Minimum number of directors - Company's obligation and consequences

Outline and Objective

• Legal provisions under the Companies Act, 2013 and erstwhile Companies Act 1956
• Number of directors falls below the minimum strength and below the minimum quorum requirement prescribed under the Act and Articles of the Company
• Number of directors falls below the minimum strength prescribed under the Act and Articles of the Company but not below the minimum quorum requirement
• Contradiction between Legal requirement under Companies Act and the Secretarial Standards issued by the Institute of Company Secretary of India
• Consequences of the improper constitution of the Board
• Time limit for filing the vacancy in the Board below the minimum strength fix under the Act and Articles of the Company
• Effect on third parties of the decisions made by the improperly constituted Board of the Company

Background

The Report of the Expert Committee on Company Law observed that the Board of Directors("Board") of a company is central to its decision making and governance process. Board's ability to ensure compliance with the law underpins the corporate governance structure in a company, the aspirations of the promoters, and the rights of stakeholders. There should be an obligation on the part of a company to constitute and maintain a Board as per the provisions of the law and to disclose particulars of the directors so appointed in the public domain through the statutory filing of information.

The Committee advised that law should provide for a minimum number of directors necessary for various classes of companies and observed that new kinds of companies will evolve and to keep pace with emerging business requirements, the law should therefore include an enabling provision to prescribe specific categories of companies for which a different minimum number may be laid down. The obligation of maintaining the required minimum number of directors on the Board should be that of the Company.

Under the English Company law, directors occupy a pivotal position in the structure of incorporated companies, so also under Indian Law. The Company Law Committee in India has emphasized as far back as in 1952, that the Board had to confine themselves to matters of general business policy and overall supervision of management and to leave the day-to-day conduct of business in the hands of executives and salaried technical and administrative officers. With the rapid growth in the size of corporate units and the growing technical and managerial complexities of business, the character of corporate management has also rapidly changed over the past few years.

In this article, we will try to dissect the provisions with respect to the obligation of a public company to have a minimum number of directors and the consequences of the strength falling below the minimum prescribed requirement.

Let us review the legal provisions pertaining to the minimum number of Directors under the Companies Act, 2013("the Act") and the erstwhile act of 1956:

Upon comparison of the provisions of the present and erstwhile Act, we can conclude that there are no changes with respect to the requirement of the minimum number of directors and quorum under the provisions of the Act and the Articles of Association under Table A and Table F of the Schedule-1 of the Act ("Articles").

Let us now have a look at the provisions provided under Secretarial Standard -1 on Board Meetings issued by the Institute of Companies Secretaries of India ("SS-1").

Number of directors falls below the minimum strength and below the minimum quorum requirement prescribed under the Act and Articles of the Company

In terms of the provisions of Section 174(2) of the Act and Article 69 of Table- F of the Schedule - I of the Act,if due to death, resignation or otherwise, the strength of the directors of a company falls below the minimum required directors and below the minimum quorum requirement prescribed under the Act and articles of the Company, there will be a casual vacancy in the Board of the Company, powers of its directors will get restricted and remaining directors or director can act only for the purpose of increasing the number of directors to that fixed for the quorum or for summoning a general meeting of the Company and not for any other purpose.

This sub-section postulates that in the event that the number of directors falls below the prescribed quorum requirement, the existing directors will be allowed to act only for the limited purpose of increasing the numbers of directors to a level that is necessary to constitute a quorum. Alternatively, they may seek to convene a general meeting of the members to appoint new directors so that the minimum quorum of directors could be formed through the appointment of new directors. The above sub section is exactly identical to Article 69 of Table- F Schedule - I of the Act.

Even clause 3.4.2 of SS-1presents the same view and concurs with the aforesaid.

Let's discuss and understand the aforesaid with an example:

In the Company (XYZ Limited) there were three directors (A, B, and C).

article 60 and 69 of the Articles of the Company are identical to the Articles 60 and 69 of Table- F of the Schedule - I of the Act.

Case 1:  A and B ceased to be a director of XYZ Limited

In the current scenario, C can act only for the purpose of increasing the number of directors of the Company to that fixed for the quorum by co-opting the directors as additional directors in accordance with the provisions of Section 160 of the Act or for summoning a general meeting of the Company and not for any other purpose.

