DIN cannot be deactivated solely for disqualification under Section 164 (2), Companies Act; Section 164 (2) not retrospective: Kerala High Court

While upholding the Constitutionality of Sections 164 (2) and 167 (1) of the Companies Act, 2013, which deal with the disqualification of Directors from companies, the Kerala High Court recently made pertinent observations on the impact of these provisions (Zacharia Maramkandathil Mohan and Ors v. Union Of India)..Justice N Nagaresh held that the disqualification of Directors under Section 164(2) is not be applicable retrospectively to the period before the Companies Act, 2013 came into force."Directors of private companies cannot be disqualified for appointment / re- appointment as mandated under section164(2) if any of such three consecutive defaults in filing Annual Returns/Financial Statements is before the financial year, 2014-2015," the judgment stated.The Court added that, "This would be especially so because up to March 31, 2014 the provisions of Section 274(1)(g) of the Act,1956 were governing the field.".Among other important conclusions, the Court has also held that the Director Identification Number (DIN) cannot be deactivated only on account of the temporary disqualification of Directors under Section 164 (2). "This court holds that the DIN of the petitioners allotted under Rule 10 of the Companies (Appointments and Qualifications of Directors) Rules, 2014 ,are not liable to be deactivated or cancelled solely for the reason that the petitioners stand disqualified for appointment / reappointment as Directors of Companies by operation of Section 164(2)," the Court said. .The Court proceeded to direct the reactivation of the DINs of the petitioners forthwith..However, the authorities were given the liberty to cancel or deactivate the DINs of the petitioners for any reasons laid down in Rule 11 of the Companies (Appointment and Qualifications of Directors) Rules, 2014 (dealing with Cancellation or surrender or Deactivation of DIN)..Case background.The Court passed the ruling while disposing of a batch of over 200 petitions challenging the disqualification of various Directors of companies under Sections 164 and 167 of the Companies Act, 2013 for the failure of their companies to file Financial Statements/ Annual Returns. Since common questions of law arose in all the writ petitions, they were heard together and disposed of by a common judgement.Advocates Navod Prasannan Pattali, Shameem Ahmed, Mohan Pulickkal, Sukumar Nainan Oommen, Sherry Samuel Oommen and Ramola Nayanpalli appeared for the petitioners. Central Government Counsel MN Manmadan and Assistant Solicitor General Vijayakumar represented the Union of India and other respondents. .The Law in question.Section 164 (2) lays down that a director of a company would stand disqualified for a period of five years if the company does not file financial statements for a continuous period of three financial years, or defaults on payment of other dues concerning debenture repayment, dividends declared etc. The proviso to Section 164 (2) states that where a person is appointed as a director of a company which is in default on account of Section 164 (2), he shall not incur the disqualification for a period of six months from the date of his appointment.Section 167 (1) (a) calls for directors to vacate their office in a company upon incurring disqualification as per Section 164 of the Companies Act, 2013. The proviso to Section 167 (1) (a) carved out that when a director is disqualified on account of the company failing to file its financial statements or it defaults on other dues prescribed under Section 164 (2), such person would have to vacate from director’s office in all other companies (in which he is director) but not the company that committed the default..Questions of Law raised.The case before the Court raised several important questions of law including, among others:Whether Sections 164(2)(a) and 167(1)(a) of the Companies Act, 2013 are ultra vires the Constitution of India, being violative of Article 14 or 19?Whether the principles of natural justice should be read into Section 164(2) in view of the nature and severity of consequences arising from its operation?Whether Section 164(2) is retrospective in its operation?Whether notice under Section 455(4) need be necessarily issued on a defaulting Company, before Section 164(2)(a) to become operational?Whether the action of the respondents in deactivating the DINs of the petitioners, is justified?.Other Important Court findings .Constitutionality of Sections 164 (2) and 167The Court ruled that Section 164(2) and Section 167(1) of the Companies Act, 2013 are not ultra vires Article 14 or Article 19(1)(g) of the Constitution of India. The petitioners contended that the incidents resulting in disqualification under 164(2) are not directly attributable to Directors and could be due to factors outside their control such as pandemics or internet restrictions. However, the consequences to Directors are grave. These legislative provisions are excessively arbitrary and would and would be hit by Article 14 of the Constitution, they stated.The Judge, however, disagreed. "The purpose of disqualification of defaulting Directors in other Companies is to make the Directors answerable to the corporate sector. The purpose is to save the corporate community from the consequences of mismanagement. It is intended to increase the standards of corporate governance. It is intended to protect creditors and the general public from mismanagement of Companies. Therefore the provisions Section 164 and Section 167 will fall within the exceptions under Article 19(6)", he observed.The Court concurred with the Karnataka High Court's judgement in Yashodhara Shroff v Union of India which had upheld the Constitutional validity of said sections..Section 164 (2) and principles of natural justiceThe petitioners submitted that the consequences under Section 164 (2) are grave since the disqualified persons are barred form being director at any other company for five years. They argued that directors should at least be extended an opportunity of hearing. Principles of natural justice or audi alteram partem (listen to the other side) should necessarily be read into Section 164 (2), it was contended.The Court, however, found that the provision does not contemplate the incorporation of such natural justice principles. "Companies Act, 2013 does not contemplate extension of opportunity of hearing to Directors of a Company while incurring disqualification under Section 164(2), and going by the scheme of the Act the principles of natural justice cannot be read into Section 164(2) or Section 167(1)", the Court observed.The Court also noted that the disqualification is done by the operation of law and is only for a few years, not perpetual. Therefore, Justice Nagaresh stated that the requirement of hearing does not arise and that the principles of natural justice cannot be read into the Act. .Impact of provisos to Sections 164(2) and 167(1)(a)Another question addressed was the impact of the provisos to Sections 164 (2) and 167(1)(a) of the Act, 2013, which was inserted by the Companies (Amendment) Act, 2017 with effect from May 7, 2018. While upholding the Constitutional validity of these provisions the Court also found that a part of the proviso to Section 167 (1)(a) was prospective, whereas another part was only clarificatory and, therefore, retrospective. While the words "provided that where he incurs disqualification under 164(2) , the office of director shall become vacant ... other than the company which is in default under that sub section“ will have retrospective operation, the words "in all companies" will have only prospective operation, the Court said.The Court observed that the intention behind inserting the said provisos were to enable the defaulting companies to file annual returns/financial statements for defaulted years, and to ensure the Director's vacation from office in all other companies upon a default..Whether notice under Section 455(4) is a sine qua non before disqualification of Directors under Sections 164 (2), 167?On this issue, the Court said that Section 455 of the Companies Act is a provision intended for an altogether different purpose i.e. to enable certain inactive companies to apply for the status of a dormant company. It did not concern the disqualification of directors for the failure to file returns, the Court opined. Rather, the Court observed that, "the provision is primarily intended to apply to Companies formed and registered for a future project or to hold an asset or intellectual property and have no significant financial transaction and also to an inactive company, to enable such companies to apply for the status of a dormant Company."The Court, therefore, held:"Section 455 cannot be construed as a provision to issue notice to defaulting Companies before their Directors become amenable to disqualification under Section 164(2). This court therefore hold that a notice under Section 455(4) is not a sine qua non for applying the provisions of Section 164(2) or 167.".Before parting with the matter, the Court also added, "Where the names of any Companies stand struck off , the petitioners in respect of such Companies are at liberty to invoke Section 252 of the Companies Act, 2013 to challenge striking off the names of their Companies from the Register of Companies and to resort to legal remedies available to them, to challenge their disqualification for holding the office of Director.".With these directions, the petitions were disposed of. .[Read Judgment]