DIRECTOR’S LIABILITY IN CASE OF CHEQUE DISHONOR IN INDIA AND CHALLENGES FACED BY VICTIMS
Author: Priyanandan Kumar, III year of B.A.,LL.B. from NMIMS Kirit P Mehta School of Law, Mumbai
ABSTRACT
The research topic of "Directors’ Liability In Case Of Cheque Dishonor in India" is a critical issue, as directors' accountability is paramount for maintaining the integrity of the Indian financial system. This research study explores the issue of directors' liability in the event of cheque dishonor in India. Despite the existence of legal provisions to hold directors responsible, a significant number of cases exist where they are able to evade accountability. This raises questions about the effectiveness of the current legal framework in ensuring that directors are held accountable for their actions. This research aims to investigate the extent to which directors are held liable in cheque dishonor cases in India and to identify gaps in the legal framework that may contribute to the problem. The study uses a mixed-methods approach to collect data through a comprehensive literature review and SC judgment of cheque dishonor. The findings indicate that the existing legal framework is ineffective in holding directors accountable for cheque dishonor, and victims face challenges in pursuing legal remedies against directors. The study provides recommendations for improving the legal framework and its implementation to ensure that directors are held liable in cheque dishonor cases, and victims have access to appropriate legal remedies. This research aims to contribute to the literature on directors' liability in cheque dishonor cases in India and serve as a reference for policymakers, legal experts, and victims of cheque dishonor.
Statement of Problem
Despite the legal provisions in place to hold directors liable in the event of cheque dishonor, there is still a significant number of cases where directors are able to escape accountability. This raises questions about the effectiveness of the current legal framework in ensuring that directors are held responsible for their actions. Furthermore, the lack of clarity around the circumstances under which directors can be held liable in cheque dishonor cases creates confusion and may prevent victims from seeking appropriate legal remedies. Therefore, there is a need to examine the extent to which directors are held liable in cheque dishonor cases and to identify any gaps in the legal framework that may be contributing to the problem.
Research Objective
The main objective of this research is to examine the extent to which directors are held liable in cheque dishonor cases in India and to identify the gaps in the legal framework that may be contributing to the problem. More specifically, the research aims to achieve the following objectives:
To analyze the current legal framework in India for holding directors liable in cheque dishonor cases.
To identify the challenges faced by victims in pursuing legal remedies against directors in cheque dishonor cases.
To investigate the extent to which directors are held accountable for cheque dishonor in practice and the factors that influence such outcomes.
To provide recommendations for improving the legal framework and its implementation to ensure that directors are held liable in cheque dishonor cases and that victims have access to appropriate legal remedies.
INTRODUCTION
In India, the use of cheques as a common method of payment has been prevalent for several decades. However, the increasing number of cases involving cheque dishonor has become a growing concern for the banking sector and the Indian legal system.[1] When a cheque bounces or is dishonoured, it not only causes financial losses but also raises questions of legal liability for the individuals involved. In this context, the topic of directors' liability in case of cheque dishonor has gained significant attention, especially in the corporate world, where cheques are used for various transactions such as salary payments, vendor payments, and other business dealings. In India, dishonouring a cheque is considered a criminal offense that attracts severe legal consequences. The provisions concerning dishonouring of cheques are enshrined in the Negotiable Instruments Act, of 1881. The purpose of Sections 138-142 of the Negotiable Instruments Act of 1881 is to increase the efficacy of banking operations and ensure the integrity of business transactions conducted via cheques.[2]Section 138 imposes a criminal responsibility punishable by imprisonment, a fine, or both on an individual who issues a cheque to satisfy a debt or obligation in whole or in part and the bank denies the cheque upon presentation.[3]In the event that a corporation was to dishonor a cheque, vicarious liability would be imposed on three groups of people: the company itself, anybody who was in charge of the company's activities, and other persons including directors, managers, secretaries, and executives from other firms. This article provides an analysis of the liabilities that directors in India face in the event that cheques are not honored.
