Supreme Court quashes criminal proceedings against directors for alleged supply of substandard materials: Sushil Sethi vs. State of Arunachal Pradesh (2020) INSC 79 (31 January 2020)

Date of the Judgment: 31 January 2020
Citation: (2020) INSC 79
Judges: Ashok Bhushan J., M.R. Shah J.

Can directors of a company be held criminally liable for alleged substandard supplies made by their company, even when the company itself is not an accused? The Supreme Court of India addressed this critical question in a recent judgment, providing clarity on the extent of directors’ liability in such cases. This case involves allegations of cheating and criminal conspiracy against the directors of a company that supplied materials for a government project.

The Supreme Court, in this judgment, examined whether the High Court was correct in refusing to quash criminal proceedings against the directors of M/s SPML Infra Limited. The court analyzed the allegations of fraud and conspiracy, and the lack of direct evidence against the directors.

Case Background

M/s SPML Infra Limited, a public limited company, entered into a contract with the Government of Arunachal Pradesh on 18 March 1993 for the construction of the Nurang Hydel Power Project. The project included the supply and commissioning of three power-generating units for approximately Rs. 24.96 crores. The defect liability period for the works was set at 18 months, as per clause 2(c) of the contract. The project was commissioned in July 1996, and the defect liability period expired in January 1998.

The project became operational and generated 90 lakh KW units by 20 September 1998. Disputes arose regarding the payment of maintenance by the government. On 9 March 2000, the company issued a notice to the government to take over the project by 31 March 2000, due to non-payment of maintenance.

Following this notice, the government lodged a complaint against the company and its directors, alleging that the company had supplied inferior quality materials, specifically runner turbines, in contravention of the contract. The complaint stated that the turbines did not meet the required specifications for nickel and chromium content.

During a physical inspection, it was found that the turbine runners were cracked and damaged. A report from the National Test House, Calcutta, indicated that the chemical composition of the broken runner contained 5.28% Nickel and 7.5% Chromium, which was not in accordance with the agreement. Consequently, an FIR was registered.

The investigation revealed irregularities in awarding the contract at a higher price and found some officials responsible for neglect of duties. A final report/chargesheet was filed on 28 May 2004, against the appellants and others for offences under Section 120B and 420 of the Indian Penal Code (IPC).

The appellants, the Managing Director and Director of M/s SPML Infra Limited, claimed they were unaware of the FIR and chargesheet until 2017. They then filed a petition before the High Court to quash the criminal proceedings under Section 482 of the Criminal Procedure Code (Cr.P.C.). The High Court refused to quash the proceedings, leading to this appeal before the Supreme Court.

Timeline

Course of Proceedings

The appellants, upon becoming aware of the FIR and chargesheet in 2017, filed a petition before the High Court of Gauhati at Itanagar under Section 482 of the Criminal Procedure Code (Cr.P.C.) seeking to quash the criminal proceedings. They argued that the dispute was purely civil and contractual, and was being given a criminal color with mala fide intentions. They also contended that the company, M/s SPML Infra Limited, was not arrayed as an accused, and there were no allegations that the appellants were in charge of the company’s affairs.

The High Court dismissed the petition, observing that there were allegations against not only the appellants but also against connected company executives and government engineers, and that there were allegations of criminal conspiracy. The High Court also noted that the other co-accused had not filed similar petitions and that it was not possible to segregate the case qua the appellants only at that stage.

Legal Framework

The case primarily revolves around Section 420 of the Indian Penal Code (IPC), which deals with cheating and dishonestly inducing delivery of property, and Section 120B of the IPC, which addresses criminal conspiracy.

Section 420 of the Indian Penal Code (IPC) states:

“Cheating and dishonestly inducing delivery of property.—Whoever cheats and thereby dishonestly induces the person deceived to deliver any property to any person, or to make, alter or destroy the whole or any part of a valuable security, or anything which is signed or sealed, and which is capable of being converted into a valuable security, shall be punished with imprisonment of either description for a term which may extend to seven years, and shall also be liable to fine.”

Section 120B of the Indian Penal Code (IPC) states:

“(1) Whoever is a party to a criminal conspiracy to commit an offence punishable with death, imprisonment for life or rigorous imprisonment for a term of two years or upwards, shall, where no express provision is made in this Code for the punishment of such a conspiracy, be punished in the same manner as if he had abetted such offence.
(2) Whoever is a party to a criminal conspiracy other than a criminal conspiracy to commit an offence punishable as aforesaid shall be punished with imprisonment of either description for a term not exceeding six months, or with fine or with both.”

