Friday, July 31, 2009

Director and Officer Liability for Dishonour of Cheques

(The following post has been contributed by Avirup Bose. Avirup is an Indian lawyer, who has graduated from NUJS Kolkata and has an LL.M from the Harvard Law School)

On July 6, a Division Bench of the Supreme Court passed a judgment in K.K. Ahuja v. V.K. Vora (MANU/SC/1111/2009, per R.V. Raveendran, J.) (“K.K. Ahuja”), where it considered the particular question as to who can be said to be persons “in-charge of, and was responsible to the company for the business of the company” under Section 141 of the Negotiable Instruments Act, 1881 (“NI Act”). Section 141 of the NI Act provides that when a company’s cheque is dishonoured under Section 138 of the NI Act, then those who were in-charge of the conduct of the business of the company, at the time the offence was committed, would be constructively liable.

K.K. Ahuja, the appellant, had filed two criminal complaints, under Section 138 of the NI Act, against M/S Motorol Speciality Oils Ltd. (the “Company”), and eight of its officers (Chairman, four Directors, VP Finance, General Manager and Deputy General Manager (“DGM”) respectively), in the Court of the Metropolitan Magistrate, Delhi, averring that at the time of the commission of the offence, all the eight officers were in-charge of and responsible for the conduct of the day-to-day business of the Company and thus deemed to be guilty under Section 138, read with, Section 141 of the NI Act. Next, the accused DGM moved to quash the proceedings against him on the ground that as DGM of the Company he was not in-charge of the conduct of the day-to-day business of the Company. This petition was allowed by the Delhi High Court, which was then challenged before the Supreme Court in K.K. Ahuja.

The Supreme Court ruled in dicta that, “[]…. to be vicariously liable under Sub-section (1) of Section 141, a person should fulfill the 'legal requirement' of being a person in law (under the statute governing companies) responsible to the company for the conduct of the business of the company and also fulfill the 'factual requirement' of being a person in charge of the business of the company.” In other words, any corporate officer accused under Section 141(1) of the NI Act has to: (1) be a person responsible to the company for the conduct of the business of the company under the provisions of the Companies Act, 1956 and (2) be in-fact also a person in-charge of the business of the company.

Requirements to satisfy the First Prong:

The Court, relying on Sections 5 and 291 read with clauses (24), (26), (30), (31) and (45) of Section 2 of the Companies Act, 1956, lists the categories of persons who under the Companies Act can be considered as persons who are responsible to the company for the conduct of the business of the company. They are:

(a) the managing director/s;

(b) the whole-time director/s;

(c) the manager;

(d) the secretary;

(e) any person in accordance with whose directions or instructions the Board of directors of the company is accustomed to act;

(f) any person charged by the Board with the responsibility of complying with that provision (and who has given his consent in that behalf to the Board); and

(g) where any company does not have any of the officers specified in clauses (a) to (c), any director or directors who may be specified by the Board in this behalf or where no director is so specified, all the directors.

The above list is exhaustive since the Supreme Court held that other employees of the company cannot be said to be persons who are responsible to the company for the conduct of the business of the company.

Requirements to Satisfy the Second Prong:

The Supreme Court, relying on past precedents, held that the words “person in charge of the business of the company” refer to a person, who is in overall control of the day-to-day business of the company. The Supreme Court further held that, since the question as to who is in “overall control” is a fact specific one, specific averment in the complaint is required. This the Court felt necessary since a person may be a Director and thus belong to the group of officers who are involved in policy-making for the company, yet he may not be in-charge of the business of the company.

Consequently, the Supreme Court provides a two-pronged test—the first prong is a legal, statute-based test, where to prove that a person is responsible to the company for the conduct of the business of the company, one needs to merely check if the accused person falls in any one of the listed categories. The second prong is a fact-based test, where through specific averments the complainant has to allege that the particular accused was in-fact in overall control of the day-to-day business of the company. Both the prongs need to be complied with. Hence, if a person does not satisfy the first prong, i.e., if he is not one of the above-mentioned officers as listed by the Supreme Court, then he is neither required to meet the second prong nor can he be held liable under Section 141(1).

However, if the accused falls under one of the categories listed by the Supreme Court, i.e., he is under statute, the Companies Act 1956, a person responsible to the company for the conduct of the business of the company, then the judgment provides for a sliding scale of averment that needs to be made in the complaint, depending upon the particular category of the officer. These are as tabularized:

Category

Degree of Averment

Reason

Managing Director or Joint Managing Director

No need to make an averment that he is in-charge of and responsible to the company, for the conduct of the business of the company. It is sufficient if an averment is made that the accused was the Managing Director or Joint Managing Director at the relevant time.