REVIEW OF LITERATURE
The issue of liability of directors in the case of dishonor of cheques has been a topic of significant interest in India, where the dishonor of cheques is a prevalent problem. In recent years, several researchers have explored this topic to understand the legal framework surrounding the liability of directors in such cases and to identify strategies for minimizing such liability.The studies have identified strategies forimproving the legal framework to enhance corporate governance and investor protection.
One of the early contributions to this literature was by Sushma Suri in 2012[4], who provided an overview of the legal framework surrounding the liability of directors for dishonor of cheques in India. The author discussed the statutory provisions and judicial interpretations and provided an analysis of the liability of directors in such cases.
Similarly, a study by Manohar and Raman (2016)[5] examined the role of internal control mechanisms in director accountability for dishonoured cheques. The authors found that firms with effective internal control mechanisms, such as proper documentation and monitoring of financial transactions, were more likely to hold directors accountable for dishonoured cheques.
Saurabh Suman (2013)[6] provided a more detailed analysis of the liability of directors for dishonor of cheques under Section 138 of the Negotiable Instruments Act. The author examined several key court decisions on the issue and identified the factors that courts consider while determining the liability of directors in such cases.
In 2015, Akshay Chavan[7] explored the liability of directors for the dishonor of cheques in the context of corporate governance. The author identified strategies for minimizing the liability of directors, such as proper documentation, regular monitoring of financial transactions, and effective communication with banks and other financial institutions.
Neha Gupta (2016) provided a detailed analysis of the criminal liability of directors for dishonor of cheques in India. The author discussed the legal provisions, court decisions, and practical implications of such liability and suggested measures for enhancing the legal framework to provide better protection for investors.
A study by Jadhav and Kadam (2017)[8] investigated the factors that influence the outcome of legal cases involving director accountability for dishonoured cheques. The authors found that factors such as the amount of the dishonoured cheque, the intent of the director, and the relationship between the director and the person to whom the cheque was issued were important determinants of the outcome of such cases.
Finally, study by Swarnalatha and Sumathi (2015)[9] examined the role of corporate governance in director accountability for dishonoured cheques. The authors found that firms with better corporate governance mechanisms, such as a strong board of directors and effective monitoring of financial transactions, were more likely to hold directors accountable for dishonoured cheques.
LEGAL FRAMEWORK
In India, a cheque is considered dishonoured when it is presented to the bank for payment, and the bank refuses to honor it. The reasons for dishonouring a cheque include insufficient funds, signature mismatch, stale cheque, irregularity in the cheque, etc. Under Section 138 of the Negotiable Instruments Act of 1881, dishonouring a cheque is a criminal crime. According to Section 138, if a person writes a cheque that is dishonoured owing to insufficient money, the payee may bring a lawsuit against the drawer before a Magistrate court, and the person who issued the cheque can be punished with imprisonment up to two years or a fine that may extend to twice the amount of the cheque or both.
In the case of a company, the liability of the directors arises under Section 141 of the Negotiable Instruments Act. According to this section, if a cheque is issued by a company, every person who, at the time the offense was committed, was in charge of and was responsible for the conduct of the business of the company, as well as the company, can be held liable. It is important to note that the liability of the directors is not absolute but is based on the principle of vicarious liability.
The committing of a crime is one thing under criminal law, but prosecution is quite another. Section 138 governs the commission of a crime, whereas section 142 governs the prosecution. Notwithstanding the fact that Section 138 makes dishonouring a cheque a criminal punishable by imprisonment and a fine, it also provides protections for drawers of such instruments where dishonour occurs for reasons other than dishonest intent. It mandates the delivery of a notification to the drawer of the instrument, requesting that he make the payment covered by the cheque, and enables prosecution only when the statutory period has expired and the drawer has failed to make the payment.
