Liability of directors under the Negotiable Instruments Act during the moratorium period under IBC

[A comment on the current judicial stance]

Introduction

In order to buttress smooth conduct of business in the economy, it is pertinent to have non-cash instruments for the business transactions. Negotiable Instruments are important to provide for the alternative of cash so that the business of the economy does not hamper. To give effect to such transactions, Negotiable Instruments (NI) like promissory note, bill of exchange and cheque etc. were introduced. Considering the importance of NI, a criminal legislation, i.e., The Negotiable Instrument Act, 1881 (‘NI Act’) was introduced with the purpose of curbing the misuse of NI and to establish thetrust of the business corporations in these instruments. Rigorous punishment and fine was provisioned for misuse of NI. The Supreme Court in Modi Cements Ltd. v. Kuchil Kumar Nandi observed that the main objective of section 138 to section 142 of the NI Act is to foster the efficacy of banking and other related operations to develop the credibility in transaction business through cheques. But, as the transactions in NI are continuously increasing, the misuse of these instruments has become rampant. As the major transactions in NI are done by businesses, the fraud committed in the usage of these instruments could lead to distrust in negotiable instruments, and therefore, can severely affect the economy  on a large scale.

Section 141 of the NI Act  pertains to the liability of persons who are in charge of the business of the company, and to curtail the misuse of the cheques and other instruments by the director who might misuse the instruments for the furtherance of personal objective and hide behind the shield of the company to shy away from the liability.

With the enforcement of the Insolvency and Bankruptcy Code (‘IBC’) in 2016, the scope of misuse of NI Act further expanded, that the directors committing the offence under section 138 may escape liability by using the moratorium period imposed before the CIRP proceedings as the shield, the accountability of the directors of the company under section 138 r/w section 141 of the NI Act when the moratorium period under section 14 of IBC is imposed on the corporate debtor.

Liability of the Directors

In the case of P.Mohanraj vs. Shah Bros. Ispat (P) Ltd, wherein the moratorium under section 14 of IBC was imposed on the company, the directors argued that they should be shielded from the proceedings under NI Act as the moratorium period was in place, in the judgement as pronounced by Supreme Court, it was held that the  Moratorium under section 14 of the IBC would be effective only to the extent that shields the corporate entity which is liable to repay the debt and no excuse can be availed by the natural persons who were involved in the day to day functions of such corporate entity. SC, in its judgement pronounced that the moratorium provisions in Section 14 of the IBC would apply only to the corporate debtor and that the natural persons mentioned in Section 141 of the Act would continue to be statutorily liable.

As the company is an artificial entity and cannot function on its own, as therefore, it operates through its management, which is headed by its Board of Directors, though it is a well-established fact as well as acknowledged legal standing that the company is a separate legal entity and is different from the shareholders of its company and is itself liable for its liabilities, but the law cannot be misconstrued to misappropriate this as a loophole by the management of company wherein the management/ directors utilise the company to further their personal interests. Therefore, the directors can be held liable for the acts that they did in the capacity of being an office bearers of the company.

Nature of offences under the two legislations

InKusum Ingots & Alloys Ltd. v. Pennar Peterson Securities Ltd, the court emphasised  the need to determine the need to fix the accountability of the directors on  a case-to-case basis, and held that directors cannot be given the liberty to take advantage of their own wrong. By the same reasoning, the directors of the accused company cannot shy away from their liability for the wrong committed by them when they were incharge of the company.

The proceedings under the NI Act are criminal in nature, whereas the proceedings under IBC are civil in nature and can be continued simultaneously. On perusal of precedents and analysing the reasoning applied by the Apex court in various cases, it can comfortably be concluded that the proceeding against the directors would be completely valid and would be in compliance with the procedure established by law. In the matter ofMr Ajay Kumar Bishnoi vs M/S.Tap Engineering, where the debtor company went into the CIRP under section 31 of IBC and moratorium in terms with section 14 of IBC was declared, while the complaints of dishonour of the cheque were pending against the company. Madras High Court held that acceptance of the CIRP under Section 31 of the IBC cannot be a ground for quashing the prosecution, initiated under Section 138 of the NI Act, against the corporate debtor and the concerned Key Managerial Persons (‘KMP’)

In Narinder Garg v. Kotak Mahindra Bank, the Court considered whether a corporate entity against which a moratorium had become effective could be prosecuted under Sections 138 and 141 of the Act. The issue also concerned the liability of natural persons such as a director’s of the Company. In its decision, the Court stated that the moratorium provisions in Section 14 of the IBC would apply only to the debtor company, and the natural persons mentioned in Section 141 of the Act would remain statutorily liable under the provisions of NI Act and when more than one directors are involved, then to establish the liability of directors, liability of each director needs to be established individually.

Liability for merely holding the office

Merely holding the position of responsibility does not conclusively impose liability on the office bearer, in the case of S.M.S. Pharmaceuticals Ltd. v. Neeta Bhalla and Anr, where the  accused was in a key position, and a man of general prudence can comfortably assume that such person would have been involved in a particular conduct by the company, but if the accused person successfully establishes the fact that, they did not have any knowledge of the offence committed or due diligence was exercised by them to avoid such commission of  such offence, they cannot be held to be liable.

Whereas, in Indus Airways Private Limited v. Magnum Aviation Private Limited, the court interpreted the explanation appended to section 138 of NI Act,  when the cheque is issued to discharge any debt or any other liability, such liability should exist on the date on which the cheque is drawn, when there is no legally enforceable debt or any other liability on the date on which the cheque has been drawn, then, no offence can be said to be committed under section 138 of NI Act. In the case where the cheque is issued towards advance payment of any contract, dishonour of such cheque would not be considered as a legally enforceable debt or any other liability, and would not attract the offence under section 138 of NI Act.

Conclusion

When, the offence under section 138 of NI Act is committed by a company, while the directors who were in charge of such related affairs, were in the position to administer control over the activities of the company, if there is nothing substantial to prove that they were not in charge of the affair of the company at the time when the alleged default is committed then, they shall be liable under section 141 of NI Act. But, mere being in the position of responsibility for such functions, which are attributable to the offence under section 138 of NI Act and is not conclusive. It needs to be established that such accused did not have any knowledge of the offence committed or due diligence was exercised by them on their part to avoid such offences. And, when the debtor company goes into CIRP and the moratorium period is in place as per section 14 of IBC, the directors who are liable under section 141 of NI Act cannot be shielded from the liability solely for the reason that the moratorium period is in place. The protection under the moratorium period is provided to the debtor company and not the management of the company, who are held to be liable under section 141 of the NI Act.

(This article is authored by Mr. Vaibhav Vyas, currently a 3rd year B.Com LL.B. (Hons.) student at Gujarat National Law University, Gandhinagar. The author can be contacted at: vaibhav20bcl017@gnlu.ac.in)