Liabilities of Directors and Shareholders when a Company Defaults in India

August 5, 2016 Posted by India Briefing Reading Time: 5 minutes

The article discusses the extent of liabilities faced by directors and shareholders in event that a company defaults on its loans. Further, it details the manner by which a ‘wilful defaulter’ is recognized by the Reserve Bank of India (RBI).

The Company as a Separate Legal Entity

If a company is unable to repay a loan, both the directors and shareholders cannot be held liable. The company is solely liable to repay the loan. This is because a company is a separate legal entity and is distinct from its shareholders and directors, as has been repeatedly upheld by the Supreme Court of India. In the eyes of the law, a company registered under the Companies Act is a legal entity, separate, and distinct from its individual members or those that hold its shares. Therefore, the property of the company is not the property of its shareholders. A shareholder merely has an interest in the company – arising under its Articles of Association, measured by a sum of money for the purpose of liability, and by a share in the distributed profit.

With regards to the liability of directors, the Supreme Court has held that a director of a company or an employee cannot be held to be vicariously liable for any offence committed by the company itself.

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Who is a Wilful Defaulter?

In July 2014, the RBI released a master circular on wilful defaulters. The “Circular” details who and under what circumstances an entity can be labeled as a wilful defaulter.

Any individual, juristic person, and business enterprise, whether incorporated or not, can be said to be a wilful defaulter, if any of the following is observed –

The unit has defaulted in meeting its payment / repayment obligations to the lender even when it has the capacity to honor said obligations.
The unit has defaulted in meeting its payment / repayment obligations to the lender, and has not utilized the finance from the lender for the specific purposes for which the finance was availed but rather has diverted the funds for other purposes.
The unit has defaulted in meeting its payment / repayment obligations to the lender and has siphoned off the funds so that the funds have not been utilized for the specific purpose for which finance was availed, nor are the funds available with the unit in the form of other assets.
The unit has defaulted in meeting its payment / repayment obligations to the lender and has also disposed off or removed the movable fixed assets or immovable property given by him or it for the purpose of securing a term loan without the knowledge of the bank / lender.

As per the Circular, a wilful defaulter should be debarred from any new funding from banks and financial institutions for existing businesses and also for floating new ventures for a period of five years. The banks must ensure that the defaulting directors are removed from the board of the companies and that they are not inducted in the board of any company in future. According to the RBI, the defaulters will be prevented from accessing the capital market and a copy of the list of wilful defaulters (non-suit filed accounts) and list of wilful defaulters (suit filed accounts) shall be forwarded to the Securities and Exchange Board of India (SEBI) by the RBI and Credit Information Bureau respectively.

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Role of Directors under the Companies Act, 2013

The board of directors as an institution plays a prominent role in corporate governance. It is responsible for directing and overseeing the business and management of the company. Given this pivotal role of the board, directors are considered as fiduciaries in that they are required to act in the interest of various constituencies in a company, such as shareholders and other stakeholders.

Being fiduciaries, directors are exposed to liabilities as a consequence of a breach of their duties. While liabilities may arise under various statutes, the focus here is on liabilities arising under company law. The first set of liabilities is statutory in nature, being specifically set forth in the 2013 Companies Act. These could be either civil liability (requiring directors to make payments to victims or the state) or criminal liability (resulting in fines or imprisonment).

Conclusion

It can be concluded from this discussion that a director will not be liable for the loan personally because of the fact that a Company is a separate legal entity from its Directors and Shareholders. There might be a possibility that the company’s assets may be attached to pay off the loan. In such an event, even a shareholder will not be held liable, unless he is holding some shares for which the amount is unpaid.

The parent company and its directors shall not be held liable in the event of default on repayment of loan by the subsidiary company. The parent company will only be held liable for repayment of loan if it has given a guarantee towards the loan.

However, the director(s) of the borrowing company shall be deemed to be a wilful defaulter if they fulfil any of the conditions stated earlier in this article.

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