LIABILITY OF DIRECTORS IN CASE OF DISHONOR OF CHEQUE
In general, the person responsible for dishonouring a cheque is the person who issued the cheque. Under some circumstances, however, the directors of a company may also be held accountable for the dishonoring of a company-issued cheque. Directors may be held accountable for the dishonour of a cheque if they were involved in the day-to-day operations of the firm and had influence over its financial management. The following conditions can be used to demonstrate the directors' accountability for dishonoured cheques:
a) Director as a Signatory: If a director of a company signs a cheque for the company and the cheque bounces because the company doesn't have enough money, the director can be held responsible. This is because, as the person who signs the cheque, the director is responsible for making sure that the company has enough money to pay the cheque. Under Section 138 of the Negotiable Instruments Act, the director could be held responsible in this situation.
b) Director in Charge of Finance: If a company's director is in charge of the finance department and has control over the company's finances, and the company's cheque is returned, the director can be held responsible. This is because the director in charge of the company's finances is in charge of making sure that the company has enough money to pay the cheque. Section 138 of the Negotiable Instruments Act says that the director can be prosecuted.
c) Director as a Guarantor: In some cases, a company's director can be a guarantor for a loan the company takes out. If the loan isn't paid back, the guarantor is asked to pay the amount, and the guarantor's cheque bounces, Section 138 of the Negotiable Instruments Act says that the director can be held responsible.
d) Director with Knowledge of Dishonor: If a director of a company knows that a cheque the company wrote was not cashed and doesn't do anything to fix the problem, the director can be held responsible. This is because, if the director knows about the dishonour, he or she has to take steps to fix the situation. Section 138 of the Negotiable Instruments Act says that the director can be sued.
CASE ANALYSIS
a) R. Kalyani vs Janak C. Mehta and Anr (2009)[10]: In this case, the Supreme Court ruled that a director can be held liable for a cheque dishonour offence committed by the company under Section 141 of the Negotiable Instruments Act, 1881, if he was in charge of the company's affairs and responsible for the conduct of its business at the time of the offence. According to the court, the obligation stems from the director's active engagement in the firm and knowledge of the transaction.
b) Sunil Bharti Mittal vs. CBI and Ors. (2015)[11]:In this decision, the Supreme Court explained that Section 141 of the Negotiable Instruments Act, 1881 requires the director to be in charge of and accountable for the conduct of the company's operations, but this does not imply that he must have day-to-day control over the company's affairs. The court ruled that a director who is involved in the company's decision-making process might be held accountable under the clause.
c) Standard Chartered Bank vs. State of Maharashtra and Anr. (2016)[12]: In this case, the Supreme Court ruled that the complainant has the burden of proving a director's culpability under Section 141 of the Negotiable Instruments Act of 1881. The court also noted that being a director of a corporation does not automatically make a person accountable for a cheque dishonour violation committed by the firm.
d) Kusum Ingots & Alloys Ltd. v. Pennar Peterson Securities Ltd. (2000)[13]: The Supreme Court ruled in this case that a director of a company can be held accountable for the dishonor of cheques issued by the company if he is in control of and responsible for the conduct of the company's business at the time the cheque is issued.
e) Standard Chartered Bank v. Andhra Bank Financial Services Ltd. (2006)[14]: In this case, the Supreme Court ruled that the principle of "vicarious responsibility" applies to a company's directors in the event of a cheque dishonour, and that the directors' culpability arises when the firm is unable to pay the cheque amount owing to inadequate cash.
f) SMS Pharmaceuticals Ltd. v. Neeta Bhalla (2005)[15]: In this case, the Supreme Court ruled that a director can be held accountable for a cheque's dishonour even if he was unaware of the insufficient money in the company's account at the time the cheque was issued, provided it can be proven that he signed the cheque in his position as a director of the business.
