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  • Ryan Joseph

Director's Liability under FEMA: Bridging the Gap Between Accountability and Investor Confidence

Ryan Joseph*



This article delves into the intricate landscape of director's liability under the Foreign Exchange Management Act, 1999 “FEMA”. In the first section, this article deconstructs theories of corporate liability and analyses the legislative and judicial framework surrounding director's liability for the illegal acts of their companies. The focal point of this analysis is Section 42 of FEMA. Through an inquiry of case laws, the analysis attempts to demystify the standard of involvement required to hold a director vicariously liable for a company’s contraventions under FEMA. In the second section, this article analyses a concerning trend of imposing liability on non-executive directors without adequately assessing their involvement in the contravention. Through this analysis, the article highlights the negative implications that arbitrary investigations could have on foreign investments in India and proposes a more balanced approach that prioritises the adjudicating authority’s need to investigate yet is cognizant of principles of equality and proportionality. 




A. Corporate Liability and the Controlling Mind

One of the foundational principles of corporate law is the separation of legal personalities where the directors and the corporation, as an entity, have two separate personalities. This implies that in ordinary circumstances, the liability of one cannot be imposed on the other. However, in exceptional circumstances, the corporate veil is pierced to hold the individuals behind it liable. The principle underlying lifting of the corporate veil is that the veil is an onerous gift to entrepreneurs to facilitate trade by mitigating business risks. However, when the veil is used as a subterfuge to use the corporation (or the separate legal personality) to commit illegal acts and limit one’s liability, the veil is lifted, and the controlling mind of the corporation is personally held liable for the actions of the corporation. Although this theory has great merit, the theory runs the risk of being applied arbitrarily to hold any director liable notwithstanding their actual involvement in the contravention.[1] Therefore, a careful balancing act must be undertaken when lifting the veil to ensure that only those individuals who are actually the “controlling mind” of the corporation are held liable for its illegal acts. The parts below will demonstrate the application of this theory in determining the vicarious liability of directors under Indian foreign exchange law.


B. Penalising the Controlling Mind Under FEMA

The principal penal force of FEMA comes from section 13 of the act which states that if any person contravenes any provision of Indian foreign exchange laws; such person shall be liable up to thrice the sum involved in the contravention.

However, when a company contravenes Indian foreign exchange law, it is ultimately the individuals behind the corporate veil who are contravening the law. With this recognition, section 42(1) of the Act ascribes the liability of contravention on persons who are responsible for the operations of the company. Section 42(2) of the Act extends the liability to other officers of the company with whose neglect, consent, or connivance, the contravention took place. The fundamental difference between 42(1) & 42(2) is that the former sub-section, imposes liability through a deeming fiction on persons who have control over the operation of the company, notwithstanding their involvement or knowledge of the contravention. Whereas section 42(2) imposes liability only when the adjudicating authority can show that the impugned individual facilitated the contravention. To mitigate arbitrary imposition of liability under 42(1); the proviso to the sub-section allows persons to discharge their liability by establishing that either the contravention took place without their knowledge or that they exercised sufficient diligence to prevent such contravention.


C. Judicial Temperament in Identifying the Controlling Mind

As discussed in the foregoing paragraph, Section 42(1) allows the imposition of liability on all the individuals responsible for the conduct of the contravening entity. Despite the broad purport of the section, judicial dicta have gracefully balanced the need to impute liability with equality and proportionality.

In S.M.S. Pharmaceuticals Ltd. v. Neeta Bhalla, the Supreme Court ruled that directors are not automatically liable for contravention, rather sufficient evidence must be furnished to show that the concerned person was involved in the contravention. Similarly, in Jaipur IPL Cricket Private Limited and Ors. v. The Special Director Directorate of Enforcement, Bangalore, the Appellate Tribunal prescribed a guiding principle that the adjudicating authority must bear in mind. The mere fact that certain individuals are directors of a company is not enough to impose a penalty on them. The authority must establish a nexus between the individuals and the contravention before penalising them. In this regard, judicial interpretation has crystalised the position of law in that “liability arises on account of conduct, act or omission on the part of a person and not merely on account of holding an office or a position in a company.”

