TMI Blog2020 (1) TMI 169X X X X Extracts X X X X X X X X Extracts X X X X ..... y. This was leading to a situation where any person who became a Director of a company which had defaulted under Section 164(2) automatically attracted Section 167(1). Thus, no person could be appointed as a Director in those companies which had defaulted under Section 164(2). Section 274(1)(g) of the Companies Act 1956 was made to protect investors rights and to ensure that Directors of companies act vigilantly in preventing any misfeasance or discrepancy which may affect investors and the public. It is thus held that the underlying object of Section 274(1)(g) is facilitating good corporate governance and it cannot be declared unconstitutional without considering the purpose that the provision serves - the legislative intent behind the inclusion of the proviso to Section 167(1)(a) is also to ensure good governance and inculcate a sense of security in investors through transparent disclosures and control over erring Directors. The filing of returns and disclosures regarding the finances of the company are vital to ensure greater transparency and accountability to the public which is the need of the hour in today's corporate set up. These measures are extremely necessary i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r.R.Rajesh ORDER Subramonium Prasad,J. The challenge in the instant writ petition is to the vires of the proviso to Section 167(1)(a) of the Companies Act, as inserted by the Companies (Amendment) Act 2017. The same is extracted hereunder:- (i) in clause (a), the following proviso shall be inserted, namely:- Provided that where he incurs disqualification under sub-section (2) of section 164, the office of the director shall become vacant in all the companies, other than the company which is in default under that sub-section. ; 2. The petitioner is a Company Secretary. The petitioner herein had previously challenged the impugned proviso before this Court through WP.No.22813 of 2018. However, the same was withdrawn on 19.11.2019 with the permission of the Court as the same was filed in the nature of a Public Interest Litigation. The petitioner has subsequently filed the instant writ petition. It is to be noted that the petitioner was not granted any liberty to institute a fresh petition for the same relief upon the earlier writ petition being withdrawn. The permission to withdraw the Public Interest Litigation was granted by this Cou ..... 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Provided that if a person has been convicted of any offence and sentenced in respect thereof to imprisonment for a period of seven years or more, he shall not be eligible to be appointed as a director in any company; (e) an order disqualifying him for appointment as a director has been passed by a court or Tribunal and the order is in force; (f) he has not paid any calls in respect of any shares of the company held by him, whether alone or jointly with others, and six months have elapsed from the last day fixed for the payment of the call; (g) he has been convicted of the offence dealing with related party transactions under section 188 at any time during the last preceding five years; or* (h) he has not complied with sub-section (3) of section 152' or** [(i) he has not complied with the provisions of sub-section (1) of section 165.] (2) No person who is or has been a director of a company which - (a) has not filed financial statements or annual returns for any continuous period of three financial years; or (b) has failed to repay the deposits accepted by it or pay interest thereon or to redeem any deb ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... re an appeal or petition is preferred within thirty days as aforesaid against the conviction resulting in sentence or order, until expiry of seven days from the date on which such appeal or petition is disposal of; or (iii) where any further appeal or petition is preferred against order or sentence within seven days, until such further appeal or petition is disposed of; (g) he is removed in pursuance of the provisions of this Act; (h) he, having been appointed a director by virtue of his holding any office or other employment in the holding, subsidiary or associate company, ceases to hold such office or other employment in that company. (2) If a person, functions as a director even when he knows that the office of director held by him has become vacant on account of any of the disqualifications specified in subsection (1), he shall be punishable with imprisonment for a term which may extend to one year or with fine which shall not be less than one lakh rupees but which may extend to five lakh rupees, or with both. (3) Where all the directors of a company vacate their offices under any of the disqualifications specified in sub-s ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... here is no justification provided for mandating the vacation of Directorship in other companies, thus leading to this provision being arbitrary and violative of Article 14 of the Constitution of India. It is also contended that the impugned provision irrationally has a detrimental effect on other, non-defaulting companies and punishes individual Directors for the defaults of a company even when fault cannot be directly attributed to them. The petitioner also claims that the impugned proviso also violates the principles of natural justice. 