“Sleeping Director” Plea To Exempt from Prosecution Rejected by NCLT – On Appeal NCLAT Confirms – Impact Thereof

Company, Its Directors – Their Duties And Relevant Legal Provisions

A "company" is a creature of law – it is an artificial juridical person created by law and its rights, obligations, powers and duties are as prescribed by law and within the powers conferred under its registered Memorandum of Association; it can do all those acts as a natural person can do. Being an artificial juridical person, it functions and carries its business through the persons manning its "Board of Directors" or "Board" in short. As per the Companies Act, 2013 (in short "CA"), "Board" in relation to a company, means the collective body of the Directors of the Company. A company Board generally consists of its Promoter Directors; Whole-time Directors; Non-executive Directors; Independent Directors; Nominee Directors; Women Directors. Its "Board" constitution would generally vary depending on the type of the company and the scale and level of its activities. In carrying on its activities and managing and controlling its day-to-day affairs, the "Key Managerial Personnel"(KMP) of a company play a significant role and such KMP means the Managing Director or the Chief Executive Officer or its Manager; its Whole-time Directors; its Company Secretary; its Chief Financial Officer. Even though the Company Directors are appointed under the Companies Act, yet the Directors are responsible not only for the due compliances with the statutory provisions of the Companies Act alone, but the company directors are also responsible for complying with the provisions of other Statutes which get attracted and applicable to a company depending upon its constitution and functions, and the company and its directors are also required to follow and comply with the instructions/directions of the concerned Regulatory Authorities and of the authorised persons under a given Statute. Indeed, failure to comply with the applicable legal provisions and non-compliance with the directions issued by the Authorities/Authorised persons attract prosecutions - civil or criminal, and the company and its directors become liable to pay such fine as the Regulatory Authority may impose as per law. Some such important Statutes are Insolvency & Bankruptcy Code (I&B Code); SEBI Act; FEMA; Negotiable Instruments Act; Environmental protections laws etc. 

Prosecution Of Company And Its Directors For Non-Compliances

Since the activities carried out by companies virtually impinge on every aspect of economic activities, it plays a crucial and since it functions through its Board of Directors, for various non-compliances with laws and regulations/directions the Regulatory Authorities very often prosecute the company directors. Thus, the subject of prosecution of company directors for offences committed by the companies continues to affect company directors and it becomes important to know how the trial Courts/Tribunals reject various arguments put forward by the affected company directors to exempt them from prosecutions, particularly when the offence is visited with criminal prosecution. However, even though prosecution is launched against all the company directors for non-compliances of provisions of the law or failure to follow/comply with directions issued to the company and its directors, it is frequently argued by non-executive/non-whole-time accused directors that since such directors are not involved in day to day management and affairs of the accused company and since such directors do not exercise control over the affairs/management of the company, they ought to be spared from prosecution.

Some Legal Provisions Of The Companies Act, 2013

Incidentally, Section 2(34) of the Companies Act, 2013 (in short "CA 2013") 2013 stipulates that "director" means "a director appointed to the Board of a company" and Section 2(59) stipulates that "officer" "includes any director, manager or key managerial personnel or any person in accordance with whose directions or instructions the Board of Directors or any one or more of the directors is or are accustomed to act."

As regards "officer who is in default", Section 2(60) of the CA 2013 makes it clear that for offences committed by the company under the CA 2013, an officer of the company who is in default shall be liable to any penalty or punishment by way of imprisonment, fine or otherwise. The said sub-section further clarifies the order in which the officer stated therein shall be held liable for the default. Incidentally, sub-clause (vi) of section 2(60) makes the role of company directors abundantly clear when it says that "every director, in respect of a contravention of any of the provisions of this Act, who is aware of such contravention by virtue of the receipt by him of any proceedings of the Board or participation in such proceedings without objecting to the same, or where such contravention had taken place with his consent or connivance" will also be roped in as an officer in default. In other words, a director, whether a non-executive/non whole-time director who receives Board minutes or resolutions on decisions arrived at a Board meeting (whether he attended it or not) but who fails to exercise due diligence in understanding the adverse impact of such decisions and fails in taking corrective measures, can still be roped in as an officer who is in default.

