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Company Appeal Nos. 4, 5, 6, 7, 8 & 9 of 2004

K. Subramony v. Official Liquidator

2009 SCC OnLine Ker 52 : (2010) 157 Comp Cas 61 : (2010) 98 CLA (SN 2) 3

(BEFORE C.N. RAMACHANDRAN NAIR AND V.K. MOHANAN, JJ.)

K. Subramony .…. Petitioner

v.
The Official Liquidator .…. Respondent
For Petitioner: Sri. M. Pathrose Matthai (Sr.)
For Respondent: Sri. K. Moni
Company Appeal Nos. 4, 5, 6, 7, 8 & 9 of 2004
Decided on January 2, 2009

JUDGMENT

Ramachandran Nair, J.

The connected appeals are filed by some of the Directors of the company in liquidation
by name Malabar Phyto Chemicals, who are convicted and sentenced by the Company
Court for offences punishable under Sections 454(5), 538(1)(c) and 541(1) of the
Companies Act. We have heard Senior counsel Sri. Pathros Mathai appearing for the
appellants and Sri. C.K. Mony appearing for the Official Liquidator.

2. The specific case of the appellants is that they were full time employees of the
financial institutions by name Kerala Financial Corporation Ltd. and Kerala State
Industrial Development Corporation Ltd. and were nominated by these Corporations to
the Board of Directors of the company in liquidation in terms of Section 27 of the State
Financial Corporations Act, 1957 (hereinafter called “the SFC Act”) and therefore, they
enjoy immunity from the alleged offences under Section 27(3)(b) of the said Act.
Consequently their prosecution and punishment for offences punishable under the
Companies Act are unauthorised is their contention. Counsel appearing for the Official
Liquidator contended that the appellants being Directors of the Company in
liquidation, answer the definition of “Officer” of the company defined in Section 2(30)
of the Companies Act and so much so, they were rightly prosecuted and punished for
the offences punishable under Sections 454(5), 538(1)(c) and 541(1) of the
Companies Act. Normally being Directors of the company in liquidation appellants are
liable to be proceeded against for the offences referred above. However, the only
question to be considered is whether they are entitled to immunity from prosecution
under Section 27(3)(b) of the SFC Act. In order to consider the claim, we have to
necessarily consider the scope of Section 27 of the SFC Act and for easy reference we
extract the said Section hereunder:

“27. Power to impose conditions for accommodation:-

(1) In entering into any arrangement under Sec.25 with an industrial concern, the
Financial Corporation may impose such conditions as it may think necessary or
expedient for protecting the interests of the Financial Corporation and securing that
the accommodation granted by it is put to the best use by the industrial concern.
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(2) Where any arrangement entered into by the Financial Corporation with an
industrial concern provides for the appointment by the Financial Corporation of one or
more directors of such industrial concern, such provision and any appointment of
directors made in pursuance thereof shall be valid and effective notwithstanding
anything to the contrary contained in the Companies Act, 1956 (1 of 1956), or in any
other law for the time being in force or in the memorandum, articles of association or
any other instrument relating to the industrial concern, and any provision regarding
share, qualification, age-limit, number of directorship, removal from office of directors
and such like conditions contained in any such law or instrument aforesaid shall not
apply to any director appointed by the Financial Corporation in pursuance of the
arrangement as aforesaid.

(3) Any director appointed in pursuance of sub-section(2) shall—

(a) hold office during the pleasure of the Financial Corporation and may be removed or
substituted by any person by order in writing by the Financial Corporation;

(b) not incur any obligation or liability by reason only of his being a director or for
anything done or omitted to be done in good faith in the discharge of his duties as a
director or anything in relation thereto;

(c) not be liable to retirement by rotation and shall not be taken into account for
computing the number of directors liable to such retirement.”