8. Prior to the Companies Act 2013, the corresponding provision to Section 164 in the 1956 Act was Section 274 and the provision corresponding to Section 164(2) was Section 274(1)(g) which was included to the Act through an amendment on 13.12.2000. Section 274 as it stood prior to the Companies Act 2013 reads as under:- 274. DISQUALIFICATIONS OF DIRECTORS. (1) A person shall not be capable of being appointed director of a company, if - (a) he has been found to be of unsound mind by a Court of competent jurisdiction and the finding is in force ; (b) he is an undischarged insolvent ; (c) he has applied to be adjudicated as an ins ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... shall become vacant if - (a) he fails to obtain within the time specified in sub-section (1) of section 270, or at any time thereafter ceases to hold, the share qualification, if any, required of him by the articles of the company ; (b) he is found to be of unsound mind by a Court of competent jurisdiction ; (c) he applies to be adjudicated an insolvent ; (d) he is adjudged an insolvent ; (e) he is convicted by a Court of any offence involving moral turpitude and sentence in respect thereof to imprisonment for not less than six months ; (f) he fails to pay any call in respect of shares of the company held by him, whether alone or jointly with others, within six months from the last date fixed for the payment of the call unless the Central Government has, by notification in the Official Gazette, removed the disqualification incurred by such failure ; (g) he absents himself from three consecutive meetings of the Board of directors, or from all meetings of the Board for a continuous period of three months, whichever is longer, without obtaining leave of absence from the Board ; (h) he (whether ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... incurs any disqualification as provided for under Section 164. However, such all-encompassing provision existed in the 1956 Act with each of the grounds for vacation being listed individually. It is important to note that liability under Section 274(1)(g) was not a ground for a Director to vacate his post in any company. 11. Before the impugned proviso was inserted in the Companies Act 2013, Directors of a company who had defaulted under Section 164(2) would have to vacate their post as Director of the defaulting company only. This was leading to a situation where any person who became a Director of a company which had defaulted under Section 164(2) automatically attracted Section 167(1). Thus, no person could be appointed as a Director in those companies which had defaulted under Section 164(2). This was noted in the judgment dated 14.11.2019, passed by the Hon'ble Delhi High Court in Mukut Pathak Ors Vs. Union of India, WP.No.9088 of 2018 which while placing reliance on the decision dated 09.07.2019 of the Hon'ble Bombay High Court in Kaynet Finance Ltd. Vs. Verona Capital Ltd., Appeal Lodging No.318 of 2019 in Arbitration Petition No.716 of 2019 wherein, the D ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ection 167(1)(a) of the Act was materially amended by the Companies Amendment Act, 2018 by introduction of the provisos to Section 164(2) and Section 167(1)(a) of the Act with effect from 07.05.2018. All directors who incur disqualification under Section 164(2) of the Act after the said date, would also cease to be directors in other companies (other than the defaulting company) on incurring such disqualification. However, the operation of the provisos to Section 164(2) and Section 167(1)(a) of the Act cannot be read to operate retrospectively. The proviso to Section 167(1) of the Act imposes a punitive measure on directors of defaulting companies. Such being the nature of the amendment, the same cannot be applied retrospectively. It is well settled that the Statute that impairs an existing right, creates new disabilities or obligations-otherwise than in regard to matters of procedure-cannot be applied retrospectively unless the construction of the Statute expressly so provides or is required to be so construed by necessary implication. Therefore, the office of a director shall become vacant by virtue of Section 167(1)(a) of the Act on such director incurring the disqualifications ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... g Director, it does not allow such consideration and he has to vacate office on conviction, even if an appeal had been preferred against such conviction and sentence. The Committee, therefore, recommended that such inconsistency be corrected and in case of requirement for vacation of office of a Director, it should not take effect until the appeals are disposed off, while in case of disqualification, it is not required to provide for period of pendency of appeal. (emphasis supplied) 13. A perusal of the above quoted report brings out the justification for the suggested proviso to Section 167(1)(a). The purpose of the amendment was that if the post of Directorship is vacated under the provision (as it was) then, this post would remain vacant as these provisions would automatically apply to any individual subsequently appointed. There were two solutions proposed to rectify this, firstly, it was recommended that vacancy of the office should only be acknowledged when the conditions under Section 164(1) are satisfied and not when there is liability under Section 164(2). The second solution suggested that disqualification under Section 167(1)(a) read with Section 16 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... time. The passing of this Bill is thus likely to be delayed further. It is however considered desirable by the Government that some more important changes in the Companies Act, 1956, are brought out in order to provide immediately certain measures for good corporate governance and for protection of investors. These measures are as follows (xiv) to provide that in case of a public company which does not file annual accounts and annual returns continuously for the last three years, the directors of such companies will be debarred from becoming the director of other public companies for five years. Similarly, in the case of any public company which fails to repay its depositors on maturity of deposit amount/debentures, dividend and interest on deposits/debentures on due dates. The whole-time directors of defaulting companies as on such date will be debarred from becoming a director of any other public company for a period of five years. 