In this article, Neitseizonuo Solo of Hidayatullah National Law University, Raipur discusses whether directors are liable if cheques issued by a company bounces.

Introduction

Cheques have become an important medium for business transactions as they provide proof of transactions. Due to the prevalence of cheques, lawmakers found it necessary to provide regulations for matters relating to the use of cheques, thus the Negotiable Instruments Act, 1881, was enacted.

Law Regarding the Bouncing of Cheques

Bouncing of cheques is the common terminology used to describe a situation where a person paid in the form of a cheque is unable to encash the cheque. It has been defined in Section 138 Negotiable Instruments Act, 1881, as any cheque drawn by a person in payment to another person, which is returned to the bank unpaid because there are insufficient funds in the account or the amount exceeds the prescribed limit. The person being paid is known as the payee or drawee and the person paying through cheque is known as the drawer or payer. Thus, it is due to the inability of the drawer to pay the amount which is owed to the payee.

Penalties

The penalties that can apply to a drawer when a cheque bounces are as follows:

1. Imprisonment which may extend to 2 years.
2. A fine double the amount which was supposed to be paid.

Conditions for Application of Section 138 of Negotiable Instruments Act, 1881

Certain conditions have been provided under this section and they are as follows:

1. The cheque is presented to the bank within 6 months of it being drawn up or within the prescribed period of validity, whichever is earlier.

With Reference to RBI Guidelines

The RBI issued guidelines known as Payment of Cheques/Drafts/Pay Orders/Banker’s Cheques on 4th November, 2011 (available here) where it was prescribed that cheques must be presented before the bank within a period of 3 months instead of the 6 months prescribed in Section 138 of Negotiable Instruments Act, 1881. This may seem like a direct contradiction of this act at first glance but on a proper reading of the section, it is clear that it is intra vires. It is given in Section 138 that cheque may be presented within a limited prescribed period and whichever time period is shorter between 6 months and prescribed period, will be the one which is applicable. Thus the RBI guidelines will be followed and cheque must be given to the bank within 3 months. 

1. The person encashing the cheque gives a notice to the person who drew up the cheque within 30 days of acquiring information that the cheque is unpaid.
2. The drawer does not pay the amount after 15 days from such notice.

Whether the Directors of a Company are Liable for a Bounced Cheque of the Company

The directors of a company as per the Companies Act of 1956, are the people hired to manage and control the affairs of the company. They can be hired under the name of director or any other name as long as they fulfill the functions of a director as stipulated in their contract. Under Section 141(2)(a) of Negotiable Instruments Act, 1881, the definition of a director has been given as partner of the concerned company.

In Section 141 of the Negotiable Instruments Act,1881, the liability of directors has been given. It is provided that “…every person who, at the time the offense was committed, was in charge of, and was responsible to the company for the conduct of the business of the company, as well as the company,” thus even the directors of a company may be liable. Only people who were in direct charge of the company with the power to direct day-to-day ongoings of the company will be held to be liable. If a director was at the time of the offence, not responsible or in charge of the company, then he/she would not be liable even if the name director is attached.

Further, it has been provided in clause 2 that the directors, managers and any other people holding office by whose consent, connivance, negligence has caused the offence, he/she will be liable.

Exceptions to director’s liability

A director will not be liable for bouncing of cheques in the following circumstances:

1. When the offence has occurred without his knowledge.
2. When he has exercised all due diligence in order to avoid it.

Essentials for Holding a Director Liable

1. When he is responsible for making decisions for the day-to-day workings of the company and the existence of mens rea does not need to be proved.
2. At the time the offence occurs, the director fulfills the above function.

Vicarious Liability: In Which Cases Will it Apply

The directors, in this case, may be vicariously liable for the bouncing of cheques issued by the company. The offence under Section 141 of the Negotiable Instruments Act, 1881, is a criminal and the vicarious liability which arises under said section must be strictly used and interpreted as it is settled law that penal vicarious liability must be strictly construed by the courts. Thus vicarious liability of directors can only be invoked in certain situations, the principles of which have been given in the following decisions:

Certain Principles Laid Down in Regards to Cheque Bouncing Cases

In the case of SMS Pharmaceuticals v. Neeta Bhalla and Anr. (2005) 8 SCC 89, the court held the following:

1. The complaint filed must specifically provide that the director was in charge of the company at the time the cheque was issued.
2. The director of a company is not liable simply because they are a designated director, they must also be responsible for the running of the company.
3. Signatory of the cheque is responsible and will be held liable

Strict Construction of Section 141

In the case of Saroj Kumar Poddar v. State (NCT of Delhi) (2007) 3 SCC 693, the court further reiterated that the provisions in Section 141 must be strictly construed and thus the complaint must specify the circumstances and substantiate the reasons why the director is to be held vicariously liable.

Liability of Directors

In the case of SMS Pharmaceuticals v. Neeta Bhalla (2007) 4 SCC 70, the court adjudged that when there are a large number of directors, only those directors who were in charge of the company at the time of the cheque being drawn up could be held liable. The other directors who had no part to play could not be held liable simply due to being called directors.

Liability of Managing Directors

In the case of K.K. Ahuja v. V.K. Vora & Anr., (2009) 10 SCC 48 the court held that in the case of Managing directors it can be assumed to be liable as by virtue of the office they are responsible for the day-to-day working of the company. This does not extend to directors and only those people who are in charge of the affairs of the company can be held liable.

