Articles

Section 274(1)(g) : Directors Special

Harshawardhan S. Chindhade, Company Secretary, Sharp India Ltd., Pune.

Section 274(1)(g) of the

Companies Act, 1956
prohibits
tainted
directors from being
appointed on the Boards
of
other
public
companies. This article
analyses the extent,
ambit and the effect of
the Rules relating to
such dis-qualifications.

e-mail :
h.chindhade@sharpindialimited.com
(A- 277)

The Companies Act, 1956 does not specify any qualification(s) for a person for being a Director in
a company. By the term qualifications one would go by the natural meaning i.e. educational
qualifications. However, the Act has neither prescribed the educational qualifications nor any
other qualifications. For the purpose of the Act the only qualification, if the Articles of Association
so require, is the share qualification. Like any other statute, the Act has enumerated qualifications
in a negative sense, i.e. by stating that a person would be disqualified from being appointed as a
Director if he is hit by any of the events mentioned in sub-section (1) of section 274.
The amendments made in the Companies Act, 1956 by the Companies (Amendment) Act, 2000 with
effect from 13-12-2000 have added one more disqualification for accepting and continuing
directorships by the person specified in that section, namely, clause (g). The addition of this clause
has rocked the thrones of directors in public companies or who intend to or are desirous of being
appointed in public companies. The basic provision needs a careful reading. The section reads thus :
274(1). A person shall not be capable of being appointed director of a company if (g) such person is already a director of a public company which, (A) has not filed the annual accounts and annual returns for any continuous period of three
financial years commencing on and after the first day of April, 1999; or
(B) has failed to repay its deposit or interest thereon on due date or redeem its debentures
on due date or pay dividend and such failure continues for one year or more.
The above provision contemplates various events and instances disqualifying a person from
being a director. An analysis of the above provision would reveal the following :
(1) Failure to file annual accounts and annual returns for three continuous financial years ;
(2) Failure to repay deposits or interest thereon on the due date ;
(3) Failure to redeem its debentures on the due date ; and
(4) Failure to pay dividend, if declared
Each of the above failure is a separate event and any company hit by any of the events will fall in
the definition of a disqualifying company. The proviso to clause (g) states : Provided that such
person shall not be eligible to be appointed as a director of any other public company for a period
of five years from the date on which such public company in which he is a director failed to file the
annual accounts and annual return under sub-clause (A) or has failed to repay its deposit or
interest or redeem its debentures on due date or pay dividend referred to in clause (B).
This provision clearly provides that clause (g) of sub-section (1) of section 274 has following
effects, viz,
(1) Prohibits a director disqualified under this clause from accepting appointment/ as director
in another public company ;
(2) The disqualification incurred is not a permanent one and is only for a period of five years.
However, this is a blanket disqualification to all the directors irrespective of the period of
office held by him and irrespective of the fact that he is not a party to the failure.
The Central Government has by a notification dated 21.10.20031 issued a set of rules viz., Companies
(Disqualification of Directors under section 274(1)(g) of the Companies Act, 1956) Rules, 2003. The
Rules have been framed to throw light on the basic provisions of the Act. Initially the Act did not
provide the manner in which one must count the period of office of the directors for making them
liable for the contraventions, more specifically in respect of sub-clause (B) of clause (g) of subsection (1) of section 274. Even after the enactment of Rules there is some ambiguity in this aspect.
The Rules have clearly defined the terms disqualifying company and appointing company.
The rules in this regard are sufficiently clear to indicate that the appointing company should be an
1. Clause (g) is to be read in conjunction with Companies (Disqualification of Directors under section 274(1)(g) of the
Companies Act, 1956) Rules, 2003 brought into force through Notification No. G.S. R. 830 (E), w.e.f. 21-10-2003.