16. According to newly amended Act, a person shall not be capable of being appointed director of a company, if such person is already a director of a public company which has not filed annual accounts and annual returns for an ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... [2005] 124 Comp Cas 161 : [2005] 60 SCL 50, and the Division Bench of the High Court has upheld the vires of section 274(1)(g) of the Companies Act by holding that: (1) The Statement of Objects and Reasons for enactment of section 274(1)(g) is for better corporate governance and protection of investment of the depositors. Such amendment would ensure transparency in the functioning of the company and would lead to the protection of investment and investors for better corporate governance. According to the wisdom of the Legislature, this can be achieved by enhancing penalty/punishment for contribution so as to ensure better compliance with the provision of the Act; (2) Article 21 of the Constitution is not at all attracted; (3) Section 274(1)(g) of the Act does not violate the directors' fundamental rights guaranteed under article 19(1)(g) of the Constitution of India. The amendment does not debar the petitioners from carrying on any business, trade or occupation, only that the person have been rendered incapable of becoming directors in other companies and the said amendment became imperative in view of a large number of companies becoming defa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s with this company, in the hope of getting reasonable interest on their deposits. It is expected that such amendment would ensure transparency in the functioning of the company and would lead to the protection of the investment of investors and better corporate governance. According to the wisdom of the Legislature, this can be achieved by enhancing penalty/punishment for contravention so as to ensure better compliance with the provisions of the Companies Act, 1956. 14. We fail to appreciate how article 21 of the Constitution is attracted, which refers to right to live. The challenge seems to be totally without any merit. We would appreciate if the submission is made on behalf of the small investors, who had deposited their lifetime savings with the petitioners and similar other companies where these small investors do not receive either the principal or interest and consequently, their children may not be provided education and/or medical treatment affecting their families' fundamental rights guaranteed under article 21 of the Constitution. Therefore, if at all there is violation of article 21, it is the violation of fundamental right under article 21 of the childr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... merit in the submission of the petitioners that this amendment is violative of article 14 of the Constitution. The provision of section 274(1)(g) does not make distinction between the Government-nominated directors and other directors. The Government of India, Ministry of Law, Justice and Company Affairs, letter dated March 22, 2003, has interpreted the composite effect of the non obstante clause in the statute of public financial institutions like Industrial Development Bank of India, Life Insurance Corporation of India, Unit Trust of India, etc., and gave an opinion that the directors appointed by these institutions cannot be disqualified as appointment as directors is by virtue of section 274(1)(g) and also directors appointed on the boards of assisted companies, etc. 17. A perusal of the above extract reveals that the Bombay High Court in Snowcem India Ltd Ors Vs. Union of India, has held that Section 274(1)(g) of the Companies Act 1956, would not violate Article 19 or 14 of the Constitution of India as it does not restrict an individual's freedom to carry on his business, trade or occupation, does not create any unreasonable classification and merely acts as ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... g company will be in the hands of those persons who know nothing about the business, operation and management of the company. It is required to be noted that on the aforesaid ground a provision of a statute cannot be declared ultra vires . One has to consider the very provision of the statute and the purpose for the said provision. The purpose is to see that under the threat of the aforesaid provision, the whole board of directors may act vigilantly and may see to it that the company is revived and the affairs of the company are managed in such a manner that ultimately deposits are repaid and/or debentures are redeemed. Otherwise, no company would try to improve their affairs and ultimately try to protect the interest of the investors. The purpose of the provision is not to punish those who are so disqualified only but to save the community from the consequences of mismanagement and to protect the public against future conduct of persons whose past records as directors shows them to be a danger to creditors and others. The hon'ble Supreme Court in R.K. Garg v. Union of India, (1981) 4 SCC 675, 690 : [1982] 133 ITR 239, has held as under (page 255): laws relating ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... or discrepancy which may affect investors and the public. It is thus held that the underlying object of Section 274(1)(g) is facilitating good corporate governance and it cannot be declared unconstitutional without considering the purpose that the provision serves. 