A timely ruling from the SAT

It is a breath of fresh air. Amidst the cacophony of accountability, and blood-thirst for pinning responsibility with any wrongdoing by a corporate, clear jurisprudence is developing to protect directors sitting on the board from a carpet-bombing approach to enforcement. 

Shareholders in companies have limited liability — limited to the extent of the share capital contributed by them. However, increasingly, directors sitting on the board of companies have been facing the threat of unlimited liability, particularly when enforcement agencies that are empowered to also play a quasi-judicial role, inflict “joint and several” liability along with the company. Such imposition of joint and several liability is routinely imposed without regard to the actual role played by each director — or no reason other than the fact that the individuals in question were directors of the company that is held to have violated the law.
 

Dealing with a joint and several obligation imposed by the Securities and Exchange Board of India (Sebi), the Securities Appellate Tribunal (SAT) has ruled that the Sebi was wrong in tarring all directors with the same brush for a company having allotted securities without issuing a prospectus. Under company law, a “private placement” cannot be made where the invitation of offers to subscribe is made to 50 or more persons.  

The company clearly had a “managing director” who is in the eyes of company law explicitly responsible for defaults — the term “officer in default” is even coined in company law for this reason. Since it would be necessary to have clarity on who exactly is the individual who would be liable for default by a company, company law explicitly sets out those who would be regarded as being in default — essentially, the managing director, whole time directors, company secretary, manager, and individuals charged with the responsibility of ensuring compliance. Only where none of such persons exist, all the directors would be liable.

Yet, the order from the Sebi, ignoring the evidence pointed to by the un-involved directors, directed that they would be jointly and severally liable to refund all the monies raised without complying with the requirement to issue prospectus. The SAT has ruled that in the absence of any finding by the Sebi that a director acted against was the managing director or the whole time director or a director made responsible by the board of directors with responsibility for compliance with the law, every director could not be made liable.

The Sebi’s approach had resulted in a monetary and pecuniary liability for the directors regardless of their role. This would have far more serious repercussions than the usual criminal prosecution cases where directors who are not responsible for the contravention can lead evidence to show they were not in charge of compliance with the relevant obligation that is alleged to have been violated. Recovery provisions entail impounding all bank accounts and financial assets. 

The Competition Commission of India, another regulator with serious powers to inflict civil liability in terms of penalties, and whose penalties are recoverable under similar provisions, has, in the past, attempted to rope in promoters of companies for imposition of penalties even while punishing the officers who were actually 

in default. 

Courts are increasingly calling for declaration of assets of all directors of companies against which allegations have been made in proceedings before them. 

In short, the office of a director is under siege. The risk-reward profile for candidates for corporate directorship has been getting so warped that most rational persons would avoid that office. Therefore, the very instrument of corporate governance that would be vital for the functioning of the corporate sector, has been under threat. In fact, new company law and Sebi regulations for listed companies brought in the standard of making a director liable only if they had knowledge of wrongdoing through board processes, and yet did not intervene. 

In this backdrop, the SAT ruling could not have come at a more apt juncture. Recently, dealing with a case of alleged insider trading, the Supreme Court too had an occasion to remind and reiterate what had once been axiomatic — that one needs something more than just the fact of directorship to make a director liable, even in cases involving civil consequences. A common misnomer is that since the criminal law standard of having to prove guilt beyond reasonable doubt is not applicable to civil cases, no proof beyond the mere fact of directorship is required. Regulators would do well to correct course and sharpen enforcement — it would instil greater fear in the hearts of the real wrongdoers.

The author is an advocate and independent counsel.  Tweets @SomasekharS