As a testament to this principle, Shashank Vyankatesh Manohar v. Union of India is an interesting case in point. BCCI had allegedly violated the provisions of FEMA by remitting money without appropriate approvals. Thus, the enforcement directorate issued a show cause notice against the president of BCCI pursuant to Section 42 of FEMA. Bombay HC was cautious in holding the president liable, despite his office, and instead carefully analysed the role of the petitioner in the contravention. The court found that the petitioner had not only played no role in the operational matters of the contravention but had even told the persons in charge that appropriate approvals must be taken before any money is remitted. In the absence of active involvement in the contravention by the petitioner coupled with his exercise of diligence to prevent such contravention, the court upheld the petitioner’s plea and dismissed any liability against him.


D. Tall Must be the Curtains to Hide the Controlling Mind

On the other hand, while directors have the benefit of claiming that they have no nexus with the contravention, the onus is still upon them to dispute the existence of such a nexus. In VS Ubhaykar v. Special Director, the Bombay High Court clarified that directors cannot simply state they had no knowledge of the contravention. Rather, they must discharge this onus with sufficient documentary or other credible evidence. In this regard, courts expect a complete hands-off approach for an individual to dispute their nexus with the contravention.

The case of Jaipur IPL Cricket Private Limited concerns an issuance of shares where due to technical reasons necessary approvals could not be obtained for the issue. The adjudicating authority issued show cause notices to the directors which were then challenged. One of the appellants, argued that he was merely a minority shareholder and one amongst nine other directors of the entity. Therefore, he was not in overall control of the entity’s operations and hence ought not to be held liable. However, the court disagreed with the contention and stated that the legislative intent of Section 42 is not to merely impose liability on the ultimate controlling figure of the entity, but to caution individuals who are privy to the operations of the entity to act in compliance with the law.  Therefore, even individuals who were aware of the contravention and allowed it to happen; albeit passively, through their neglect or consent, would be vicariously liable for the said offence. 

Another case in point is Suborno Bose v. Enforcement Directorate. A show-cause notice (“SCN”) was issued to the appellant under section 42 as he was the managing director of a company that was guilty of a continuing offence under FEMA. The appellant sought to dismiss the SCN on grounds that he became the managing director long after the company contravened Section 10(6) of FEMA. Therefore, he was not responsible for the operations of the company when the contravention occurred and hence cannot be held vicariously liable for the same. Disagreeing with the appellant, the Supreme Court ruled that Section 10(6) is a continuing actionable offence. This implies that the company and its officials are liable for the said contravention till they rectify it. Although the appellant became the managing director after the contravention took place, during his tenure when the contravention was ongoing, he made no efforts to rectify the contravention despite being aware of it. Therefore, the appellant had allowed the contravention to occur through his neglect and thus the court found the appellant liable to be proceeded against under Section 42.

In conclusion, to hold officers-in-charge vicariously liable for a contravention by a corporate entity, the test is not of the title or office of the concerned individual, rather the focus is on the involvement of the concerned individual in the contravention. Furthermore, the standard of discharge of liability under Section 42 has a very high threshold in as much as directors are expected to have no involvement whatsoever in the contravention. Even the knowledge of a contravention and failure to act upon it may lead to the director becoming liable for the said contravention. 


India has a corporate practice of concentrated shareholding instead of diversified shareholding which is a common structure in developed countries. Which in practice means that the foreign investor is likely to have a minimal stake vis-à-vis the promoter who holds a substantial chunk. This leaves investors vulnerable to agency costs such as information asymmetry and concomitant inefficiencies such as poor governance mechanisms or inefficiency in operations. Adapting to these differences in capital structures, investors have developed a different strategy when investing in India. One of these differences is having strong contractually agreed investment protection structures in the form of nominee or non-executive directors. Unlike executive directors who are in charge of the daily operations of the company, the role of non-executive directors is to simply oversee the functioning of the board and to protect the interests of the investor. Despite the limited functionality of such directors, a worrying trend has been noticed in Section 42 adjudication where SCNs are frequently issued to such directors notwithstanding their limited role in the functioning of the company. 

