MANAGING BUSINESS LEGALLY

BY

PRAVEEN DALAL*

 The aim of this article is to clarify the legal position regarding the liability of the companies for the violation of provisions of Information technology Act, 2000. A special mention of the requirement of “due diligence” has been made, so that the misty dogma surrounding it can be cleared and explained.

 I. Introduction

 Every business is conducted either single handedly or in association with other persons. The benefits of managing business in group and associations are numerous and hence it is a common and most desirable form of doing business. The Companies Act, 1956 provides that the expression “company” means a company formed and registered under the Act[1]. It is, however, not essential that all “associations” must be registered under the Companies Act. These associations, however, cannot have unlimited number of members if they do not get themselves registered under the Companies Act. Section 11(2) of the Companies Act provides that no company, association or partnership, consisting of more than twenty persons[2] in general and ten in case of “banking business”, shall be formed for the purpose of carrying on any business that has for its objects the acquisition of gain for itself or for its members unless it is registered as a company under the Companies Act or is formed in pursuance of some other Indian law. If it is not so registered, it becomes an “illegal association”. Thus, a group of individuals working together must be either a company registered under the Companies Act, or a “partnership firm” or other “association of persons”, which may be a legal or illegal association, depending upon the number of members constituting it.

If the group has acquired a status of company, whether public or private, then it has certain privileges and advantages, which are not available to partnership firms and other associations. On incorporation, the company acquires a separate legal entity distinct from and independent of its members. Unlike a partnership firm, which has no separate legal entity, a company has a separate corporate existence. Since a company has a separate legal entity, a shareholder can be the Director, creditor of the company, office bearer of the trade union, etc all at the same time. A shareholder cannot be held personally liable for the acts of omission and commission of the company, even though he holds almost the entire share capital of the company. This is because when a company is incorporated, all dealings are with the company and all persons behind the company are disregarded, however important they may be. Thus, a veil is drawn between the company and its members. Normally, the principle of corporate personality of a company is respected in most cases.

The separate personality of the company is, however, a statutory privilege; it must be used for legal and legitimate business purposes only. Where a fraudulent, dishonest or improper use is made of the legal entity, the concerned individual will not be allowed to take shelter behind the corporate personality. The court will break through the corporate shell and apply the principle of “Lifting of the corporate veil”. The court will look behind the corporate entity and take action as though no entity separate from the members existed.

In other words, the benefit of separate legal entity will not be available and the court will presume the absence of such separate existence. This will make the persons concerned vulnerable to the judicial scrutiny and they will be personally liable for their acts. The protection of separate legal existence of the company will not save them from various civil as well as criminal sanctions. The Companies Act, 1956 contains certain provisions[3], which empower the courts to lift the veil to reach the persons who are in fact responsible for the culpable or wrongful act. The corporate veil can be lifted in the following cases:

(1) Where the doctrine conflicts with the Public policy,

(2) Where corporate veil has been used for fraud or improper conduct,

(3) Where the corporate facade is only an agency instrumentality,

(4) For determining the real character of the company,

(5) Where the veil has been used for evasion of taxes,

(6) In quasi-criminal cases,

(7) For investigating the ownership of the company,

(8) For investigating the affairs of the company[4],

(9) Where the company is used as a medium to avoid various welfare and labour legislations,

(10) In case of economic offences,

(11) Where the company is used for some illegal and improper purpose, etc[5].

 II. Accountability and reasonableness mandates

 The accountability and reasonableness requirements are safeguarded by affixing liability of the companies under almost all the statues that are enacted from time to time. It is ensured by incorporating a provision in the respective statue making the company liable for the wrong for which general public has also been made liable.

For instance, under the environmental laws, taxation laws, etc the companies are also made liable for the respective wrong committed under these statutes. An interesting aspect of these provisions is that the language used in these statutes is virtually similar in all of them. This is a normal and well- acceptable practice, which is uniformly followed by the “legislature”.

The degree of reasonableness and accountability is same in all these statues and hence while interpreting the provisions of a particular statute, support and aid can be taken of the judicial precedents given under other statutes.

For instance, Section 85(1) of the Information Technology Act (ITA), 2000 provides that where a person committing a contravention of any of the provisions of this Act or of any rule, direction or order made thereunder is a Company, every person who, at the time the contravention 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 guilty of the contravention and shall be liable to be proceeded against and punished accordingly.