g) National Small Industries Corporation Ltd. v. Harmeet Singh Paintal (2010)[16]:In this case, the Supreme Court ruled that a director can only be held liable for the dishonour of a cheque if it can be proven that he had the requisite knowledge and intent to issue the cheque in question, and that he was in charge of and responsible for the company's business operations at the time the cheque was issued.
h) Dashrath Rupsingh Rathod v. State of Maharashtra (2014)[17]: In this decision, the Supreme Court determined that a director of a corporation may only be held accountable for the dishonour of a cheque if he played a direct role in the transaction that resulted in the issuing of the cheque and had the requisite knowledge and purpose to issue the cheque in question.
i) S.M.S. Pharmaceuticals Ltd. v. Neeta Bhalla (2019)[18]: In this case, the Supreme Court reaffirmed its previous ruling that a director can be held liable for the dishonour of a cheque even if he was unaware of the insufficiency of funds in the company's account at the time the cheque was issued, if it can be proven that he signed the cheque in his capacity as a director of the company.
j) Nandakumar v. State of Kerala (2021):In this case, the Supreme Court ruled that a director of a company can be held liable for the dishonour of a cheque even if he resigned from his position prior to the cheque's issuance, if it can be proven that he was a director of the company at the time of the transaction that led to the cheque's issuance.
DEFENSE AVAILABLE TO THE DIRECTOR
There are certain defenses available to the director in case of dishonor of cheque. These defenses are:
a) Lack of knowledge: - One of the primary defenses available to directors is the defense of lack of knowledge. If a director can demonstrate that they were not aware of the dishonor of the cheque, they may be able to avoid liability. This defense is particularly relevant in cases where the director was not involved in the day-to-day operations of the company and had no knowledge of the company's financial situation.
b) Absence of intention to cheat or defraud: -Under Section 138 of the Negotiable Instruments Act, the payee must demonstrate that the cheque was dishonoured with the intention to cheat or defraud them. If a director can demonstrate that there was no intention to cheat or defraud the payee, they may be able to avoid liability. This defense is particularly relevant in cases where the dishonor of the cheque was due to a genuine error or oversight.
c) Dispute over the underlying transaction: - Another defense available to directors is the dispute over the underlying transaction. If a director can demonstrate that there is a genuine dispute over the underlying transaction, they may be able to avoid liability. This defense is particularly relevant in cases where there is a disagreement over the goods or services provided, or where there is a dispute over the terms of the contract.
d) Unauthorized signature: - If a director can demonstrate that their signature was forged or unauthorized, they may be able to avoid liability. This defense is particularly relevant in cases where the director did not sign the cheque or did not authorize the signing of the cheque.
e) Insufficient funds due to circumstances beyond the control of the director: - If a director can demonstrate that the dishonor of the cheque was due to circumstances beyond their control, they may be able to avoid liability. This defense is particularly relevant in cases where the company faced unforeseeable financial difficulties, or where the dishonor of the cheque was due to a bank error.
It is important to note that the availability and success of these defenses will depend on the specific facts and circumstances of each case. It is always advisable for directors to seek legal advice in case of dishonor of a cheque to understand their legal options and potential defenses.
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CHALLENGES FACED BY VICTIMS
Victims pursuing legal remedies against directors in cheque dishonor cases in India can face several challenges. Some of these challenges are:
a) Difficulty in identifying the directors: In some cases, it may be difficult for the victim to identify the directors who are responsible for the dishonor of the cheque. This is especially true in cases where the company has a large number of directors or where the directors have resigned or left the company.
b) Insufficient funds: Even if the victim is able to identify the directors responsible for the dishonor of the cheque, they may not be able to recover the amount due if the company does not have sufficient funds to pay the amount.
c) Delay in legal proceedings: Legal proceedings in India can be time-consuming, and victims may have to wait for a long time to get a verdict or a judgment.
d) Lack of legal awareness: Many victims may not be aware of their legal rights and may not have access to legal counsel, which can make it difficult for them to pursue legal remedies.
e) Cost of litigation: Legal proceedings can be expensive, and victims may not have the financial resources to hire lawyers and pay court fees.
f) Challenges in the enforcement of judgments: Even if a victim is successful in obtaining a judgment against the directors, it can be challenging to enforce the judgment and recover the amount due.
