Liability of the Erstwhile Directors: Section 138, Negotiable Instruments Act versus Insolvency and Bankruptcy Code, 2016

The dishonour of a cheque invites quasi-criminal proceedings under Section 138 of the Negotiable Instruments Act, 1881¹ (NI Act) against the drawee. However, in matters that attract such proceedings against default committed by a corporate person i.e. a company, undergoing insolvency, the law has been made certain and express by the Supreme Court in P. Mohanraj v. Shah Bros. Ispat (P) Ltd.² (P. Mohanraj) whereby it has been stated that proceedings under Section 138 of the NI Act shall be stayed against such accused company as and when the company has entered corporate insolvency resolution process (CIRP) under the Insolvency and Bankruptcy Code, 2016 (IBC, 2016)³ and as per Section 14⁴ IBC, 2016 a moratorium shall come into effect and proceedings shall be stayed.

The IBC, 2016 is still considered a relatively new statute and hence, is in its nascent stage. Thus, the same requires interpretation and clarification on a number of aspects qua continuation of proceedings against the corporate debtor as well as the ex-management of such a debtor.

Corporate insolvency resolution process and the liability of erstwhile director(s) under Section 138 of the NI Act

P. Mohanraj judgment⁵ is landmark in clarifying that the proceedings against the directors and the erstwhile management of the accused company, who are responsible for the affairs of the company and/or, being a signatory to the dishonoured cheque shall continue to be tried under Section 138 of the NI Act complaint. The judgment stated that imposition of moratorium as prescribed under Section 14 IBC, 2016 does not pose an embargo upon continuation of the proceedings against the natural persons mentioned under Section 141 of the NI Act⁶, who shall continue to be statutorily liable under Chapter 17 of the NI Act.

The decision of the Supreme Court in the said judgment⁷ has been reiterated and upheld in pronouncements that have followed. In fact, the Supreme Court in Ajay Kumar Radheyshyam Goenka v. Tourism Finance Corpn. of India Ltd.⁸ (Ajay Kumar Goenka) has clarified the nature of the proceedings under IBC, 2016 and the NI Act⁹ further.

In Ajay Kumar Goenka judgment¹⁰, the Court states that extinguishment of the debt under Section 31¹¹ and/or under Sections 38 to 41¹² IBC, 2016 for the corporate debtor when moratorium comes into effect would not ipso facto mean extinguishment of criminal proceedings against the erstwhile management of the corporate debtor, that is, officials of the corporate debtor, under whose management the defaults have taken place shall not be absolved of their liabilities.

The judgment is distinctive and prominent for the reasons that Pardiwala, J. dissects the nature and legal framework of both IBC, 2016 and the NI Act and further states that in the light of the new management taking control of the corporate debtor post the CIRP, the same would still not result in the extinguishment of the liability and criminal prosecution initiated against the natural persons under Section 138 read with Section 141 of the NI Act.

The Supreme Court has taken a step further and in a recent judgment in Ashok Shewakramani v. State of A.P.¹³ has held that a person cannot be implicated in a cheque bounce case against the company merely on the premise that he was managing the company’s business. Through this judgment, Abhay S. Oka, J. has given a cardinal observation qua Section 141 of the NI Act, that helps understand the officials that are liable to be held responsible for their actions, and the ones who cannot be roped into the proceedings merely because they held the office as key managerial personnel at a certain point:

19. Section 141 is an exception to the normal rule that there cannot be any vicarious liability when it comes to a penal provision. The vicarious liability is attracted when the ingredients of sub-section (1) of Section 141 are satisfied. The section provides that every person who at the time the offence was committed was in charge of and was responsible to the company for the conduct of business of the company, as well as the company shall be deemed to be guilty of the offence under Section 138 of the NI Act.

It is sufficed to say that the Supreme Court has settled on the question that the insolvency of a defaulting company shall not bar the continuation of criminal proceedings against the erstwhile directors under whose management the defaults have been incurred in the name of the company.

Insolvency resolution process of erstwhile directors of the company under Sections 94 and 95 IBC, 2016 versus Section 138 of the NI Act

In an interesting pronouncement from the Bench of Jasmeet Singh, J. of the Delhi High Court, it has been held that a person who has been arrayed as an accused in a criminal proceeding under Section 138 of the NI Act in his capacity as a Managing Director of a company cannot seek shelter under Section 96 IBC, 2016¹⁴.

