Background

Several provisions of the Companies Act, 2013 (the 2013 Act) require proceedings to be initiated against ‘officers in default’ liable for various non-compliances under the 2013 Act.

Section 2(60) of the 2013 Act defines ‘officers in default’ to include the following:

1. Whole-time director
2. Key managerial personnel
3. Where there is no key managerial personnel, such director or directors as specified by the Board in this behalf and who has or have given his/her or their consent in writing to the Board to such specification, or all the directors, if no director is so specified
4. Any person who, under the immediate authority of the Board or any key managerial personnel, is charged with any responsibility including maintenance, filing or distribution of accounts or records, authorises, actively participates in, knowingly permits, or knowingly fails to take active steps to prevent, any default
   Any person in accordance with whose advice, directions or instructions the Board of Directors of the company is accustomed to act, other than a person who gives advice to the Board in a professional capacity
5. 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/her consent or connivance
6. In respect of the issue or transfer of any shares of a company, the share transfer agents, registrars and merchant bankers to the issue or transfer.

Directors of the company include Independent Directors (IDs) and Non-Executive Directors (NEDs).

New development

The Ministry of Corporate Affairs (MCA) through its circular dated 2 March 2020 (the circular) provides a clarification on both the prosecution filed as well as internal adjudication proceedings initiated by the Registrar of Companies (Registrar) against IDs, non-promoter and non-Key Managerial Personnel (KMP) NEDs. As per the circular:

• Civil or criminal proceedings should not unnecessarily be initiated against IDs or NEDs[1] (non- promoters and non-KMP) unless sufficient evidence exists against them, and
• Registrars are required to follow a standard operating procedure, as prescribed by MCA while initiating proceedings against ‘officers in default’.

This issue of first notes provides clarification on the above provisions.

MCA Circular

Officers to be held in default

The circular reiterated Section 149(12)[2] of the 2013 Act and clarified that IDs and NEDs (non-promoter and non-KMP) should not be implicated in any criminal or civil proceedings under the 2013 Act, unless they were a part of a default/non-compliance committed by the company. A default/non-compliance would include such acts of omission or commission by a company which had occurred with the knowledge of the IDs or NEDs attributable through Board processes with their consent or connivance or where they did not act diligently.

Standard operating procedures to be followed by the registrar while initiating proceedings against IDs and NEDs

For all ongoing cases or cases where proceedings are to be initiated, the registrar should follow the below standard operating procedures:

• Ascertain the nature of the default: The registrar should determine the nature of default in a company.
• Ascertain officers in default: At the time of serving notices to the company, during inquiry, inspection, investigation, or adjudication proceedings, registrar should seek necessary documents, to ascertain the involvement of the concerned officers of the company. (Records available in the office of the registrar, including e-forms DIR-11^[3] or DIR-12^[4], along with copies of the annual returns or financial statements should be examined to ascertain whether a particular director or KMP was serving in the company as on the date of default.)
• Proceedings against IDs or NEDs: Where lapses are attributable to the decisions taken by the Board or its committees, all care must be taken to ensure that civil or criminal proceedings are not unnecessarily initiated against IDs or the NEDs unless sufficient evidence exists to the contrary.
• Guidance from MCA on proceedings: In case of any doubts with regard to the liability of any person, for proceedings to be initiated, guidance may be sought from MCA (through the office of the Director General of Corporate Affairs). Consequently, any such proceedings must be initiated after receiving due sanction from the MCA.

Cases which are already under prosecution, but which do not meet the criteria mentioned in the circular, then those cases should be submitted to MCA for necessary examination and further direction thereon.

Our comments

Section 149(12) of the 2013 Act provides that the liability of IDs or NEDs who is not a KMP, is restricted to actions of omission or commission committed by a company which had taken place with the knowledge of ID or NED and with his or her consent, connivance, or where he/she had not acted diligently.

The recent circular of MCA does not provide a blanket protection to IDs or NEDs (non-promoter and non-KMP) from prosecution under civil/criminal proceedings under the 2013 Act. It requires registrars to follow a principle-based approach and understand the nature of default before indicting IDs and NEDs (non-promoter and non-KMP). It lays down a standard operating procedure that should be followed by the registrar while dealing with any proceedings against them. 

The presence of IDs and NEDs are an important cog in the wheel of corporate governance. The 2013 Act puts a lot of emphasis on the seat of the IDs. However, it was perceived that IDs and NEDs (non-promoter and non-KMP) were being put on an equal footing to the executive directors notwithstanding the fact that there is information asymmetry between executive directors and their non-executive counterparts. The circular seems to address this matter by casting a greater responsibility/obligation on the registrar to examine relevant information such as board agenda, minutes of the board meetings to ascertain participation of the directors, records of appointment and resignation of directors and copies of the annual returns or financial statements before proceeding against the IDs and NEDs (non-promoter and non-KMP).  

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^[1] Typically, non-promoter and non-KMP NEDs (apart from IDs) would exist in the following cases:

• Directors nominated by the government on the public sector undertakings,
• Directors nominated by public sector financial institutions, financial institutions or banks having participation in equity of a company, or otherwise,
• Directors appointed in pursuance to any statutory or regulatory requirement such as directors appointed by the National Company Law Tribunal (NCLT).

² Section 149(12) is a non-obstante clause, which states that an independent director and a non-executive director (not being promoter or key managerial personnel), would be held liable, only in respect of such acts of omission or commission by a company which had occurred with his knowledge, attributable through Board processes, and with his consent or connivance or where he had not acted diligently.

³ Notice of resignation of director to the registrar

⁴ Particulars of appointment of directors, KMP and the changes among them

To access the text of the MCA circular, please click here.