Disqualification of Directors: Legal Framework and Judicial Review in India

This article is written by Anjali Chaudhary, BA.LLB,2021, AMITY UNIVERSITY, NOIDA during her internship at LeDroit India.                                                                                             

Abstract

Directors occupy a critical role in the governance and functioning of companies. Their disqualification under the Companies Act, 2013, reflects the law’s intent to ensure accountability, compliance, and corporate hygiene. However, the expanding scope of disqualification, its retrospective application, and its consequences on civil liberties and commercial operations have raised significant constitutional and jurisprudential concerns. This article provides a comprehensive analysis of the legal framework governing the disqualification of directors in India and critically examines judicial interpretations that have shaped its application. It delves into comparative perspectives, rule of law implications, and emerging trends, concluding with recommendations for a balanced and constitutionally sound disqualification regime.

1. Introduction

Corporate entities, though artificial legal persons, operate through human agents — primarily the Board of Directors. The directors are entrusted with managing the affairs of the company and are bound by fiduciary duties towards shareholders, creditors, and other stakeholders. Given their substantial powers, it becomes imperative to ensure that individuals who assume such positions meet ethical, legal, and professional standards. Disqualification provisions serve as gatekeepers, restricting unfit persons from managing companies and protecting the public interest.

In India, the primary framework for disqualification of directors is found under the Companies Act, 2013. While the Act imposes automatic disqualifications, it also allows courts and regulators to bar individuals through adjudicatory proceedings. Yet, the mass disqualification of over 300,000 directors in 2017 by the Ministry of Corporate Affairs (MCA) sparked debates over constitutional validity, retrospective application, and violation of natural justice. This

article critically analyses the disqualification framework, evaluates judicial responses, and proposes reforms.

2. Legal Framework Under the Companies Act, 2013

2.1 Section 164: Disqualifications for Appointment/Reappointment

Section 164 provides for automatic disqualifications under two heads:

Section 164(1)

Personal Disqualifications

These include:

• Unsound mind (as declared by a competent court)
• Undischarged insolvent;
• Conviction for offences involving moral turpitude with imprisonment for at least six months;
• Order of disqualification by a court or tribunal;
• Non-payment of calls on shares;
• Conviction for offences under SEBI Act, FEMA, and other economic laws.

Section 164(2)

Company-Related Defaults

A person shall not be eligible to be reappointed as a director in a company or appointed in any other company if:

• The company has not filed financial statements or annual returns for three consecutive years; or
• The company has failed to repay deposits, redeem debentures, or pay declared dividends for one year or more.

Effect: The disqualification under Section 164(2) lasts for five years from the date on which the company fails to comply.

2.2 Section 167: Vacation of Office

Section 167(1)(a) mandates that a director shall vacate the office if he incurs any disqualification under Section 164(1). There was controversy over whether disqualification under Section 164(2) would also lead to automatic vacation. The Companies (Amendment) Act, 2017 inserted a proviso to clarify that Section 167(1) does not apply to Section 164(2) if the company is in default and the director is trying to regularise compliance.

2.3 Other Legal and Regulatory Disqualification Triggers

In addition to the Companies Act:

• Securities Laws: SEBI can bar individuals from becoming directors for insider trading or fraud under SEBI (LODR) Regulations.
• Insolvency and Bankruptcy Code (IBC), 2016: Insolvent individuals are disqualified under Section 29A.
• Income Tax Act: Persistent tax defaults may lead to regulatory blacklisting.
• FEMA and RBI Guidelines: Disqualifications may arise in regulated financial institutions.

3. Regulatory Process and Role of MCA and ROC

The Registrar of Companies (ROC) plays a central role in verifying non-compliance. Upon identification of default, the ROC:

• Updates the MCA21 database;
• Issues notices or deactivates Director Identification Number (DIN);
• Flags directors as “disqualified” under Section 164(2).

Directors are then barred from appointment or reappointment for a five-year period. Their Digital Signature Certificate (DSC) may also be deactivated, further paralyzing compliance.

4. Constitutional Challenges and Judicial Review

4.1 Retrospective Application of Section 164(2)

The core issue has been whether defaults prior to the enactment of the Companies Act, 2013 (i.e., before April 1, 2014) can trigger disqualification.

Leading Cases:

• Bhupendra Kansagra v. Union of India, Gujarat HC (2018): Held that retrospective application of Section 164(2) is arbitrary and violative of Article 14.
• Mukut Pathak v. Union of India, Delhi HC (2019): Held that disqualifications under Section 164(2) must be applied prospectively, and natural justice must be followed.

The courts found that retrospective application without explicit legislative intent violated the constitutional doctrine of legality and fairness.

