Nominee Directors Cannot Seek Blanket Exemption From Trial Merely Due To Their Non-Executive Status – Madras High Court

Madras High Court, in a significant ruling by Justice Senthilkumar Ramamoorthy, passed a reportable order in Company Application - addressed critical questions surrounding the liability of nominee non-executive directors in misfeasance proceedings initiated under Section 542 of the Companies Act, 1956 for alleged fraudulent conduct of business during the winding up of First Leasing Company of India Limited (FLCIL).

The court refused to strike out the names of Mr. N. Srinivasan and Mr. V. Sreenivasulu, who were nominee non-executive directors representing CDC (now British International Investment plc), from the list of respondents in the misfeasance application filed by the Official Liquidator, but vacated prior freezing orders on their personal bank and demat accounts. The ruling provides a nuanced interpretation of fiduciary responsibility, pleading standards in fraud cases, and the scope of Section 542, setting an important precedent for corporate jurisprudence in liquidation contexts.

"Being A Nominee Director Does Not Confer Immunity From Judicial Scrutiny Under Section 542" – Court Emphasises Fiduciary Accountability Even Without Day-To-Day Control

The Madras High rendered a crucial decision under Section 542 of the Companies Act, 1956, refusing to allow nominee directors to be struck out from misfeasance proceedings at a preliminary stage. The Court, however, vacated the freezing orders passed against them on the grounds of lack of prima facie material and hardship caused.

The judgment balances the need to uphold directors’ fiduciary obligations with safeguards against premature imposition of liability, particularly where pleadings are non-specific. The applicants were allowed liberty to reapply for deletion if the Official Liquidator fails to bring specific evidence during trial.

The matter arises out of Comp.A.No.276 of 2024, filed by the Official Liquidator against eighteen respondents, including Mr. N. Srinivasan and Mr. V. Sreenivasulu, seeking a declaration that the business of First Leasing Company of India Ltd. (FLCIL) was conducted fraudulently, and that the respondents were personally liable without limitation for the company’s debts amounting to ₹1,302 crore, as per the SFIO report dated 31.01.2022.

Both Srinivasan (respondent no. 9) and Sreenivasulu (respondent no. 8) had been nominee non-executive directors representing CDC. They argued that they had no operational role in the company’s management, had attended only a few board meetings, and that there were no specific allegations of fraud or complicity against them in the SFIO report or the affidavit filed by the Official Liquidator.

They sought deletion from proceedings under Order VII Rule 11 CPC (rejection of plaint), Order I Rule 10 CPC (striking out of unnecessary parties), and Order VI Rule 4 CPC (requirement of specific pleadings in fraud cases).

Scope of Section 542 – “Knowingly Party” Includes Directors Not In Management

Rejecting the applicants’ argument that Section 542 applies only to persons managing company affairs, the Court observed:

“The expression ‘knowingly parties to the carrying on of the business’ is used and this phraseology, in my view, expands the scope of subsection (1) to take within its fold all persons who were parties to the carrying on of the business… even if such persons were not formally part of the management.” [Para 33]

The Court adopted the interpretation in Re BCCI (UK) and held that the Indian provision is pari materia with Section 213 of the UK Insolvency Act, thereby rejecting the proposition that only executive directors are liable.

Pleading Standards Under Order VI Rule 4 CPC – Some Latitude For Official Liquidator

The applicants relied on Order VI Rule 4 CPC, which requires specific particulars in fraud cases, to argue that the misfeasance application lacked any definite accusations. While acknowledging the generic nature of the pleadings, the Court held:

“Unlike the typical applicant for relief before a Court, the Official Liquidator is at a distinct disadvantage… some latitude should be extended albeit by safeguarding the rights of persons accused of fraud.” [Para 31]

The Court permitted the Official Liquidator to file an additional affidavit with specific allegations prior to trial and granted the applicants liberty to respond.

Trial Is Necessary – Deletion Not Permissible At Threshold

Though it found no specific role attributed to Srinivasan or Sreenivasulu in the SFIO report or pleadings, the Court concluded:

“It cannot be said ex facie that there is no case under Section 542 against the respective applicant.” [Para 39]

The Court thus held that the matter must proceed to trial and that deletion at the preliminary stage was not permissible, especially where material documents like board minutes and investment agreements were incomplete or unavailable.

"Severe Interim Freezing Orders Cannot Continue In Absence of Prima Facie Case" – Interim Orders Vacated For Nominee Directors

Interim Orders – Balance of Convenience Favors Relief

Taking note of the ex parte freezing orders dated 09.08.2024, which restrained the applicants from dealing with their bank accounts, demat holdings, and properties, the Court found that continuing these restrictions would cause grave prejudice. It was particularly moved by Sreenivasulu’s affidavit, which stated that his life savings were frozen.

“At this juncture, in the absence of any specific allegations or any documentary evidence indicating their complicity… the balance of convenience is not in favour of continuing the interim order.” [Para 40]

Accordingly, the Court vacated the freezing orders vis-à-vis both applicants.

Key Takeaways from the Judgment

• Section 542 of Companies Act, 1956 includes nominee and non-executive directors within its ambit if they are “knowingly parties” to fraudulent business conduct.

• The Court clarified that designation alone (such as “non-executive” or “nominee”) does not shield directors from trial or scrutiny under Section 542.

• Pleading standards under Order VI Rule 4 CPC require specificity, but latitude is allowed for the Official Liquidator due to limited access to records.

• Interim reliefs such as freezing of assets must be supported by prima facie evidence, failing which they cannot continue.

• The judgment upholds the principle that mere attendance at board meetings is insufficient for conviction, but sufficient to warrant trial where fraud is alleged and fiduciary duties are invoked.

The Madras High Court’s ruling marks a significant development in Indian corporate insolvency law, especially in delineating the scope of liability of non-executive nominee directors in liquidation proceedings. By striking a balance between ensuring accountability and protecting directors from vague and unsupported allegations, the Court has paved the way for a more structured adjudication in misfeasance matters.

This judgment not only strengthens the jurisprudence under Section 542 of the Companies Act, 1956, but also serves as a caution to all board members of companies under liquidation, that fiduciary duties are not diluted by their titles or roles.

Date of Decision: 16 September 2025