3. The scheme of the Companies Act provides for management of the affairs of the
company by the Board of Directors of the company constituted in accordance with the
provisions of the Companies Act, Memorandum and Articles of Association of the
company. However, Section 27(1) of the SFC Act authorises a financial institution to
enter into arrangement with the company to which it extends financial assistance, to
appoint Directors to the Board of the company which is to protect the interest of the
financial institution. It is clear from sub-section(1) of Section 27 itself that the
purpose of appointment of directors by a financial company is to protect it's interest
and not for any other purpose. In fact, by virtue of sub-sections (2) and 3(c) of
Section 27, Section 27 of the SFC Act is given precedence over the provisions of the
Companies Act, the Memorandum and Articles of Association of the company in regard
to appointment, share-qualification, age limit, provision for retirement etc. of the
Directors. In other words, the appointment of Directors representing the interest of a
financial institution in the Board of a company under Section 27 is essentially
contractual and the provisions of the Companies Act, Memorandum and Articles of
Association on share qualification, age limit, removal, retirement by rotation etc.
applicable to other Directors of the Company do not apply to any Director appointed by
a financial institution under sub-section (1) of Section 27 of the SFC Act. Further, it is
provided in clause 3(a) of Section 27 that the Director appointed by a financial
institution to the Board of Directors shall be removed or substituted by order in writing
by the Financial Institution. This provision makes it clear that the Director
representing financial institution holds office at the pleasure of the financial institution
and it is for such institution to withdraw him or to substitute him by another person, if
they so desire, by order in writing. Sub-section 3(b) of Section 27 provides immunity
to a Director appointed by a financial institution for anything done or omitted to be
done in good faith in the discharge of his duties as a Director or in relation thereto.
The purpose of this clause is to protect nominee Directors appointed by financial
institutions from being proceeded against for acts or omissions done in good faith in
the discharge of their duties as Directors of the company. Even though sub-section 3
(b) of Section 27 is by way of immunity for acts and omissions, counsel for the Official
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Liquidator rightly pointed out that the immunity is not absolute. The acts and
omissions protected are only things done or omitted to be done in good faith in the
discharge of his duties as a Director. As already stated, a Director appointed by a
financial institution to the Board of a company has to predominantly protect the
interest of the financial institution. Financial institutions advance funds to the
company by way of loans or they even participate in the equity of the company. As a
director representing the Financial Institution, he is concerned about the application of
funds by the company, financial management etc. and he should ensure that the
company acts not to the detriment of the interest of the financial institution Therefore,
nominee director of a financial institution is not engaged in regular management of the
company such as maintenance of books of accounts, filing of returns etc. which are
routine works of regular employees including whole time or working director. In fact it
is for the financial institution to oversee whether their nominee Director acts in such a
way to protect it's interest and for his acts and omissions, it is for the Financial
Institution to take action depending on his terms of appointment or to remove him, if
he is found unfit. In other words, we are of the view that a nominee Director is not
involved in the routine management of the company and he cannot be assigned any
such work by the company except to be called to attend meetings and to participate in
the proceedings of the Board of Directors required under the Companies Act and the
Memorandum and Articles of Association. So much so, Directors appointed by financial
institutions cannot be held responsible for acts and omissions which the officers of the
company including other members of the Board of Directors are required to comply
with. However, for any act or omission as a director not done in good faith, even a
Director nominated by a financial institution under Section 27(1) of the SFC Act can be
proceeded against.

4. The next question to be considered is whether the appellants being Directors

appointed by financial institutions to the Board of Directors of the liquidated company,
can be proceeded against for various offences referred above for which they are
punished. The offences covered by Section 454(5) is failure on the part of the
Directors to file statement of affairs before the Official Liquidator without any proper
excuse. Liquidation is only winding up of the company and the interest of the financial
institution is only to see whether in the distribution of assets on liquidation, they can
retrieve any amount. The nominee Director appointed by financial institution under
Section 27(1) has to protect the interest of the financial institution which has
advanced funds to the company. The company obviously failed, whatever be the
reason for the same, and the appointment of the Director by financial institution did
not serve the purpose of protecting the interest in as much as it has also lost the
funds. We have already expressed our view that in the winding up proceeding, the
financial institution gets arrayed as a creditor and all what they have to see is whether
the funds of the liquidated company are appropriated in accordance with law.
Therefore, we are of the view that the nominee Director has no role in the filing of
statement of accounts by the liquidated company before the Official Liquidator. So
much so, appellants as nominee Directors appointed by financial institutions under
Section 27(1) have immunity from proceeding initiated under Section 454(5) of the
Companies Act.

5. The next offence alleged is under Section 541(1) of the Companies Act wherein the
Directors of the company were found to have failed to maintain statutory registers,
books of accounts and records as specified in the Companies Act. Here again, we feel
that these are duties of employees and Directors in regular management of the affairs
of the company and the nominee Directors of financial institutions are not supposed to
involve in regular management and so much so, they are not liable for offences
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punishable under Section 541(1) of the Companies Act.

6. The last offence leveled against the appellants is under Section 538(1)(c) of the
Companies Act for failure of the Directors to hand over all the books of accounts,
registers and other papers of the company to the Official Liquidator even after
repeated demands. Here again, since the nominee Directors appointed by financial
institutions are not in the control of books of accounts or registers of the company,
they cannot be held guilty for failure to hand over these registers to the Official
Liquidator. The appellants are not charged with any overt act amounting to an offence
under any provisions of the Companies Act. On the other hand, allegation is only on
their failure or omission to do certain things, which as members of the Board of
Directors, the appellants were not bound to do. As already found, the omissions
alleged were not acts required to be done by the appellants as nominee Directors of
financial institutions and so much so, the offences alleged are not maintainable
against them. We, therefore, hold that the conviction and sentence of the appellants
for offences punishable under Sections 454(5), 538(1)(c) and 541(1) of the
Companies Act are unauthorised and we, therefore, allow the appeals by setting aside
the impugned orders of the Company Court.

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