The Supreme Court also considered Section 482 of the Criminal Procedure Code (Cr.P.C.), which grants the High Court inherent powers to prevent abuse of the process of any court or to secure the ends of justice.

The Court examined the interplay of these provisions in the context of the allegations against the appellants.

Arguments

Appellants’ Submissions:

• The High Court erred in not quashing the criminal proceedings under Section 482 Cr.P.C. The case is a civil dispute disguised as a criminal case.
• The allegations in the FIR, even if taken at face value, do not disclose a prima facie commission of an offence under Section 420 of the IPC.
• There is no evidence of fraudulent or dishonest intention from the start of the transaction. The FIR alleges supply of inferior materials, but does not suggest any fraudulent intent.
• The defect liability period had expired before the complaint was filed. The company continued maintenance work, and the project was operational.
• The FIR was filed with mala fide intentions after the company demanded payment for maintenance.
• Disputes between the parties were pending before arbitrators.
• The company, M/s SPML Infra Limited, was not arrayed as an accused. The directors cannot be held vicariously liable without the company being a party.
• There are no allegations that the appellants were in charge of the company’s affairs to establish vicarious liability.
• The company replaced the defective turbines even after the defect liability period had expired, indicating no intention to cheat.
• The company was only responsible for procuring the turbines, not manufacturing them. They relied on the manufacturer’s certificate.
• The chargesheet went beyond the allegations in the FIR, and the police investigated the commercial efficacy of the project.
• The company was the lowest bidder and awarded the contract after due deliberation.

Respondents’ Submissions:

• The High Court rightly refused to quash the criminal proceedings, as there was a prima facie case for the offence under Section 420 IPC.
• The appellants supplied substandard runner turbines, which were not in conformity with the specified standards.
• There was a criminal conspiracy between the accused to cheat the government.
• The arbitration proceedings have nothing to do with the criminal dispute.
• A proceeding can have both civil and criminal aspects.
• Kartik Steel Limited, Chennai, tested the components and found them substandard, showing the appellants had prior knowledge of the low quality of the materials.
• The appellants charged exorbitant rates for the turbines, despite knowing they were substandard. The cost as per the manufacturing company was Rs. 1,61,04,000/-, while M/s SPML Infra Limited charged Rs. 5,18,50,049/-.
• The supply of substandard material at three times higher rates shows criminal intent.
• The appellants, as Managing Director and Director, were in charge of the company and vicariously liable.
• The submissions made by the appellants are their defenses, which should be considered during the trial.

Submissions Table

Issues Framed by the Supreme Court

The primary issue before the Supreme Court was:

1. Whether a case has been made out to quash the FIR and the chargesheet against the appellants for the offences under Section 420 read with Section 120B of the IPC, in exercise of powers under Section 482 Cr.P.C.?

Treatment of the Issue by the Court

The following table demonstrates as to how the Court decided the issues

Authorities

The Supreme Court considered the following authorities:

Judgment

The Supreme Court allowed the appeal, setting aside the High Court’s judgment. The criminal proceedings against the appellants were quashed, but the proceedings against other accused were to continue.

How each submission made by the Parties was treated by the Court?

How each authority was viewed by the Court?

The Court relied heavily on the principles laid down in State of Haryana v. Bhajan Lal [1992 Supp. (1) SCC 335]* to determine when inherent powers under Section 482 Cr.P.C. can be exercised to quash criminal proceedings. The Court also used Hira Lal Hari Lal Bhagwati v. CBI, New Delhi [(2003) 5 SCC 257]* and Vesa Holdings Private Limited v. State of Kerala and others [(2015) 8 SCC 293]* to highlight that for cheating, there must be a dishonest intention from the beginning. The court also relied on Sharad Kumar Sanghi v. Sangita Rane [(2015) 12 SCC 781]* to emphasize that criminal proceedings against a Managing Director or officer are not maintainable if the company is not an accused and there are no specific allegations of vicarious liability. The Court distinguished the facts of the present case from those in Sau. Kamal Shivaji Pokarnekar v. The State of Maharashtra and others [2019 SCC Online SC 182]* cited by the respondents, and held that the facts were not applicable to the present case.

What weighed in the mind of the Court?