The fact that a single director can be a quorum for the meeting of the Board for the purpose of increasing the number of directors to that fixed for quorum when the number of directors has fallen below the requisite quorum has been examined numerous times by the Courts and upheld. [Ananthalakshmi Ammal (A.) v. Indian Trades and Investments Ltd., Shailesh Harilal Shah and Others vs Matushree Textiles Ltd. and Other.]

Case 2: A, B, and C ceased to be the director of XYZ Limited

In the present scenario Section 167(3) of the Act can be referred to which provides that where all the directors of a company vacate their offices, the promoter or, in his absence, the Central Government shall appoint the required number of directors who shall hold office till the directors are appointed by the company in the general meeting.

To address the practical difficulties with respect to the filing of appointment forms theMinistry of Corporate Affairs of India vide General Circular No. 3/2015 dated 3rd March 2015 had issued a clarification wherein the Registrar of the Companies may allow any one of the earlier director (who was an authorized signatory of the Company) to file the e-forms subject to the compliance of other provisions of the Act.

Number of directors falls below the minimum strength prescribed under the Act and Articles of the Company but not below the minimum quorum requirement

In terms of Section 174(2) of the Act and Article 69 of Table- F of the Schedule - I of the Act, if due to death, resignation, or otherwise, the strength of the directors of the Company falls below the minimum required directors prescribed by the Act or by the Articles of the Company, there will be a casual vacancy in the Board. However, the continuing directors may act notwithstanding any vacancy in the Board and as long as or provided that their number is such that it does not fall below the requirement of a minimum quorum.

Clause 3.4.2 of SS-1along with the guidance note on the same presents contrary views and requires that where the number of directors is reduced below the minimum limit fixed by the Articles and even if the requisite number of Directors to form a Quorum as per the Act is present, no business shall be transacted unless the number is first made up by the remaining directors or through a General Meeting.

Let's discuss and understand the aforesaid with an example:

In the Company (XYZ Limited) there were three directors, since inception, A, B, and C.

Case 1: A ceased to be a director of the Company and the Articlerequires Company to have a minimum of three directors and Article 69 is identical to Article 69 of Table- F of the Schedule - I of the Act.

In the current scenario, the Board which was originally competent to transact businesses was diminished to a number less than that required by the Act or the Articles of the Company but the number of remaining directors was sufficient to form a quorum of the meeting of the Board. As per the provisions of the Act, the continuing directors may act notwithstanding any vacancy in the Board as their number is such that it does not fall below the requirement of a minimum quorum.

The question that continuing directors who satisfy the requirements prescribed for the quorum are competent to transact the business of the Company has been examined by the Courts various times and upheld. [Shailesh Harilal Shah and Others vs Matushree Textiles Ltd. And Other and Shailesh Harilal Shah and Others vs Matushree Textiles Ltd. And Other.]

Case 2: A ceased to be a director of the Company and the Articlerequires the Company to have a minimum of four directors and Article 69 is identical to Article 69 of Table- F of the Schedule - I of the Act.

In the current scenario, there is a vacancy in the composition of the Board from the beginning as the Articlerequires the Company to have a minimum of 4 directors and now with the cessation of A, the number is reduced to 2 directors; however, this reduced number is sufficient to form a quorum as required under Act and the Articles. As per the provisions of the Act, the continuing directors may act notwithstanding any vacancy in the Board as their number is such that it does not fall below the requirement of a minimum quorum.

The question of whether continuing directors could transact the business of the Company where the number of directors in Board is insufficient from the inception has been examined by the Courts and held that continuing clause will be applicable only when there was a Board originally competent to transact and not otherwise. [Sly Spink & Co. In Re. (1911) 2 Ch. 430]

The contradiction between Legal requirement under the Companies Act and the Secretarial Standards issued by the Institute of Company Secretary of India

SS-1 provides that where the number of directors is reduced below the minimum strength fixed by the Articles, no business shall be transacted unless the number is first made up by the remaining director(s) or through a General Meeting, even if the requisite number of Directors to form a quorum as per the Act is present.

Section 174(2) and Article 69 of Table A of Schedule -1 of the Act are divided into two parts:

The first part provides that the continuing directors may act notwithstanding any vacancy in the Board, which is an unrestricted power and the second part places the restriction on the powers of the continuing directors to act only for the limited purpose of increasing the number of directors to that fixed for the quorum or for summoning a general meeting of the Company and for no other purpose, if and so long as their number reduced below the quorum.

The restriction on the power of the Board is placed under the second part if their number is reduced below the minimum fixed for quorum and till the time number is not made up to that fixed for a quorum, once that impediment is amputated, the continuing directors may act without any restriction, even if the strength of the Board is less than the minimum number of required directors.

