Liability of Directors under Section 138 NI Act: Supreme Court Judgment on IBC Resolution Plans (March 15, 2023)

Date of the Judgment: March 15, 2023
Citation: 2023 INSC 232
Judges: Sanjay Kishan Kaul, J. and Abhay S. Oka, J. (authored by Sanjay Kishan Kaul, J.) and J.B. Pardiwala, J. (Concurring Opinion)

Can a director of a company be held liable for a cheque bounce under Section 138 of the Negotiable Instruments Act, 1881 (NI Act), even if the company’s debt is resolved through an Insolvency and Bankruptcy Code, 2016 (IBC) resolution plan? The Supreme Court of India recently addressed this critical question, clarifying the extent of directors’ liabilities in such cases. This judgment has significant implications for corporate governance and the enforcement of financial obligations.

Case Background

M/s Rainbow Papers Limited, with Ajay Kumar Radheyshyam Goenka as its Promoter and Managing Director, obtained a loan of Rs. 30.00 crores from Tourism Finance Corporation of India Limited (TFCI). A loan agreement was executed on March 27, 2012, in New Delhi. To fulfill its obligations, the company issued a post-dated cheque of Rs. 25,47,945, dated February 15, 2016. However, the cheque was returned on April 7, 2016, with the remark “Account Closed.”

TFCI issued a demand notice on April 19, 2016, under Section 138 of the NI Act, to the company and Ajay Kumar Goenka, seeking settlement of the debt. Despite acknowledging the liability on April 28, 2016, the payment was not made. Consequently, TFCI filed a criminal complaint on May 16, 2016, under Section 138, 141, and 142 of the NI Act.

In 2017, M/s Neeraj Paper Agencies Limited initiated Corporate Insolvency Resolution Process (CIRP) against Rainbow Papers Limited under Section 9 of the IBC. The National Company Law Tribunal (NCLT) admitted the insolvency application on September 12, 2017. TFCI filed its claim on October 13, 2017. During the CIRP, TFCI was considered an Unsecured Financial Creditor, leading to objections before the National Company Law Appellate Tribunal (NCLAT).

The Metropolitan Magistrate dismissed Ajay Kumar Goenka’s application for exemption from personal appearance on November 12, 2018, citing the NCLAT’s view that Section 138 of the NI Act is a penal provision not covered by Section 14 of the IBC. Subsequently, his application for discharge was dismissed on November 1, 2019, and the High Court dismissed his revision petition with costs. This led to the appeal before the Supreme Court.

Timeline

Course of Proceedings

The Metropolitan Magistrate dismissed the Appellant’s application for exemption from personal appearance, relying on the NCLAT’s view that Section 138 of the NI Act is a penal provision not covered by Section 14 of the IBC. Subsequently, the Magistrate dismissed the Appellant’s application for discharge. The Criminal Revision Petition before the High Court was also dismissed with costs. The Appellant then approached the Supreme Court challenging the High Court’s order.

Legal Framework

The case primarily revolves around the interpretation of Section 138 of the Negotiable Instruments Act, 1881, and its interaction with the Insolvency and Bankruptcy Code, 2016.

• Section 138 of the NI Act: This section deals with the dishonor of a cheque for insufficiency of funds. It states that if a cheque is returned unpaid, the drawer is deemed to have committed an offense and can be punished with imprisonment or fine or both. The explanation to this section defines ‘debt or other liability’ as a legally enforceable debt or other liability.
• Section 141 of the NI Act: This section addresses offenses by companies, holding every person in charge of and responsible for the company’s business liable for the offense committed by the company.
• Section 14 of the IBC: This section provides for a moratorium on proceedings against a corporate debtor once the CIRP is initiated.
• Section 31 of the IBC: This section deals with the approval of a resolution plan, which is binding on all stakeholders, including the corporate debtor, creditors, and guarantors.
• Section 32A of the IBC: This section provides that the liability of a corporate debtor for an offense committed before the commencement of the CIRP ceases if the resolution plan results in a change of management or control, with certain exceptions. However, it also states that individuals responsible for the company’s conduct remain liable.

Arguments

Appellant’s Submissions:

• The appellant argued that the trigger for Section 138 of the NI Act is the non-payment of a legally enforceable debt. Once the debt is extinguished under the IBC, the basis for Section 138 disappears.
• The nature of proceedings under Section 138 is primarily compensatory, with punitive elements to enforce compensation. Therefore, if recovery is made, Section 138 proceedings should not continue.
• If the company’s debt is resolved, payments should be governed by the resolution plan or the distribution of assets under Section 53 of the IBC.
• The appellant relied on the judgment in P. Mohanraj and Others v. Shah Brothers Ispat Private Limited [(2021) 6 SCC 258], stating that while a corporate debtor is protected during the moratorium, natural persons are not, but argued that the proceedings in this case are beyond the moratorium period.
• The liability is primarily of the company, and the prosecution of natural persons under Section 141 of the NI Act is vicarious to the prosecution of the company.

