The Author, Stuti Nayak, is a third-year law student pursuing a B.A. LL.B. (Hons.) from Himachal Pradesh National Law University, Shimla.
Introduction
A company, being an artificial entity, cannot function on its own. It is run by the alter ego of the corporation, which is the management led by the board of directors. Usually, the Directors act for and on behalf of the Company. Section 291 of the Companies Act, 1956 provides that subject to the provisions of that Act, the Board of Directors of a Company shall be entitled to exercise all such powers and to do all such acts and things as the Company is authorized to exercise and do.[1]Section 166 of the Companies Act, 2013(hereinafter referred to as C.A., 2013, enshrines that the directors must act in the best interests of the Company and its shareholders.[2] The directors are subject to the fiduciary duties with a company at all the phases of a corporation, be it the times of solvency or insolvency. The liabilities and duties of the directors are enshrined under two central legislations: the Companies Act, 2013, and the Insolvency Bankruptcy Code, 2016(hereinafter referred to as IBC).
In this article, I have delved into the liabilities of the Directors with an analysis of the case laws from the past ten years period. It covers the liability of the Directors during the insolvency period and after the Company turns insolvent. In addition to the provisions of the IBC and C.A., 2013, It also discusses the provisions under related statutes, such as the Income Tax Act,1961, and Central Goods and Services Act, 2017, with respect to the liability of directors.
Liabilities under IBC
IBC establishes provisions such as Section 65(Fraudulent or malicious initiation of the proceedings) [3]and Section 66 (Fraudulent trading or wrongful trading)[4] to address liabilities arising from fraudulent or improper conduct during insolvency proceedings and impose liabilities on individuals engaging in such conduct. Furthermore, the code outlines provisions for Preferential, Undervalued, Fraudulent, or Extortionate (PUFE) transactions from sections 43 to 50, which holds the management liable for breach of their fiduciary duties.
Wrongful Trading
The case of Vinod Agarwal v. Jagdish Kumar Parulkar [5] talks about the liability of directors and management under Sections 43 and 66 of the IBC, 2016, pertaining to preferential and fraudulent transactions. It was alleged by the resolution professional (RP) that the suspended directors of the corporate debtor engaged in fraudulent sales with fictitious debtors and subsequently misrepresented stock statements, which constitute wrongful trading under Section 66. However, NCLT initially dismissed the RP's application. Later, the NCLAT found out that the RP had sufficiently substantiated the allegations and held the management and directors liable for misusing corporate funds. Therefore, suspended management was to be directed to pay back sums received from corporate debtors and reverse sums siphoned off from corporate debtors through RP. The suspended director of the corporate debtor challenged NCLAT's order. Nevertheless, there was no merit in the instant appeal, and thus, the same was to be dismissed.
Moratorium: Shields the Corporate Debtor, not Individuals
A blanket protection is given under section 14 of the IBC [6] , which temporarily halts all the legal proceedings and recovery claims and enforcement of claims against the corporate debtor during the Corporate Insolvency Resolution Process (hereinafter referred to as CIRP). The main object behind this provision is to allow a breathing space for corporate debtors for restructuring or liquidation without any external pressure. However, this protection is limited to corporate debtors and does not extend to individuals' liabilities of the directors.
In the case of P. Mohanraj vs M/S. Shah Brothers Ispat Pvt. Ltd., on 1 March 2021,[7] the court stated that statutory language and purpose do not support extending immunity to directors and officers of an undertaking for their personal liabilities. Hence, the director's personal liabilities do not get automatically suspended because the Company has entered insolvency proceedings, meaning that the legal actions initiated against directors in their individual capacity may continue. Furthermore, any legal proceeding or liability that has already been commenced against directors individually is not put on hold or stayed just because the Company is in insolvency, advocating the idea that the insolvency law does not extend to shield the directors from actions concerning their personal conduct or obligations. Although insolvency laws declare a moratorium under Section 14 IBC, 2016, to protect the Company's assets and operation during the insolvency process, this blanket protection under the moratorium is not applicable to proceedings targeting the personal liabilities of the directors.
In Dinesh Hariram Valecha vs. State of U.P. And Another on 13 February 2024, [8] it was clarified by the court that the directors of a company could not escape their personal liability for criminal offenses committed before the initiation of the CIRP. Section 32A provides immunity only to the corporate debtor under new management, safeguarding it from liabilities arising from the previous management's actions.[9]However, every person who was in any manner in charge of, or responsible of the corporate debtor for the conduct of its business or associated with the corporate debtor in any manner and who was directly or indirectly involved in the commission of such offense shall be proceeded with, in accordance with the law.
