India: Note On Vicarious Liability Of Directors And Shareholders

The Companies Act, 2013 as well as the erstwhile Companies Act, 1956 contain a set of liabilities restricting the activities/actions of the Directors and also the Shareholders. The present article covers the various liabilities of the Directors and Shareholders under Companies Act, 2013 as well its comparison with the liabilities set forth in the erstwhile Companies Act, 1956.

The first set of liabilities is statutory in nature, being specifically set forth in the Companies Act, 2013 (hereinafter referred to as "the 2013 Act"). These could either be a civil liability requiring directors to make payments to victims or the state, or they could be criminal liability resulting in fines or imprisonment. The approach in the new regime has been to impose stiffer penalties in case of a criminal offence so as to act as a strong deterrent on directors' conduct when it falls short of the desired standards.

The second set of liabilities could arise from claims made against the directors either by the company or the shareholders for breach of directors' duties. Since directors owe the duties to the company, at the outset it is the company that can bring a claim. Where the company is unable (or does not wish) to do so, it is open to the shareholders to bring a derivative claim on behalf of the company to recover monies for breach of directors' duties. Under the 2013 Act, there is a mechanism that allows a group of shareholders (constituting a minimum of 100 shareholders or those holding 10% shares in the company) to bring an action on behalf of all affected parties, which includes claims for compensation from directors for any fraudulent, unlawful or wrongful act or omission or misconduct on their part. The term "officer who is in default" has been defined under Section 2 (60) of the 2013 Act as: "officer who is in default for the purposes of any provision in this Act which enacts that an officer of the company who is in default shall be liable to any penalty or punishment by way of imprisonment, fine or otherwise, means any of the following officers of a company, namely – (vi) 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 has taken place with his consent or connivance." It is pertinent to note here that the term 'officer in default' now seeks to implicate every director (including nominee director) who is aware of the contravention. He need not even participate in any meetings of the board, but if the information as to a contravention is contained in any of the proceedings of the board received by him, he is deemed liable. Also, in view of the aforesaid provisions, a director needs to ensure that any objection raised by him at a board meeting is duly recorded in the minutes.

Liability of Directors under Companies Act 2013 and its applicability.

Contravention of provisions of Section 166 (relating to codified duties) is punishable with a fine which shall not be less than Rs.1 Lakh but which may extend to Rs.5 lakhs. Further, penal provisions throughout the 2013 Act have been made more stringent and provide for increased penalties as compared to the Companies Act, 1956. On an average, the minimum amount of fine that is imposed under certain Sections of the 2013 Act is Rs. 25,000/- which in certain cases extends to Rs.25 crores or even more. Set out below is the list of few contraventions, where the penalties are Rs.1 crore or more:

  1. Violation of provisions relating to not-forprofit companies (Section 8);
  2. Violation of provisions relating to subscription of securities on private placement (Section 42);
  3. Issue of duplicate share certificates with an intent to defraud (Section 46 (5));
  4. Failure to repay deposits within specified time (Section 74 (3));
  5. Contravention of provisions relating to insider trading (Section 195 (2)).

Apart from monetary penalties, certain offences even attract imprisonment. Most of the offences leading to imprisonment under the 2013 Act are non-cognizable (that it would need warrant to arrest) but there are certain serious offences which are cognizable in nature and would not require a warrant to arrest. These offences are mainly connected to fraud or intent to defraud. Some of such offences are listed below:

(a) Section 7(6) - Furnishing of any false or incorrect particulars regarding any information or suppressing any material information, in any of the documents filed with the Registrar of Companies in relation to the registration of a company.

(b) Section 34 - Including in the prospectus, any statement which is untrue or misleading in form, or context in which it is included, or where any inclusion or omission of any matter is likely to mislead.

(c) Section 36 - Fraudulently inducing persons to invest any money.

(d) Section 56 - Default under Section 56 relating to transfer and transmission of shares with an intent to defraud;

(e) Section 66 - Offences relating to reduction of share capital.

(f ) Section 53- Prohibition on issue of shares at discount

Fine on Company - Not less than Rs.1 lakh and may extend to Rs.5 lakhs.

Officer in default- Maximum imprisonment of 6 months or a fine not less than Rs.1 lakh which may extend to Rs.5 lakhs or both.

