Former directors stay on the hook despite successful CIRP

By Karthik Somasundram and Alabh Lal, Bharucha & Partners

Under section 138 of the Negotiable Instruments Act, 1881 (NI Act), if a dishonoured cheque is not subsequently met or paid, the issuer of the cheque will have committed an offence. Where the defaulter is a company, its directors and signatories are also vicariously liable under section 141. In Aneeta Hada v Godfather Travels & Tours (P) Ltd (2012), the Supreme Court held that a prosecution against the directors or signatories under the NI Act is not independent and cannot continue without prosecuting the defaulting company. This has been the settled position at law for over a decade.

Karthik Somasundram
Bharucha & Partners

As with other settled positions of law, the introduction of the Insolvency and Bankruptcy Code, 2016 (IBC), and section 32A in particular, has forced a closer examination of the decision in Aneeta Hada. In Ajay Kumar Radheyshyam Goenka v Tourism Finance Corporation of India Ltd, the Supreme Court dealt with a situation where the defaulting company, a corporate debtor under the IBC, was successfully rescued by a resolution applicant. However, a prosecution under the NI Act against the appellant, a former director of the defaulting company, continued. The appellant argued that, following the decision in Aneeta Hada, the prosecution against him under the NI Act must come to an end. The corporate debtor’s liability had been discharged by the approval of the resolution plan under section 31 of the IBC. The appellant argued that a former director could not be liable when the principal defaulter’s liability had been discharged. His liability was only vicarious.

The Supreme Court disagreed. While, under section 32A of the IBC, the corporate debtor’s liabilities were extinguished by the approval of the resolution plan, the second proviso to section 32A of the IBC did not discharge its directors or signatories. The court noted that even the decision in Aneeta Hada had carved out an exception for the continuation of prosecutions for the vicarious liability of directors or signatories where a company could not be prosecuted because of a legal impossibility. In the present case, section 32A of the IBC made the continuation of the prosecution against the corporate debtor a legal impossibility. However, directors or signatories of a corporate debtor would continue to be vicariously liable even after approval of the resolution plan or liquidation of the company. To hold that they did not continue to be vicariously liable would lead to absurd and unintended situations such as the release of convicted directors or signatories on the approval of the resolution plan.

The Supreme Court also drew a parallel between the continued liability of a guarantor despite the resolution of a corporate debtor and vicarious liability under the NI Act. In Lalit Kumar Jain v Union of India and Others, the Supreme Court had held that the approval of the resolution plan does not discharge a guarantor’s liability. Similarly, and more so by virtue of section 32A of the IBC, the liability of offences by former directors or signatories will continue independently.

The court also noted its earlier judgement in P. Mohanraj v Shah Bros. Ispat (P) Ltd, in which it had held that the prosecution under the NI Act against the corporate debtor would be stayed during the insolvency process because of the moratorium under section 14 of the IBC. However, such protection is not available to directors or signatories during the insolvency process. Even in that case, the court relied on the exception it had noted in Aneeta Hada to hold that the legal suspension under section 14 of the IBC against a company would not protect the directors or signatories and their prosecution under the NI Act would continue.

The decision in Goenka’s case confirms that the many legal guardrails created to promote the revival of a corporate debtor and maximise its value under the IBC will at no stage be available to its previous management. They cannot evade criminal responsibility and will remain liable. As the jurisprudence under the IBC continues to evolve, it is forcing corporate India to adopt better, more ethical corporate practices. The dubious practices of promoters during the era of the Sick Industrial Companies Act, 1985 which eroded the net worth of lenders and limited the availability of credit is slowly but surely becoming a thing of the past. The IBC is truly a game changer.

Karthik Somasundram is a partner and Alabh Lal is an associate at Bharucha & Partners

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