Thus, the directors can still be held accountable for their actions even during the insolvency period if those actions fall under the personal capacity, separate from the obligations of the corporation. With this ruling, the court aimed to prevent the misuse of the insolvency law by the officials of the Company. The officials, such as directors, cannot hide behind the wall of the corporate shield (i.e., moratorium) and escape for their actions done in a personal capacity. The court has reinforced the principle of individual liability within the framework of corporate governance and protecting the interests of other stakeholders, such as creditors.
Criminal Liability under Negotiable Instruments Act, 1881(N.I. Act)
Again, in the case of Mukund Ajay Kumar Choudhary and 2 Others vs. K. B. Board Mills Llp Thr. Its Partners, 2023,[10]the Hon'ble apex court held that the moratorium provision contained in Section 14 of the IBC Code would apply only to the corporate debtor, and the natural persons mentioned in Section 141 would continue to be statutorily liable under Chapter XVII of the N.I. Act. Therefore, the accused, who are the directors in the present case, are not entitled to the benefit of the imposition of an interim moratorium. The court reaffirmed the principles laid down in the Aneeta Hada Case[11] , which differentiated between natural persons and corporate entities. It clarified that the legal impediment and bar created by Section 14 would only shield the corporate debtor from proceedings. However, it does not extend to the natural persons. It stated that the protection under the moratorium would be applicable to the corporate debtor and not to individuals like directors, officers, and authorized signatories who will remain statutorily liable under Sections 138/141 of the N.I. Act.
The moratorium provision does not extinguish any civil or criminal liability but only casts a shadow on proceedings already initiated and on proceedings to be initiated, which is lifted when the moratorium period comes to an end. Moreover, once a resolution plan is approved and new management takes over, then the corporate debtor is protected from prosecution under Section 138 of the N.I. Act. However, the same immunity is not available to the directors. The emphasis is placed on the individual liability of the persons holding higher positions in the management, therefore upholding the principles of corporate governance. Moreover, it prevented the misuse of the moratorium provisions while aligning with the legislative intent of IBC and N.I. Act.[12]
Independent Contractual Obligations
In Narendra Singh Panwar v. Pashchimanchal Vidyut Vitran Nigam Ltd., [13]It was settled by the court that the approval of the resolution plan under Section 31 of the IBC does not ipso facto absolve guarantor of his liability arising out of an independent contract of guarantee.[14] However, to what extent the liability of a guarantor can be pressed into service would depend on the terms of the guarantee/contract itself. Hence, the demand notice issued in the name of the directors cannot be challenged on the ground that the approval of the resolution plan extinguished their personal liabilities.
Liabilities under Companies Act, 2013
Companies Act 2013, under Chapter 20 (Part III), lays down the provisions for the office bearers pertaining to insolvency. As such, the term insolvency is not mentioned in these provisions. However, they establish the liabilities of the directors from Section 336 (Offences by officers of companies in liquidation)[15], 337 (Penalty for frauds by officers)[16], 338(Liability where proper accounts not kept)[17], 339(Liability for fraudulent conduct of business)[18], 340(Power of Tribunal to assess damages against delinquent directors)[19], 341 (Liability under sections 339 and 340 to extend to partners or directors in firms or Companies)[20], 342 (Prosecution of delinquent officers and members of Company)[21]and other applicable sections.
In the case of Usha Ananthasubramanian vs Union Of India on 12 February 2020 [22], the court referred to Section 241(2), 337,339 of the C.A, 2013, while clarifying the meaning of the expression "Business in the manner aforesaid" under Section 339(1), held that it specifically applies to those persons who knowingly participated in fraudulent activities directly related to the business of the mismanaged Company and not to the business of any other company. Thus, the court said that the freezing of assets of a person not belonging to the Company whose affairs are alleged as being mismanaged/fraudulently conducted is impermissible under the Jurisdiction of S. 339.
The aforesaid section does not allow freezing the assets of any person who was knowingly a party to the carrying on of the fraudulent conduct of the business of the Company alleged to be mismanaged but who does not belong to that very Company. Hence, the powers under S. 241(2), 337, and 339 cannot be utilized for a person who may be the head of some other organization to be roped in and his or her assets to be attached.
The court, in this case, aimed to carefully apply the statutory provisions to ensure the liability and punitive measures are appropriately confined to the individuals and entities directly connected to the alleged mismanagement and the fraudulent conduct of a company. This averts the undue harassment of persons and organizations not directly involved with the mismanaged companies from legal actions. With this judgment, the Hon'ble Court has established clear boundaries as to the application of S.339 and maintains judicial safeguards against the overreach.
