K.S. Mehta Vs. M/S Morgan Securities & Anr. : Supreme Court Reiterates That Non-Executive Directors Are Not Vicariously Liable U/S 138 of NI Act

Introduction

The Supreme Court in K.S. Mehta & Ors. vs. M/S Morgan Securities & Credits Pvt. Ltd. reaffirmed that non-executive and independent directors cannot be held liable under Section 138 read with Section 141 of the NI Act unless their direct involvement in financial transactions is established. The Court emphasized that vicarious liability under the NI Act must be interpreted strictly, and mere designation as a director does not automatically impose financial liability.

Background

The dispute in K.S. Mehta & Ors. vs. M/S Morgan Securities & Credits Pvt. Ltd. arose from an Inter-Corporate Deposit (ICD) agreement dated September 9, 2002, executed between M/S Blue Coast Hotels & Resorts Ltd. and the respondent, M/S Morgan Securities & Credits Pvt. Ltd., under which a financial facility of ?5 crores was availed. As part of the repayment, the company issued two post-dated cheques, which were later dishonored due to insufficient funds. Subsequently, the respondent initiated criminal proceedings under Section 138 read with Section 141 of the Negotiable Instruments Act, 1881 (NI Act) against all the directors, including the appellants, K.S. Mehta and Basant Kumar Goswami, who were designated as non-executive directors.

The appellants argued that they were not involved in the company’s financial transactions, had no role in the issuance or dishonor of the cheques, and their position in the company was purely non-executive, confined to governance oversight. Additionally, corporate governance reports (CGR) and Registrar of Companies (ROC) records confirmed their non-executive status, indicating that they had no executive authority or control over financial decision-making. Despite this, the Delhi High Court dismissed their petition seeking quashing of the criminal proceedings, leading to the present appeal before the Supreme Court.

Questions of Law

1. Whether non-executive and independent directors can be held vicariously liable for dishonored cheques under Section 138 read with Section 141 of the NI Act.
2. Whether mere designation as a director or attendance at board meetings is sufficient to impose liability under the NI Act.
3. Whether criminal proceedings against non-executive directors can be sustained in the absence of specific allegations proving their direct involvement in financial decisions.

Findings and Rationale

1. Non-Executive Directors Are Not Liable Without Direct Involvement: The Supreme Court ruled that non-executive and independent directors cannot be held liable under Section 138 NI Act unless specific allegations demonstrate their active participation in the company's financial transactions. The Court observed:"This Court has consistently held that non-executive and independent director(s) cannot be held liable under Section 138 read with Section 141 of the NI Act unless specific allegations demonstrate their direct involvement in the affairs of the company at the relevant time." The Court emphasized that vicarious liability must be interpreted strictly, and unless a director was actively in charge of and responsible for the company’s business at the relevant time, they cannot be held liable.
2. Mere Attendance at Board Meetings Does Not Create Liability: The respondents argued that since the appellants attended board meetings, they were aware of financial dealings and should be held accountable. However, the Court rejected this contention, holding : "Mere attendance at board meetings does not suffice to impose financial liability on the Appellant(s), as such attendance does not automatically translate into control over financial operations." Citing National Small Industries Corpn. Ltd. v. Harmeet Singh Paintal, the Court held that a director must have been responsible for the day-to-day affairs of the company at the time of the offense to be held liable.
3. Vicarious Liability Requires Specific Allegations: The Court relied on several precedents, including S.M.S. Pharmaceuticals Ltd. v. Neeta Bhalla, (2005) 8 SCC 89, which held that mere designation as a director is not enough specific allegations of active involvement must be made and Pooja Ravinder Devidasani v. State of Maharashtra, (2014) 16 SCC 1, which clarified that non-executive directors, whose roles are limited to governance oversight, cannot be held vicariously liable. Applying these precedents, the Court observed: "The complaint lacks specific averments that establish a direct nexus between the Appellant(s) and the financial transactions in question or demonstrate their involvement in the company’s financial affairs."
4. Non-Executive Status Confirmed by Regulatory Records: The Court noted that corporate governance reports (CGR) and Registrar of Companies (ROC) records confirmed the appellants' non-executive status, further proving that they were not responsible for the company's financial dealings. The Court held: "There is no material on record to suggest that they were responsible for the issuance of the cheques in question. Their involvement in the company's affairs was purely non-executive, confined to governance oversight, and did not extend to financial decision-making or operational management." Thus, merely being listed as a director does not create automatic liability under the NI Act.

Conclusion

The Supreme Court quashed the criminal proceedings against the appellants, holding that non-executive and independent directors cannot be held vicariously liable under Section 138 read with Section 141 NI Act unless there is clear evidence of their active involvement in the company’s financial transactions.

The ruling reinforces that corporate governance roles should not be misinterpreted as managerial responsibilities and protects independent directors from wrongful prosecution. This decision sets a crucial precedent ensuring that vicarious liability in cheque bounce cases is applied strictly and fairly.

Disclaimer

This post is for educational and informational purposes only. It is not intended to defame, discredit, or tarnish the reputation of any individual, entity, or organization. The opinions expressed are based on publicly available judicial decisions and are aimed at fostering a better understanding of legal principles. For specific legal advice, readers are encouraged to consult a professional.