In September, the Ministry of Corporate Affairs (MCA) struck off names of 2,17,239 companies, indicating that such companies have not been carrying on business activities for a long period and could be operating as shell companies. Concurrently, companies which have not filed compulsory filings with the Registrar of Companies have been identified as defaulting companies.
Simultaneously, the MCA identified a total of 3,19,637 individuals who have been disqualified as directors under the Companies Act.
Given the government’s focus on tackling the black money menace and non-compliance, it is likely that there will be many more companies and individuals who will be adversely impacted. Some estimate that as many as 4.5 lakh individuals may face disqualification for their association with both non-compliant and or shell companies.
What is going on?
This first-of-its-kind mass disqualification exercise has grabbed the headlines, with details of companies and individuals being publicly available on the MCA website.
Individuals who have served on boards of defunct or defaulting companies are being asked – What have you been doing? Why has the company failed to make filings on your watch? Why have filings not been made for three or more financial years? What steps did you personally take to set things right?
Even as such individuals struggle to respond to these questions, the implications for them are stark and real. They have been debarred from re-appointment as a director.
Such disqualified directors will continue to have liability, if any, as if the company has not ceased to exist, in terms of section 248(7) of the Companies Act. The disqualified directors will be accountable for malafide, fraudulent actions or other contraventions and non-compliances during their directorship.
Consequences for compliant companies
Apart from the defunct or defaulting companies where the individuals served as directors, there are implications for other functioning and compliant companies because of such individuals.
In terms of the Companies Act, the disqualified directors cannot be appointed to the boards of any company. A compliant company that has a disqualified director will face problems in running its board. For example, suspension of the digital signature of a disqualified director, or rejection of any document or application filed by such individual, can impede the work of the compliant company.
For listed companies and companies in the regulated financial services sector, the board or its committee that evaluates directors will be required to re-establish and reaffirm whether the individual is ‘fit and proper’ to continue as a director, or whether they should ask for the individual's’ resignation.
Even if resignation is not asked for or tendered – when the term of appointment as director ends, the individual would be ineligible for reappointment. Given that ineligibility is for five years, the individual would be exiled from the boardrooms until 2021.
Companies in such situations would need to identify and appoint eligible and qualified individuals. Given this state of affairs, including in terms of the MCA taking stern action, individuals would need to be discerning about accepting invitation to boards. Eligible and qualified individuals can expect to be in demand. Companies should ready themselves to present an effective and adequate culture of compliance in order to attract the right potential directors.
Similarly, companies should be cognizant of the other directorships held by both existing and future directors on their board. Corporate governance experts state that an effective pre-vetting mechanism by companies ensures that a proposed director is not disqualified and an undertaking to that effect, by such an individual will help companies mitigate risk on this count. Companies may be in the practice of obtaining these anyway, but these become even more important in light of the recent action by the MCA.
What of the disqualified directors?
Several individuals named as disqualified directors are protesting their disqualification. Some claim to have resigned from the board before the company became defunct or started defaulting. Others claim to have been wrongly disqualified.
Such individuals are expected to furnish evidence of having resigned from the boards of such defunct/defaulting companies. The requisite forms, if filed with the Registrar of Companies in this behalf, could be a material item to establish if they were indeed disassociated or not.
Given that the number of directors disqualified is in lakhs, it may be that only a handful or even a hundred or so could provide evidence of having disassociated themselves well ahead of a company becoming defunct or starting to default.
What options are open to a disqualified director?
Kalpana Unadkat, partner at law firm Khaitan & Co., says: “The disqualified directors may make a representation to the RoC and the MCA stating that the inclusion of their name in the list without grant of opportunity of hearing is unfair and could request for a hearing. If such representation is not acted upon or if the ROC and the MCA cannot recall the list, then filing a writ before the relevant High Court might be a remedy. The High Court could then stay the impact of inclusion in the list and also direct the ROC or the MCA to provide an opportunity of being heard to such individuals.”
It’s noteworthy that some reports mention that the MCA had invited inputs on an initial list of companies that it proposed to strike off in terms of section 248. Companies or stakeholders who voiced a concern are not in the final list of struck off companies nor are the directors of such companies debarred as yet. Hence, the MCA could argue that a fair opportunity was indeed provided prior to its actions taken now.
What next for defaulting companies?
Those who are part of a defaulting company—ones which failed to file annual returns and financial statements for three years or more—would move to ensure such filings are made expeditiously and restored to the status of a compliant company. The aggrieved company whose name has been stuck off by the RoC may file an appeal with the National Company Law Tribunal (NCLT) within three years from the date of the order of the RoC.
Cogent reasons and justifications need to be provided for restoration in terms of section 252 of the Companies Act. Unadkat says that the disqualified director can also follow up with the company to ensure that an application is filed for compounding the non-compliances under the Act, and that the company has paid the penalties under the compounding order.
Those who are part of a defunct company—which failed to commence any activity or did not undertake any activity for two consecutive financial years—would need to consider options in terms of section 248 of the Companies Act, which includes an orderly winding up or liquidation of the company.
Finally, those who are part of a shell company will need to prepare themselves for severe actions including under the Prevention of Money Laundering Act.
The identification and striking off of shell, defunct and defaulting companies and disqualification of directors marks the beginning of a cleanup of corporate India. Companies lingering in the shadowy corners have been thrust into the public eye, and face extinction.
Disqualified directors will be exiled from the corporate world for five years. It also impacts companies that may have to appoint directors in place of disqualified individuals and revisit how they evaluate potential directors.
It also marks a point of distinction for companies which dutifully comply with the laws of the land, and those that do not. This will hopefully usher in an era of more professional and vigilant directors and compliant companies.
Shweta Rao is head of Vahura OnBoard, the board search and consulting practice at Vahura.
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