Wednesday, June 28, 2017

Minimizing the Liability of Directors: SEBI’s Order in the Zylog Case

[Guest post by Amitabh Robin Singh, who is a corporate lawyer practising in Mumbai]

Liability of directors is a sensitive topic in India, particularly for foreign investors who propose to nominate directors to the boards of their Indian investee companies. That is why clauses are inserted in shareholders’ agreements to the effect that the investor’s nominee director will not be identified (to the extent permitted by applicable law) as an “officer who is in default” or “employer” or “occupier” for the purposes of various laws. Also, shareholders’ agreements often record that the promoter/founder of the company will be in charge of the day-to-day affairs of the investee company.

Further, directors are often advised to record their objections or reservations to any action by the company which they are against, for the purpose of insulating themselves from any punitive action that may be initiated by regulatory authorities for alleged non-compliances. This thought may stem inter alia from the definition of “officer who is in default” in the Companies Act, 2013, which has a clause as follows: “every director, in respect of a contravention of any of the provisions of this Act, who is aware of such contravention by virtue of the receipt by him of any proceedings of the Board or participation in such proceedings without objecting to the same, or where such contravention had taken place with his consent or connivance”.

An apt case broaching this particular point was recently decided by a whole time member of the Securities and Exchange Board of India ("SEBI") in the matter relating to Zylog Systems Limited ("Zylog").

Zylog had declared dividend on its shares, which was approved at its annual general meeting held on September 25, 2012. In relation to this declaration, Zylog failed to deposit the amount of the dividend in a separate account within five days of its declaration, as mandated by section 205(1A) of the Companies Act, 1956 (with section 123(4) of the Companies Act, 2013 prescribing a similar requirement). Further, Zylog did not disburse the dividend within 30 days of declaration in contravention of section 207 of the Companies Act (that corresponds with section 127 of the Companies Act, 2013).

A violation of section 205 of the Companies Act, 1956 will result in the company and every officer of the company who is in default being punished with a fine for every day during which the failure continues. Separately, contravening section 207 of the Companies Act, 1956 attracts a punishment of imprisonment of up to three years and fine for every director of the company who is knowingly a party to the default, and the company will be liable to pay interest on the amount.

SEBI had issued show cause notices to all the individuals who were directors of the Zylog on the date of declaration of dividend. Two independent directors of Zylog, Mr. S. Rajagopal and Mr. V.K. Ramani responded to the show cause notices stating that they were not associated with the day to day operations of Zylog, and that the default occurred without their knowledge and consent. Mr. Rajagopal stated that he was unaware of the default until it was brought to his notice by a certificate furnished by the company secretary and managing director. Mr. Rajagopal, who was also the chairperson of Zylog's audit committee, submitted minutes of the audit committee dated November 14, 2012 in his defence, which recorded that the audit committee looks seriously upon such defaults and the matter needs to be brought up before Zylog's board with a direction to make all statutory payments.

Mr. Ramani contended that he came to know of the default at the board meeting dated November 14, 2012.  Both Mr. Rajagopal and Mr. Ramani placed reliance on the minutes of this board meeting, where it was recorded that defaults had been committed and Mr. Rajagopal desired that steps be taken to remedy such defaults. Also, observations were made regarding the non-payment of certain dues (apart from the unpaid dividend) such as provident fund contribution.

Based on the above minutes, both Mr. Rajagopal and Mr. Ramani contended that they acted promptly and diligently. Also, both resigned from the board of directors within two months of the abovementioned board meeting.

SEBI’s whole-time member noted that independent directors have a very important role to play in both protecting the minority shareholders and guiding the management of companies. Further, it was observed that independent directors also should ensure that the company operates in compliance with applicable laws. With respect to the matter of Zylog, he went on to say that Mr. Rajagopal and Mr. Ramani took strong stands to convince the board to comply with its statutory obligations and, with Zylog failing to do so, they resigned from the board of the directors.

Seeing that Mr. Rajagopal and Mr. Ramani were not in charge of the day to day operations of Zylog, and discharged their duties as independent directors by using their best efforts, it was held that there was no need for action against them.

From this case, it may be noted that for directors to protect themselves from punitive action for acts of the company, they should inter alia always ensure that the objections raised by them are duly recorded in the minutes. To accomplish this, the directors should exercise their right to comment on the draft minutes which have been circulated to them. Further, caution should be exercised to ensure that the directors provide their comments on the draft minutes within the stipulated period of within seven days of circulation. This is because if the comments are given subsequent to such period, their consideration will be at the discretion of the chairman of the board. If the directors fail to provide any comments on the draft minutes, then they are deemed to be approved by such directors. Hence, directors, whether nominees, independent, or otherwise, should be very vigilant in order to limit their individual exposure to regulatory action.

- Amitabh Robin Singh

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