Vicarious liability of directors

LEGAL EYE

After the bulls and bears of the capital markets, the interiors of a Board room exude a sense of comfort. Quite misleading, because the persons who meet there at least four times a year, carry the burden of the limited liability company on their collective shoulders, some more than others. Directors are the trustees of the company's money and properties, transact business and take on responsibilities as its representatives. They are also the fall guys, who, under the concept of vicarious liability, are liable for the corporation's offences.

Usually a penal provision in a statute makes every person(s) in charge and responsible for the conduct of the Company's business and affairs liable for prosecution. There are over hundred such Acts and only a few, such as the Factories Act make a director specifically liable. To satisfy the test of vicarious liability, the complainant has to allege and prove that the accused director was indeed responsible for the conduct of the particular business.

In recent years, directors' liability in respect of negotiable instruments has been a hotly contested subject. The Companies Act, under Section 47, provides that a bill of exchange hundi or pronote if is manifestly made, accepted, drawn or endorsed by the company, the signatory would not be liable. This language being very wide, the credibility of cheques became low because of poor remedial measures in cases of dishonour.

The Negotiable Instruments Act 1881, an antiquated piece of legislation, had not envisaged this probability, and the civil remedy by way of recovery in a civil suit was self-defeating. The pursuit of criminal proceedings under IPC were equally fallible because of the rigid requirements of proof. The Courts treated dishonour as an act of cheating, which required establishment of mens rea or awareness on the director's part.

In 1988, the Act was amended to insert Sections 138 to 142, specific to cheque-bouncing with the intent that drawers of cheque treat the instrument with due sanctity and to end the farce of "stop payment' incidents. Simultaneously the definition of "officer in default" in the Companies Act was substantially amended following certain high court decisions where ,again, prosecution failed for absence of mens rea, particularly in relation to managing and whole time directors.

The general description was replaced by specifics including managing director, whole time directors, and in the absence of identifiable officers or directors, the entire Board. However, nominee directors of Government and public sector banks are excluded from prosecution.

Initially, the Courts were quite uncertain as to the relevant reasons and persons culpable. But clarity was provided by the Supreme Court in the Anil Hada case in 2000, that three categories of persons fall within the purview of the legal fiction of the section: the company, the person(s) responsible for its business, and any director or manager with whose connivance or neglect the offence has been committed.

However, on facts, the courts have consistently held that in order to prosecute directors, there has to be specific allegations as to how the directors were involved in and responsible for the offence, departing from the rule of vicarious liability.

The Supreme Court has held that the legal fiction created by Section 141 is subject to the strict compliance of statutory requirements, based on averments in the complaint, and is not easy for a complainant to build up a non-rebuttable case proving the director's involvement in the company's affairs.

Kumkum Sen is a Partner at Rajinder Narain & Co.

kumkumsen@rnclegal.com