Critical Analysis of the Criminal Liability of directors under the Company law

Written by Sparsh Jain

Junior Editor at Law & Order

Third Year, BBA. LLB. Symbiosis Law School, Pune



Disclaimer: Please note that the views expressed below represent the opinions of the article's author. The following does not necessarily represent the views of Law & Order.



Introduction:


A dive into the composition of Board Members of the successful companies in India which have been carrying their operations for several decades would result in the conclusion that, often, honesty coupled with a certain level of qualification and expertise is often the secret sauce for the success of these companies. In the past year, despite pandemic and severe health crisis being faced by the people across the globe, a record number of companies have converted themselves into Public-listed companies to raise funds from the public. At the same time, this means added responsibilities on the directors of the existing companies as now, they have a ‘fiduciary’ relationship with a larger number of shareholders. The directors of the companies are not only liable under the Companies Act, 2013, but also under several other legislations like the Negotiable Instruments Act, Income-tax act, labor laws etc. if they are found in breach of their duties. In this article the author seeks to outline the regulations governing the liability of the directors of a company in the US, UK and India, with an added emphasis on the provisions of Companies Act’ 2013 and also provides recommendations for improving the same.

Regulations governing the liability of the Directors in the U.S.:


In the U.S.A it was the catastrophic collapse of Enron, WorldCom that triggered and drew attention towards the weakness in the existing corporate governance mechanisms.[1] The WorldCom scandal resulted in the drafting and implementation of the Sarbanes-Oxley Act, 2002. WorldCom was once one of the world’s largest telecommunication companies and used to pay regular dividends to its shareholders. However, in 2001, the company manipulated it’s financial data in order to increase its earnings on its Profit and Loss statement by nearly $4 billion and which later led to downfall of the company and massive losses to shareholders once the financial fraud came into limelight. With the new Act, the existing corporate governance model was re-designed and it provided for enhanced punishment for wrongdoers, especially the Directors of the company who are also referred to as the “officers of the company”.

The Act further specified the duties of the Directors and also liabilities if Directors are found to be in breach of any of these duties. For the Public-listed companies, NASDAQ and NYSE made it mandatory for them to have a majority of the board members to be independent directors.[2]

Regulations governing the liability of the Directors in the U.K.:


Under the Companies Act, 2006 of the U.K. executive directors and non-executive directors or independent directors owe the same duty to the company and no such distinction between the duties owed by them can be found under the Act. However, it is implied that executive directors owe a higher level of duty of care by virtue of the position they hold in the company. While the executive directors are responsible for the day to day operations of the company, the independent directors are responsible for reviewing and monitoring the performance of the Board.[3] For the public-listed companies, the regulations with respect to independent directors were strengthened with the publication of a new code in 2017[4] by the Financial Reporting Council.


Furthermore, according to Section 232 of the U.K. Companies Act 2006 [5], even if a company wishes to, it cannot exempt it’s the director from liability arising out of any default, breach of duty or trust, or negligence, and neither can such director be indemnified by the company.


Provisions under the Indian Companies Act, 2013:


Under the Companies Act, 2013 the quantum of penalty and imprisonment for criminal liability to be levied on the directors of the company was increased to some extent.[6] The Act mentions “officers in default”, now this would include whole-time directors, the person holding Key Managerial positions in the company (KMP), and every single director who is acquainted with the commission of the act in breach of duty within the company.


Specific provisions under the Companies Act’ 2013 regarding the criminal liability of directors are:


Section 34- If the prospectus of the company is found to be misleading or carrying statements that are not true, then every single person with whose authorization such prospectus was published would be criminally liable under the Companies Act, 2013. The punishment would be imprisonment up to 10 years or a fine ranging from 1 Lakh to 5 lakh or both.


Section 53- The Directors of the company are barred from issuing securities of the company to any person at a discount. Any person found to be in violation would be punished with imprisonment up to 6 months or a fine ranging from 1 Lakh to 5 lakh or both.