The proviso to section 85 (1) provides that such person will not be liable for punishment if he proves that the contravention took place without his knowledge or that he exercised all due diligence to prevent such contravention.

Section 85(2) provides that where a contravention of any of the provisions of this Act or of any rule, direction or order made thereunder has been committed by a company and it is proved that the contravention has taken place with the consent or connivance of, or is attributable to any neglect on the part of, any director, manager, secretary or other officer of the company, such director, manager, secretary or other officer shall also be deemed to be guilty of the contravention and shall be liable to be proceeded against and punished accordingly.

The explanation to section 85 provides that the expressions “company” means any body corporate and includes a firm or other association of individuals and the expression "director", in relation to a firm, means a partner in the firm.

The language of the section is not alien to our legal system and it is surprising that a lot of hue and cry has been raised recently regarding the “due diligence” requirement. It is strange that people are demanding to take aid of the American System, whereas the matter has authoritatively and conclusively decided by the Supreme Court in various cases that arose under different statutes.

The accountability, reasonableness and due diligence requirement are incorporated in all the statutes so that the Fundamental and other rights of the people are safeguarded in their widest and truest perspectives. It is established that Fundamental Rights themselves have no fixed content; most of them are empty vessels into which each generation must pour its contents in the light of its experience. The attempt of the court should be to expand the reach and ambit of the Fundamental Rights by process of judicial interpretation. There cannot be any distinction between the Fundamental Rights mentioned in Chapter III of the Constitution and the declaration of such Rights on the basis of the judgments rendered by the Supreme Court[6]. Thus, horizons of Constitutional law are expanding. The Supreme Court in its truest perspective has appreciated this felt necessity by extending the scope of Article 12 and making both public and private persons[7] responsible for the violation of various Fundamental Rights.

There is, however, an emergent need to “expressly declare” that private persons can also be held liable for violating the Fundamental Rights of others. The need for the declaration of private persons as State is immediate and compulsive in nature. This has arisen due to globalisation, privatisation and decentralization. The traditional “welfare state functions” have now slipped into the hands of private individuals due to this phenomenon. The crucial “public interest” has also been transferred to these private persons as far as the transferred business is concerned. This is, however, not the end of the story. The duties and limitations by which the traditional State was bound are also, with necessary modifications, passed to the private persons. These duties and limitations, though not as stringent and rigorous as were meant for traditional State, are still in existence and are required to be followed by the “successors” of those welfare state functions.

 It is no doubt true that private individuals cannot be expected to play the role of “parents or guardians” of the nation, but certain minimum fair and reasonable obligations, commensurate with the basic Human Rights, Fundamental Rights and Constitutional Rights, have to be met reasonably. The welfare state requirements mandate that if the power and essential functions of a state are decentralized or delegated to private persons, they retain their mandates of welfare requirements, though in a modified form. For instance, if a public company, performing crucial public functions, is privatized, then the successors are required to act justly, fairly and reasonably.  An arbitrary, unreasonable or oppressive act of a “privatized public company” should be equally vulnerable to the challenges of unconstitutionality.

Thus, the changed socio-economic conditions of India require a different outlook and this makes the declaration inevitable and essential[8]. In the landmark judgment of Kapila Hingorani v State of Bihar[9] the Apex Court analysed the rights and liabilities of a company vis-à-vis the Fundamental rights and Human Rights of the individuals. The Court observed: “A company incorporated under the Companies Act is a juristic person and has a distinct and separate entity vis-à-vis its shareholders. The corporate veil, however, can in certain situations be pierced or lifted. Whenever a corporate entity is abused for an unjust and inequitable purpose, the court would not hesitate to lift the veil and look into the realities so as to identify the persons who are guilty and liable thereof. The veil can indisputably be lifted when the corporate personality is found to be opposed to justice, convenience and interest of the revenue or workman or against public interest”.

Thus, it is clear that corporate façade cannot provide a “blanket protection” from the liabilities arising under various statutes, including the Information Technology Act, 2000.

 III. The concept of due diligence

 The law expects every person to act fairly, reasonably and diligently. That is why deviations from these standards are made punishable by the law. One cannot in the zeal of earning profit or in the sense of indifference take the law casually. There are certain well-recognised cardinal principles of criminal laws, which need to be discussed before proceeding further. These are: 

(1) The ignorance of law is no excuse,

(2) The “presumption of innocence” continues until the guilt of the accused is proved,

(3) The guilt of the accused must be proved “beyond reasonable doubt”,

(4) No person is guilty of an offence unless it is accompanied by both an act/ omission and the guilty intention for the same,

(5) The law may presume the guilty intention if the commission of the act is proved. This is known as “strict liability offences”, and

(6) The law may fix the liability of certain individuals on a “notional basis”.