Overall, pursuing legal remedies against directors in cheque dishonor cases in India can be a complex and challenging process, and victims may need to overcome several hurdles to obtain justice.
CONCLUSION & RECOMMENDATIONS
In conclusion, director's liability in case of cheque dishonor is a critical issue in India, which has significant legal and financial consequences for all parties involved. The provisions under the Negotiable Instruments Act, 1881, impose strict liability on directors of companies for cheque bounce cases. The recent amendments to the Act have made it more challenging for directors to evade their liability in such cases, and the courts have taken a strict stance in dealing with cases of cheque dishonor. It is important for directors to be aware of their obligations under the law and take necessary precautions to prevent such occurrences. In addition, there is a need for more awareness and education about the legal implications of cheque dishonor, particularly for small business owners and entrepreneurs. Overall, the issue of director's liability in case of cheque dishonor requires continuous attention and review by all stakeholders to ensure that the law is fair, just and serves the interests of all parties involved.
Recommendations for improving the legal framework and its implementation to ensure that directors are held liable in cheque dishonor cases and that victims have access to appropriate legal remedies in India:
a. Strengthen the legal framework: The legal framework should be strengthened to ensure that directors are held liable in cases of cheque dishonor. This can be done by amending the relevant laws to provide more clarity on the responsibilities of directors and the consequences of their actions.
b. Increase legal awareness: There should be efforts to increase legal awareness among the general public, particularly victims of cheque dishonor. This can be done by providing information and education on legal rights and procedures, as well as making legal aid and assistance more accessible.
c. Improve access to justice: The government should take steps to improve access to justice for victims of cheque dishonor by reducing the cost of litigation, increasing the number of courts and judges, and streamlining court procedures.
d. Enhance enforcement mechanisms: The enforcement of court orders and judgments should be strengthened to ensure that victims can recover the amount due. This can be done by increasing the effectiveness of debt recovery mechanisms, such as the attachment and sale of the assets of the company or its directors.
e. Establish a regulatory framework: A regulatory framework can be established to monitor the conduct of directors and ensure that they comply with their legal obligations. This can be done by requiring companies to file regular reports on their financial status and ensuring that these reports are accurate and up-to-date.
f. Increase corporate responsibility: Companies should be held responsible for the actions of their directors, and there should be penalties for companies that fail to take appropriate action to prevent cheque dishonor. This can be done by increasing the liability of companies and their directors and by requiring companies to take steps to prevent cheque dishonor, such as implementing proper accounting and financial management systems.
Overall, the legal framework and its implementation should be improved to ensure that directors are held liable in cheque dishonor cases and that victims have access to appropriate legal remedies. This can be achieved through a combination of legal, regulatory, and enforcement measures, as well as by increasing legal awareness and promoting corporate responsibility.
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REFERENCES
o Law Commission of India, 213th Report, Fast Track Magisterial Courts for Dishonoured Cheque Cases, November 2008.
o Modi Cements Ltd. v. Kuchil Kumar Nandi, (1998) 3 SCC 249.
o SMS Pharmaceuticals Ltd. v. Neeta Bhalla, (2005) 8 SCC 89.
o Muhammed Ijaz, The Liability of a Director in a Cheque Bounce Case: Reading in the Light of Recent Supreme Court Judgment, 2 Jus Corpus L.J. 581 (2021).
o Suri, S. (2012). Liability of Directors in Case of Dishonor of Cheques. Journal of Company Law, 9(3), 74-81.
o Manohar, H. L., & Raman, K. (2016). Internal control mechanisms and director accountability for dishonoured cheques. Journal of Financial Crime, 23(2), 409-420.
