CIRCULAR ISSUED AGAINST THE UNNECESSARY PROSECUTION OF NON-EXECUTIVE AND INDEPENDENT DIRECTORS OF INDIAN COMPANIES
Background and Jurisprudence
Typically, independent and non-executive directors of Indian companies are not involved in the daily management or decision-making of a company. Nevertheless, under Indian company law, they are required to exercise due and reasonable care, and act in good faith and in the best interests of the company. In addition, they are required to safeguard the interests of the minority shareholders and play an impartial role on the board.
Under a safe harbor provision of Indian company law, independent directors and non-executive directors (collectively, referred to as “NEDs”) are liable only for acts or omissions that have occurred with their knowledge, or which can be attributable through the processes of the board of directors, or where they have consented, connived, or failed to act diligently.
Following these legal principles, courts have consistently held that NEDs should be treated differently from whole-time directors. The Supreme Court has noted that there may be many directors in a company, but only those directors associated with the management of the day-to-day affairs of the company are vicariously liable for any offence committed by the company. (SMS Pharmaceuticals v. Neeta Bhalla (2007) 4 SCC 70.) On similar lines, the Delhi High Court has ruled that NEDs who are not involved in the day-to-day affairs of the company and do not take any corporate decisions cannot be prosecuted for the company’s offences. (Har Swarup Bhasin v. Origo Commodities India Pvt. Ltd. 2020 II AD (Delhi) 169.) In a separate case, the Delhi High Court has ruled that only if NEDs have been involved in the day-to-day affairs of the company can they be prosecuted and convicted as officers in default. (Somendra Khosla v. State and Anr. (Crl. MC. 3982/2017).)
Although Indian law and jurisprudence has required an assessment as to whether NEDs are involved in the management and decision making of the company before holding them liable as fiduciaries, in the last couple of years, various government authorities have acted in a trigger-happy manner and commenced prosecution against NEDs without applying the prescribed yardsticks.
In order to prevent such excesses, on March 2, 2020, the Ministry of Corporate Affairs (the “MCA”) issued a circular (the “Circular”) to its Regional Directors, the Registrars of Companies (“RoCs”) and official liquidators cautioning them against unnecessarily prosecuting NEDs without sufficient evidence for lapses attributable to them. We have summarized the key points of the Circular below:
- The Circular has pointed out that whole-time directors and key managerial personnel (the “KMP”) of a company are ordinarily liable for offences by a company. In the absence of any KMP, only those directors who have given consent for incurring liability on behalf of the company under Form GNL-3 should be prosecuted.
- The Circular states that NEDs are not responsible for filing records, maintaining corporate registers or attending to other statutory compliances under Indian company law. This is a positive development for NEDs as many non-executive directors have been disqualified by the RoCs for failing to file annual returns or financial statements for three (3) years.
- The Circular requires the RoCs to ascertain the involvement of the NEDs in a company’s business, and check the filings to verify whether the NEDs were directors on the date of the default. It reiterates that for lapses attributable to the board of directors or committees of the board, NEDs must not be subject to civil or criminal proceedings without sufficient evidence.
- The Circular has clarified that the Director-General of Corporate Affairs may be consulted by the RoCs for any doubts, and the MCA must be notified of the ongoing cases that do not meet the liability criteria for NEDs mentioned in the Circular.
- The Circular has, specifically, listed NEDs of public sector undertakings and public sector financial institutions or banks having equity in a company, as well as directors appointed pursuant to any statutory or regulatory requirement of the National Company Law Tribunal, and has directed the RoCs to ensure that they are not subjected to any civil or criminal proceedings without sufficient evidence.
In our view, the Circular is consistent with the intent and provisions of Indian company law, and is in line with the judicial decisions. It will surely reduce the fear in the minds of NEDs and allow them to perform their duties on a company board more freely.
However, it must be highlighted that the MCA and the RoCs are not the only authorities that can take action against NEDs. Foreign exchange regulatory violations are prosecuted by the Enforcement Directorate, and in cases of fraud, the Central Bureau of Investigation or Serious Fraud Investigation Office gets involved. This apart, different agencies deal with anti-corruption, environmental law, income tax and other statutory violations. Recently, in the Infrastructure Leasing & Financial Services scam, NEDs were charged with mismanagement, and investigations by the Serious Fraud Investigation Office against them are still ongoing. In addition, in the Punjab National Bank fraud case, the Indian government issued a lookout circular against Mr. Sanjay Rishi, NED at Firestar International Private Ltd., although the main culprit appears to be the promoter, Mr. Nirav Modi. Whether these NEDs were actually responsible for the misdeeds of the company is not clearly established.
Notwithstanding the issuance of the Circular, it is important that NEDs take abundant caution and safeguard themselves against prosecutions for lapses or offences committed by a company by:
(a) ensuring provisions in the employment agreement or appointment letter detailing the specific role of the NED in the company;
(b) seeking an indemnification clause in the employment agreement or appointment letter from the company and its promoter indemnifying the NED from any costs incurred due to any offences committed by the company or the promoter;
(c) ensuring that the company obtains an international Directors and Officers Liability insurance policy that covers the NED from the issuance of the first notice or summons against the NED;
(d) actively attending board meetings to ensure that any dissent of the NED is duly recorded, which can help prove that there was no failure on part of the NED to act diligently; and
(e) ensuring that the NED does not take part in any day-to-day decision making or management of the affairs or the business of the company (via e-mail or otherwise).