(g) Section 57 - Punishment for personation of shareholder

Such a person in default- Minimum 1 year to maximum 3 years imprisonment or a fine not less than Rs.1 lakh which may extend to Rs.5 lakhs.

(h) Section 58(6) - Refusal of registration to transfer after order of tribunal

Such person in default- Minimum 1 year to Maximum 3 years imprisonment or a fine not less than Rs.1 lakh which may extend to Rs.5 lakhs.

(i) Section 59(5) - Non-rectification of register of members as per the order of tribunal

Fine on Company - Not less than Rs.1 lakh which may extend to Rs.5 lakhs

Officer in default Maximum imprisonment of 1 year or a fine not less than Rs. 1 lakh which extend to Rs.3 lakhs or both.

(j) Section 68(11) - Power of Company to purchase its own securities

A fine on Company not less than Rs.1 lakh which may extend to Rs.3 lakhs.

Officer in default- Maximum imprisonment of 3 years or a fine not less than Rs.1 lakh which may extend to Rs.3 lakhs or both.

(k) Section 71(11) - Debentures

Officer in default- Maximum imprisonment of 3 years or a fine not less than Rs.2 lakh which may extend to Rs.5 lakhs or both.

(l) Section 86 - Failure to Register Charge

A fine on Company not less than Rs.1 lakh which may extend to Rs.10 lakhs.

Officer in default- Maximum imprisonment of six months or a fine not less than Rs. 25,000 which may extend to Rs.1 lakh or both.

(m) Section 92(5) - Failure to file Annual return

A fine on Company not less than Rs. 50,000/- which may extend to Rs.5 lakhs.

Officer in default - Maximum imprisonment of six months or a fine not less than Rs. 50,000/- which may extend to Rs.5 lakhs or both.

(n) Section 118(12) - Tampering with the minutes of proceedings of general meeting, meeting of Board of Directors and any other meetings and resolutions passed by postal ballot.

Any person found guilty of tampering with the minutes - Maximum imprisonment for 2 years and a fine not less than Rs. 25,000/- but which may extend to Rs.1 lakh.

(o) Section 128(6) - Failure to keep Books of accounts.

Officer in default- Maximum imprisonment of 1 year or a fine not less than Rs. 50,000 which may extend to Rs.5 lakhs or both.

(p) Section 185(2) - Loan to directors in contravention of section 185

A fine on Company not less than Rs.5 lakhs which may extend to Rs.25 lakhs.

Officer in default Maximum imprisonment of 6 months or a fine not less than Rs.5 lakhs which may extend to Rs.25 lakhs or both.

(q) Section 186(13) - Loan and investment by Company.

A fine on Company not less than Rs. 25,000/- which may extend to Rs.5 lakhs.

Officer in default- Maximum imprisonment of 2 years or a fine not less than Rs. 25,000/- which may extend to Rs.1 lakh or both.

(r) Section 187(4) - Investments held in its own name.

A fine on Company not less than Rs. 25,000/- which may extend to Rs.25 lakhs.

Officer in default- Maximum imprisonment of 6 months or a fine not less than Rs. 25,000/- which may extend to Rs.1 lakh or both.

The company has the right to initiate legal action against directors, in case of breach of their duties. Apart from this, the 2013 Act has also introduced the novel concept of 'class action suits' under Section 245. Under this concept, a group of shareholders (constituting a minimum of 100 shareholders or such minimum percentage of total shareholders as may be prescribed) can bring an action on behalf of all affected parties, against the company and/or its directors, for any fraudulent or wrongful act or omission of conduct on its/their part.

Comparison between some common provisions of Companies Act 1956 and 2013.

Liability Towards Company

Liability arising from Provisions in Companies Act 1956 and 2013
Breach of Fiduciary Duty The Acts recognize that most of the powers of the Directors are 'powers of trust' and acting dishonestly towards the interest of the company or acting in furtherance of their own interest shall entail liability.
Ultra Vires Acts The powers and duties of the Directors are restricted within the Articles and Memorandum of Association (MOA) of the Company and stepping outside these prescribed limits would be considered as ultra vires act and personal liability would be incurred.
Negligent Acts When the Directors fail to exercise reasonable care, skill and diligence, they shall be deemed to have acted negligently in the discharge of their duties and consequently shall be liable for any loss or damage resulting therefrom.
Acts caused by mala fide intentions Directors are the trustees of the assets of the company including money and property, and also exercise power over them. If they exercise such power dishonestly or perform their duties in a mala fide manner, they will be held liable for the breach of trust and would be asked to reimburse the company, for whatever the loss company suffers due to such an act.