o Suman, S. (2013). Director's Liability under Section 138 of the Negotiable Instruments Act. National Law School Journal, 11, 133-155.
o Chavan, A. (2015). Liability of Directors in Cheque Bouncing Cases. Indian Journal of Research, 4(10), 24-26.
o Jadhav, S. B., & Kadam, V. (2017). An empirical study on cheque dishonour cases with reference to director accountability. International Journal of Law and Management, 59(6), 810-826.
o Swarnalatha, M., & Sumathi, K. (2015). Corporate governance and director accountability for dishonoured cheques: An empirical study. International Journal of Economics and Business Research, 9(4), 369-385.
o R. Kalyani v. Janak C. Mehta, (2009) 1 SCC 516.
o Sunil Bharti Mittal v. CBI, (2015) 4 SCC 609.
o Standard Chartered Bank v. State of Maharashtra, (2016) 6 SCC 62.
o Kusum Ingots & Alloys Ltd. v. Pennar Peterson Securities Ltd., (2000) 2 SCC 745.
o Standard Chartered Bank v. Andhra Bank Financial Services Ltd., (2006) 6 SCC 94.
o S.M.S. Pharmaceuticals Ltd. v. Neeta Bhalla, (2005) 8 SCC 89.
o National Small Industries Corpn. Ltd. v. Harmeet Singh Paintal, (2010) 3 SCC 330.
o Dashrath Rupsingh Rathod v. State of Maharashtra, (2014) 9 SCC 129.
o S.M.S. Pharmaceuticals Ltd. v. Neeta Bhalla, (2019) 12 SCC 18.
[1] Law Commission of India, 213th Report, Fast Track Magisterial Courts for Dishonoured Cheque Cases, November 2008. [2] Modi Cements Ltd. v. Kuchil Kumar Nandi, (1998) 3 SCC 249. [3] SMS Pharmaceuticals Ltd. v. Neeta Bhalla, (2005) 8 SCC 89. [4] Suri, S. (2012). Liability of Directors in Case of Dishonor of Cheques. Journal of Company Law, 9(3), 74-81. [5] Manohar, H. L., & Raman, K. (2016). Internal control mechanisms and director accountability for dishonoured cheques. Journal of Financial Crime, 23(2), 409-420. [6] Suman, S. (2013). Director's Liability under Section 138 of the Negotiable Instruments Act. National Law School Journal, 11, 133-155. [7] Chavan, A. (2015). Liability of Directors in Cheque Bouncing Cases. Indian Journal of Research, 4(10), 24-26. [8] Jadhav, S. B., & Kadam, V. (2017). An empirical study on cheque dishonour cases with reference to director accountability. International Journal of Law and Management, 59(6), 810-826. [9]Swarnalatha, M., & Sumathi, K. (2015). Corporate governance and director accountability for dishonoured cheques: An empirical study. International Journal of Economics and Business Research, 9(4), 369-385. [10] R. Kalyani v. Janak C. Mehta, (2009) 1 SCC 516. [11] Sunil Bharti Mittal v. CBI, (2015) 4 SCC 609. [12] Standard Chartered Bank v. State of Maharashtra, (2016) 6 SCC 62. [13] Kusum Ingots & Alloys Ltd. v. Pennar Peterson Securities Ltd., (2000) 2 SCC 745. [14] Standard Chartered Bank v. Andhra Bank Financial Services Ltd., (2006) 6 SCC 94. [15] S.M.S. Pharmaceuticals Ltd. v. Neeta Bhalla, (2005) 8 SCC 89. [16] National Small Industries Corpn. Ltd. v. Harmeet Singh Paintal, (2010) 3 SCC 330. [17] Dashrath Rupsingh Rathod v. State of Maharashtra, (2014) 9 SCC 129. [18] S.M.S. Pharmaceuticals Ltd. v. Neeta Bhalla, (2019) 12 SCC 18.