4.2 Natural Justice and Procedural Fairness

Even though Section 164(2) is worded as an automatic disqualification, courts have underscored that:

• It imposes civil consequences;
• It requires adherence to audi alteram partem (right to be heard);
• Deactivation of DINs and DSCs affects fundamental rights to carry on business under Article 19(1)(g).

Case Law:

• Yatin Narendra Oza v. ROC, Gujarat HC: Show cause notice is mandatory before disqualification.
• Rajendra Shah v. Union of India, Bombay HC: Differentiated between executive and non-executive directors in determining liability.

4.3 Article 14 and Equality Jurisprudence

Article 14 prohibits arbitrary state action. Blanket disqualification of directors, regardless of their role or knowledge, has been challenged as being disproportionate and non-discriminatory.

Courts have applied the principle of “manifest arbitrariness” laid down in Shayara Bano v. Union of India to quash such actions.

4.4 Judicial Remedies Under Article 226

The High Courts have been approached under writ jurisdiction to:

• Quash disqualification notifications;
• Restore DIN and DSC;
• Direct reconsideration with hearing;
• Restrict retrospective application.

Courts have emphasized that judicial review of administrative actions affecting civil liberties is essential in upholding constitutional governance.

5. Comparative Legal Perspective

5.1 United Kingdom

The Company Directors Disqualification Act, 1986 provides for:

• Disqualification only by court order;
• Grounds include fraud, wrongful trading, unfitness;
• Opportunity for directors to defend themselves.

5.2 Australia

Australian Corporations Act allows for disqualification by ASIC (regulator) or by court, but only after:

• A formal hearing;
• An assessment of director conduct;
• Reasoned orders subject to appeal.

Key Difference with India: Disqualifications abroad require adjudication, while in India they may occur automatically and without hearing.

6. Analysis of Key Judgments

7. Criticisms and Concerns

7.1 Lack of Differentiation

The law does not distinguish between:

• Executive vs non-executive directors;
• Nominee vs promoter directors;
• Active vs sleeping directors.

This has led to blanket disqualification, contrary to principles of fairness.

7.2 Regulatory Overreach

The MCA’s 2017 action disqualified 300,000+ directors without adequate notice, undermining business operations and raising fears of regulatory excess

7.3 Impact on Ease of Doing Business

India’s push towards improved corporate governance must align with its aim of being business-friendly. Overbroad and inflexible enforcement creates legal uncertainty.

8. Suggested Reforms

8.1 Procedural Safeguards

• Mandatory show-cause notice before disqualification.
• Right to appeal before NCLT or Tribunal.
• Opportunity for directors to present evidence.

8.2 Graded Liability

• Penalize only those directors actively involved in default.
• Protect independent, non-executive, or nominee directors unless complicity is proven.

8.3 Restorative Measures

• Allow directors of defaulting companies to cure defaults and seek reinstatement.
• Introduce one-time condonation window for bona fide cases.

8.4 Regulatory Clarity

• Clear MCA guidelines on treatment of retrospective defaults.
• Timely publication of FAQs, rules, and appellate mechanisms.

9. Emerging Trends

• Increased litigation post-2017 disqualifications shows corporate sensitivity.
• Higher judicial scrutiny has pushed MCA towards more transparent procedures.
• Use of technology and AI in ROC’s default detection may increase disqualifications, requiring stronger procedural checks.

10. Conclusion

The disqualification of directors is vital for corporate governance, but it must not be wielded as a blunt instrument. The regulatory framework under the Companies Act, 2013, though well-intentioned, has suffered from overbreadth, procedural gaps, and constitutional infirmities.

Judicial review has acted as an essential safeguard, ensuring that natural justice, equality, and proportionality are preserved. Going forward, the legislature and regulators must strive to craft a regime that is not only effective in deterring corporate misconduct but also fair and just in its implementation.

A balanced approach, rooted in due process and targeted enforcement, will ensure that the disqualification provisions serve their intended function without sacrificing the constitutional values that form the bedrock of Indian democracy.

References

1. Mohan, M.P.R., & Shah, U. (2021). Tracing Director Liability Framework during Borderline Insolvency in India. IIMA Working Paper. PDF
2. Kalwade, S., & Raichandani, J. (2021). Disqualification of Directors: An Enigma. Supremo Amicus. PDF
3. Mukut Pathak v. Union of India, 2019 SCC OnLine Del 10764
4. Bhupendra Kansagra v. UOI, 2018 SCC OnLine Guj 2023
5. Yatin Oza v. ROC, Special Civil Appl. No. 22435/2017, Gujarat HC
6. Gaurav Dalmia v. ROC, W.P. (C) No. 7806/2017, Delhi HC
7. Sundaresh, G. (2018). Fiduciary Duties of Directors During Corporate Failure in India. Michigan B.E.L. Rev. Link

Singh, V.P. (2021). Directors’ Fiduciary Duties: UK and Indian Comparison. Trusts & Trustees. DOI