Articles
entity other than the disqualifying company. The section is also
clear in indicating that to attract section 274(1)(g) there should
necessarily be two different companies, firstly a company where
default under section 274(1)(g) has occurred and secondly another
public company which has not defaulted under this clause and
where a person is an existing director in the defaulting company
seeks appointment on the Board of Directors of such other
company. The section provides a blanket disqualification to all
the directors who are the directors in the defaulting company
and happen to be on the boards of other public companies.
However, Rule 3 of said Rules is crucial and important in deciding
whether a Director has attracted the disqualification or not. The
relevant rule is as under:
3. Disqualifications under clause (g) of sub-section (1) of
section 274 of the Companies Act, 1956(a) Whenever a company fails to file the annual accounts and
annual returns, as described in sub-clause (A) of clause (g)
of sub-section (1) of section 274, persons who are directors
on the last due date for filing the annual accounts and the
annual returns for any continuous three financial years
commencing on and after the first day of April, 1999, shall
be disqualified.
(b) If a company has failed to repay any deposit, irrespective
of the enactment, rules or regulations under which the
deposits have been accepted by the companies, or interest
thereon, or redeem its debentures, or pay any dividend
declared on the respective due dates, and if such failure
continues for one year, as described in sub-clause (B) of
clause (g) of sub-section (1) of section 274, then the directors
of that company shall stand disqualified immediately on
expiry of that one year from the respective due dates :
Provided that all the directors who have been directors in
the relevant year, from the due date to the expiry of one
year after the due date, will be disqualified.
The First Proviso, above is the key factor in deciding whether a
director is actually disqualified under clause (B) of section
274(1)(g). When one interprets the above proviso, a logical
interpretation should be as under :
(1) The director in the disqualifying company should be a
director throughout the period of one year of default;
(2) He should have been a director on the date of default and
should have continued to be so till the completion of the
relevant year of the default;
This implies that a person should fulfill both the above conditions
for being categorized as a tainted or disqualified director under
clause (B) of section 274(1)(g). If either of the condition is not
fulfilled then it would be open to such person to plead exemption
from disqualification and as such he would not then be a
disqualified director. The essence of the section is continuity of
default for one year and continuity of the person in office as a
director in the disqualifying or defaulting company from the
due date on which payments mentioned in clause (B) actually
fell due. Secondly, he should have been a director, without any
break till the completion of one year as contemplated in the
section and Rule 3. These intentions are not clarified by the Rules
which it should have been the case. To exemplify this contention
it is possible to have hypothetical cases as under :

Section 274(1)(g) : Directors Special

(a) X is a public company which has defaulted in repayment of

debentures on the due date. Assuming the due date to be
say, 1st January 2005 the grace period for making good the
default will be one year. The default under section 274(1)(g)
will in this case be deemed to have been committed on or
after 1st January 2006, since the section contemplates that
such failure continues for one year or more. If Y is a person
who is appointed on the Board of Directors of X limited on
say 31st May 2005 and continues to be on the Board of the
disqualifying company even after 1st January 2006. This
appointment is made to fulfill the requirements of law
requiring a public company to have at least three directors.
Other Directors who were directors on the due date have
continued to be the directors throughout the period of one
whole year. In such a situation by reading the first proviso
to Rule 3 one can have an interpretation that, Mr. Y to be
termed as a disqualified director for the purpose of section
274(1)(g)(B) has not been a director on the due date.
(b) Secondly, a case exactly opposite to the one above. A person
is a director on the Board of Directors of a company on the
due date of the default. After a period of 5 months he realizes
that the company will not be able to make good or rectify
the default. Such a person resigns from the Board of
Directors on the expiry of 6 months. After the expiry of one
year it is noticed that the company did not make good the
default. In such a situation the person who resigned earlier,
anticipating such default will also be disqualified from
being appointed as a director on the Board of Directors of
other companies, which is not the case. Such directors, who
had been on the Board of Directors of such tainted company
for some time, would then lose their directorships in other
companies, which is not intended by the Act.
The important words in the proviso are relevant year. The
term relevant here is to be construed in its normal grammatical
connotation. Further the word relevant has been described by a
phrase from the due date to the expiry of one year after the due
date. This set of words acts as adjectival phrase, describing who
should be a director to be termed as a disqualified director. In
other words, these words and phrases ought to have been used in
relation with the term Director and also to indicate the time or
the period of office held by such director(s) simultaneously. If
and only if that person has held office during the relevant period,
as given above then only he will be disqualified. Otherwise a
person appointed later on the Board, to comply with section 254
or for any other reason, will unnecessarily be disqualified from
being appointed as a director in another public company, simply
because he happened to be on the Board of the disqualifying
company at some point of time during the relevant year. Such an
interpretation would be improper. Further, commission of
default on the due date is not the fault of the director who is
inducted later on the board of such defaulting company.
In the first case it would be proper to treat Y as a director not
disqualified from being appointed or reappointed as a director
on the Board of another public company. The above interpretation
also has the support of the forms designed under the prescribed
rules. Form DD-A is the prescribed form in which a disqualified
director has to confirm his disqualification in other companies
to the Board of the company where he seeks appointment or
reappointment. A similar rule will apply in case (b) above. The