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

• Lack of Fraudulent Intent: The court emphasized that for an offense of cheating under Section 420 of the IPC, there must be a fraudulent or dishonest intention from the very beginning of the transaction. In this case, there were no specific allegations or evidence to suggest that the appellants had any such intention at the time the contract was entered into. The court noted that the company had even replaced the defective turbines, which was contrary to the intention of cheating.
• Absence of Company as an Accused: The court highlighted that the main allegations were against the company, M/s SPML Infra Limited, which was not made a party to the criminal proceedings. The court reiterated that without the company being an accused, the directors could not be held vicariously liable, especially when there were no specific allegations against them.
• No Specific Allegations of Vicarious Liability: The court pointed out that there were no specific allegations or averments in the FIR or chargesheet that the appellants, as Managing Director and Director, were in charge of the administration and management of the company. Without these specific allegations, vicarious liability could not be established.
• Civil Dispute Given Criminal Color: The court observed that the case appeared to be a civil dispute being given a criminal color, particularly noting that the FIR was filed after the company demanded payment for maintenance.
• Delay in Proceedings: The court noted that although the FIR was filed in 2000 and the chargesheet in 2004, the appellants were only served summons in 2017, indicating a significant delay in the proceedings.

Sentiment Analysis of Reasons Given by the Supreme Court

Fact:Law Ratio

Logical Reasoning

The court considered alternative interpretations, particularly the respondents’ argument that a prima facie case of cheating was made out. However, the court rejected this argument because of the lack of evidence of dishonest intent from the beginning, and the absence of the company as an accused. The court also considered the delay in the proceedings and the fact that the case appeared to be a civil dispute given a criminal color.

The court’s decision to quash the criminal proceedings was based on the finding that no prima facie case for the offense under Section 420 of the IPC was made out. The court emphasized that the prosecution failed to establish the necessary elements of cheating, particularly the fraudulent intent from the beginning of the transaction.

The court highlighted that the company had replaced the defective turbines, indicating a lack of intent to cheat. The court also noted that the company was not made an accused, and there were no specific allegations to establish vicarious liability of the directors.

The court stated, “From a bare reading of the FIR and even the chargesheet, there are no allegations that there was a fraudulent and dishonest intention to cheat the government from the very beginning of the transaction.”

The court also noted, “Even there are no specific allegations and averments in the FIR/chargesheet that the appellants were in-charge of administration and management of the company and thereby vicariously liable.”

The court further stated, “If the intention of the company/appellants was to cheat the Government of Arunachal Pradesh, they would not have replaced the turbines which were found to be defective.”

There were no dissenting opinions in this case.

Key Takeaways

• Fraudulent Intent is Crucial: To establish cheating under Section 420 IPC, a fraudulent or dishonest intention from the very beginning of the transaction is essential.
• Company as an Accused: Criminal proceedings against directors for company actions may not be maintainable if the company itself is not an accused.
• Vicarious Liability: Specific allegations are necessary to establish vicarious liability of directors for company actions.
• Civil Disputes: Civil disputes should not be given a criminal color without proper evidence of criminal intent.
• Inherent Powers of High Court: High Courts have inherent powers under Section 482 Cr.P.C. to prevent abuse of process and secure the ends of justice.

This judgment clarifies that directors cannot be automatically held criminally liable for company actions. It emphasizes the need for specific allegations and evidence of fraudulent intent. This ruling could have a significant impact on cases involving corporate liability, particularly where there is a lack of direct evidence against the directors.

Directions

The Supreme Court quashed the criminal proceedings against the appellants but clarified that the proceedings against other accused would continue.

Development of Law

The ratio decidendi of this case is that for an offense of cheating under Section 420 of the Indian Penal Code (IPC), a fraudulent or dishonest intention from the very beginning of the transaction is essential. Further, criminal proceedings against directors for company actions are not maintainable if the company is not an accused and there are no specific allegations to establish vicarious liability. This case reinforces the principle that civil disputes should not be given a criminal color and clarifies the limitations of vicarious liability in corporate criminal cases. There is no change in the previous position of law, but it reinforces the existing principles and provides clarity on their application in cases of corporate criminal liability.

Conclusion

The Supreme Court’s decision in Sushil Sethi vs. State of Arunachal Pradesh provides a significant clarification on the criminal liability of directors in cases involving alleged substandard supplies by their company. By emphasizing the need for evidence of fraudulent intent from the beginning of the transaction and the necessity of making the company an accused, the court has set a precedent that protects directors from undue harassment in cases where the company is primarily at fault. This ruling underscores the importance of distinguishing between civil disputes and criminal offenses and ensures that criminal proceedings are not used as a tool for settling commercial disputes.