Liability towards the third party

Liability arising from Companies Act 1956 Companies Act 2013
Misstatement in Prospectus In case of any omission to state any particulars as per the requirement of section 56 and Schedule II of the Act, or misstatement of facts in the prospectus, renders a director personally liable for damages to the third party. Sec 35- Civil Liability: Where any person has subscribed to securities acting on misleading statements in the prospectus, the director is liable without any limitation, and for all losses and damages incurred by that person.
Sec 62 - Civil Liability

Sec 63 - Criminal Liability: Imprisonment extended to 2 years or fine upto Rs.50 thousand or both.
Sec 34 - Criminal Liability: Where any prospectus issued, circulated or distributed includes any untrue or misleading statements, every person shall be made liable under Sec 447.

Penalty Provision:

Imprisonment not less than 6 months which may extend to 10 years.

Fine not less than the amount involved in the fraud and can extend to 3 times that amount.
Allotment of Shares

Failure to repay application monies when application for listing of securities are not made or is refused
Under section 73(2)-Where the permission for listing of the shares of the company has not been applied or such permission having been applied for, has not been granted, the company shall forthwith repay, without interest, all monies received from the applicants in pursuance of the prospectus, and, if any such money is not repaid within eight days after the company becomes liable to repay, the company and every director of the company who is an officer in default shall from the expiry of the eighth day, be jointly and severally liable to repay that money with interest rate of not less than four per cent but not more than fifteen per cent, as may be prescribed, having regard to the length of the period of delay in making the repayment of such money. Sec 40 – Every Company shall, before making a public offer, make an application to a stock exchange and obtain permission for the securities to be dealt with. Monies received on application from the public shall be kept in a separate bank account etc.

Default in compliance to such provision would make the Company liable.

The director shall be punished by imprisonment that may extend to one year or a fine not less than fifty thousand rupees which may extend to three lakh rupees or both.
Fraudulent Trading If the directors have been found guilty of fraudulent trading during the course of business, they may also be made personally liable by an order of the court under section 542.

Sec 542(3) provides that every person who was knowingly a party to the carrying on of the business in the manner aforesaid, shall be punishable with imprisonment for a term which may extend to two years, or with fine which may extend to fifty thousand rupees, or with both.
Sec 339 – For any fraudulent conduct in business, every person who was knowingly a party to the aforementioned manner, shall be liable under sec 447.

Vicarious Liability of Directors

The basic test for determining this has been provided for by the courts in various judgments. The Hon'ble Supreme Court of India laid down in the case of Maksud Saiyed vs. State of Gujarat and Ors. that the vicarious liability of the Managing Director and Director would arise provided any provision exists in that regard in the statute. This was re-iterated by the Supreme Court once again in S.K. Alagh's case where it held that in absence of any provision laid down under the statute, a Director of a company or an employee cannot be held to be vicariously liable for any offence committed by the company itself. The decision of Tesco has been referred to by the earlier division bench decisions of the Supreme Court in J.K Industries Limited and Others v. Chief Inspector of Factories and Boilers and Others and P.C Agarwala v. Payment of Wages Inspector, M.P and Others wherein it has been held that in the context of vicarious liability under strict liability statutes, a person in charge would be deemed to be responsible for the acts of the company. Thus, the decision of the three-judge bench of the Supreme Court has clearly brought some clarity on the principles of attribution and vicarious liability in the context of corporate criminal liability vis-à-vis strict liability under a statute.

The provisions of Section 138 of the Negotiable Instruments Act, have been incorporated and the bouncing of a cheque has been made a criminal offence which was earlier a civil offence with the intent of making the cheque truly acceptable in the commercial world. Not only this, but the concept of vicarious liability has also been incorporated by Section 141 of the Negotiable Instruments Act, making the director, manager, secretary, and other officers of the Company liable if the offence is attributable to any neglect on their part, thereby, incorporating the concept of vicarious liability.