It also needs to be appreciated that Section 166 of the CA 2013 which defines the "duties of directors" stipulates thatsubject to the provisions of the Act, a director of a company shall act in accordance with the Articles of Association of the company. The said section further stipulates, inter-alia, that "a director of a company shall act in good faith in order to promote the objects of the company for the benefit of its members as a whole, and in the best interests of the company, its employees, the shareholders, the community and for the protection of environment". The said section further provides that "a director of a company shall exercise his duties with due and reasonable care, skill and diligence and shall exercise independent judgment."

Recent Decision of NCLT, Chandigarh Bench

In the aforesaid background, the recent decision of the NCLT, Chandigarh Bench in respect of a case under the I&B Code concerning non-compliant defaulting directors, assumes significant importance as to how the Tribunal negated the various pleas taken by such defaulting directors to escape from the dragnet of facing criminal prosecution which Insolvency and Bankruptcy Board of India (IBBI) was directed to initiate against such company directors under sections 70 read with section 236 of the I&B Code.

Brief facts leading to the aforesaid decision, relevant for the purpose of this article, are that the Resolution Professional (RP) appointed in respect of Corporate Insolvency Resolution Process (CIRP) directed the Directors of the corporate debtor (CD) to furnish certain information and documents which the Debtor Company directors failed to comply. Thereafter, the RP filed application u/s 19(2) of the I&B Code before the Adjudicating Authority (AA) – i.e. NCLT, Chandigarh Bench, seeking necessary directions from the AA in respect of the suspended former Directors of the DC to furnish all the requisite "books", "financial data", "information", "returns" w.e.f. 1.4.2014 till date and computer systems containing accounting records along with software being used w.e.f. 1.4.2014 till date and the assets of the CD to the RP to enable him in carrying out his duties in an effective and efficacious manner.

The affected DC directors contended before the AA/NCLT that there was no specific averment in the complaint by the RP that he had ever contacted the directors and further that the averment about the non-cooperation by the members of the former Board of Directors of the CD, were general in nature. It was also contended that as per the scheme of the Companies Act, 2013, the Independent Directors (ID) and Non-Executive Directors (NED) have been so designated to protect and prevent them from being held liable for the acts of the corporate debtor, which was beyond the control of such IDs and NEDs and not within their mandate. As "outside directors", they were not involved in the day to day affairs of the corporate debtor. The accused directors contended that the AA had failed to apply its judicial mind to consider the contentions raised by the accused directors. In their reply to the Notice received by them, the accused directors mentioned that they were "Sleeping Directors" and have no role to play in the day to day affairs, management and conduct of the debtor company and that their contention that they are "Independent Directors" was not contested by the RP. The accused directors further contended that non-consideration of their aforesaid plea was not in consonance to the decision of the Supreme Court in respect of some FERA proceedings. They also contended that provisions of law cannot be read to mean that whosoever was the Director of the company at the relevant point of time when contravention took place shall be deemed to be guilty of the contravention. Further, the accused directors contended that in the absence of specific powers given under the Statute, the AA committed a patent error in presuming their jurisdiction and referring the matter to the Central Government/Insolvency and Bankruptcy Board of India (IBBI) for initiating action against the accused directors of the CD u/s 70 read with section 236 of the I&B Code.

The accused directors also contended that the "Books of Accounts" of the debtor company which were lying in the administrative office of the company which was situated in the factory premises and that consequent upon the declaration of the debtor company as a 'Non-Performing Account' (NPA), the factory premises was taken over by the Union Bank of India on 5.10.2018 under SARFAESI Act and that the accused directors were made to sign on a blank panchnama which was prepared by "Authorised Officer" and the directors of the company were called at the site and were asked to sign on the blank panchnama and that they were not allowed to participate in the entire taking-over process. The accused directors of the CD also contended that since the AA did not consider the replies filed by the said directors, the adjudication process was a farce exercise. They also contended that since the Chairman and MD of the CD was running the affairs solely and that since the remaining directors were "Sleeping Directors" they had no role to play in the day to day affairs, management and conduct of the company and hence the order of the AA was unjustified and the allegation of non-cooperation by them and non-furnishing of accounts and documents for the previous years was untenable.

The AA in one of its orders dated 4.10.2019 noted that the accused directors were misconducting themselves in the course of CIRP by not extending their cooperation and assistance to the RP and were withholding and not disclosing the information supposed to be furnished by them and did not furnish the books and documents belonging to the CD which were supposed to be maintained by the directors at the relevant point of time. Yet, the AA also gave another opportunity to the directors to comply with the RP's notice to furnish the details of the stocks that were removed from the factory premises of the CD, but the directors continued to maintain that they were "Sleeping Directors" and had no role to play in the day to day affairs and management of the CD.