Articles

Section 274(1)(g) : Directors Special

person who resigned after a short while need not be treated as a

disqualified person under section 274(1)(g).
To support the contentions advanced above one can resort to
form DD-A, prescribed under Rule 9 of the Rules, which also
justifies the intention to exclude the directors who have not held
the office for a continuous period of relevant year. The form
contains two columns, one- date of appointment and seconddate of cessation. Otherwise these specific columns would not
carry any meaning and will not serve the desired purpose.
However, the Rules do not provide a clear, unambiguous, logical
and workable interpretation of section 274(1)(g). The intention
appears to be so but the words do not afford such interpretation.
The Rules need a re-drafting to render prudent and commercial
interpretation.
The section as well as the Rules are clear enough to indicate that
the prohibition is only for a period of five years from the due
date and the same is in the nature of penalty. The logic appears to
be very apt, that a defaulter should not get a chance to hold office
of the director in another public company. As a matter of general
rule if there is an anomaly in the Act and the Rules the provisions
of the Act prevail. However in this situation the Rules are not
anomalous, nor contradictory. By applying the interpretation in
the above examples it would be clear that appointments made
after the due date but where the person have continued to be
directors till the completion of one year from the due date need
not be made a party to such default. The intention of Rule 3 is to
exempt unrelated and unconcerned Directors from undue
hardship and penalty for the defaults to which they were not a
party. Similarly, the grace period of one year for making good
the default regarding the payment of dues as mentioned in subclause (B) is to enable existing Directors, i.e. the person who
were directors on the due date and have continued on the Boards
till the conclusion of one year. In other words the grace period of
one year for making good the default is given to enable the
persons who are Directors in other public companies, (whether
listed or not) to quit from the Boards of such disqualifying
companies to enable them to retain their Directorships in other
public companies, where their expertise, knowledge and guidance
in the capacity as a Director, (not as an employee) is most required.
If a person is hit by the provisions of section 274(1)(g) merely
because he sought an appointment on the Board after the date of
default and has continued thereafter, then, unnecessarily stringent
interpretation of section 274(1)(g) would make him ineligible
from becoming a director on the Board of the public company,
which is absurd. This will also force persons who are otherwise
competent and qualified, and able to steer out companies out of
danger to quit the Boards of public companies; which would
ultimately lead to depletion in quality and procrastinate growth
of business. The second interpretation of the whole related law is
that a person who accepts appointment on the Board of the
disqualifying company after the expiry of one year of the default
then he will not incur any disqualification under section 274(1)(g)
even if the default continues. Such interpretation would be
improper. A practical and workable interpretation of that section
and the Rules need to be adopted in such cases.

SOME ANOMALIES/DISCREPANCIES
(1) An observation in respect of the form DD-A is worth noting.
This form is a declaration given by each director to the

Board of appointee companies. However the form contains

the words: director/managing director/manager. This
declaration is to be given by only a person who is a director
in the company. A Manager need not give it, since section
274 applies only to directors and not to managers.
(2) The basic section does not provide that the default is a
continuing one. However, any default in complying with
the rules is made a continuing offence. Rule 11 contains
this provision. The penalty that would be levied may extend
to Rs. 5000/- in the first instance with a further penalty of
Rs. 500/- per day during which the default continues. This
appears to be unjust and against the basic provision and
the scheme of the Act.
(3) If any person incurs any disqualification by virtue of clause
(d) or (e) then the Central Government is empowered to
remove the same. However, by a plain reading of the section
it is clear that the Central Government does not have the
power to remove the disqualification under clause (g).
However Rule 10 of the Rules confers power on the Central
Government to decide the applicability of the Rules. This
again is contradictory to the section. The only category of
directors exempted from applicability of section 274 is
nominee directors appointed by financial institutions to
safeguard their interest.
The decision of the Calcutta High Court in Pawan Jain v. Hindustan
Club Ltd. [(2005) 62, SCL 610 (CAL)] has given a very appropriate
dimension and has rightly pointed out that the auditor should
make an independent evaluation whether section 274(1)(g) is
attracted or not. In this landmark judgement the Court has also
observed that mere filling in Form DD-A is not sufficient; thus
impeaching the reliability of Form DD-A to a certain extent.
Further it has been rightly observed that the eligibility of director
for being appointed as such in another company would arise not
at the time of filing his nomination but at the time of actual
appointment. Though this may not be applicable in totality to
limited companies, the same decision can be applied at the time
of proposing candidature but will arise at the time of appointment,
if it is made in the Annual General Meeting or during the Board
meeting in which a Director is being appointed.

CONCLUSION
In the present context, the Rules framed under section 274(1)(g)
warrant a further clarification to enable the interpretation of the
basic provision in a comprehensive, correct and unambiguous
manner. The first proviso to Rule 3 should be redrafted to grant
exemption to persons who were not party to the default but
happen to be on the Board of the disqualifying company for
some time or period of the failure. Similarly such a provision
may be inserted amending the Act itself. Form DD-A prescribed
under the rules needs correction and that the word manager needs
to be deleted. These amendments would bring more clarity in
the application of the provision of section 274(1)(g). It is for the
prospective Directors and companies to ensure that appropriate
disclosures are made and disqualified Directors are not appointed
on the Boards of Companies. Similarly auditors need to be more
cautious than ever. Mere reliability on declaration is insufficient
because an independent evaluation may prove the innocence on
the part of the appointee.