Shell company links: 800 firms feel the heat on directors' disqualification

Exchanges have sent or are about to send notices to 800 companies seeking explanation on how individuals disqualified by MCA should continue onExchanges have sent or are about to send notices to 800 companies seeking explanation on how i their boards

More companies are facing the heat for having “disqualified directors” on their boards.

According to reports, exchanges have shot or are in the process of issuing notices to as many as 800 companies seeking explanation on how individuals disqualified by the Ministry of Corporate Affairs (MCA) should continue on their boards.

The MCA has disqualified over 100,000 individuals from taking directorship at listed companies for their alleged association with “suspected shell companies” or companies that have failed to comply with regulatory filing such as submitting financial statements or annual returns. Notices are being sent to companies which may have some of these individuals on their boards. 

Experts said regulatory action against individuals or companies is not unknown, particularly against scores of listed companies that are small or have now turned defunct. However, this time the list of those barred include a few marquee names. According to reports, Pawan Goenka of Mahindra & Mahindra, S Narayan of Apollo Tyres, Vinod Kumar Dasari of Ashok Leyland, S Sridhar of DCB Bank, and GV Krishna of Hindustan Petroleum, are also on the list.

Experts believe crackdown against errant individuals or companies is necessary but an abrupt decision to disqualify thousands of individuals could disturb the functioning of boards and hurt business sentiment.

“Such a move will disturb the composition of the board of directors prescribed under the Listing Regulations till a successor is appointed with the requisite eligibility criteria. If the disqualified director happens to be an independent one, then it will also have an impact on the performance evaluation of such a director who is also a requirement prescribed under the Listing Regulations,” said Yogesh Chande, partner, Shardul Amarchand Mangaldas.

Experts said the MCA’s move to disqualify directors was similar to the one that barred 331 “suspected shell firms” without following principles of natural justice. “This could lead to large-scale legal implications. Being on defunct companies is not sufficient to disqualify a director as holding such a position doesn’t prove any wrongdoing. Such unilateral actions could create chaos,” said Sandeep Parekh, founder, Finsec Law Advisors.

According to the Companies Act, a disqualified director cannot serve on the board of any company for a period of five years. Legal experts said while the rules were clear on appointment or reappointment of such directors, there was uncertainty over removal of a functioning director. “The company law is ambiguous whilst dealing with the issue of automatic removal of a director of a disqualified company from his other directorships. Legally it is clear that such disqualified directors have to vacate directorship in the company concerned and also can’t seek a fresh directorship or re-appointment in any other firm. However, what it does not suggest is a cascading removal from boards of other firms,” said Tejesh Chitlangi, partner, IC Legal.

Experts say the firms can challenge the NSE or the MCA’s decision seeking removal of directors. Till the issue is settled, the companies can impose restrictions on those individuals.

“The companies can keep such directors away from day-to-day board activities. They can be barred from accessing any board agenda or any important policy matters till the issue gets resolved. Meanwhile, the directors can challenge the decision, both in company law tribunal and high court,” says Parekh.

“We confirm that the NSE has sent out letters to companies concerned and has sought clarifications (from the companies) on the subject matter,” an NSE spokesperson said.