Because the prefix ‘Managing’ to the word ‘Director’ makes it clear that he was in charge of and was responsible to the company, for the conduct of the business of the company.

A director or an officer of the company who signed the cheque on behalf of the company

No need to make a specific averment that he was in charge of and was responsible to the company, for the conduct of the business of the company or make any specific allegation about consent, connivance or negligence.

Because the very fact that the dishonoured cheque was signed by him on behalf of the company, would give rise to responsibility under Sub-section (2) of Section 141.

Director, Secretary or Manager or a person referred to in clauses (e) and (f) of Section 5 of

Companies Act

An averment in the complaint that he was in charge of, and was responsible to the company, for the conduct of the business of the company is necessary. (Such officers can also be made liable under Section 141(2) by making necessary averments relating to consent and connivance or negligence).

The Supreme Court also held that other officers of the company, apart from those tabularized above, cannot be made liable under Section 141(1) of the NI Act. Such officers can however be made liable under Section 141(2), which provides for liability to corporate directors/officers who may not be in-charge of the conduct of the business of the company, but nevertheless the offence under Section 138 of the NI Act (dishonour of cheque) was committed with their consent or connivance or due to their negligence. However, in such circumstances, specific averments must be made in the complaint as to how and in what manner the accused was guilty of consent and connivance or negligence.

This brings us to an interesting issue, albeit beyond the scope of the present case-- say a non-executive director who is a financial expert and a past banker sits on the Board of a company, which has issued certain cheques, which have been dishonored and returned by the respective banks unpaid. By merely being a non-executive director he is most likely not one of the officers responsible for the conduct of the business of the company, nor is he in-charge of the business of the company. Hence, in the absence of special circumstances, as per KK Ahuja, such a non-executive director will probably not be held liable under Section 141(1). However, the scope of Section 141(2) is wide open. In case such a director votes in favor of a resolution, which provides for payment of a certain sum of money, from one of the several bank accounts of the company, to a supplier/contractor and that cheque bounces—is the director liable? Can his consent be construed from his “yes” vote? I would argue that the case then depends upon how the executive director went about doing his job. Did he ask relevant questions, did he try to inquire if the company had sufficient funds in that particular account, especially if he had reason to believe otherwise? Does the fact that he is a financial expert make him more readily liable under Section 141(2) of the NI Act than the other directors? In fact, in U.S. the Delaware chancery court in re Emerging Communications, Inc. Shareholders Litig., 2004 WL 130 5745 (Del.Ch. June 4, 2004)) found that a particular director who was a former investment banker with relevant experience in the particular industry be held to a higher standard of inquiry than non-expert directors when he failed to apply his “specialized financial expertise”, when evaluating a going-private transaction. The case was uniformly held to have taught directors, especially the non-executive and independent ones, not to simply rely on information either given by the management or outside professionals, especially when they were themselves experts in the relevant field.

One might wonder why the complainant needs to specifically aver in a complaint under Section 138 and 141 of the NI Act, that at the time when the offence was committed, the person accused was in-charge of, and responsible for the conduct of the business, since in the absence of such an averment, as held by the Supreme Court in the three judge decision of S.M.S. Pharmaceuticals Ltd. v. Neeta Bhalla and Anr (“S.M.S. Pharma”(MANU/SC/0622/2005)), Section 141 of the NI Act cannot be invoked. The Supreme Court’s logic in requiring such specific averments before any corporate director/officer can be held liable, as held in a series of decisions [See generally: OP Faizi & Ashish Aggarwal, Khergamvala on The Negotiable Instruments Act 514 – 525(2008)], is that the liability under Section 141(1) is raised by legal fiction, such that even though a person is not personally liable, he will be held liable vicariously and hence a clear case connecting the accused with the commission of the crime, as required under Section 141(1) has to be spelled out in the complaint through specific factual averments. However, the obvious disadvantage the complainant suffers when he has to specifically aver that a certain director or officer was in-charge is that, being an outsider, he might not know exactly how the internal business of the accused company is organized i.e., who are its principal executive officer bearers and who are only involved in business policy making. This is easy when dealing with the Managing Director and the signatories of the cheque, but beyond that the picture becomes fuzzy.

