Issue 27 Full Page

Insights

What the (S)Hell?

Insights – What the (S)Hell?

The Statistics

As of February 2016, it was estimated that 16 lakhs companies were incorporated under the Companies Act, 1956 / 2013. Out of these companies, only a little over 10 lakh companies were active. While there were approximately 30,000 companies that under the process of fast track closure, the remaining were not accounted for as they existed, but were consistently not complying the annual filing requirements of corporate law. The government was silently watching such inactive companies which showed no sign of activity for long.

The Demonetisation effect

Post the November 2016 demonetisation that jolted the nation out of its slumber, these companies continued to remain under the radar. Some startling facts came to notice – companies which constituted only 2.5%1 of the total (of companies carrying on any business or filing returns) had suddenly a cumulative inflow of approximately Rs. 4,500 crores into their bank accounts. Such enormous deposits were almost immediately withdrawn. Further, it was noticed that each company had several hundred bank accounts in its name! This gave strength to the presumption of the government that these registered companies, though not carrying on any business act as shell companies for illegal funds and money laundering purposes.

Insights – What the (S)Hell?

Three pronged action by Government on Companies – Bank accounts – Directors

By April 2017 the Ministry of Corporate Affairs (MCA) began issuing show cause notices to such inactive and non-complying companies to comply with the required filings or get their registration cancelled. Such notices were issued under section 248 of the Companies Act which contained provisions relating to striking off the name of the Companies on certain grounds. The offices of thee ROC is said to have issued notices at least two times to the identified list of defaulting companies. While many companies got their act together and complied with filings as required, over 2.17 lakh companies were struck off from their respective RoC jurisdictions for not carrying on business for long and defaulting in annual filings for more than 3 years.

Insights – What the (S)Hell?

The highs & lows of Companies struck off

Comparative analysis	RoC	Number of Companies struck off
Highest Number	Hyderabad	20,082
Least number	Shillong	249

Based on the figures available and reported by respective RoCs on the website of Ministry of Company Affairs as on 6th October, 2017

Within a few weeks, bank accounts of such companies were frozen. No operations could be carried out through them. The cancellation or registration / strike off of company name directly affected the management viz Directors of the company. With one stroke, in September 22, 2017 around 3.19 lakh directors stood disqualified for failure/default to file financial statements / annual returns of companies for 3 years or more. Such disqualification of directors was under provisions of section 164(2) (a) of the Companies Act, 2013. There are a number of politicians, actors, bureaucrats and other professionals on the list of disqualified directors.

The professional fraternity – Lawyers, Chartered Accountants and Company Secretaries are understandably up in arms. The legal and technical interpretation and application of section 164(2) (a) of the Companies Act, 2013 is being widely analysed and discussed.

Insights – What the (S)Hell?

Section 164(2) (a) of the Companies Act, 2013 – Dissected

Section 164(2) (a) of the Companies Act, 2013 like its predecessor section 274(1)(g) of the Companies Act, 1956 expressly provides for disqualification of directors for not filing annual returns for 3 continuous financial years. However, the fundamental difference between the two sections – while the old Act (1956) exempted private companies from such disqualification, the new Act (2013) has made this applicable to all companies (including private companies).
Also section 164(2) sub section (a) specifically attracts disqualification to directors for default in company compliance such as failure to file the return or repay interest or principle amount on debentures or deposits. This seems to be the legal aspect of applying section 164 (2) (a) to disqualify directors.

Section 164 (2) (a) expressly disqualifies directors both past and present of a company that has defaulted in filing annual returns for any continuous three financial years.

(Mis) interpretation of the Section?!

A legislation is to be applied prospectively and not retrospectively. The Companies Act, 2013 came into effect on 1st April, 2014. Section 164(2) (a) also came into effect on and from that date. From that stand point, section 164 (2) (a) has to be applied prospectively. This means that disqualification of directors should be attracted for failure to file annual returns for FY 2014-15, 2015-16 & 2016-17. However, several ROCs have disqualified directors for failure to file annual returns for FY 2013-14, 2014-15 & 2015-16. This means that the law has been applied retrospectively.
Some lawyers have represented such directors in Courts praying for stay of such disqualification on directors because the law must be applied prospectively only.

Insights – What the (S)Hell?

Impact of such disqualification on directors

Directors have been caught unawares due to their disqualification. Disqualification will mean such directors cannot be directors in other existing companies or incorporate new companies for 5 years from their disqualification.

Consequent to disqualification there is ambiguity on whether the board resolutions, other agreements and transactions passed by such directors during the period for which they incurred disqualification will remain valid. Also majority companies are carrying on commercial operations and business. Such companies legitimately carrying on operations have been left in the lurch due to corporate no compliance.

The road ahead

The Central government has clarified that it shall not relent in its fight against black money in the economy. It shall continue to crack down on shell companies. However, the government has also clarified that it will ensure the functioning of genuine companies that have slipped up in its compliance. The Government has begun running checks on the backgrounds of director(s) to judge their credibility. Till such time the government provides clarity in future, such companies are lying low and adopting a “wait and watch” policy before they take their next course of action. On 11^thOctober, 2017 the government issued a circular allowing promoters to appoint directors in those companies where all directors have been disqualified. This has been done with a view to ensure ease of operations of genuine companies. Lull after the storm.