20. In our opinion, the legislative intent behind the inclusion of the proviso to Section 167(1)(a) is also to ensure good governance and inculcate a sense of security in investors through transparent disclosures and control over erring Directors. The Hon'ble Supreme Court in N.Narayanan Vs. Adjudicating Officer, Security and Exchange Board of India, (2013) 12 SCC 152, in paragraphs 35 and 36 state as under:- 35. Gower and Davies in Principles of Modern Company Law, 9th Edn. (2012) at p. 751, reiterated their views on the scope and rationale of annual reporting required under the Companies Acts, as follows: On the basis that forewarned is forearmed the fundamental principle underlying the Companies Act has been that of disclosure. If the public and the members were enabled to find out all relevant information about the company, this, thought the founding fathers of our company law, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... cise all due diligence necessarily to ensure that the company abides by laws and regulations. The relevant paragraphs are extracted hereunder:- 45. It is certainly a question of fact, to be determined upon the evidence in each case, whether a Director, alleged to be liable for misfeasance, had acted reasonably as well as honestly and with due diligence, so that he could not be held liable for conniving at fraud and misappropriation which takes place. A Director may be shown to be so placed and to have been so closely and so long associated personally with the management of the Company that he will be deemed to be not merely cognizant of but liable for fraud in the conduct of the business of a Company even though no specific act of dishonesty is proved against him personally. He cannot shut his eyes to what must be obvious to everyone who examines the affairs of the Company even superficially. If he does so he could be held liable for dereliction of duties undertaken by him and compelled to make good the losses incurred by the Company due to his neglect even if he is not shown to be guilty of participating in the commission of fraud. It is enough if his negligence is of s ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of their authority and must disclose that they are acting on behalf of the company. The fiduciary capacity within which the Directors have to act enjoins upon them a duty to act on behalf of a company with utmost good faith, utmost care and skill and due diligence and in the interest of the company they represent. They have a duty to make full and honest disclosure to the shareholders regarding all important matters relating to the company. It follows that in the matter of issue of additional shares, the Directors owe a fiduciary duty to issue shares for a proper purpose. This duty is owed by them to the shareholders of the company. Therefore, even though Section 81 of the Companies Act, 1956 which contains certain requirements in the matter of issue of further share capital by a company does not apply to private limited companies, the Directors in a private limited company are expected to make a disclosure to the shareholders of such a company when further shares are being issued. This requirement flows from their duty to act in good faith and make full disclosure to the shareholders regarding affairs of a company. The acts of Directors in a private limited company are required to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s or creditors does not continue as Director in other companies. This proviso will also act as a deterrent from incorporating shell companies to park illegally obtained money. There is thus a rational nexus between the amendment and the object for which the amendment was brought about in the Companies Act 2013. The contention of the petitioner that the proviso to Section 167(1)(a) is irrational, manifestly arbitrary and unreasonable, and thus must be declared as ultra vires Article 14 of the Constitution of India cannot be accepted. 24. It is well established by decisions of the Hon'ble Supreme Court such as Subramanian Swamy v. Director, Central Bureau of Investigation, (2014) 8 SCC 682, Indian Express Newspapers (Bombay) Private Ltd. v. Union of India, (1985) 1 SCC 641 and Cellular Operators Association of India v. Telecom Regulatory Authority of India, (2016) 7 SCC 703 that legislation can be struck down if the same is shown to be manifestly arbitrary and thus violative of Article 14 of the Constitution of India. 25. The test for examining whether or not a legislation is manifestly arbitrary has been examined in detail by the Hon'ble Supreme Court in Sh ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... pers (Bombay) (P) Ltd. v. Union of India, (1985) 1 SCC 641 : 1985 SCC (Tax) 121] , this Court said that a piece of subordinate legislation does not carry the same degree of immunity which is enjoyed by a statute passed by a competent legislature. A subordinate legislation may be questioned under Article 14 on the ground that it is unreasonable; unreasonable not in the sense of not being reasonable, but in the sense that it is manifestly arbitrary . Drawing a comparison between the law in England and in India, the Court further observed that in England the Judges would say, Parliament never intended the authority to make such rules; they are unreasonable and ultra vires . In India, arbitrariness is not a separate ground since it will come within the embargo of Article 14 of the Constitution. But subordinate legislation must be so arbitrary that it could not be said to be in conformity with the statute or that it offends Article 14 of the Constitution. 