Disqualification of directors under section 164 read with section 167

This article is written in relation to recent MCA notices for the disqualification of directors under section 164 (2) of the Companies Act. Efforts have been made to make reader understand the section 164 along with section 167 of the Act.

Notice appears on MCA website:

As per the notice appears on MCA website:

'Any person disqualified under section 164(2) of the Companies Act, 2013 [the Act] is advised not to act as director during the period of the disqualification and not to file any document or application with MCA as the same shall be summarily rejected.

However, this shall be without prejudice to the  liability of the said person for violation of section 164(2) read with section 167 of the Act including the action under section 448 r/w 447 of the wherever warranted.'

MCA has mentioned both section 164(2) and 167 in the notice. Thus, it appears that MCA is in opinion that the provision in section 167(1) (a) would apply in the cases covered by section 164(1) and covered by section 164(2).

Introduction

The Act, 2013 has linked section 164 to section 167 leading to an impression that disqualification under section 164 leads to automatic vacation. Section 164 of the Companies Act, 2013 (herewith referred to as the 'Act') states various disqualifications for appointment/ reappointment of Director in a company. Further, Section 167 of the Act states the instances for the occurrence of the vacation of the office of director. Additionally, a statutory auditor is also mandated under Section 143 (3) (g) of Act, 2013 to report whether any director is disqualified from being appointed as a director under Section 164 (2) in the Auditor's report. This article intends to discuss the applicability of one such provision as specified under Section 164 (2) of the Act read with Section 167.

Position under old Act

Please note that that Section 164(2) correspond to Section 274(1)(g) of Companies Act, 1956,with the difference that Section 274 (1) (g) was not applicable to private companies, however in case of Section 164(2) there is no such distinguishment between Private Company or Public Company.

Further note that Section 167 corresponds to Section 283 of Companies Act, 1956 pertaining to vacation of office of a director. Section 167 (1) provides the premises when office of a director shall become vacant and Section 167 (2) specifies the consequence if a director continues to hold the office despite attracting any of the premises under Section 167 (1).

In present piece of writing, author has made efforts to make reader understand the effect of clause (a) of sub section (2) of section 164 read with clause (a) of the sub-section (1) of section 167 of the Act to the extent. Further it may be noted that sub section (1) of section 164 has different footing than section 164 (1). Author would like to divert the reader towards a point that Section 167(1)(a), mentions that "he incurs any disqualification specified in Section 164". The section collectively talks about the disqualification under Section 164 without further bifurcating as disqualification specified under Section 164(1) or Section 164(2).

Therefore, let's begin with interpretation and clear understanding of Section 164 (1) and Section 164 (2) of the Act.

Sub section (1) of Section 164:

Sub section (1) of section 164 calls for the circumstances which are beyond the control of director i.e it provides with the grounds where a director can stand disqualified from his current position of directorship and simultaneously becomes ineligible for appointment in other companies and may further call for immediate vacation from the place of directorship as per clause (a) of sub section (1) of section 167of the Act as he might become incompetent to act as director.

A person shall not be eligible for appointment as a director of a company, if -

(a) he is of unsound mind and stands so declared by a competent court;

(b) he is an undischarged insolvent;

(c) he has applied to be adjudicated as an insolvent and his application is pending;

(d) he has been convicted by a court of any offence, whether involving moral turpitude or otherwise, and sentenced in respect thereof to imprisonment for not less than six months and a period of five years has not elapsed from the date of expiry of the sentence:

Provided that if a person has been convicted of any offence and sentenced in respect thereof to imprisonment for a period of seven years or more, he shall not be eligible to be appointed as a director in any company;

(e) an order disqualifying him for appointment as a director has been passed by a court or Tribunal and the order is in force;

(f) he has not paid any calls in respect of any shares of the company held by him, whether alone or jointly with others, and six months have elapsed from the last day fixed for the payment of the call;

(g) he has been convicted of the offence dealing with related party transactions under section 188 at any time during the last preceding five years; or

(h) he has not complied with sub-section (3) of section 152 (DIN NO)

From aforesaid provisions one can infer that if one were to be disqualified under section 164(1) i.e. become an undischarged insolvent or is declared as being of unsound mind by a Court. Most certainly such a person cannot continue as a director. However sub section (2) of section 164 of the act has different impression.