When Director Can Escape Liability

In the case of Gunmala Sales Pvt Ltd v. Navkar Infra Projects Pvt Ltd Criminal Appeal Nos.2261-2265 OF 2014, the Supreme Court held that the directors will escape liability only when there is incontrovertible proof of their non-involvement in the proceedings of the company due to prolonged illness or resignation etc.

Issuing of Notices to Directors

In the case of Krishna Texport & Capital Markets Ltd. v. Ila A. Agrawal & Ors Criminal appeal No.1220 of 2009, the court held that separate notices to all the individual directors are not necessary. The court further held that when a notice is served by the company in question, the directors of the company will be aware of it. There is no need to lengthen the procedure without proper reasons.

From the above cases, the following rules for the application of Section 141 and 138 of the Negotiable Instruments Act, 1881, have been laid down as follows:

1. A director is liable only when he/she is in charge at the time the cheque was drawn up, further the complaint must specifically hold the information to prove the director was responsible for the company.
2. The Managing director of a company is liable as it is in the nature of his job to be responsible for the day-to-day working of the company.
3. No separate notices to all directors are necessary, one to the company is enough.
4. The provisions of Section 141 must be strictly constructed.

Defenses Available to Directors

1. The accused director may take the defense that he/she was not in charge of the day-to-day activities at the time of the bounced cheque being issued.
2. The accused director may take the defense of the exceptions provided in Section 138, i.e. he/she has had no knowledge of it or he/she had exercised all due diligence in order to avoid the cheque bouncing.
3. The complaint has not been made in accordance with Section 138 or 141.

Quashing of Criminal Proceedings Under Section 482 of Code of Criminal Procedure

If a case is registered against a drawer unjustly under Section 138 of Negotiable Instruments Act, 1881, the drawer has the recourse to approach the High Court under Section 482 of Code of Criminal Procedure to quash the legal proceedings.

Director Must be Wrongly Arraigned

In the case of Gunmala Sales Pvt Ltd v. Navkar Infra Projects Pvt Ltd Criminal Appeal Nos.2261-2265 of 2014, the court held that in order for legal proceedings to be quashed it is necessary that the director in question has been wrongly arraigned.

In Cases Where Cheque Acts as Security

In the case of HMT Watches Ltd. v. Abida Crl. Appeal No;472 of 2015, the Supreme Court held that legal proceedings cannot be quashed by the court on the grounds that cheque is issued as a security.

How to File a Case if Cheque Bounces

In case a cheque issued by a company cannot be encashed by the bank than an individual may seek recourse after fulfilling the conditions given in Section 138. The complaint must be filed and registered in the Magistrate Court. An appeal can be filed in the Sessions Court. Section 142 of the Negotiable Instruments Act, 1881, provides the procedure for filing a complaint.

The procedure is as follows:

1. A complaint must be made in writing by the payee.
2. The complaint must be made within one month of serving notice and fifteen days of non-payment.
3. No court inferior to the Metropolitan Magistrate or the Judicial Magistrate can try the case.

Calculation of One Month Period

In the case of Sadanandan Bhadran v. Madhavan Sunil Kumar AIR 1998 SC 3043, the court held that the one month period prescribed in Section 142(b) of Negotiable Instruments Act, 1881, is to be calculated after the expiry of 15 days from the date on which the notice is issued to the company in question.

No Complaint to be Entertained After One Month

In the case of N. Samant v. M/s. K.G.N. Traders, (1994) 3 Crimes 725 (Karnataka), the court held that no complaint can be filed after the expiry of the one month period prescribed in Section 142(b) of Negotiable Instruments Act, 1881.

Documents Required to File a Case

1. An affidavit.
2. A copy of the notice sent as well as the post receipt.
3. The original cheque along with the memo of return from the bank.

Case Filed under Section 420 of IPC

It is permissible to file a complaint under Section 142 along with a criminal complaint under Section 420 of IPC. Under this section, it is provided that if any person by cheating, fraudulently induces delivery of property or “make, alter or destroy” any valuable security, they would be punished with imprisonment that may extend to 7 years and they shall also be liable for a fine.

Mens rea is necessary in the case of Section 420 of IPC unlike in Section 138 as the intention to cheat has to exist. Clear evidence must exist in this case in order to prove the existence of the intention to cheat at the initial stages of a cheque being issued.

Recovery of Money in Civil Suit

If the money is not recovered during the course of the case before the Magistrate or on appeal to Sessions Court, the aggrieved may file a separate Civil case for recovery of the amount under Order 37 of the Code of Civil Procedure 1908. The case will be in the nature of a summary suit which means that the defendant does not have a right to defend themselves until permission is granted by the court.

Conclusion

The laws regarding the bouncing of cheques have been pretty thorough in providing adequate means of attaining justice for the aggrieved. The directors of a company can even be held to be vicariously liable for the act of cheque bouncing. This increases accountability and encourages the growth of natural principles of law even in the corporate field.

References

1. Liability of the director of a company in cheque bouncing cases, (https://blog.ipleaders.in/liability-of-the-director-of-a-company-in-cheque-bouncing-cases/)

Further Reading

1. Dos and Don’ts in a cheque bounce case, (https://blog.ipleaders.in/cheque-bounce-dos-donts/)
2. How To File a Case Against Cheque Bounce, (https://blog.ipleaders.in/how-to-file-a-case-against-cheque-bounce/)