The AA noted that at the time of taking over possession of the factory premises of the CD by the Union Bank of India, there was no machinery and any other inventory was found in the factory premises and the premise was totally empty and that this points out that the defence of the directors that the documents were locked in the factory premises was actually "sham and an afterthought" resorted to by the directors to justify their non-compliance with CIRP process as well as the directions of the AA.

On behalf of the RP, it was pointed out that Section 19 of the I&B Code imposes an obligation on the personnel and promoters of the CD to extend all assistance and cooperation to the IPR/RP and where such personnel of the CD does not render assistance or cooperation to the IRP/RP, the AA is empowered to pass orders and direct the personnel of the CD to comply with the instructions of the IRP/RP and cooperate with him in the collection of information and management of the CD.

The AA noted that in so far as the "Independent Director" and directors other than the promoter or key managerial personnel, the burden of proof is on them to establish that the act of commission or omission by a company, which are contrary to the law, was carried out without their knowledge and that the acts of commission or omission of any actions of the company, which is within their knowledge through the Board process, could be attributed to them.

ON APPEAL, NCLAT CONFIRMS DECISION OF NCLT

While considering the contentions raised by the affected directors of the CD, the Appellate Tribunal (NCLAT) observed that the defence of not possessing the documents/records of the CD and IDs not knowing acts done by the CD in violation of law, may be available to the IDs only, and that too under the Companies Act, 2013 only. NCLAT held that the IDs are part of the Board of Directors of a company and have similar duties and responsibilities as that of other directors. Even some important committees formed by the Board of Directors perform important statutory functions and in which the IDs must be included as per law. In fact, the IDs are an integral part of the Board of Directors of a company and therefore, their duties and functions should be read in conjunction with the statutory provisions mentioned in Section 166 of the CA 2013 which speaks of "Duties of Directors" and not in isolation.

With regard to the contentions raised by the accused directors that the Ministry of Corporate Affairs (MCA) general circular 1/2020 dated 2.3.2020 mentions some exemptions to directors from prosecution, the NCLAT observed that the said circular can be taken advantage of only by IDs and that too only under the CA, 2013. As per Section 149(12)(ii) of the CA, 2013 under most of the other laws applicable to a company, the "Directors" are, at the first instance, deemed to be aware of the offence committed by the company and resultantly held liable for default.

With regard to the contention of the accused directors that they were merely "Sleeping Directors", the Appellate Authority in its final order dated 23.09.2020 held that section 19 of the I&B Code is not only restricted to the MDs/Executive Directors but it applies to other KMPs, Directors, Managers, Employees and designated partners of the CD. In fact, one cannot find the term "Sleeping Directors" either under the CA 2013 or under the I&B Code. Therefore, the NCLAT negated the contentions raised in this regard as unworthy of acceptance and held that the impugned order passed by the AA (NCLT, Chandigarh) had not exceeded its jurisdiction and hence dismissed the appeals.

Allahabad High Court's Decision on Duties of Company Directors

Interestingly, in another decision on the disqualification of directors upon failure to file statutory returns etc. and upon failure to comply with the statutory obligations under the Companies Act 2013, in a recent decision dated 16th January 2020, the Allahabad High Court pertinently observed that a person who has been appointed as a company Director has to comply with the requirement of statutory obligations faithfully and effectively and upon failure of such Director to comply with the statutory obligations, the consequential effects of disqualification, as mentioned in the relevant provisions of the Companies Act, can be brought into operation. While making a distinction between a tainted Director who has failed to comply with statutory obligatory provisions of the Act, and a Director who has complied with requirement of statutory obligations faithfully and effectively, the High Court held that the object was to make compliance of statutory provisions more stringent so that people may not have any liberty to disobey the statutory provisions without facing any consequence.

Conclusion

The aforementioned recent decision of the NCLAT and the above cited judgement of the Allahabad High Court unmistakably point out that the non-compliant, erring company directors cannot escape prosecution from the regulatory authorities and will have to face consequences of the trial and cannot escape prosecution simply by taking the plea of being merely "sleeping directors" or non-whole time directors. Hopefully, this will bring in the required positive change in the compliance of the laws and regulations by companies and improve good corporate governance.

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