Independent Director cannot be considered as a wilful defaulter if the alleged acts occurred without his/her knowledge

According to Section 149(6) of the Companies Act, an independent director in relation to a company, means a director other than a managing director or a whole-time director or a nominee director:

a. who, in the opinion of the Board, is a person of integrity and possesses relevant expertise and experience;

b. who is or was not a promoter of the company or its holding, subsidiary or associate company or is not related to promoters or directors in the company, its holding, subsidiary or associate company;

c. who has or had no pecuniary relationship with the company, its holding, subsidiary or associate company, or their promoters, or directors, during the two immediately preceding financial years or during the current financial year;

d. none of whose relatives has or had pecuniary relationship or transactions with the company, its holding, subsidiary or associate company, or their promoters, or directors, amounting to two per cent, or more of its gross turnover of total income or fifty lakh rupees or such higher amount as may be prescribed, whichever is lower, during the two immediately preceding financial years or during the current financial year

e. who, neither himself nor any of his relatives:

i. holds or has held the position of a key managerial personnel or is or has been employee of the company or its holding, subsidiary or associate company in any of the three financial years immediately preceding the financial year in which he is proposed to be appointed

ii. is or has been an employee or proprietor or a partner, in any of the three financial years immediately preceding the financial year in which he is proposed to be appointed, of:

• a firm of auditors or company secretaries in practice or cost auditors of the company or its holding, subsidiary or associate company; or

• any legal or a consulting firm that has or had any transaction with the company, its holding, subsidiary or associate company amounting to 10% or more of the gross turnover of such firm

iii. holds together with his relatives 2% or more of the total voting power of the company; or

iv. is a Chief Executive or director, by whatever name called, of any non-profit organisation that receives 25% or more of its receipts from the company, any of its promoters, directors or its holding, subsidiary or associate company or that holds 2% or more of the total voting power of the company;

f. who possesses such other qualifications as may be prescribed;

According to Section 149(12) of the Companies Act, an independent director or a non-executive director not being promoter or key managerial personnel shall be held liable, only in respect of such acts of omission or commission by a company which had occurred with his knowledge, attributable through Board processes, and with his consent or connivance or where he had not acted diligently.

Let us refer to the case of V. Selvaraj v. Reserve Bank of India where the petitioner came forward to seek directions to the respondents to declassify him from the List of Wilful Defaulters where the issue under consideration was whether an independent director be considered as a wilful director and be subjected to further penalties and proceedings on being classified as a wilful defaulter even if the alleged acts occurred without his/her consent or knowledge.

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Facts of the Case and Submissions by the Petitioner

• The petitioner is a retired IAS Officer and he had held several posts in the State Government and the Central Government.
• He was now a Non-Executive Independent Director in a Public Limited Company which was engaged in the business of leasing, hire purchase and financing.
• The concept of establishing a leasing Company was the brain child of Mr. Farouk Irani, who was the Founder Member and Managing Director of the company.
• He was in absolute control of the entire affairs and working of Company right from its inception.
• The day-to-day operations of the Company were looked after by him and he also acted as heads of all the Departments, viz., financial, accounting and etc., and no other Officer of the Company interfered in the overall control of the company.
• Petitioner joined as a Non-Executive Independent Director of the company on 14/8/2012.
• Reserve Bank of India (RBI) during annual inspection conducted in the year 2013 into the books of accounts of the Company, found accounting malpractices in the Company and issued various direction in order to protect the public interest.
• The petitioner alleged that the said Farouk Irani and his Team developed a software to create fictitious data/entries in the Companies account.
• The Forensic Auditor submitted a final report stating that the Managing Director of the Company was identified for all the misdeeds and recommended to lodge criminal action to unearth the fraud committed by him and his team of employees.
• The petitioner stated that during the check period, he had attended 4 Board meetings of the Company.

