Yet another ruling on director liability

Unless the culture of compliance seeps into enforcement, judgments would be mere essays

The Supreme Court has spoken yet again — quashing criminal proceedings initiated against the managing director of a company that runs a hotel in New Delhi — about the liability of a managing director in a company charged with crime for no reason other than his being the managing director. Yet, whether this would lead to any reform in the conduct of enforcement agencies is a question that could end up being rhetorical.

The facts seem straight out of the movie October.  A visitor to the hotel fell from the sixth floor to the fourth floor. It was found that a terrace next to the club lounge on the sixth floor was often used as a smoking area, with the hotel not stopping smokers from using the place. The charge was that the hotel did not take adequate precautions to maintain safety.  
 

The managing director was charged on the grounds that he was the only executive director of the company, he chaired all board meetings, and he would therefore, be responsible for all acts of omission or commission by his officials. Indeed, employees involved in hotel operations were charged too, but the managing director had been roped in as an accused only for the reason that he was the chief executive. The Delhi High Court refused to quash the proceedings at the request of the managing director. The Supreme Court disagreed.

The law declared by the Supreme Court is that before issuing summons to an individual as an accused, the criminal court is required to be satisfied from the material on record that the person named as the accused needs to be proceeded against. If the court does not find adequate material to rope in an individual as an accused, but later during trial finds material to rope in a person not hitherto named as an accused, it can rope in the accused at that stage too (Section 319 of the Criminal Procedure Code). Yet, summons do get routinely issued against every person named by the prosecutor.  

Summons can also get issued after a judge decides that the person named as an accused must be tried for criminality.  In the case at hand, indeed, the Delhi High Court agreed that it was rightly issued. All that the charge sheet stated as the ground to rope in the managing director was that he is responsible for the overall operations of the company, and being the only executive director, he would be the accused. It would also imply that if there were other executive directors, they too would have been roped into the proceedings.

The situation gets even more complex with quasi-civil proceedings, conducted by regulators who have the role of legislature, executive and judiciary, all rolled into one organisation. Recently, the Securities Appellate Tribunal was faced with an appeal where the capital market regulator routinely directed all directors to personally refund money raised without issuance of a prospectus. The tribunal has declared the law unequivocally — indeed also relying on Supreme Court judgments — to rule that liability under the law cannot arise merely by designation but from the responsibility and role played by the individual at the relevant time. Implying that “vicarious liability” cannot be automatically imputed, in the absence of a shred of evidence that the individual in question was responsible. 

In fact, the Companies Act, 2013, the post-Satyam corporate law that raises the bar of criminality under company law to the level of anti-drug trafficking law when it comes to bail where fraud is alleged, took care to stipulate that for charging a director, one must apply one’s mind to knowledge and involvement applying “board processes”. Regulations governing listed companies’ obligations made by the capital market regulator too lay down the standard of having to determine knowledge and involvement by applying board processes.  

When a director sits on the board of a company, she necessarily has to rely on the processes necessary for the board of directors to be briefed by the management. If the director on the board is unaware despite doing all that a reasonable person would to make herself aware of the goings on in a company, the law would not permit the director to be charged in any proceedings. Yet, in practical application, this standard gets diluted. Enforcement agencies prefer to “err on the side of caution” and rope in everyone they can lay their hands on, leaving the burden of correcting the error to the judicial system. More judgments can follow on the subject, but unless the culture of compliance seeps into enforcement too, these would merely be essays to be relied on after the judiciary has already been burdened with the task of correcting the errors of the enforcement agencies.

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