As per S.M.S. Pharma (which the Supreme Court heavily relied upon in KK Ahuja):

“The liability arises from being in charge of and responsible for conduct of business of the company at the relevant time when the offence was committed and not on the basis of merely holding a designation or office in a company. Conversely, a person not holding any office or designation in a Company may be liable if he satisfies the main requirement of being in charge of and responsible for conduct of business of a Company at the relevant time. Liability depends on the role one plays in the affairs of a Company and not on designation or status.” (Emphasis Added)

Imagine a family based company having a majority shareholder holding more than 50% of the stock. The company is nevertheless, run by a team of non-familial professional managers. Can such a majority shareholder be held liable if, the managers of the company, which he controls, issue a cheque, which, is dishonoured by the banks. In KK Ahuja one of the people listed by the Supreme Court in paragraph 14 as persons responsible to the company for the conduct of the business of the company is:

“(e) any person in accordance with whose directions or instructions the Board of directors of the company is accustomed to act;”

A controlling shareholder can very well be someone who regularly instructs the Board and the senior management. Yet, when the complaint would want to include such a controlling shareholder in his complaint, under Section 141(1), he will need to make specific factual averments, showing how in-fact such controlling shareholder was regularly consulted by the Board or otherwise in-charge of the business of the company. The complainant might not have access to such materials if they are not in the public domain. It is not enough for the courts if the complainant merely states that the accused is a “controlling shareholder.” The decision in KK Ahuja fails to take into account such practical business scenarios. The Court could have provided some more guidance, like examples of factual averments that will be required, when a complainant wants to hold corporate officers, who are not managing directors or signatories of the bounced cheques, liable under Section 141(1) of the NI Act. The standard of averment that the Court in KK Ahuja suggests, in paragraph 9, (quoting Saroj Kumar Poddar v. State (NCT of Delhi) MANU/SC/0711/2007): “the complaint should contain averments as to how and in what manner the accused was responsible for the conduct of the business of the company, or otherwise responsible for its functioning”, is general and vague, especially in scenarios described above.

Why cannot the complainant sue the entire Board and the senior management under Section 141 and then such officers can prove that they were not in-fact in-charge of the company’s business at the time of the commission of the crime? It would be much easier for the directors to deny responsibility than for an outsider to aver responsibility on part of internal corporate officers at the trial stage. This view although a minority one, found voice in a two judge bench decision of the Supreme Court in N. Rangachari v. Bharat Sanchar Nigam Ltd (2007) II CCR 191 (SC), which held the following in obiter:

“[]…a person in the commercial world having a transaction with a company is entitled to presume that the directors of the company are incharge of the affairs of the company. If any restrictions on their powers are placed by the memorandum or articles of the company, it is for the directors to establish it at the trial. It is in that context that Section 141 of the Negotiable Instruments Act provides that when the offender is a company, every person, who at the time when the offence was committed was incharge of and was responsible to the company for the conduct of the business of the company, shall also be deemed to be guilty of the offence along with the company. It appears to us that an allegation in the complaint that the named accused are directors of the company itself would usher in the element of their acting for and on behalf of the company and of their being incharge of the company…..

A person normally having business or commercial dealings with a company, would satisfy himself about its creditworthiness and reliability by looking at its promoters and Board of Directors and the nature and extent of its business and its Memorandum or Articles of Association. Other than that, he may not be aware of the arrangements within the company in regard to its management, daily routine, etc. Therefore, when a cheque issued to him by the company is dishonoured, he is expected only to be aware generally of who are incharge of the affairs of the company. It is not reasonable to expect him to know whether the person who signed the cheque was instructed to do so or whether he has been deprived of his authority to do so when he actually signed the cheque. Those are matters peculiarly within the knowledge of the company and those in charge of it. So, all that a payee of a cheque that is dishonoured can be expected to allege is that the persons named in the complaint are in charge of its affairs. The Directors are prima facie in that position.”

To conclude, the Supreme Court in K.K. Ahuja fine-tuned the principles relating to director and officer liability for dishonour of cheques and built upon the policy laid down in the previous case of S.M.S. Pharma. However, there continue to be some open issues as discussed above, and the Court has left complainants with a somewhat insurmountable burden of averment as outsiders to the company.

- Avirup Bose

1 comment:

Gopal said...

Dear sir,
I was a director in a firm registered in 2004. since i had better business opportunity out of India i setup a trading unit in Thailand and proceeded to do business there. meanwhile the other director of my company filed the returns of the company back in india until 2006. kindly note i had not applied nor do i have a DIN number issued. sometime in 2007 my other partner was approached by a business associate to permit him to operate our company. since my partner was the CEO in the company of this associate he obliged. now i am been given to understand from the various 138 cases that are filed against me and my company that cheques were issued to various parties by this associate to avail of domestic factoring facility. since i have not signed any of the cheques in the past 6 years and enjoy a NRI status in india due to me extensively living abroad am i liable to be prosecuted under section 138? i would appreciate your input on this matter ....regards Gopal Nair