• When the Managing Director and the Company’s Statutory Auditors reported that financial results of the Company was very good and accounts were certified to be maintained properly as per the accounting standards by the Statutory Auditors, neither the petitioner nor the Board of Director had reason to suspect any foul play and only after the Special Audit conducted by the RBI and other Agencies, the misdeeds of the Managing Director and his chosen Officers of the Company came to light.
• It was a case of the petitioner that he had no role in either verifying the accounts or in maintaining accounts of the Company.
• He had no knowledge about the fabrication of accounts and he had also no way of knowing the window dressing of the accounts of the Company.
• The State Bank of Mysore, one of the creditors of the Company had declared the assets of the fourth respondent as a non-performing.
• Subsequently, the said bank issued a letter to the Company and its Directors, stating that an appropriate committee of the Bank had examined the violations of the terms and conditions and had approved the proposal for inclusion of the name(s) of the Company and it is Directors/Guarantors in the RBI/CIBIL list of Wilful Defaulters and in case of any grievance, they could send a representation within a period of 15 days to the Grievance Redressal Committee of the Bank at their Headquarters.
• In response to the letter, the petitioner submitted a detailed reply, stating that the petitioner’s name was not to be included in the list of wilful defaulters.
• He also sent another representation, categorically stating that since he neither a Whole Team Director nor a Promoter of the Company, he cannot be declared as a wilful defaulter.
• However, without considering the same, the petitioner was classified as a wilful defaulter.
• Petitioner urged that he had joined in the Company’s Board as Non-Executive Independent Director of the Company.
• By referring Sections 149(6) and 149(12), he submitted that an Independent Director shall be held liable, only in respect of such acts of omission or commission by a Company which had occurred with his knowledge, consent or connivance.
• As he was never involved in the day-to-day affairs of the Company and no material was available to hold that the illegality of the company has taken place with his consent and connivance, the petitioner could not be declared as a ‘wilful defaulter’.

Reference by the High Court to the Master Circular of RBI, dated 1-7-2015

According to Clause 2.5 of the Master Circular(pertaining to Penal measures), the following measures should be initiated by the banks and FIs against the wilful defaulters identified.

a. No additional facilities should be granted by any bank/FI to the listed wilful defaulters. In addition, such companies (including their entrepreneurs/promoters) where banks/FIs have identified siphoning/diversion of funds, misrepresentation, falsification of accounts and fraudulent transactions should be debarred from institutional finance from the scheduled commercial banks, Financial Institutions, NBFCs, for floating new ventures for 5 years from the date of removal of their name from the list of wilful defaulters as published by RBI/CICs

b. The legal process, wherever warranted, against the borrowers/guarantors and foreclosure of recovery of dues should be initiated expeditiously. The lenders may initiate criminal proceedings against wilful defaulters, wherever necessary

c. Wherever possible, the banks and FIs should adopt a proactive approach for a change of management of the wilfully defaulting borrower unit

d. A covenant in the loan agreements, with the companies to which the banks/FIs have given funded/non-funded credit facility, should be incorporated by the banks/FIs to the effect that the borrowing company should not induct on its board a person whose name appears in the list of Wilful Defaulters and that in case, such a person is found to be on its board, it would take expeditious and effective steps for removal of the person from its board

It would be imperative on the part of the banks and FIs to put in place a transparent mechanism for the entire process so that the penal provisions are not misused and the scope of such discretionary powers are kept to the barest minimum. It should also be ensured that a solitary or isolated instance is not made the basis for imposing the penal action.

According to Clause 3 of the Master Circular(pertaining to Mechanism for identification of Wilful Defaulters), the mechanism referred to in Clause 2.5 should include the following:

a. The evidence of wilful default on the part of the borrowing company and its promoter/whole-time director at the relevant time should be examined by a Committee headed by an Executive Director or equivalent and consisting of two other senior officers of the rank of GM/DGM

b. If the Committee concludes that an event of wilful default has occurred, it shall issue a Show Cause Notice to the concerned borrower and the promoter/whole-time director and call for their submissions and after considering their submissions issue an order recording the fact of wilful default and the reasons for the same. An opportunity should be given to the borrower and the promoter/whole-time director for a personal hearing if the Committee feels such an opportunity is necessary

