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Disqualification of Directors - Paying price for Non Compliance

As a part of cracking the black money and to streamline the system, the Government had adopted some stringent measures, by disqualifying the directors of shell companies. The said initiative is a follow up action of demonetization drive and to regularize the activities of non-operational companies.On 14th of September 2017, the Ministry of Corporate Affairs (MCA) and Central Board of Direct Taxes (CBDT) signed a Memorandum of Understanding (MOU) to facilitate sharing of data and information with each other on an automatic and regular basis.

According to MCA, the move is targeted to curb the menace of shell companies, money laundering and black money in the system and to prevent misuse of corporate structure of shell companies for various illegal purposes.In August 2017, the SEBI had delisted the stock exchanges to initiate action against 331 listed companies and bar them from trading. Further to that, the Ministry of Corporate Affairs (MCA) had cancelled the registration of around 2,09,032 defaulting companies. The Ministry of Finance (MOF) had directed the banks to restrict operation of the bank accounts of such companies by directors of such companies or there authorized representatives. Following this the MCA has identified 1,06,578 directors for disqualifications under section 164 (2)(a) of the Companies Act 2013 as on 12th September, 2017.

Shell Company.

The term shell company is not defined under companies Act 2013 or Income Tax Act or SEBI Act, 1992. Shell Company is a corporation without active business operations or significant assets. But one cannot term all the in-operational entities as shell companies merely due to inactivity or in-operation. There are several reason for in-operative status of a company such as time delay for fund mobilization, delay in obtaining of permits, license etc.There are companies which are being used by large public companies, shady business persons or private individuals for the purpose of tax avoidance or tax evasion. It is important to crack down on shell companies, but at the same time it is not justifiable to bracket all defaulting companies as ‘Shell Companies’.

Defaulting Companies.

As per provisions of section 92 (4) of the Companies Act, 2013 every Company shall file with the Registrar a copy of Annual Return, within 60 days from the date on which Annual general Meeting (AGM) is held or should have been held, with such fees as may be prescribed.If the Company fails to file its annual return, the company shall be punishable with fine which shall not be less than Rupees fifty Thousand only which may extend to Rupees five lakhs and every officer of the company who is in default shall be punishable with imprisonment for a term which may extend to six months or fine which h shall not be less than fifty thousand rupees but which may extend to five lakhs rupees, or with both.Similarly as per section 137 of the Companies Act, 2013 the financial statements are not filed within 30 days from the date of AGM penal provisions will be as specified in section 137 (3) of the Act.

Grounds of Disqualification

As per provisions of section 164 (2), if a company has not filed the financial statements or annual returns for a continuous period of three(3) financial years the directors of such company shall be disqualified to act as director of the company. He /She will also be disqualified in all other companies, in which he / she is holding the directorship. Apart from that the said person shall not be eligible to be reappointed as a director of that company or in other company for a period of Five(5) years from the date of disqualification.

Obligations of the company on default.

Whenever a company fails to file the financial statements or annual returns, or fails to repay deposit interest, dividend or fails to redeem its debentures as specified in section 164 (2), the company shall immediately file Form DIR - 9 to the Registrar furnishing the name and address of all the directors of the company during the financial year.

Effect of Disqualification.

The disqualification is having far reaching effects as the defaulter will immediately get vacated from all the directorships he is holding in all his companies. The minimum period of disqualification is 5 years and during that period he cannot form a new company or join the board of a new company. So literally it is a freeze.

If a person is disqualified to act as director of the company pursuant to section 164 of the companies Act, the office of the director shall become vacant as per section 167 of the Act. If the said person continues to act as director even when he knows, that the office of the director held by him was vacant on account of any disqualification, he shall be punishable with imprisonment for a term of one year or with fine or with both.If all the directors of the company are so disqualified the promoter may appoint required number of directors who shall held office till next general meeting. In the absence of promoter Central Government shall appoint such new directors to the Board.This is a new provisions introduced in the companies Act, 2013.

If all the directors of a company became disqualified that will directly affect the operations of the company as none of them can represent the company before any forum. In strict sense such directors cannot represent the company in any manner and any violations will attract penal provisions as mentioned above.

The show must go on….

As the provisions of the Act are very clear the following are the practical steps that can be taken by a company to continue the operations of the company.

  1. The Company have to intimate the details of disqualified persons in DIR-9 within 30 days of disqualification.

  2. Convene a general meeting and appoint new directors to the Board. There is a technical issue in updating the details of newly appointed directors to MCA as the system presently not accepting any new eforms with the signature of existing directors.

  3. The disqualified director may file DIR -10 to remove disqualification. The same is a physical form. The filing fee is Rs. 10000/- for the eform

  4. The section clearly mentions the period of disqualification as 5 years the matter can be resolved only at judiciary level or through an amendment of Act. By adopting the above steps the company will be able to proceed with its normal business matters

The recent development happened in corporate world demands for better corporate governance mechanism and all the stake holders have to ensure proper compliance standards to avoid this kind of situations. Please keep in mind that cost of non compliance is much higher than the cost of compliance. So be complied!..

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