Sub section (2) of section 164 read with clause (2) of sub section (1) section 167:

The relevant extract of the provision under the aforesaid sections are as follows:

Section 164. "(2)No person who is or has been a director of a company which -

(a) has not filed financial statements or annual returns for any continuous period of three financial years; or
(b).....,

Shall be eligible to be re-appointed [1] as a director of that company or appointed in other company for a period of five years from the date on which the said company fails to do so."

Note: Clause (a) of sub-section (2) requires continuation of the default for three years and clause (b) requires it for one year.

Section 167. "(1)The office of a director shall become vacant in case -

(a) he incurs any of the disqualifications specified in section 164;"

As per the aforesaid provisions there are two situations when the disqualification arises, if any of the two situations arises, all the directors of such company get attracted with such disqualification. It is under such circumstances that the board of the defaulting company will have to take steps to make good the failure.

The failure to file financial statements or inability to redeem debentures may be due to circumstances beyond the control of the company and as a Consequence of the disqualification, as per Section 164 (2), is that such director neither can be re-appointed in that company nor appointed as a director in any other company. If such situation prevails company can be regarded as 'board less' and ultimate power lies with the shareholders of the company.

The difference between section 164 and 167 is that, while section 164 provides for disqualifications which must be considered in respect of a person who is proposed to be appointed or re-appointed as a director of any company), section 167 provides for grounds for vacation of office of a person who is already a director of a company. In other words, section 164 is applicable at the time of appointment of a person as a director of any company, section 167 is applicable to a person who is already a director

Whether there would be immediate vacation of office of director as per section 167 (1)(a) due to incurring disqualification under section 164 (2)?

The disqualification under section 164(2) does not envisage immediate vacation of office. As stated earlier if default arises as per section 164 (2) of the act, all the directors of the company becomes disqualified and company remains without board and  company can possibly not function without a board, therefore provisions of sections 164 (2) calls for way out which do not call for immediate vacation of place of directorship by disqualified director.

The disqualified director shall not be eligible to be re-appointed as a director of that company or be appointed in other company for a further period of 5 years from the date on which the company fails to do so, however the director is allowed to serve his present tenure in that company and in other companies in which he is a director. So it makes it clear that vacation of office is to be done at the end of tenure of directorship.

Please note that as per the provisions of sub section (3) of section 167, where all directors' stands disqualified and need to vacate their place of directorship, new board of directors will be appointed by the promoters of company (usually promoters and directors are same in small or private companies) so in their absence by central government.

One has to interpret[2] provisions of section 164 and section 167 together in respect to have clear understanding. As it seems that section 164 (2) and section 167(1) (a) are linked but from above interpretations it can be infer that section 167 pertains to vacation in case of disqualifications under section 164(1) only. Accordingly, the provision in section 167(1) (a) would not apply in the cases covered by section 164(2).

Thus newly appointed director after the occurrence of default as stated under section 164(2) will also be held liable?

Sub section (2) of section 164 of the Act states that 'No person who is or has been a director of Company.' In this regard one to attract disqualification under section 164(2)(b), it is important that the individual has to be on the board of the company when the default actually happened. at least for a part of the period of three years or one year, but not necessarily for the entire three-year or one-year period.

Therefore new director, during whose directorship the default did not occur, cannot be held responsible for the same and suffer the misdeeds of his predecessors. If that would have been situation then possibly no director will be willing to get appointed in such a defaulting company. This, however, cannot be the intent of law. Even if companies end up defaulting, then adequate opportunity should be given to the company and its directors to make good the default.    