c. The Order of the Committee should be reviewed by another Committee headed by the Chairman/Chairman & Managing Director or the Managing Director & Chief Executive Officer/CEOs and consisting, in addition, to two independent directors/non-executive directors of the bank and the Order shall become final only after it is confirmed by the said Review Committee. However, if the Identification Committee does not pass an Order declaring a borrower as a wilful defaulter, then the Review Committee need not be set up to review such decisions

d. As regard a non-promoter/non whole-time director, it should be kept in mind that Section 2(60) of the Companies Act, 2013 defines an officer who is in default to mean only the following categories of directors:

i. Whole-time director

ii. where there are no key managerial personnel, such director or directors as specified by the Board in this behalf and who has or have given his or their consent in writing to the Board to such specification, or all the directors, if no director is so specified;

iii. every director, in respect of a contravention of any of the provisions of this Act, who is aware of such contravention by virtue of the receipt by him of any proceedings of the Board or participation in such proceedings and who has not objected to the same, or where such contravention had taken place with his consent or connivance. Therefore, except in very rare cases, a non-whole-time director should not be considered as a wilful defaulter unless it is conclusively established that:

• he was aware of the fact of wilful default by the borrower by virtue of any proceedings recorded in the Minutes of the Board or a Committee of the Board and has not recorded his objection to the same in the Minutes, or
• the wilful default had taken place with his consent or connivance

iv. As a one-time measure, Banks/FIs, while reporting details of wilful defaulters to the Credit Information Companies may thus remove the names of non-whole-time directors (nominee directors/independent directors) in respect of whom they already do not have information about their complicity in the default/wilful default of the borrowing company. However, the names of the promoter directors, even if not while time directors, on the board of the wilful defaulting companies cannot be removed from the existing list of wilful defaulters

Observations of High Court on whether the petitioner could be declared as a wilful defaulter or not

• Section 149(6) prescribed the qualification of the Independent Director of a Company and it further distinguished the Independent Director from the Managing Director or Whole-time Director or a Nominee Director of a Company.
• Section 149(12) dealt with the responsibility and liability of the Independent Director.
• Clause 2.5 of the Master Circular of RBI, dated 1-7-2015, referred to penal measures to be initiated by the banks and financial institutions, after a person is declared as a ‘wilful defaulter’. Clause 3, prescribed mechanism for identification of Wilful Defaulters.
• In the present case, it was not disputed that out of the check period of 11 years, the petitioner acted as an Independent Non-Executive Director for 7 months and during that period, he participated in 4 Board Meetings of the Company.
• It was the specific case of the petitioner that Mr. Farouk Irani was heading all the Departments of the Company, including Finance and accounts and his decision was final and nothing was available to implicate the petitioner for the misdeeds committed by the Managing Director of the Company.
• Section 149(12) made it very clear that an Independent Director shall be held responsible only in respect of such acts of commission or omission by a Company which occurred with his knowledge, consent or connivance.
• However, in the matter on hand, no materials were brought on record to show that the petitioner had actively participated in the day-to-day affairs of the Company or in the Board Meeting and the commissions and omissions alleged against the Company had taken place with the knowledge, consent or connivance of the petitioner to satisfy the ingredients of Section 149(12).

• The persons identified as wilful defaulter had to meet the consequence of the subsequent proceedings to be initiated by the Banks and Financial Institutions in tune with the Master Circular.
• Therefore, unless the allegations were supported by material documents, no one could be declared as a ‘wilful defaulter’. It was settled position of law that the penal provisions required strict proof and it could not be exercised in a casual manner.
• Also, the Wilful Defaulter Identification Committee of the State Bank of India, after perusing the entire records came to the conclusion that they were not sufficient to declare the petitioner as a ‘wilful defaulter’.
• There was absolutely no evidence available to declare the petitioner as a ‘wilful defaulter’. Moreover, the explanation offered by the petitioner was not considered and the decision was taken against the provisions of the Act and clause 3 of the Master Circular issued by the RBI.

In conclusion, an independent director cannot be considered as a wilful director and be subjected to further penalties and proceedings on being classified as a wilful defaulter if the alleged acts occurred without his/her consent or knowledge.

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