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Introduction
Under Companies Act, 2013 a company is an independent entity. But someone needs to give direction to it and also run its day to day affairs. It’s where the role of Directors comes in who by working day and night make a company a thriving and profitable concern.
But more often than not it is seen that Directors are made scapegoats for the acts which they were not even responsible for. One example of this can be seen when some dues of the company like Provident Fund arrears are pending. Now in order to recover these dues the Directors are unnecessarily harassed and demands are made from them rather than recovering it from the assets of the Company. As a Company is an independent entity, no one else other than the company is responsible for paying its debts, not even its directors. The only exception to this rule is when the Directors of the company commit some offence by routing the company finances for their personal gain. But this is an exception and gernerally any person or entity, be it EPFO, ESIC or Official Liquidator, cannot force a Director to pay for any liability for which a company is responsible.
In this case we will discuss about such a demand which was made by the Official Liquidator on the Managing Director of a Company and the how the said Managing Director moved the Bombay High Court, and rightly so, to declare such demand as illegal and ultra vires of the power of the Official Liquidator.
Brief Facts
Shree Vimal Kumar Rajesh Shah (hereinafter the called the Petitioner) was the Managing Director of Chelan Foundries Limited. As the company was declared Sick and there was no chance of its revival Official Liquidator started its liquidation.
Probably most of it is difficult to comprehend, so let me explain what the above Paragraph means. Whenever a company is incurring losses or is unable to pay the debt of its creditors, it is very obvious to assume that today or tomorrow it will sink. In such circumstances the company is called Sick Industrial Company under Sick Industries Companies Act, 1985 (called SICA amongst lawyers). Under Section 3 (o) of SICA a “sick industrial company” is defined as “an industrial company (being a company registered for not less than five years) which has at the end of any financial year accumulated losses equal to or exceeding its entire net worth.” This definition makes it very much clear that the Company which is accumulating losses more than its value needs some interference in its functioning.
So either the company, its creditors or even its employees could take the said company to BIFR (Board of Industrial and Financial Reconstruction) which is formed under Sick Industries Companies Act, 1985 (called SICA amongst lawyers). Though kindly also note that SICA is now repealed and today a sick company is regulated under the provisions of Insolvency and Bankruptcy Code, 2016. When the company is taken to BIFR the first attempt of the Directors or other creditors is to revive the company but if the company is beyond redemption then BIFR allows its liquidation. Liquidation of an industrial concern means that it is broken into bits and pieces and sold so that its debt can be paid. So let’s say there is a Plant which manufactured bicycles. Now if it goes into liquidation then its land (on which the Plant stands), its machinery, its goodwill etc. will be sold separately to the highest bidder. This selling can happen by the way of a public auction and in case nobody bids for the company’s assets in the public auction these assets can be sold by way of a private treaty. (SICA proceedings were very complicated and I am only trying to explain its working knowledge so that the readers can understand the facts of the instant case. In some future article I will certainly deal with the full aspect of SICA which remains substantially same under its new avatar, IBC).
For the purposes of liquidation an Official Liquidator is appointed by the BIFR. Now the Official Liquidator’s aim is to maximise the sum of money which can be obtained by the selling of assets of the company. Further if someone owes a debt to the company then the Official Liquidator has the right to recover it from him on behalf of the company. (Much like the Official Assignee under Presidential Insolvency Act, a Testator under Indian Succession Act and a Trustee under Indian Trusts Act).
Now reverting back to the facts of the case. It was observed by the Official Liquidator that EPFO demands were made on the Company. This means that the money which the Official Liquidator will receive from selling the company have to be given to the EPFO authorities. Therefore rather than recovering the money by selling the assets the Official Liquidator asked the previous Managing Director of the company to pay the EPFO dues from his personal bank account. Managing Director denied any liability and declined to do so on the ground that when a company owes a debt to a person, individual directors are not liable to pay it. When the Official Liquidator did not agree with the argument of the Petitioner, he moved to Bombay High Court against such high handedness of the Official Liquidator.
The Bombay High Court agreed with this contention of the Petitioner by relying on the decision of Supreme Court in ESIC V/S SK AGGARWAL [Writ Petition No. 407 OF 2003], where it have been held that “Principal Employer” (read the Company or Factory) under ESIC Act, 1948 does not include the Directors of the company and if ESIC wants to effect a recovery from the company it can sell the assets of the company but the personal assets of the Directors are out of reach for it. The provisions of Provident Fund Miscellaneous Provisions Act, 1952 are similar to the ESIC Act, therefore the said judgment is also applicable to EPFO dues. Therefore the ESIC authorities or the Official Liquidator will be outside its power to demand any money from the Directors and a Writ of Certiorari will be maintainable against such demand.
Conclusion
The importance of the Company Directors is often understated, may be due to the socialist bias of the Indian Economy from the beginning. But it is also a fact that every company cannot reach the pinnacle and it may incur losses which causes it to finally destabilize. But to hold a Director responsible for such a failure and to demand from him the money which the company owes to its creditors is to bypass law and amounts to unduly punish a Director for something which is outside his control. The sinking of a Company is a very possible scenario and a person dealing with a company must embrace it. Therefore whenever an illegal demand is made on a Director or Promoter of a company, the right course of action will be to knock on the doors of the Court with a request for Certiorari to quash such demand.
Parveen Semwal
Advocate, High Court of Delhi and Supreme Court of India