Treating Returns Of Allotment Penalty Provision To Exclude Adjudicating Officer's Discretion Unconstitutional: Bombay HC

The Bombay High Court has held that penalties for defective filings relating to the issuance of securities cannot be imposed through a mechanical computation exercise without examining the nature, gravity, and impact of the default.

It also called arbitrary the multiplication of penalties based solely on the number of directors on a company's board, while modifying a ₹64 lakh penalty imposed on a Nidhi company and its directors.

Justice Somasekhar Sundaresan, hearing a petition by N.S.J.L Nidhi Ltd and its directors, said construing the penal provision as excluding adjudicatory discretion would make it constitutionally suspect.

“In my opinion, the reading of Section 39(5) of the Companies Act, a penal provision, as a stipulation that does not permit the Adjudicating Officer to exercise adjudicatory discretion to examine the nature, the gravity, and the impact of the default is an unreasonable reading of the provision, which would render it unconstitutional. The very same provision can be read in a constitutionally valid manner and that entails the power of the Adjudicating Officer, which is indeed a power coupled with a duty to exercise such discretion in discharge of an adjudicatory function,” the Court observed.

The court was dealing with a challenge to an October 11, 2023 adjudication order passed by an adjudicating officer under the Ministry of Corporate Affairs, which imposed an aggregate penalty of ₹64 lakh over sixteen returns of allotment filed between February 10, 2019 and January 26, 2021.

The authorities alleged that while the company had filed Form PAS-3 returns relating to the issuance of securities, the attached lists of allottees were not separately certified as required under Rule 12(2) of the Companies (Prospectus and Allotment of Securities) Rules, 2014. The petitioners argued that the affirmation clause in Form PAS-3 itself certified the correctness of all attachments.

A key plank of the ruling was the Court's rejection of the adjudicating officer's approach of imposing the maximum penalty and then multiplying it by the number of directors. The court said this produced arbitrary outcomes with no nexus to the gravity of the breach.

“The scale of the penalty has shot up because the Adjudicating Officer has not only imposed the maximum penalty under Section 39(5) of the Companies Act (which is variously defended as a minimum penalty and a fixed penalty), but has also multiplied the maximum penalty by the number of directors the Company had. If the Company had ten directors, this approach would have led to a multiplication of the maximum penalty by ten; if the Company had only two directors, it would have led to a multiplication by two; and so on. This too has rendered the Impugned Order vulnerable to the charge of being arbitrary and unconstitutional in the quantification of penalty imposed,” the Court observed.

The court also rejected the respondents' argument that the penalty provision mandated either a minimum or fixed penalty without room for discretion. Referring to Supreme Court rulings interpreting an identically worded penalty provision under the SEBI Act, it held that adjudicating officers must consider aggravating and mitigating circumstances while determining penalties.

The court further observed that the legislative scheme under the Companies Act contemplates remediation and not punishment merely because the power to penalise exists.

Rejecting the company's defence on the merits, however, the Court held that the requirement of separate certification could not be overridden by the form's general affirmation clause. It said the requirement served the purpose of maintaining data integrity in company records, though the breach in the present case was technical in nature.

“This list is required to be certified by the same signatory of the Form PAS-3. The affirmation clause in Form PAS-3 simply states that the list of allottees is complete and correct as per the company's records. If I were to accept Mr. Agrawal's contention, I would necessarily have to hold that the proforma affirmation clause would efface the explicit stipulation in subordinate legislation i.e. Rule 12(2) of the Allotment Rules. Subordinate legislation that is tabled on the floor of Parliament for the specified period, after which it becomes part of the law cannot be wished away by an interpretation of the format of the return,” the Court said.

However, the Court made clear that the technical nature of the lapse did not erase the breach altogether and declined to entirely quash the penalty. It also noted that the adjudicating officer had failed to analyse the basis for treating every director as an officer in default in the facts of the case.

Exercising its writ jurisdiction, the court modified the impugned order and restricted the penalty to ₹1 lakh per violation, payable jointly and severally by the company and its directors.