The fall out of the above is that it has opened a floodgate of criminal litigations under Section 138 and 141 of the Negotiable Instruments Act, in which the directors are also made parties. The issue has also been settled by the Hon'ble Supreme Court in line with judgments which state that Directors are liable under Sections 138 and 141 of the Negotiable Instruments Act. But since the offence is bailable, one can seek bail as a matter of right, which serves to considerably lessen the heat felt in the Corporate World.

The Hon'ble Delhi High Court, in case of Kamal Goyal Vs. United Phosphorus Ltd, has relied upon Form No.32 to establish cessation of a person as a Director of the Company. Taking in view that certified copy of Form 32 is a public document authenticity of which had not been disputed, it could be considered in proceedings under Section 482 of the Code of Criminal Procedure, this Court also relied upon the decision of the Hon'ble Supreme Court in All Carogo Movers (I) Pvt. Ltd. v. Dhanesh Badarmal Jain and Anr. (2007) 12 SCALE 39, V.Y. Jose and Anr. vs. State of Gujarat and Anr. (2009) I AD SC 567, and Minakshi Bala v. Sudhir Kumar. An analysis of the above mentioned judgments establishes that if the certified copy of Form No.32 is brought on record of the case – it establishes that the person has resigned as a Director. In case the offence has been committed after the date of cessation as a Director, that person cannot be arrayed as accused person in the criminal complaint by the complainant by invoking the principle of vicarious liability.

Liabilities of Directors under other Acts

Liability of Directors under Section-415 and 409 and other provisions of Indian Penal Code.

In the case of GHCL Employees Stock Option Trust vs. Kranti Sinha reported at MANU/SC/0271/2013: (2013)4 SCC 505, the Managing Director and Joint Managing Director, Company along with its Directors were prosecuted for the offences punishable under Sections 120-B,415 and 409 r/w Section 34 of the Indian Penal Code. A process was issued by the learned Metropolitan Magistrate against all the accused including the Managing Director. The Managing Director and Directors filed a petition before the High Court of Delhi challenging the issuance of summons against the Company, the Managing Director of the Company, Company Secretary and Directors of the Company. The High Court of Delhi quashed the process issued against the Managing Director, Company Secretary and Directors of the Company and upheld the order of process issued against the Company. The matter was carried to the Supreme Court by the complainant.

Some Case Laws on Vicarious Liability of Directors :

In the case of K.K. Ahuja vs. V.K. Vohra, (2009) 10 SCC 48, Hon'ble Supreme Court has held that:

"It is evident that a person who can be made vicariously liable... is a person who is responsible to the company for the conduct of the business of the company and in addition is also in charge of the business of the company. There may be many directors and secretaries who are not in charge of the business of the company at all ... a person may be a director and thus belongs to the group of persons making the policy followed by the company, but yet may not be in charge of the business of the company; that a person may be a Manager who is in charge of the business but may not be in overall charge of the business; and that a person may be an officer who may be in charge of only some part of the business.

In the case of Ajay Mitra vs. State of M.P 2003 Cri LJ 1249, the Hon'ble Supreme Court held that:

"Since the appellant were not in picture at all at the time when complainant alleged to have spent money in bottling plant, neither any guilty intention can be attributed to them nor there possibility of any intention on their part to deceive the complainant. No offence of cheating can, therefore, be said to have been committed by appellants.

In the case of N.K. Wahi vs. Shekhar Singh & Others, (2007) 9 SCC 481, the Hon'ble Supreme Court held that:

"To launch a prosecution, therefore, against the alleged Directors there must be a specific allegation in the complaint as to the part played by them in the transaction. There should be clear and unambiguous allegation as to how the Directors are in-charge and responsible for the conduct of the business of the company. The description should be clear. It is true that precise words from the provisions of the Act need not be reproduced and the court can always come to a conclusion in facts of each case. But still, in the absence of any averment or specific evidence the net result would be that complaint would not be entertainable.

In the case of Sunil Bharti Mittal vs. Central Bureau of Investigation, (2015) 4 SCC 609:

Principle of 'alter ego' - a company acts through persons in charge of its affairs and the intent of such person is the mens rea in an offence by the company.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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