Sub section (2) of the section 164 of the Act is exempted to Government Companies:

As per the provisions of this section, opinion can be drawn directors of company that is Government Company are exempted from the provisions of section 164(2) of the Act who has defaulted in which has not filed financial statements or annual returns for any continuous period of three financial years; or has failed to repay the deposits accepted by it or pay interest thereon or to redeem any debentures on the due date or pay interest due thereon or pay any dividend declared and such failure to pay or redeem continues for one year or more and simultaneously are also exempted from the provisions of section 167(1)(a) i.e. they are not required to vacate their office of directorship and can be reappointed or appointed as director in other companies

Director who is shareholder

Note that if the director is disqualified and removed/ stands vacated from office as a director, this will not usually affect the director's position (if he/she has one) as a shareholder in the company. This is often a relevant consideration in private companies, where often a director is also a shareholder.

So opinion can be drawn where such situations prevails in companies where promoters, directors and shareholders are same person specially in case of 'private limited companies', provisions of Article of Association can be entrenched making it more stringent providing that a shareholder who ceases to be a director is deemed to have given the company a transfer notice in respect of his or her shares, so that the shares can, in effect, be compulsorily acquired.

In nutshell, powers to appoint new Board of directors in company rely with shareholders of Company.

Removal of Disqualifications: The Companies (Appointment and Qualification of Directors) Rules, 2014 contain a provision empowering the Registrar of Companies to remove the disqualification.

Rule 14(5) states that, 'Any application for removal of disqualification of directors shall be made in Form DIR-10.' However it does not provide any procedure to be followed.

Penalty provisions

Are this offence Compoundable?

As per provision of Section 441 (1) of the Act, 2013-Any offence punishable under this Act, whether committed by a company or any officer thereof, with fine only, may, either before or after the institution of any prosecution, be compounded to the extent, if default is made good. Power of Compounding of offence is with NCLT/ Regional Director/ Person authorized by Central Government. Amounts exceeding Rs 5,00,000 will be adjudicated upon by the NCLT and the amounts lesser than Rs 5,00,000 by the RD or the Central Government authorized person.

As per the current scenario, where two lakhs companies have been struck off, where more than one lakh directors have been declared disqualified under section under section 164 (2) seems non-compoundable and under section 167 Offence seems to be compoundable for officers only. Further note that any offence under section 447[4] and 448[5] of the Act are non-compoundable.

Who will represent the company in further proceedings, if any before tribunal, if all directors are ineligible for re-appointment under sub section (2) of section 164 of the Act?

Dear reader would request to refer Case law: Arvind Mohan Johari v/s M/s Mohan Carlton Hotel Pvt Limited interim order dated 21/11/2016 as the case is pertaining to 'Mismanagement and Oppressions' affairs of company where all directors are disqualified under section 164(2). Final order is yet to be passed.

(Link provided) - click here.

DISCLAIMER: The entire contents of this document have been developed on the basis of relevant information and are purely the views of the authors. Though the authors have made utmost efforts to provide authentic information however, the authors expressly disclaim all or any liability to any person who has read this document, or otherwise, in respect of anything, and of consequences of anything done, or omitted to be done by any such person in reliance upon the contents of this document.

READER SHOULD SEEK APPROPRIATE COUNSEL FOR YOUR OWN SITUATION. AUTHOR SHALL NOT BE HELD LIABLE FOR ANY OF THE CONSEQUENCES DIRECTLY OR INDIRECTLY.

The author can also be reached at csanjali.gorsia@gmail.com

[1] The use of the specific words 're-appointed' and 'appointed' in the concluding portion of subsection (2) is significant. These words must be interpreted according to their natural meaning in the context of the provisions of the Companies Act concerning directors. Section 152 of the Act indicates that the word 're-appointment' is used to refer to a director who is liable to retirement by rotation under section 152 and who is appointed again at an annual general meeting at which his current term office as a director comes to an end.

[2] When there are in an enactment two provisions which cannot be reconciled with each other, they should be so interpreted that; if possible, effect should be given to both. This is what is known as the rule of harmonious construction.(Venkataramana Devaru v. State of Mysore AIR 1958 SC 255)

[3] Officers in default is defined

[4] Punishment for fraud

Punishment for false statement[5]