Direct Involvement Needed: SC’s Ruling On Vicarious Liability Of Non-Executive Directors In Cheque Dishonour Cases

Introduction:

Supreme Court in the case of K.S. Mehta vs. M/s Morgan Securities and Credits Pvt. Ltd.[1] quashed criminal proceedings against non-executive directors under Section 138 read with Section 141 of the Negotiable Instruments Act (NI Act), serving a critical reminder that mere association with a company does not automatically imply liability for its financial misdeeds.

Background of the Case:

The appellants, K.S. Mehta and Basant Kumar Goswami, served as directors in Blue Coast Hotels & Resorts Ltd., but their role in there was strictly of a non-executive kind. Their appointment was directly in line with SEBI regulations, which clearly and thoroughly define the oversight function of non-executive directors, leaving the important day-to-day financial operations and decision-making to executive personnel at the company.

The controversy stemmed from that certain Inter-Corporate Deposit (ICD) agreement dated 09.09.2002 between Blue Coast Hotels & Resorts Ltd., as well as the respondent. The deal sought to provide a monetary resource of ₹5 Crores. It was protected by particular collaterals for 180 days. Notably, K.S. Mehta, as well as Basant Kumar Goswami, did not attend the board meeting when this deal was approved. Additionally, they neither signed the ICD agreement nor other later financial documents, like the post-dated checks for deposit repayment.

Following the company’s complete failure to repay the deposit, two post-dated cheques—one dated 28.02.2005 as well as another dated 30.03.2005 were issued. Both those cheques bounced by reason of inadequate funds, thereby prompting the respondent for initiating criminal proceedings against each one of the directors, all-embracing of the non-executive directors under question.

Arguments of the Parties:

The appellants argue that the clients, merely being non-executive directors, had no role in the operational or financial decision-making of the company. This position is backed by supporting documents including CGRs and ROC records. Counsel maintained that without being an authorized signatory to the cheques in question, or directly involved in the ICD agreement, no liability could attach to them under Section 141.

The respondent’s counsel claimed that their names only appearing on company records during the relevant period should suffice to imply their participation in the overall company operations. Further, the proposition was that the burden of proving their non-involvement lay upon the appellants in question and that an act of resignation from the board is no escape route either in a case where actions were taken while the appellants were members of the board.

Judicial Precedents:

The approach of the Supreme Court was systematic and grounded in established judicial norms. The Court made it clear that while vicarious liability may arise under Section 141, this is not an automatic case triggered by the simple act of being a director. Thus, there should be explicit and clear allegations showing that a director was directly connected to and made decisions concerning the financial activities of the company at the relevant time of the offence. Several key judicial precedents were instrumental in the Court’s decision:

1. National Small Industries Corpn. Ltd. v. Harmeet Singh Paintal[2]: The court held that an explicit and deliberate assertion regarding a director’s involvement in corporate business transactions must feature in a complaint. The common simplistic statement that a director is “in charge” of the company will not satisfy the requirements for finding liability.
2. S.M.S. Pharmaceuticals Ltd. v. Neeta Bhalla[3]: The court in this case clarified that merely being a director does not create an assumption that this person took part in related financial decisions. Rather, the claim must specify in what way the director took part in the relevant transactions.
3. Pooja Ravinder Devidasani v. State of Maharashtra[4]: The case reinforced the idea that, since non-executive director’s duties only involve supervision and checking of the company, they will not be liable unless there are clear allegations stating that they were directly involved in the financial workings of the company.

The Court’s Verdict:

The Supreme Court held that unless substantial evidence is presented to demonstrate their direct involvement in the financial operation of the company during the commission of the alleged offence, non-executive and independent directors cannot be vicariously liable under Section 141 of the Negotiable Instruments Act for the dishonour of cheques. The Court concluded that the appellants’ roles, as documented, were strictly of an oversight governance nature. Their non-involvement in agent decision-making or any operational or financial management considerations, coupled with the absence of any specific allegations implicating them in the transaction concerned, rendered the criminal proceedings impossible. The Court thus set aside the earlier High Court judgment and quashed the criminal proceedings under Complaint Nos. 15857 and 15858 of 2017.

Implications for Corporate Governance:

The ruling effects the corporate governance as far as the roles and liabilities of non-executive directors are concerned. The ruling reminds one that the mere title of a director does not, by itself, make one liable for the financial misfeasance of a company. It elaborates on the distinction between directors involved in the day-to-day management and those who serve purely to oversee the business and give strategic guidance.

This decision offers tranquillity to non-executive directors since it ensures that these people, who are primarily advisors and overseers in nature, are not unfairly judged because of decisions taken by executive management. By this judgment, it has been made clear that when complaints are framed seeking to impose vicarious liability under the NI Act, specific and concrete allegations have to be made, showcasing actively how a certain director was involved in the financial transactions. Statements made in an ambiguous or generalized manner never suffice and hence are deficient when it comes to the rigorous standards of proof as required by law.

Conclusion:

The decision of the Supreme Court has concluded that non-executive and independent directors cannot be held liable under Section 141 of the NI Act for an act of dishonour of a cheque, unless there is specific and clear evidence showing their active involvement in the financial affairs of the company. This ruling acts not only as a protective cover for those directors who merely function in a governance role but also, at a minimum, serves as a warning to regulatory authorities and complainants of the high and demanding requirements of proof needed to underlie findings of liability under penal legislation.

[1] Criminal Appeal No. of 2025 [Arising out of SLP (Criminal) No. 4774 of 2024]

[2] (2010) 3 SCC 330.

[3] (2005) 8 SCC 89.

[4] (2014) 16 SCC 1.

King Stubb & Kasiva,
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