Section 68(11)- Imposes criminal liability on the directors of the company which includes imprisonment up to 3 years and a fine which would range from 1 lakh to 3 Lakh or both. The Directors would be liable only if he/she is found to be fraudulently involved in selling or purchasing of the shares of the company illegally or in contravention of guidelines laid down by the SEBI.[7]


Section 71(11)- A company that wishes to issue debentures must appoint a debenture trustee. Additionally, it is expected of a company to pay the required amount at the time to maturity of the debenture to the debenture holder. In case, a company fails to make the payment on the maturity date, debenture holders can file a case before the NCLT and NCLAT. In case the company fails to comply with such an order, the officer-in-default would be liable for imprisonment up to 3 years or a fine ranging from 2 to 5 lakhs or both.


Section 92(5)- The company must file annual returns before the end of the financial year before the Registrar of Companies in the prescribed format within 60 days from the date of the Annual General Meeting as under Section 403 of the Act. Non-compliance with the above requirement would result in punishment being imposed and which would include a fine up to 50 thousand for the officer-in-default or imprisonment up to six months or both.


Section 118(12)- Any officer who is found to be guilty of tampering with the minutes of the company meeting is liable for imprisonment up to 2 years or fine up to 1 lakhs or both.


Section 128(6)- A company must maintain proper books of account as required by the legislation which would include year-end financial statements and such data being shared with the relevant government authorities when asked. Failure to maintain proper books of account would result in punishment up to 1 year ( imposed on the Managing Director or the CFO of the company).


Section 129- A company must maintain financial statements in the prescribed form including statements of its subsidiary and any failure would result in a penalty being imposed of a fine up to 5 lakhs or imprisonment for up to one year.


Similarly, Section 134, 167, 185(2) of the Companies Act provides for criminal liability being imposed on the Directors of the Company if the financial statements are not approved by them, if they failed to vacate the office premises despite termination of their agreement, or if the Director seeks loan from the company respectively. The officer-in-charge would not only be liable for the fine but also in addition to the fine, would be required to go under imprisonment.


Section 188(5) provides that if any company enters into a contract with any related party and such transactions take place without the approval of the Board of Directors through a resolution being passed, then non-compliance would result in criminal liability being imposed for imprisonment up to one year or a fine ranging from 25 thousand to 5 lakhs.


Similarly, Sections 229, 447, and 448 provides for criminal liability being imposed on the directors of the company for furnishing false statements, a commission of fraud resulting in loss to shareholders or directors having knowledge of falsification of any data or any omission respectively.


Imprisonment for a term ranging from 3 years to 10 years may be imposed in addition to a fine up to 10 lakhs if any officer-in-charge including the director furnishes false evidence before the government authorities.

Similarly, there are several other provisions within the Companies Act read with different legislations that provide for criminal liability being imposed on the directors of the company.


Rulings of the Indian Courts on the criminal liability of the Directors:


Now, further discussing some rulings of the Indian Court with respect to the criminal liability of Directors.


1) SEBI v. Gaurav Varshney[8]

The court in the above case while dealing with the issue of whether the criminal liability to be imposed on the director of a company observed that such liability arises when the director was in charge and responsible for the conduct of the company.[9] Thus, liability largely arises out of the role played and not merely with the virtue of holding the position or designation.


2) Pritha Bag v. SEBI

In the above case, a differentiation between the officer in default and the other remaining directors was made by the Securities Appellate Tribunal. The liability was imposed under Section 2(60) of the Companies Act on finding that it was those who were officers in charge who were responsible for illegal acts.


It is further important to analyse section 149(2) of the Companies Act, 2013 which states that liability can be imposed on Independent Directors for the act which is commissioned by the company under the knowledge, attributable to such Independent Directors through board processes. Even if an Independent Director consented to an act and failed to act diligently he/she will be liable to be criminally prosecuted.[10]


Recommendations:


1) Under the Companies Act, 2013 strict penalties have been provided for acts that are not so grave in terms of non-compliances.[11] However, it is argued that rarely we see that in cases where the directors are held accountable for criminal offences under company law, they are required to go to imprisonment for the maximum tenure which is prescribed under the Act, and generally, the sentence is for minimum prescribed tenure under the act. Hence, in cases where directors are held accountable and are made to undergo imprisonment for a higher tenure than the average would result in directors of Indian companies being extra-cautious. The author believes that it would result in a fall in cases of non-compliance and that would be very healthy for the shareholders of the company.


