RETROSPECTIVE EFFECT OF THE DISQUALIFICATION OF DIRECTORS UNDER THE COMPANIES ACT, 2013

Source : Company Bug

This article has been authored by Thrisha Rai, a second year student of Jindal Global Law School, Jindal Global University.

The Companies Act 2013, under section 164(2)(a), stipulates that if a director of a company fails to file its financial statements or annual returns for a consecutive period of three or more financial years then he shall face disqualification for a period of five years.

In September 2017, the Ministry of Corporate Affairs published a list of directors who had been disqualified by virtue of their failure to file the annual returns or financial statements of their company for the financial year (‘FY’) 2014-2016. Additionally, the Ministry also published two more lists with defaulting directors for the FYs 2012-2014 and 2013-2015. The Director Identification Number (DIN) of these directors was also deactivated without giving them any prior notice by the ministry with the rationale that disqualified directors would have to vacate their office in all the other companies where they were directors and hence, they are not permitted to act as directors for a period of five years. The three lists were challenged by the disqualified directors in the Delhi High Court in the case of Mukut Phatak vs Union of India.

Retrospective Application

The petitioners, among other grounds, challenged the lists on the grounds that it was retrospective in nature as Section 164 of Companies Act, 2013 was a penal provision and hence could not have a retrospective application. The petitioners had reasoned that the section came into force on 1st April, 2014 whereas they had been disqualified for defaults that occurred for the years prior to April 1st 2014. While considering the issue of retrospective application the court observed that the respondents had not contended that the Act would be retrospectively applicable. Hence, the Court observed that the legislation could be only prospectively applicable. The Court established that the pertinent question while deliberating the issue of retrospective application was that whether a failure to file financial statements and annual returns for the FYs 2013-2014 and the subsequent application of the section 164(2) Companies Act, 2013 could be construed as retrospective application?

Rationale

The Court opined that a statute cannot be termed as retrospective for the sole reason because it “affects existing rights or because a part of the requisites for its action is drawn from a time antecedent to its passing.” The court viewed the issue of retrospective application by the yardstick of whether it divests a person of vested rights or if it creates new obligations or disability in respect of transactions or actions done in the past. It also gave consideration to the fact that there was no contention to the fact that the earlier Companies Act of 1956 and the Act of 2013 both compel a company to file its financial statement within the required time. Thus, the court concluded that even though the financial year ending on 31st March 2014 had ended before section 164 of the Act had come into force, the Annual General Body Meeting was to be held within by September 2014, which is after the Act came into force and financial statements had to be filed within thirty days and the annual returns within 60 days of the AGM.

Therefore, the court ruled that a director could not contend that he had a vested right against penalization for default just because the financial year had closed prior to the Act’s enforcement as the date on which the default occurred is clearly after the date of the enforcement of the Act as the respondent were not claiming any default which had occurred or an action which had to be performed prior to the Section 164 coming into force. Therefore, the court concluded that a failure of filing the returns for the financial year ending March 2014 will be considered for ascertaining if a director was liable to be disqualified under section 164(2) of Companies Act, 2013.

While the court upheld the disqualification by the first list, it ruled that the directors who were disqualified for the default in the financial years ending on 31st march 2013, 2014 and 2015 and the default in the years ending 31st March 2012,2013,2014 must be quashed. With the same rationale that the default and filing of financial statements which were to be latest done by 31st October 2013, which was prior to the Act coming into force. Therefore, the second and third lists were set aside.

This view of the Delhi High Court was in contrast to the judgements delivered by the High Court of Madras, Gujrat and Karnataka.

The High Court of Karnataka in the case of Yashodhara Shroff vs Union of India held that for a default under the Section 164(2) of Companies Act, 2013, no year prior to 2014 could be considered and hence the it ruled that it could only have a prospective order.

In agreement with the above stance, the High Court of Gujarat in Gaurang Balvant Lal Shah vs Union of India held that the provision will not be applicable retrospectively as it is not specified in the law. The court also considered that the Companies Act, 1956 did not have a provision for the disqualification of directors of a private company. Therefore, if the Section is upheld it will alter the rights of the directors of the private company.

Further, the High Court of Madras, in Bhagavan Das Dhananjaya Das vs Union of India set aside the list of disqualified directors for financial years 2013-14 as it considered it to be applicable for financial year ending 2015 as the general circular was released on 4th April 2014. Employing a similar rationale like the High Court of Gujarat, the High Court of Madras reasoned that the under the previous act, the directors of private companies were not subject to disqualification.

The Delhi High Court also considered the issue of whether the directors who were disqualified under the Section 164(2)would be compelled to demit their office as a director in all the companies. In accordance with Section 167(1)(a) of Companies Act, 2013 the court decided that for the statutory interpretation, the plain or literal rule could not be applied for interpreting the provisions and therefore the court read down the provisions of section 167 of the Act to apply only to instances of disqualification falling under section 164(1) of the Act and not section 164(2) of the Act. Consistent with this the court held that the directors would be disqualified from only the defaulting companies and would do be required to demit their position in the other non-defaulting companies.

Road ahead

While the Delhi High Court has contradictory views with other High Courts in this case and seems to be more pragmatic with rationale employed with respect to the vested rights of the directors, by trying to examine which action or from when the Act would be prospectively applicable there still seems to be a lot ambiguity around the issue of application of the statute.

In December 2020, the Delhi High Court upheld the decision in Mukut Phatak vs Union of India while deciding the case of Sandeep Agarwal v Union of India and stated that proviso to Section 167(1)(a) of the Act is not to be read and applied retrospectively. Exhibiting the importance of purposive or legislative intent interpretation the court also held that the notification of CFSS (Companies Fresh Start Scheme) launched by the Government on March 30,2020 with the intention of giving a relief to companies who had defaulted in filing the requisite documents and helping them make a fresh start. Therefore, in the cases where petitioners are directors of multiple companies, disqualification from a non-defaulting active company should not be sustained as, if the directors are disqualified perpetually then the objectives of CFSS scheme would not be met.

While there are several challenges, there is no stay on the judgement passed in Mukut Phatak vs Union of India, it continues to hold persuasive value in the other High Court jurisdictions but with the difference of opinions among different courts the onus lies on the Supreme Court to address the ambiguity especially with so many other schemes likely to be introduced in a post-pandemic economy to decide as to what exactly will constitute a retrospective application of law and disqualification of directors and its subsequent effect on the business environment in the country.