New Companies Act may give Directors Sleepless Nights

The old corporate testament of 1956 has been pushed into the annals of history, beginning the All Fools Day this year. 282 vital sections of the new company law have been made effective, giving vent to a modern, resilient regulatory testament.

The new law assumes directors and key management personnel to be the sentinels of governance. It seeks to put in a quandary the questionable independence of independent directors.

A host of rulings by various courts in India in the past have established that a corporate body can be prosecuted and penalised, yet not be imprisoned! But will the new law permeate down to the decision makers harboured behind the facade of a corporate body? The attribution of criminality to the "officer who is in default" is established under section 2(60) of the Companies Act, 2013. He shall be liable to penalty or imprisonment.

The new Act craves to implicate every director, who is "aware" of any 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.

Without doubt he is liable, too, in case he participates in such proceedings without objecting to a contravention, or where such contravention has taken place with his consent or connivance. The intent of law here seems to entice an independent director to turn a whistleblower.

A mere awareness of a contravention makes a director liable to penal action, and it's ironical the law seems to turn a blind eye in protecting the whistleblower. Even though section 2(60) says "for the purpose of any provision in this Act", it is debatable whether it will ringfence the liability of a director to a contravention under company law.

The responsibility of a director under this umbrella law could in all possibility be cited in proceedings under several other laws (like FEMA) wherein a director's responsibility to comply is specifically enshrined.

In Iridium India Telecom Limited vs Motorola and others (2011), the Supreme Court observed that a corporation is virtually in the same position as an individual, and may be convicted of common law as well as statutory offences, including those requiring mens rea.

The court reiterated its earlier position in Standard Chartered Bank vs Directorate of Enforcement that a company is liable to be prosecuted and punished for criminal offences, even though the criminal act is committed through its agents.

The apex court, thus, recognises that a legal persona needs agents to conceive and execute malice. Now, the penal section oft-repeated in the new company law, ie, Section 447. The section seeks to imprison a guilty for a minimum of six months (three years, in case the fraud involves public interest) up to a maximum of 10 years.

'Fraud' in relation to the affairs of a company includes any act, omission, concealment of any fact or abuse of position with intent to deceive, to gain undue advantage from, or to injure the interests of the company or its stakeholders. It is difficult for a director to stay clear of all these four intents and prove innocence.

Given the object apathy to compliance with law, coupled with the enforcement mechanism enmeshed in corruption rendering it dysfunctional, 'fraud' as defined above is a source of sustenance for many a corporate. Also, certain independent directors representing specialised/technical areas of expertise may not have the depth of legal and financial acumen to detect the nuances of 'fraud'.

In this backdrop, can any independent director absolve himself of his criminal liability under the new law? To add fuel to fire, Sebi is deepening the 'PIT' Regulations, and this is bound to have huge criminal implications on 'connected persons'. It seems law has got serious with frauds, with Serious Fraud Investigation Office buttressed with a legal status under the new company law.

Directors are bound to have sleepless nights if the enforcement machinery is disturbed from its slumbers, regulatory system is cleaned up, and surveillance becomes technology-driven. Will the new government at the Centre be a harbinger of the clean-up act?

Economic Times, New Delhi, 09-04-2014