Under IBC, 2016, Sections 94¹⁵ and 95¹⁶ deal with the insolvency resolution process of the personal guarantor of a corporate debtor. Under Section 94, the insolvency is initiated by the personal guarantor in their own capacity, whereas under Section 95 of the Code, the insolvency is initiated by the financial creditor against the personal guarantor. However, in both scenarios as soon as the application either under Section 94 or Section 95 is filed, an interim moratorium under Section 96 comes into effect from the date of filing of such application by or against the personal guarantor.

The law of interim moratorium under Section 96 IBC, 2016 has been very well dealt with by the High Court of Delhi in Axis Trustees Services Ltd. v. Brij Bhushan Singal¹⁷ wherein it observed that even a bare reading of Section 96 IBC, 2016 makes it clear that the relevant date for the interim moratorium to come into effect is the date “… when an application is filed under Sections 94/95….”

Further, in Vijay Kumar Ghai v. Pritpal Singh Babbar¹⁸, the High Court of Punjab and Haryana held that any legal action or proceedings pending in respect of a debt, as per Section 96 IBC, 2016 covers within itself, proceedings under Section 138 of the NI Act, 1881.

The Supreme Court in Indian Overseas Bank v. RCM Infrastructure Ltd.¹⁹ observed that since moratorium under Section 14 IBC and that under Section 96 IBC are akin in their purpose and legislative intent, an interim moratorium under Section 96 IBC shall interdict any legal action in respect of the debt of the guarantors/mortgagors and shall operate as a stay for the actions initiated prior to application under Section 94 or Section 95 IBC, 2016.

The Supreme Court and various High Courts have made the said provisions of IBC, 2016 explicitly clear and the imposition of the same, however, it is not farfetched to state that the same provisions have been misused by the erstwhile management of the companies under CIRP to circumvent their liabilities and seek a temporary escape from fulfilling the same. As the provisions and the recent interpretations attached to the functioning of Section 96 is quite clear, a number of personal guarantors have run off to NCLT in filing an application under Section 95 and/or Section 94 and using the said application before courts seeking a stay of proceedings initiated against them.

In a recent judgment by the High Court of Delhi titled Sandeep Gupta v. Shri Ram Steel Traders²⁰ the Bench not only recognised the antics of the accused persons attempting to circumvent their liabilities and unnecessarily harass the complainants but gave a cogent and coherent resolution that shall put a halt to the trend of seeking escape by filing of such applications by the management to unnecessarily delay matters and harass innocent complainants.

In Sandeep Gupta judgment²¹, the accused being aggrieved by the order of the trial court dismissing his narrative that as per filing of Section 94 application by him an interim moratorium had come in place and hence, proceedings against the accused could not continue was rejected. Hence, he sought to appeal the same before the Delhi High Court. The Delhi High Court, while relying on the judgments in P. Mohanraj²² and Ajay Kumar Goenka²³ held:

25. In the present case as well, the petitioner is seemingly trying to escape his liability by trying to urge that his application under Section 94 IBC in his individual capacity would stay the complaint under Section 138 of the NI Act against him. It is clear that the petitioner is facing criminal proceedings for being a signatory to the cheque which has been dishonoured. He is covered under natural person under Section 141 of the NI Act.

26. The debt in the present case is not of the petitioner but that of Respondent 2. Section 141 of the NI Act fastens liability on every officer of the company who was in management and control of the affairs of the company.

27. Hence, in my considered view, the provisions of Section 96 IBC would not be applicable in the facts of the present case as the petitioner is arrayed as an accused in the complaint under Section 138 of the NI Act in his capacity of the Managing Director of Respondent 2.

28. It is also clear that Section 138 of the NI Act prescribes a punishment and compensation for the offence that is bouncing of cheque and is not recovery proceeding. Hence under Section 138 of the NI Act the court cannot direct payment of the cheque amount to the complainant but can only award punishment and compensation by way of fine. Thus, what could be dissolved, is only the company, not the personal penal liability of the accused covered under Section 141 of the NI Act i.e. only the corporate debtor (i.e. the company) is protected by the moratorium while the signatories/directors cannot escape from their penal liability under Section 138 of the NI Act by filing personal insolvency proceedings.²⁴

Keeping in view the Sandeep Gupta judgment²⁵, when an accused approaches the NCLT under Section 94 IBC, 2016 qua his personal capacity as a surety in a contract of guarantee for a corporate debtor, the interim moratorium shall come into effect when matters being tried against him relate to debt and default committed in his personal capacity. However, in cases where the person is arrayed as an accused in his capacity as a Director/Managing Director of the Company, such persons shall fall under the category of “natural persons” under Section 141 of the NI Act and hence, are barred from taking shelter under Section 96 IBC, 2016.