2) The author argues that the directors of the Company (executive and non-executive) must be required to attend every board meeting and absence from board meetings should be an exception and not the norm. The result and impact of the above suggestion would be multi-fold, and it would ensure that a higher number of directors possess knowledge of various affairs of the company.


3) The minutes of the Board meetings should be detailed and provision should be introduced for meeting minutes to mandatory record dissenting opinions of any directors if any, which would be a crucial piece of evidence in future if a director is questioned.


4) The newly appointed directors including Independent Directors must be provided training on their respective duties and a detailed overview of the company’s corporate governance structure.



Conclusion:


With the passage of time, regulations with respect to Corporate Governance have become stringent. The Companies Act, 2013 imposes criminal liability on directors under various provisions as discussed above. The Indian courts have increasingly expanded the scope of provisions with respect to corporate criminal liability and liability of directors of the company. A trend has been seen in recent times, where shareholder and director agreements are being amended or the newly drafted contract is increasingly including director indemnification clauses.

Again, it is crucial that such clauses are thoroughly negotiated.

Furthermore, there is an emergence of Directors liability insurance in India as a popular tool, and some insurance covers directors even after their resignation. However, at the same time with rapid changes in India’s corporate environment and with higher M&A transactions and foreign direct investment, it is crucial that existing laws are given the full attention of lawmakers and are amended and updated with changes in the corporate environment.


[1] Troy Segal, Enron Scandal: The Fall of a Wall Street Darling, Investopedia.com.

[2]Debanshu Mukherjee, The Liability Regime for Non-executive and Independent Directors in India, Vidhilegalpolicy.in, 2019.

[3] Holly Gregory, 36, Page. 205.

[4] UK Corporate Governance Code, 2017

[5] Section 232, U.K., Companies Act 2006.

[6] Sharda, Balaji, Criminal Liabilities of Directors under the Companies Act, Novo Juris Legal, 2014.

[7] Animesh Tiwari, Criminal Liability of Directors under Companies Act, Ipleaders, 2018.

[8] SEBI v. Gaurav Varshney, Criminal Appeal Nos. 827-830 of 2012

[9] Raagini Ramachandran, Reviewing the Standard of liability of independent directors, Cbclblog.in, 2020

[10] M. Kannappan, A Critical Study on Corporate Criminal Liability with Reference to Indian Case Laws, 119, International Journal of Pure and Applied Mathematics, 2018

[11] Stuti Galiya, Director’s Duties and Liabilities under Companies Act, 2013, Lexology.com, 2014

BIBLIOGRAPHY


Articles


1) Debanshu Mukherjee, The Liability Regime for Non-executive and Independent Directors in India, Vidhilegalpolicy.in, 2019


2) Sharda, Balaji, Criminal Liabilities of Directors under the Companies Act, Novo Juris Legal, 2014.


3) Dhaval Ghusani, Directors and Officers liability in India, taxguru.in, 2020.


4) Animesh Tiwari, Criminal Liability of Directors under Companies Act, Ipleaders, 2018.


5) Raagini Ramachandran, Reviewing the Standard of liability of independent directors, Cbclblog.in, 2020


6) M. Kannappan, A Critical Study on Corporate Criminal Liability with Reference to Indian Case Laws, 119, International Journal of Pure and Applied Mathematics, 2018.


Cases:

1) Standard Chartered Bank v. Union of India, AIR 2005 SC 1072.


2) K.K Ahuja v. V.K Arora & Another, 10 SCC 48.


3) State of Maharashtra v. Syndicate Transport Co., 1964.


4) Iridium India Telecom Ltd. v. Motorola Inc, AIR 2011 SC 20.


5) SEBI v. Gaurav Varshney, Criminal Appeal Nos. 827-830 of 2012.


Books:


1) Butterwoths, Guide to the Companies Act, 16th Edition, Lexis Nexis, 2008.


2) Mortimore, Company Directors duties Liabilities & Remedies, Oxford University Press, 2009


3) LVV Iyer, Guide to Company Directors, 3rd edition Lexis Nexis, 2011.


Statutes:


1) Companies Act, 2013 (India)


2) Companies Act, 2006 (U.K.)

0 comments