Respondent’s Submissions:

• The respondent argued that the cheque was issued with mala fide intent to defraud the company.
• The proceedings under the NI Act were initiated before the IBC proceedings.
• The respondent emphasized that Section 32A of the IBC states that individuals involved in the commission of an offense by the corporate debtor remain liable, even if the corporate debtor’s liability ceases.
• The respondent contended that the offence under Section 138 of the NI Act was complete when the cheque was dishonored and a notice was issued, and the criminal proceedings should continue.

Innovativeness of the Argument: The appellant innovatively argued that the compensatory nature of Section 138 proceedings should cease once the debt is addressed under the IBC, and that the directors’ liability is vicarious to the company’s liability.

Issues Framed by the Supreme Court

The Supreme Court framed the following issue for consideration:

1. Whether, in light of (i) the complainant participating in the IBC proceedings and accepting a share as a creditor, and (ii) the approval of the resolution plan under Section 31 of the IBC, the signatory/director in charge of the day-to-day affairs would stand discharged from the penal liability under Section 138 of the NI Act?

Treatment of the Issue by the Court

Authorities

The Court considered the following authorities:

Judgment

The Supreme Court dismissed the appeals, holding that the directors of a company remain liable under Section 138 of the NI Act, even if the company’s debt is resolved through an IBC resolution plan. The court emphasized that:

How each authority was viewed by the Court:

• The Court followed the ratio in P. Mohanraj and Others v. Shah Brothers Ispat Private Limited [(2021) 6 SCC 258]* and stated that the moratorium under Section 14 of the IBC applies only to corporate debtors and not to natural persons mentioned under Section 141 of the NI Act. The second proviso to Section 32A(1) was also discussed, which holds individuals responsible for the company’s conduct liable.
• The Court distinguished Ajit Balse v. Ranga Karkere: (2015) 15 SCC 748* and held that the director can be prosecuted even if the company is not being prosecuted.
• The Court relied on Aneeta Hada v. Godfather Travels & Tours (P) Ltd. , (2012) 5 SCC 661* to support that the moratorium provision under Section 14 of the IBC applies only to the corporate debtor, and not to the natural persons mentioned in Section 141 of the NI Act.
• The Court cited Swiss Ribbons Private Limited and Another v. Union of India and Others (2019) 4 SCC 17* to explain that the resolution professional has no adjudicatory powers.
• The Court cited Committee of Creditors of Essar Steel India Limited v. Satish Kumar Gupta and Others (2020) 8 SCC 531* to explain the process of information memorandum and submission of resolution plan.
• The Court cited Ebix Singapore Private Limited v. Committee of Creditors of Educomp Solutions Limited and Another (2022) 2 SCC 401* to explain that resolution plan binds even the persons who have not consented.
• The Court cited Manish Kumar v. Union of India and Another (2021) 5 SCC 1* to uphold the constitutional validity of Section 32A of the IBC, and to show that wrongdoers are not allowed to get away.
• The Court relied on JIK Industries Limited and Others v. Amarlal V . Jumani and Another (2012) 3 SCC 255* to highlight that the sanction of a scheme under Section 391 of the Companies Act, 1956 will not lead to any automatic compounding of offence under Section 138 of the NI Act without the consent of the complainant.
• The Court relied on State of Rajasthan v. Shamsher Singh 1985 supp SCC 416* to explain the maxim Lex Non Cogit Ad Impossibilia.
• The Court relied on Goa State Cooperative Bank Limited v. Krishna Nath A. and Others (2019) 20 SCC 38* to explain that the defaulters cannot take benefit of their own action.
• The Court relied on State Bank of India v. V . Ramakrishnan and Another (2018) 17 SCC 394* to explain that the object of the Code is not to allow guarantors to escape from independent and co-extensive liability.
• The Court relied on Vijay Kumar Jain v. Standard Chartered Bank (2019) 20 SCC 455* to explain that members of the erstwhile Board of Directors are vitally interested in a resolution plan.
• The Court relied on Lalit Kumar Jain v. Union of India and Others (2021) 9 SCC 321* to explain that the sanction of a resolution plan does not operate as a discharge of the guarantor’s liability.
• The Court relied on Indorama Synthetics (I) Ltd., Nagpur v. State of Maharashtra and others 2016 SCC OnLine Bom 2611* to explain that Section 446(1) of the Companies Act, 1956 does not include criminal proceedings under Section 138 NI Act.
• The Court relied on Narinder Garg and Others v. Kotak Mahindra Bank Ltd . and Others (2022) SCC OnLine SC 517* to reiterate that the moratorium under Section 14 of the IBC applies only to the corporate debtor and not to the natural persons mentioned in Section 141 of the NI Act.