44. Also, in Sharma Transport v. State of A.P. [Sharma Transport v. State of A.P., (2002) 2 SCC 188] , this Court held: (SCC pp. 203-04, para 25) 25. The tests of arbitrary action applicable to executive ac ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... om the consequences of mismanagement and also to prescribe strict standards of corporate managership. The purpose of the disqualification is not only to punish the Director but also to protect the public against future conduct by person whose past record as directors shows a great danger to creditors and others. The intention of the impugned amendment is to ensure proper governance of companies, transparency in working of companies and also to ensure more effective enforcement of the provisions of the Companies Act 2013. The petitioner placing a reliance upon paragraphs 15 and 18 of the decision of the Hon'ble Supreme Court in B.Manmad Reddy Vs. Chandraprakash Reddy, (2010) 3 SCC 314, contended that any classification must be done in a just manner, bearing a rational relation to the object that is sought to be achieved. He further placed reliance on paragraphs 31 to 36 of the decision of the Hon'ble Supreme Court in Lok Prahari Vs. State of Uttar Pradesh, (2018) 6 SCC 1, contending that any legislation that is irrational and manifestly arbitrary is violative of Article 14 of the Constitution of India. However, based on the above reasoning, the impugned proviso cannot be see ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of vacating the office of a director of a defaulting company in the defaulting company and in all other companies in which he is a director is in the interest of transparency, probity and protection of share-holders' rights. It is also in order to achieve greater accountability in corporate governance. For the same reason, it is held that Section 167(1)(a) of the Act is also not unreasonable as it has been made in public interest and is not in violation of Article 19(1)(g) of the Constitution as it is saved under Article 19(6) of the Constitution. 195.At the outset, it would be relevant to delineate on the scope and object of a proviso to the provision. (a) The normal function of a proviso is to except something out of the provision or to qualify something enacted therein which, but for the proviso, would be within the purview of the provision. As a general rule, a proviso is added to an enactment to qualify or create an exception to what is in the enactment and ordinarily, a proviso is not interpreted as stating a general rule. In other words, a proviso qualifies the generality of the main enactment by providing an exception and taking out as it were, fr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... and not merely, an exception or qualifying what has been stated before In other words, if the substantive enactment is worded in the form of a proviso, it would be an independent legislative provision concerning different set of circumstances than what is worded before or what is stated before. Sometimes, a proviso is to make a distinction of special cases from the general enactment and to provide it specially. (d) At this stage, the construction or interpretation of a proviso could be considered. InIshverlal Thakorelal Almaulav.Motibhai Nagjibhai[AIR 1966 SC 459], while dealing with the Bombay Tenancy and Agricultural Lands Act, 1948, the Hon'ble Supreme Court held, that a proper function of a proviso is to except or qualify something enacted in the substantive clause, which but for the proviso, would be within that clause. InKaviraj Pandit Durga Dutt Sharmav.Navaratna Pharmaceutical Laboratories[AIR 1965 SC 980], while considering proviso to Section 6 of Trade Marks Act, 1940, it was observed that it would not be a reasonable construction for any statute, if a proviso which in terms purports to create an exception and seeks to confer certain special rights on a par ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... (3) it may be so embedded in the Act itself as to become an integral part of the enactment and thus acquire the tenor and colour of the substantive enactment itself; and (4) it may be used merely to act as an optional addenda to the enactment with the sole object of explaining the real intendment of the statutory provision. (f) The approach to the construction and interpretation of a proviso are enunciated in the following cases. In M. Pentiahv.Muddala Veeramallappa, [AIR 1961 SC 1107], it was observed that while interpreting a section or a proviso, if the choice is between two interpretations, the narrower of which would fail to achieve the manifest purpose of the legislation, one should avoid a construction which would reduce the legislation to futility and should rather accept the bolder construction based on the view that Parliament would legislate only for the purpose of bringing about an effective result. In Superintendent Remembrancer of Legal Affairs to Govt. of West Bengal v. Abani Maity, [(1979) 4 SCC 85:AIR 1979 SC 1029], the Apex Court observed that the statute is not to be interpreted merely from the lexicographer's angle. The Court must g ..... X X X X Extracts X X X X X X X X Extracts X X X X
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