In a significant ruling, the Allahabad High Court has upheld the constitutional validity of Section 164(2) of the Companies Act, 2013, which stipulates that a Director whose company has not filed financial statements or annual returns for any continuous period of three financial years, shall be disqualified from holding the position for five years.
The Court has also held that the "financial year" for the purpose of the Section will start only from 2014-15.
Articles 14 & 19 of the Constitution
The division bench of Justices Sudhir Agarwal and Rajeev Misra said that the provision rightly differentiated between tainted and untainted Directors on the basis of an intelligible classification and thus, was not violative of Article 14 of the Constitution.
"a broad distinction has been made in respect of a person who has acted as a Director and complied with requirement of statutory obligations faithfully and effectively, vis-a-vis such person who though appointed as Director, but has failed to observe statutory provisions of Act. Therefore, a tainted Director stands in a different class than one who has regularly complied with statutory provisions, therefore, Article 14 of the Constitution, in our view, does not apply. There is a valid classification between a tainted and untainted Director and it also has a reasonable nexus with the object sought to be achieved i.e. to make compliance of statutory provisions more stringent and providing stringent provisions so that the people may not have any liberty to disobey provisions without facing any consequences," they said.
The court also found the provision to be in consonance with Article 19 of the Constitution, inasmuch as it put no embargo in carrying on business, profession etc. It observed that the provision was intended to infuse good corporate governance in regulation of corporate affairs and remarked, "A limited prohibition is applied that too in respect of a tainted Director, who has failed to comply with statutory obligatory provisions of Act".
Principles of Natural Justice
The observations were made in a bunch of petitions filed by disqualified Directors of various delinquent companies, stating that they were not issued show cause notices nor given an opportunity of being heard, before an adverse action was taken against them. The Petitioners had sought quashing of order of disqualification as well as deactivation of their DINs, passed by the ROC.
Refuting the argument, the court held that disqualification under Section 164 was automatic by operation of law as soon as default is committed and identified by concerned Registrar. Clearly, it required no order or declaration by any authority and hence, it was held that the principle of audi alterm partem will not be applicable in the case, except for establishment of facts.
"There is no scope of doubt that as soon as disqualifications stated therein are incurred, Director concerned shall stand disqualified by operation of law and/or Office of Director shall become vacant by operation of law, under Section 164 and 167, respectively, as the case may be. Therefore, to attract the consequences, if eventuality which attracts disqualification or vacation of Office of Director has occurred, being automatic, it cannot be said that principles of natural justice are required to be applied at that stage and must be observed. In fact no authority under Act, 2013 has been required to make such a declaration. Instead Statute itself makes declaration," the court held.
"Every provision which excludes principles of natural justice cannot be said to be per se arbitrary. It depends upon the facts and circumstances, nature of Statutes, object, purpose and other relevant factors to examine whether compliance of principles of natural justice is necessary or not," the bench added.
However, the court noted that basic facts with regard to alleged disqualification were not pleaded in the petitions and nor were disclosed by the ROC. Criticizing this, the court said,
"If conditions precedent to attract Section 164 (2) of Act, 2013 is established to exist, consequences are by operation of law but the condition precedent is that the condition of disqualification actually exists and for this purpose, in our view, a bare minimum requirement of notice to such Directors would be necessary to verify, whether such condition exists or not.
…a notice would be necessary to find out whether the alleged disqualification which according to ROC has been incurred by any Director, is an undisputed fact or if disputed, opportunity to concerned person has to be given to establish otherwise."
Retrospective Applicability of Section 164
The court also held that for attracting mischief of Section 164(2)(a), the 'Financial Year' would commence from 2014-15 and not prior thereto .
"A perusal of Section 2(41) of Act, 2013 shows that for a provision, which came into force on 01.04.2014, 'Financial Year' which ended on 31.03.2014 will not be relevant, inasmuch as, disqualification under Section 164(2)(a) of Act, 2013 is failure of submission of Financial Statements or Annual Returns for any continuous period of three Financial Years and this provision, which is adverse and penal in nature, cannot be made applicable to a Financial Year which had already lapsed and when there was no such condition attracting any disqualification on an event as provided under Section 164(2) (a) of Act, 2013," the court held.
Reliance was placed on the ruling of Gujarat High Court in Gaurang Balvantlal Shah v. Union of India, 2019 GLH (1) 444.
The observations made by the Allahabad HC are similar to decisions of Gujarat, Madras, Karnataka and Madhya Pradesh High Courts on the position of law in disqualification of directors under Section 164(2) of the Companies Act.
The Allahabad HC has disagreed with the ruling of the Delhi High Court in Mukut Pathak & Ors. v. Union of India & Anr., WP (C) No. 9088/2018, which 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.
"Merely because an enactment draws on events that are antecedent to its coming in force does not render the said enactment retrospective," Justice Vibhu Bakhru had held therein.
Power to Deactivate DIN
Notably, many Petitioner-directors were directors in multiple companies and deactivation of their DIN affected their position in other non-delinquent companies as well.
The court held that while the statute provides automatic disqualification of a director in case of a default under Section 164, there is no provision which empowers ROC to de-activate DIN, only on the ground that a Director has incurred disqualification under Section 164(2) (a) or his Office has become vacant under Section 167(1) (a).
To this end, the bench relied on common view taken by various other high courts, including Lucknow bench of the Allahabad High Court in Mohd. Tariq Siddiqui & Ors. v. Union of India & Ors., Misc Bench No.16173/2019.
The bench thus said,
"We hold that in absence of any provision to deactivate DIN of petitioners if they have incurred disqualification under Section 164 of Act, 2013, the action of respondents and in particular of ROC, in deactivating DIN of petitioners, cannot be sustained."
Accordingly, the court quashed the action of respondents in deactivating the Petitioners' DIN and directed the ROC to give a notice to the Petitioners to verify and establish the facts whether disqualification alleged to have been suffered by them so as to attract Section 164 (2) actually existed or not.
Case Title: Jai Shankar Agrahari v. Union Of India & Anr. (with other connected matters)Case No.: Writ C No. 12498/2019Quorum: Justice Sudhir Agarwal & Justice Rajeev Misra
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