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The management of a company operates under a delicate balance between its board of directors and its shareholders, who act as risk bearers. As an artificial legal person, a company relies on its board of directors to function effectively and in compliance with the law. Directors have a legal obligation to act in the best interests of the company. However, their liability – especially criminal liability – becomes complex in cases where a company undergoes insolvency resolution.
This article analyzes the legal framework governing the criminal liability of directors, particularly in cheque dishonour cases under the Negotiable Instruments Act, 1881 (NI Act), and examines how insolvency resolution proceedings under the Insolvency and Bankruptcy Code, 2016 (IBC) impact such liability.
The dishonour of a cheque is a criminal offence under Section 138 of the NI Act. This provision seeks to prevent fraud and ensure financial accountability by imposing liability on individuals who issue cheques without sufficient funds. Section 141 of the NI Act extends this liability to directors and officers of a company who were in charge of its business at the time of the offence.
In S.M.S Pharmaceuticals Ltd. v. Neeta Bhalla1, the Supreme Court held that directors can only be held liable under Section 141 if they were actively responsible for the company’s affairs at the time of the cheque dishonour. Independent and non-executive directors (NEDs) can escape liability if they were not involved in the company’s day-to-day management.
The IBC provides a moratorium under Section 14, which prevents the initiation or continuation of legal proceedings against a corporate debtor during the resolution process. The Supreme Court, in Vishnoo Mittal v. M/s Shakti Trading Company2, reaffirmed that criminal proceedings under Section 138 of the NI Act cannot be sustained if a moratorium is imposed before the cause of action (expiry of the demand notice period of 15 days) arises.
However, the moratorium under IBC only protects the corporate debtor, not its directors. In P. Mohanraj v. Shah Brothers Ispat Pvt. Ltd.3, the Supreme Court clarified that while the moratorium applies to the corporate debtor, the natural persons associated with cheque dishonour (such as directors) continue to remain liable. However, if the cause of action arises after the imposition of the moratorium, criminal proceedings cannot be initiated.
The liability of independent and non-executive directors for cheque dishonour is a contentious issue. In K.S. Mehta v. M/s Morgan Securities and Credits Pvt. Ltd.4 (2025), the Supreme Court ruled that NEDs cannot be held vicariously liable under Sections 138 and 141 of the NI Act unless there is a specific allegation regarding their involvement in the company’s financial decision-making.
This judgment strengthens corporate governance by ensuring that independent directors are not wrongfully prosecuted for decisions they did not influence. It reinforces the principle that corporate liability should not automatically extend to individuals unless their role and responsibilities in the company justify such liability. This protection encourages independent professionals to take on board positions without fear of unwarranted litigation, fostering better governance and accountability in corporate India.
The Companies Act, 2013, and the IBC impose distinct but complementary obligations on directors. While the Companies Act outlines directors’ duties throughout a company’s operational life, the IBC focuses specifically on insolvency resolution and creditor protection.
These laws collectively ensure that directors act responsibly, particularly in times of financial distress. The IBC focuses on financial recovery rather than criminal punishment unless fraud is involved.
The Supreme Court’s rulings clarify that criminal liability under Section 138 of the NI Act does not automatically cease after resolution proceedings under IBC. While the moratorium under IBC prevents legal action against the corporate debtor, it does not absolve directors of personal liability unless the cause of action arose after the moratorium’s imposition. Furthermore, independent and non-executive directors cannot be held liable unless their direct involvement in the company’s affairs is proven.
This legal framework strikes a balance between financial accountability and protecting individuals from wrongful prosecution. It ensures that directors who are responsible for financial misconduct are held accountable while safeguarding independent directors from undue litigation. By maintaining this balance, the Indian legal system upholds corporate governance principles and fosters investor confidence in the business environment.