In the case of Sudipa Nath v. Union of India [23], the court said that the provision in Section 339 of the C. A, 2013 and the provision in Section 66(1) of the IBC, Both these provisions were aimed at making such persons personally liable for such fraudulent trading to recouping losses incurred thereby and to relief the Company of the liabilities incurred by fraudulent trading. Furthermore, S.66 provided that the NCLT can pass an order holding such persons liable to make such contributions to the assets of the corporate debtor as it may deem fit. However, it was stated by the court that no power had been conferred on NCLT to pass such orders against other organizations/legal entities (other than corporate debtors) with whom such business was carried out against any person responsible in such other organizations/legal entities for carrying on business with the corporate debtor. The court held that the judgment in the case of Usha Ananthasubramanianwould apply in this case as well.
However, the interpretation by the court in this decision as to not extend the liability outside the corporate debtor to other individuals and entities can be seen as overly restrictive. This narrow reading by the court will allow the perpetrators to escape accountability by moving assets or businesses to other entities and limiting the effectiveness of IBC in holding these individuals responsible. The court overlooks the possibility that the fraud spans various entities, and the assets of these linked businesses will be crucial when recovering losses. It dilutes the intention of the IBC to make those individuals accountable and responsible for misconduct and contributing to the losses, as the other related entities should be held jointly liable. In addition to this, it hinders the resolution process and defeats the purpose of the legislation as the individuals remain shielded by the corporate veil.
Furthermore, the court added that there would not be any impact on civil or criminal actions. An application under S.66(1) will not bar civil actions for recovery of dues payable to the corporate debtor by other entities. Therefore, any legal action for recovery or redress, whether by the resolution professional, liquidator, or the debtor post-CIRP, remains independent of the proceedings under S. 66(1). Likewise, the application under S. 66(1) does not affect the legality or validity of any independent criminal actions against third-party organizations or individuals responsible for fraudulent activities with the corporate debtor. Besides, the civil and criminal actions by the resolution professional, liquidator, or corporate debtor, even after successful CIRP, remain untouched by proceedings under S.66(1) and can be pursued separately as per the law.
Nevertheless, this could lead to a fragmented approach to accountability. Instead of amalgamating the claims within the regulatory framework of the insolvency process, these separate claims could lead to a delay in the resolution. Consequently, it also poses the risk of conflicting rulings between the different courts, which could lead to uncertainty for the corporate debtors, creditors, and other relevant stakeholders. Also, it could lead to ambiguity in relation to other provisions. For example, continuing insolvency resolution proceedings may end in conflict with or delay other civil actions, such as asset recovery lawsuits. These resources may not adequately account for fraud involving multiple actors. Therefore, this lack of clear guidance on how these contrasting legal routes should interact could lead to inefficiencies and missed opportunities to maximize recovery.
Liabilities under Tax Laws
Income Tax Act, 1961
Section 179(1) of the income tax[24] makes the directors jointly and severally liable for the dues of the private Company. It says that every person who was a director of the private Company at any time during the relevant previous year shall be jointly and severally liable for the payment of such tax unless he proves that the non-recovery cannot be attributed to any gross neglect, misfeasance or breach of duty on his part in relation to the affairs of the Company.
In Rajendra R. Singh v. Asst. CIT, 2022[25], the scope of the provision of Section 179 of the Income Tax Act was delineated by the court. It was noted that for the operation of section 179, there are certain conditions which need to be satisfied i.e., if the tax dues could not be recovered from the private Company, then only the directors will be liable. However, in the present case, there was nothing to suggest that the tax could not be recovered from the Company. Hence, the director cannot be held liable for the breach of the duty. Similarly, in Devendra Babulal Jain v. ITO, 2023 [26]case, it was held by the court that the directors had prima facie shown that non-recovery of dues of Company could not be attributed to any gross negligence, misfeasance or breach of duty of directors of Company, since essential ingredients of section 179 were not fulfilled, impugned order passed against directors raising demand under section 179 and attaching accounts was without jurisdiction and thus liable to be set aside.
Central Goods and Services Tax, 2017
Likewise, Section 88(3) of the CGST Act[27] establishes the liability of all the directors with respect to private Companies who held the office at the relevant time and are jointly and severally liable for the dues. However, a director can escape the liability by proving that non-recovery was not caused by gross neglect, misfeasance, or breach of duty.