What weighed in the mind of the Court?

The Supreme Court’s decision was primarily influenced by the following factors:

• Penal Nature of Section 138 NI Act: The Court emphasized that Section 138 of the NI Act is a penal provision aimed at maintaining the integrity of commercial transactions, not just debt recovery.
• Co-extensive Liability: The Court highlighted that under Section 141 of the NI Act, directors’ liability is co-extensive with the company’s liability.
• Intent of Section 32A IBC: The Court noted that Section 32A of the IBC was intended to protect the corporate debtor from past offenses, not to absolve individuals responsible for those offenses.
• Harmonious Interpretation: The Court interpreted the provisions of the IBC and NI Act harmoniously, ensuring that the objectives of both statutes are met.
• Principle of “Lex Non Cogit Ad Impossibilia”: The Court applied this principle to ensure that the practical difficulties in prosecuting the company under Section 138 of the NI Act after the approval of the resolution plan do not absolve the natural persons from their liability.
• Guarantor’s Liability: The Court drew an analogy with the liability of guarantors, stating that an involuntary act of the principal debtor leading to loss of security would not absolve the guarantor of its liability.
• No Automatic Compounding: The Court clarified that the resolution plan does not automatically compound the offense under Section 138 of the NI Act.

Logical Reasoning:

The Court considered alternative interpretations, such as the argument that the resolution plan extinguishes all liabilities, including those under Section 138 of the NI Act. However, the Court rejected this interpretation, emphasizing that Section 32A of the IBC specifically excludes individuals responsible for the company’s conduct from the protection afforded to the corporate debtor.

The Court’s decision was based on a step-by-step analysis of the legal provisions and precedents, ensuring that the intent of both the NI Act and the IBC are upheld. The final decision was that the directors remain liable under Section 138 of the NI Act.

“We are unable to accept the plea that if proceedings against the company come to an end then the Appellant as the Managing Director cannot be proceeded against.”

“The criminal liability and the fines are built on the principle of not honouring a negotiable instrument, which affects trade. This is apart from the principle of financial liability per se.”

“To say that under a scheme which may be approved, a part amount will be recovered or if there is no scheme a person may stand in a queue to recover debt would absolve the consequences under Section 138 of the N.I. Act, is unacceptable.”

Key Takeaways

• Directors of a company cannot escape liability under Section 138 of the NI Act for cheque dishonor, even if the company’s debt is resolved through an IBC resolution plan.
• The moratorium under Section 14 of the IBC applies only to the corporate debtor and not to the directors.
• Section 32A of the IBC does not protect directors from criminal liability under Section 138 of the NI Act.
• The resolution plan under the IBC does not automatically compound the offense under Section 138 of the NI Act.
• The proceedings under IBC and NI Act are different and do not intercede each other.

This judgment reinforces the principle that individuals responsible for the financial conduct of a company cannot evade their liabilities by taking recourse to the IBC. It also clarifies the interplay between different statutes and ensures that the penal provisions of the NI Act are not undermined by the resolution process under the IBC.

Directions

No specific directions were given by the Supreme Court in this case.

Development of Law

The ratio decidendi of this case is that the directors of a company remain liable under Section 138 of the NI Act, even if the company’s debt is resolved through an IBC resolution plan. This judgment clarifies the interplay between the NI Act and the IBC, reinforcing the directors’ accountability. There is no change in the previous position of law, but it provides further clarity on the liability of directors in cheque bounce cases in the context of IBC resolution plans.

Conclusion

The Supreme Court’s judgment in this case reaffirms the principle that directors cannot evade their criminal liabilities under Section 138 of the NI Act by citing the resolution ofcompany’s debt through the IBC. It underscores the importance of responsible corporate governance and the need for directors to ensure that financial obligations are met. This ruling provides much-needed clarity on the extent of directors’ liabilities in cheque dishonor cases, particularly in the context of IBC resolution plans, and will have a significant impact on corporate behavior and the enforcement of financial obligations.