Allegations such as siphoning-off funds through excessive executive pay, misrepresentation of state of affairs, camouflage of debt stress etc. are subjective and require real substance to be proven to be true before the courts of law.
Puneet Shah and Niharika Rao
Earlier this month, the government moved the National Company Law Tribunal (NCLT) to oust the board of IL & FS, a systemically important institution, which is facing financial trouble. It has also directed the Serious Fraud Investigation Office (SFIO) to investigate the affairs of IL&FS and its subsidiaries including the role of the past directors. The charges against the erstwhile board primarily included siphoning-off funds through excessive executive pay, financial mismanagement, misrepresentation of true state of the group’s financial fragility, suppression of material information to camouflage debt stress and exaggerated depiction of non-current assets.
While that process is on, an interesting question emerges: Are the erstwhile directors automatically disqualified to continue as directors of other companies?
The 2013 Companies Act prescribes certain criteria for disqualifying a director. One criterion is the existence of a court or tribunal order in force disqualifying him to continue as a director on the board. Interestingly, the order of Mumbai Bench of NCLT passed on the application of the central government is silent on this issue. It merely refers to the fact that the suspended IL&FS directors shall not represent the firm anymore and not exercise any power as a director in any manner before any statutory authority. There is no express mention of disqualification of such directors in the NCLT order.
The Companies Act also envisages that the office of a director in a company becomes vacant if he is removed from such an office in accordance with the provisions of the Act. However, the Act does not say that this would automatically lead to such a director vacating his directorships in other companies. Besides, the removal of a director by NCLT order as in the given context doesn’t automatically disqualify a director from holding the office in other companies.
On the other hand, if shareholders of a company consider removing such directors (alleged in cases related to other entities) from its board, they should first carefully consider the allegations against the said directors. For instance, allegations such as siphoning-off funds through excessive executive pay, misrepresentation of true state of affairs, camouflage of debt stress etc. are very subjective and require real substance to be proven to be true before the courts of law.
Some areas which NCLT may look into are whether the executive pay was approved by the remuneration and compensation committee, what were the competitive pay packets of executives in the same industry during the occurrence of siphoning events, was there any mala fide intent behind such payments, whether auditors had qualified their report while presenting the true and fair statement of affairs, were there adequate management representations to back the auditors’ report, whether audit committee was kept abreast of the state of affairs, whether there were numerous auditors reporting on the different group companies, among others.
The results of the investigation by the SFIO into the affairs of IL&FS and the investigation of the newly constituted National Financial Reporting Authority (NFRA) into the role of IL&FS’s auditors in the lapses may help answer some of these questions. If the decision taken by the management was a good faith business decision with coordinated consultation at board and committee level, and the board proceedings were appropriately minuted in the records, then it may be difficult to establish any form of management wrongdoing, negligence and incompetence before the court, unless the contrary is proved with concrete evidences.
Another point of contention here is the discrimination by the central government by not making certain institutional shareholders’ nominees as party to the NCLT application. This may be in light of the government’s own commercial wisdom and to save its reputation before some of the international investors or may be to secure future funding, if any.
The Act provides provisions for the appointment of a nominee director by an institutional shareholder. The intent of such nomination is to supervise the governance and transparent functioning of the company to safeguard the interest of the institution appointing such nominee. It is pertinent to note that the Act, while codifying the duties of directors, does not discriminate between the role of an executive or a non-executive nominee director. Shareholders' nominee directors are not, in any way, precluded from acting in the interest of the company and abide by their fiduciary obligations. Under the provisions of the Act, they are equally held liable in respect of acts of omission or commission by a company, which had occurred with their knowledge, attributable through board processes and with their consent or connivance or where they had not acted diligently. The records of board proceedings may be referred here to ascertain their role in the decision-making. While the involvement of nominee director is to be determined from the investigation into the affairs of IL&FS, would the nominee directors require to be impleaded as parties to the proceedings at the later stage? Only time will tell.(Puneet Shah is partner and Niharika Rao an associate with law firm IC Universal Legal. Views expressed are personal.)