Tuesday, April 12, 2011

MCA Circular on Prosecution of Directors

One of the disincentives that operate against directors, particularly non-executive directors, is that they are often susceptible to prosecution for offences committed by the company that it not within their knowledge. Occasionally, innocent directors have been subject to victimization by requiring to answer allegations that are often frivolous in nature. This concern has now been addressed, at least partially, by a Circular issued on March 25, 2011 by the Ministry of Corporate Affairs to all Regional Directors, Registrars of Companies (ROC) and Official Liquidators.
The Circular relates primarily to independent directors and nominee directors, who are not in charge of the day-to-day affairs of the company. It calls upon the ROC to take extra care in examining the cases where such directors are identified as “officers in default” for the purposes of actions to be taken under the relevant penal provisions of the Companies Act. The Circular further states:
No such Directors as indicated above shall be held liable for any act of omission or commission by the company or by any officers of the company which constitute a breach or violation of any provision of the Companies Act, 1956, and which occurred without his knowledge attributable through Board process and without his consent or connivance or where he has acted diligently in the Board process. The Board process includes meeting of any committee of the Board and any information which the Director was authorised to receive as Director of the Board as per the decision of the Board.
The Circular imposes greater obligations on the ROC to verify relevant information and records before initiating prosecution against independent or nominee directors. These include the status of the director and timing of resignation relative to the commission of the offence by the company. Special provisions have been made for identification of the appropriate “officer in default” in connection with violation of the provisions relating to accounting and financial statements. In sum, the Circular moves away from the erstwhile regime where ROC could potentially adopt a trigger-happy approach while initiating criminal prosecution of directors to one where the ROC is compelled to exercise “proper application of mind”. 

This is a welcome move as it prevents harassment of innocent directors who have been kept in the dark by managements. The Circular, however, does not go as far as proposals discussed in the context of the Companies Bill, 2009 that call for complete immunity to independent directors from prosecution. By conferring discretion on the ROC (to be exercised in an informed manner), the Circular adopts a principles-based approached by avoiding the rigidity involved in complete immunity. This would continue to spur non-executive directors to perform their role diligently, but at the same time protect them against prosecution risks in the event of their innocence.


Renu Gupta said...

Thank you for the post Umakanth. This is an indeed a welcome move by the MCA.

However, in my experience, this circular in itself does not nullify the harassment which is usually faced by independent directors, bulk of which is in the context of dishonour of cheque cases, under Section 138 of Negotiable Instruments Act.

Similar relief needs to be extended in this branch of law, where independent directors are impleaded as accused in frivolous criminal complaints, long after they have ceased to be directors.

Although, a recent Supreme Court judgment in Harshedndra's case provides protection to directors who cease to be directors when the offence of dishonour od cheque is committed, summons are issued in routine by District Magistrates on every frivolous complaint.

V. Umakanth said...

@ Renu Gupta. That is a pertinent observation as the MCA Circular only covers offences under the Companies Act. As regards offences under other socio-economic legislation, including the Negotiable Instruments Act, the general law laid down by the Supreme Court will apply in addition to the relevant statute. To that extent, the scope of MCA Circular is limited.

Anonymous said...

Nice post, Uma. Thanks. On the flip side, may directors go away scot free because the RoC is no aware of the offenses committed. How does an aggrieved shareholder initiate action against wheeler-dealer directors?