If the construction/ interpretation of the Section 174(2) and Article 69 of Table A of Schedule -1 of the Act as put by SS-1 accepted that no business shall be transacted unless the number is first made up by the remaining Director(s) or through a General Meeting, it shall rendered the words "so long as" as surplusage and redundant, which I believe is not the intent of Act.

An important rule of interpretation is that a provision of a statute should have to be read as it is, in a natural manner, plain and straight, without adding, substituting or omitting any words. While doing so, the words used in the provision should be assigned and ascribed their natural, ordinary or popular meaning. Only when such plain and straight reading, or ascribing the natural and normal meaning to the words on such reading, leads to ambiguity, vagueness, uncertainty, or absurdity which were not obviously intended by the Legislature or the Lawmaker, a tool kit containing the settled rules of construction and interpretation should be open.While using the tools of interpretation, it should remember that we are not the author of the Statute who is empowered to amend, substitute or delete, so as to change the structure and contents but only interpret the provision, to make it meaningful and workable so as to achieve the legislative object, when there is vagueness, ambiguity or absurdity. [Union of India v. Deoki Nandan Aggarwal [1992 Supp (1) SCC 323], and Shyam Kishori Devi v. Patna Municipal Corpn. [AIR 1966 SC 1678], and Sri Jeyaram Educational Trust & Ors., v. A.G.Syed Mohideen & Ors. reported in 2010 CIJ 273 SC (1)]

Consequences of improper constitution of the Board

Case 1: Strength below minimum and below quorum

Nobusiness can be transacted by the remaining director or directors except for increasing the number of directors to that fixed for the quorum, or of summoning a general meeting of the Company.Penal provisions under Section 172 of the Act will get attracted.

Case 2: Strength below minimum but above quorum

Continuing directors may act notwithstanding any vacancy in the Board, but the Company will be under default in terms of the provisions of Section 149 of the Act and penal provisions under Section 172 of the Act will get attracted.

Penal provisions: No specific penalty is provided for contravention of Section 149 of the Act with respect to compliance with the minimum number of directors. However, Section 172 of the Act provides that if a company contravenes any of the provisions of Chapter XI Appointment and Qualifications of Directors the Company for which no specific punishment is provided therein then every officer of the Company who is in default shall be punishable with fine which shall not be less than fifty thousand rupees but which may extend to five lakh rupees.

Time limit for filing the vacancy in the Board below the minimum strength fix under the Act and Articles of the Company

Time Limit: Section 149 of the Act prescribesa time to fill vacancy in the Board due to cessation of independent director or women director till immediate next Board meeting or three months from the date of such vacancy, whichever is later. However, no specific time limit is provided for complying with the requirement of minimum number of directors in case of vacancy in the Board.

Since it is a duty of the Company to have minimum number of directors at all time, in case number of directors falls below minimum number fixed for quorum, vacancy should be filed before transacting any business in meeting of the Board and keeping in mind the requirement of Section 173 of the Act with respect to minimum number of meeting of the Board and maximum time gap allowed.

Further, if a number of remaining directors are sufficient to form quorum, vacancy should be filed at the earliest keeping in mind the penal provisions given under Section 172 of the Act and chances of actions of the Board getting challenged on the grounds of mala fide intentions.

Effect on third parties of the decisions made by the improperly constituted Board of the Company

The bona fide acts of the Board or any committee appointed by it shall, notwithstanding any vacancy in the Board or committee or any defect in the appointment of any Director, be as valid as if no such vacancy or defect had existed.[British Asbestos Co. Ltd.; Channel Collieries Trust Ltd]

Protection for all bona fide acts done in any meeting of the Board or of a committee thereof or by any person acting as a director is also given by Section 176 of the Act and Article 74 of Table F of schedule I of the Act.

Doctrine of indoor management provides protection to the outsiders dealing with the Company. According to this doctrine, as laid down in Royal British Bank v. Turquand, (1856) 119 E.R. 886, persons dealing with a company having satisfied themselves that the proposed transaction is not in its nature inconsistent with the memorandum and articles, are not bound to inquire the regularity of any internal proceedings. In other words, while persons contracting with a company are presumed to know the provisions of the contents of the memorandum and articles, they are entitled to assume that the provisions of the articles have been observed by the officers of the Company. It is no part of the duty of an outsider to see that the company carries out its own internal regulations.