors of various companies who were disqualified from being appointed / reappointed as directors for a period of five years, under Section 164(2)(a) of the Companies Act, by virtue of their companies failing to file financial returns in the past 3 consecutive years.

Further, the names of some of the companies, in which the petitioners were holding the office of directors, were also struck off from the Register of Companies.

Therefore, the Petitioners had sought directions to be issued to the Ministry of Corporate Affairs to allow them to use their Digital Signature Certificates (DSC) and Director Identification Number (DIN).

In the pursuance of their case, the Petitioners had made the following submissions before the court:

The action of the respondents in disqualifying the Petitioners is arbitrary inasmuch as the petitioners were not afforded an opportunity to be heard. They contended that the said action is in violation of principles of natural justice.

Section 164 of the Act, which mandates the disqualification of directors, being penal in nature, could not be applied retrospectively.

On the plain interpretation of Section 164(2)(a) of the Act, the petitioners cannot 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

Defaults under Section 164(2) of the Act result in the directors being disqualified from being appointed/re-appointed as directors but does not result in them demitting office as directors.

The Respondents, on the other hand, argued that sufficient opportunity had been provided to the petitioners to correct the default of not filing the statutory documents.

Retrospective Applicability of Section 164

While dealing with the issue regarding retrospective applicability of section 164(2), the court faced with a significant question as to whether the default as contemplated in clause (a) of Section 164(2) of the Act, in respect of a financial year prior to the said provision coming into force, could be considered for the purposes of the said Section.

The court rejected the claim of the Petitioners by opinions that non-filing of financial returns was already prohibited under the Companies Act. Therefore, when the same prohibition was envisaged under section 164, the retrospective application of the same has no significant adverse effect on the rights of the defaulting companies.

Therefore, the court held that 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.

However, the penalty under section 164(2) would not extend to defaults committed prior to 01.04.2014

Justice Vibhu Bakhru highlighted that:

merely because it also takes into account an event that had occurred prior to the Act coming into force, the same would not render the said enactment as retrospective. Such a law would not suffer from the vice of being ex post facto. This is so because it neither impairs any vested or accrued right nor imposes any new disabilities in respect of events that had occurred earlier’.

Whether a prior notice and an opportunity of being heard was required

The court opined that Section 164 (2) of the Act merely sets out the conditions, which if not complied with would disqualify an individual a person from being reappointed or appointed as a director.

This provision does not entail any decision-making process on the part of the Authorities administering the Act. No Authority is required to exercise any discretion or take any judicial or quasi-judicial decision regarding the disqualification of a director.

Therefore, the rule of audi alteram partem is incapable of section 164(2).

The court also provided the following reason for the same:

Undisputedly, in a large number of cases, withholding of information was willful as the information pertained to shell companies, which were incorporated to serve a limited purpose. The purpose of debarring such directors from

participating in any corporate entity as a director is to ensure that persons who take up the mantle of becoming directors of companies are conscious of their responsibility of ensuring that the companies comply with the statutory requirement’.

Interpretation on Section 164(2) of The Companies Act

Interpretation of Section 164(2)

The court denied the interpretation put forward by the Petitioners, and went on to hold that the disqualification under section 164(2) would also apply to ‘reappointments’.

The court also clarified that directors disqualified under Section 164(2), that happened 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.

The court also directed the Respondents to reactivate the DIN and DSC of the petitioners. While doing so, the court noted that the Central Government has framed the rules specifying the conditions in which a DIN may be canceled, cannot cancel the same on any other ground and without reference to such rules.

 Conclusion

The ministry, through circulars issued on September 6 and 12, 2017, removed over 1 lakh companies that had failed to file their annual returns and other documents from the register of companies in a crackdown on shell entities.

Over 3.5 lakh directors of such companies were disqualified with retrospective effect from April 1, 2014. Their director identification numbers (DINs) were deactivated, preventing them from acting in this capacity in other companies.

In the first such instance of its kind, the high court also revived the DINs of directors affected by the government’s move. “Their DINs will be revived forthwith,” the court said.

The order, allowing directors to function in other active companies, for now, is expected to open the floodgates for other similarly placed individuals to move the courts for appropriate relief. The petition, filed through lawyers GP Madaan and Ishan Madaan, contended that the Companies Act of 2013 could not have been applied retrospectively to remove their companies from the register without first giving them a hearing under the 2016 rules.

It argued that the move to disqualify them retrospectively made all their earlier actions suspect under law. Besides, it would prevent them from filing papers for other companies that were otherwise active, adding to the already existing sick units.

The directors raised several important law points, including whether the 2013 law could penalize them for acts done before it came into force.

Companies can be struck off the register only after due notice, they argued. In this case, no such opportunity was given to the companies, they said.

The directors were not only disqualified from the companies struck off the list, but also new ones under Sections 164 (2) and 167 of the 2013 act. They contested the legality of Section 164 on the ground that it was borrowed from Section 274 (1) (g) of the Companies Act, 1956, which applied only to public limited companies.

ALSO READ: Delhi High Court – The Zero Pendency Project