Vicarious liability of directors narrowed

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The Supreme Court in National Small Industries Corp v Harmeet Singh Paintal and Anr laid down guidelines to determine the vicarious liability of a company’s directors. Significantly narrowing the liability of directors, the court held that only those who were in charge of and were responsible for the conduct of the business of the company at the time the offence was committed could be held liable for it.

The case was brought to the Supreme Court by the National Small Industries Corporation, which was challenging a Delhi High Court judgment quashing the summons issued to the directors of various companies in a batch of cheque-bouncing cases. In dismissing the appeal the Supreme Court cited section 141 of the Negotiable Instruments Act, 1881, which made it clear that every person connected with the company cannot be held liable.

Supreme_Court_of_IndiaThe court also held that section 291 of the Companies Act, 1956, states that the board of directors of a company would be entitled to exercise all powers and to do all acts and things that the company is authorized to exercise and do. A company, though a legal entity, can act only through its board of directors. The settled position is that a managing director is in charge of and responsible for a company’s business and affairs and can be prosecuted for offences by the company. But other directors can be prosecuted only if they were in charge of and responsible for the conduct of the business of the company. A combined reading of sections 5 and 291 of the Companies Act with the definitions in clauses 24, 26, 30, 31 and 45 of section 2 of that act shows that the following are considered to be responsible to the company for the conduct of its business: (a) the managing director/s, (b) the whole-time director/s, (c) the manager, (d) the secretary, (e) any person in accordance with whose directions or instructions the board of directors of the company is accustomed to act, (f) any person charged by the board of directors with responsibility, provided that the person so charged has given his consent in this behalf to the board, (g) where any company does not have any of the officers specified in clauses (a) to (c), any director or directors who may be specified by the board or where no director is specified, all the directors.

When the board exercises any power under (f) or (g), the Companies Act requires that it file a return with the registrar within 30 days of the exercise of such powers. But under section 141(1) of the act the accused cannot be made vicariously liable if he does not fall under the category of “persons who are responsible to the company for the conduct of the business of the company”. Merely stating that “he was in charge of the business of the company”, or “he was in charge of the day-to-day management of the company” or “he was in charge of, and was responsible to the company for the conduct of the business of the company” is not enough. To establish liability the complaint should state how and in what manner the accused was guilty of consent and connivance or negligence and therefore, responsible under sub-section (2) of section 141 of the act.

The Supreme Court after reiterating its own pronouncements in various decisions laid down seven principles for establishing vicarious liability. These include:

  • The complainant is responsible for making specific allegations in the complaint so as to make the accused liable. It cannot be presumed that every director knew about the transaction.
  • Vicarious liability on the part of a person must be pleaded and proved and not inferred.
  • If the accused is the managing director or joint managing director then it is not necessary to make specific allegations in the complaint.
  • By virtue of their position they can be held liable.
  • If the accused is a director or an officer of a company who signed the cheques on behalf of the company then it is not necessary to make specific allegations in the complaint.
  • To be made liable the person should be in charge of and responsible for the conduct of the business of the company at the relevant time. This has to be stated as a fact, as there is no deemed liability of a director in such cases.
  • The court while rejecting the appeal filed by National Small Industries Corporation held that when the cheques alleged in the complaint were signed, the respondent Harmeet Singh Paintal was no longer a director of the company. This was evident from the sixth annual report for the year 1996-97 of the accused company.

The update of court judgments is compiled by Bhasin & Co, Advocates, a corporate law firm based in New Delhi. The authors can be contacted at [email protected] or [email protected] Readers should not act on the basis of this information without seeking professional legal advice.