In Smt. K. Malathi v. State Tax Officer, 2023[28], It was held that the new cause of action would arise to recover sales tax dues from Ex-directors of the Company in liquidation if there were no funds available with the Company in liquidation. In the present case, the issue of the non-availability of funds with the official liquidator for the disbursement of claims has yet to be decided. Therefore, at present, no cause of action has arisen to initiate action against Ex-Directors to recover tax dues payable by the Company in liquidation.
Conclusion
From the above-mentioned cases, it can be observed that the liabilities of the directors during the insolvency period depend on a circumstantial basis. The courts place a strong emphasis on the individual liabilities of the directors and suggest that corporate officials do not get any leeway and hide behind the corporate veil. Statutory provisions, with the help of fines and penalties, create a deterrent effect on the part of the individuals so they do not engage in any wrongdoing. This reinforces the principle that directors must act with utmost care during times of insolvency and fulfil their fiduciary duties. They should be vigilant and transparent and comply with the applicable laws to avoid any civil or criminal liability. Nevertheless, it has also been ensured that the office bearers are not falsely accused, and an opportunity is also given to them to prove that they have not engaged in any misconduct and breached their fiduciary duties. The trend of the case laws under IBC, Companies Act, and Income Act strikes the balances between the individual liability of the directors while safeguarding the interest of the corporation.
References:
[1] The Companies Act, 1956, §291, No. 1, Acts of Parliament, 1956(India).
[2] The Companies Act, 2013, §166, No. 18, Acts of Parliament, 2013(India).
[3] The Insolvency and Bankruptcy Code, 2016 §65, No. 31, Acts of Parliament, 2016(India).
[4] The Insolvency and Bankruptcy Code, 2016 §66, No. 31, Acts of Parliament, 2016(India).
[5] Vinod Agarwal v. Jagdish Kumar Parulkar, (2024) 245 Comp Cas 831.
[6] The Insolvency and Bankruptcy Code, 2016 §14, No. 31, Acts of Parliament, 2016(India).
[7] P. Mohanraj v. Shah Brothers Ispat (P) Ltd., (2021) SCC Online SC 3253.
[8] Dinesh Hariram Valecha v. State of U.P., (2024) SCC Online All 377.
[9] The Insolvency and Bankruptcy Code, 2016 §32A, No. 31, Acts of Parliament, 2016(India).
[10] Mukund Ajay Kumar v. K.B. Board Mills LLP, (2023) SCC Online Bom 2910.
[11] Aneeta Hada v. Godfather Travels & Tours (P) Ltd., (2012) 5 SCC 661.
[12] M/S Shrid Metals Technologies Pvt. Ltd v. M/S Sanvijay Rolling And Engineering MANU/MH/0145/2023.
[13] Narendra Singh Panwar v. Pashchimanchal Vidyut Vitran Nigam Ltd., (2023) SCC Online All 19.
[14] The Insolvency and Bankruptcy Code, 2016 §31, No. 31, Acts of Parliament, 2016(India).
[15] The Companies Act, 2013, §336, No. 18, Acts of Parliament, 2013(India).
[16] The Companies Act, 2013, §337, No. 18, Acts of Parliament, 2013(India).
[17] The Companies Act, 2013, §338, No. 18, Acts of Parliament, 2013(India).
[18] The Companies Act, 2013, §339, No. 18, Acts of Parliament, 2013(India).
[19] The Companies Act, 2013, §340, No. 18, Acts of Parliament, 2013(India).
[20] The Companies Act, 2013, §341, No. 18, Acts of Parliament, 2013(India).
[21] The Companies Act, 2013, §342, No. 18, Acts of Parliament, 2013(India).
[22] Usha Ananthasubramanian v. Union of India, AIR 2020 SC (1061); Developer Group India (P) Ltd. v. Surinder Singh Marwah, (2023) 7 SCC 814; Gluckrich Capital (P) Ltd. v. State of W.B., (2023) SCC Online SC 1187.
[23] Sudipa Nath v. Union of India, (2023) SCC Online Tri 79.
[24] The Income Tax Act, 1961, §179(1), No. 43, Acts of Parliament, 1961(India).
[25] Rajendra R. Singh v. Asst. CIT, (2022) SCC Online Bom 1582.
[26] Devendra Babulal Jain v. ITO, (2023) 450 ITR 520.
[27] The Central Goods and Services Act, 2017, §88(3), No. 12, Acts of Parliament, 2017(India).
[28] Smt. K. Malathi v. State Tax Officer (2023) ibclaw.in 927 HC.
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