This usually happens where a company is involved in the commission of an offence or wrong. The imputation of criminal liability to certain “natural persons” is logical because a company, being an artificial person, cannot operate automatically. Thus, to conduct the affairs of the company certain natural persons are required, who alone can be saddled with the liability of the wrongs committed by the company.

It requires common sense to understand that a company, being a non-living entity, cannot commit any wrong and in the ultimate analysis some natural person is responsible for the wrong. That is why the liability can be fixed upon a living person only.

As a corollary, only that person can be held liable for the wrong who was responsible for the conduct of the business at the time when the wrong was committed. This practice has the support of logic and common sense because the supreme authority, on whose orders and directions the company is bound to act, can safely be presumed to have the “express” as well as the “constructive knowledge” of the wrong committed by the company.

He cannot escape his liability by merely “pleading’ either ignorance of the law or ignorance of the “factum of the wrong”. If the supreme authority was in charge of the day-to-day affairs of the company at the relevant time and the commission of the wrongful act was within his powers, competence, authority and reach, then the law can safely presume that its commission had a backing of that authority.

This is, however, a rebuttable presumption that can be rebutted at the trial stage. Till then the law will consider the authority as the responsible person. This approach also seems to be just and fair because if the supreme authority cannot prevent the commission of the wrong then none can prevent such wrong. It would be wrong to presume that a subordinate staff can take decisions in the active presence and participation of the supreme authority. In fact, when the matter pertains to involvement of government departments/institutions, then the “head of the department/institution” is held liable for the wrong. Thus, there cannot be any “preferential treatment” in favour of private person as the same may violate the provisions of Article 14, 19 and 21 of the Constitution of India.

Similarly, when the wrongful act was committed with the consent or connivance of, or is attributable to any neglect on the part of, the supreme authority, who was responsible for the day to day functioning of the company, such authority shall also be deemed to be guilty of the contravention and shall be liable to be proceeded against and punished accordingly.

The companies, generally appoint and declare, a particular individual as the “Principal officer” or “Officer in default”, who alone is responsible for the compliance of certain rules, regulations and laws. If any contravention occurs, then such officer in default is responsible for the same. Such officer in default can escape his liability if he proves that the contravention happened without his knowledge or that he had taken all reasonable precautions for the prevention of the same.

There may be a situation where the officer in default may be forced to take actions, which are in contravention of the law, by the supreme authority. In that situation, the primary liability of the contravention will be that of the supreme authority, though the officer in default will also be liable. The court may, while awarding the punishment, consider this fact and may grant a lesser punishment. But in no case he is exonerated from the liability. Thus, the officer in default must take the mandates of law very seriously. The officer in default must restrain from being a part of such contravention and must take a safer recourse. In such a situation he can claim that he took all reasonable precautions to prevent the commission of the contravention. Another example where the defence of “preventive precaution” is where despite the best tangible efforts on the part of the officer in default, the commission of the contravention could not be prevented. In that situation the company is exonerated from the liability as it has exercised all ‘Due Diligence” for the prevention of the commission of the contravention.  

IV. Conclusion

 The law have conferred and assigned a special status to the companies, which is not available to other forms of associations. It expects the companies to contribute for the growth and development of the nation. The companies are expected to perform their “Social responsibilities” so that people can enjoy a qualitative life. The role of the companies is so important that we can see provisions touching and regulating their functioning in almost all the spheres of   life. This is particularly so in a country like India which is a “Welfare State” by nature. The State formulates various laws and regulations keeping in mind its welfare state role. Thus, a balance has been maintained between social responsibilities of the company on the one hand and conferment of absolute autonomy and freedom from interference upon the company on the other. The formation of a company has its own merits. In the present scenario companies play a very important role in the growth and development of the nation. Thus, they should be encouraged and motivated to contribute more. This can be achieved by providing them additional benefits, concessions and privileges. Their functioning and operations should not be made complicated by forcing them to comply with unnecessary and technical formalities. In fact, the various technical and procedural formalities governing them should be made more liberal and simplified so that the “corporate governance” can become a real and effective governing force.                      

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