The Appellate Tribunal of New Delhi in Pankaj Gupta v. Enforcement Directorate was adjudicating over an appeal filed by a non-executive director of a company who was charged under Section 42 for contravention of Section 8 of FEMA read with allied regulations, by the company.[2] What makes this case stand out is that the impugned non-executive director had nothing do with the operations of the company. The individual was merely an engineer appointed to develop a project who was made a non-executive director so that he could sign documents on behalf of the company instead of requiring the executive directors to travel from Mumbai to Indore every time a document had to be signed. The appellant never attended any board meetings of the company and was never involved in the operations of the company.

In a similar case, in Jaipur IPL Cricket, Ms Haldi was issued a SCN notwithstanding the fact that she was merely a nominee director who was to act on the instructions of a foreign investor. She had no role in the daily operations of the company and her scope of work was limited to providing administrative and secretarial support to the board and she had no knowledge of the impugned contraventions.


A. Commercial Impact of ED Scrutiny

Inevitably in both cases, the court sided with the appellant and dismissed the SCNs issued against them. Although non-executive directors are “directors” in the strict sense, they are fundamentally different from executive directors. They are not involved in the daily functioning of the company, nor do they exercise control over or direct any officials of the company. Their role is limited to being the eyes and ears of investors. As established in the previous section an individual can be vicariously held liable only for their involvement in the alleged contravention and not on account of their office or title. Therefore, in the absence of any active role played by such special directors, it is very concerning that the Enforcement Directorate chooses to issue SCN’s against them by holding them vicariously liable.

Commercially, issuances of SCN are taken very seriously by foreign investors who may not fully understand the nuances of Indian criminal law. Likewise, arbitrary issuances of SCNs can instil serious apprehensions in the minds of non-executive directors who are merely nominees of foreign investors. This fear could be further aggravated by the fact that many times – for instance, Ms Haldi in Jaipur IPL Cricket – even when a director files a response to the SCN, it may be rejected arbitrarily. This would require the director to initiate the appellate mechanism provided under FEMA to absolve themselves. Such measures involve the expenditure of considerable resources and add to the cost of doing business in India.

Such apprehensions may disincentivise individuals from taking up directorship positions in Indian companies. There is even statistical evidence to suggest that a growing trend of resignations exists owing to the inability of differentiating between executive and non-executive directors. This could have a concerning impact on foreign investment because board representation is a strongly negotiated right as it reduces the information asymmetry regarding the internal functioning of the company. As an obvious sequitur, foreign investors would prefer individuals who work with them to be directors and oversee the operations of Indian companies. However, if such directors fear taking up directorship posts, the cost of finding new directors would increase. Although as a commercial workaround, investors attempt to appoint “observers” instead of board members, who are not liable like a typical a director. However, the disadvantage is that observers do not having voting rights which again impacts the investment protection rights that an investor can exercise.  

Lastly, directors often take up director insurance to protect themselves against statutory liabilities. An increase in arbitrary section 42 litigation could potentially increase the premium on director insurance which would once again increase the transaction costs of investing in India. Considering India’s ambition to become a business-friendly jurisdiction, the ED’s mindset of arbitrarily imposing liability without considering the actual involvement of directors in the contravention needs a relook.

Although, from a policy perspective, it is only reasonable for the ED to issue SCNs to any individual who may reasonably be in control of the contravening company; however, it is unreasonable for the ED to not seriously consider the evidence submitted by non-executive directors that proves their non-involvement in the contravention. A more balanced approach could be found by considering the response filed by non-executive directors more seriously. A thorough investigation should be conducted and if need be, more evidence should be sought. However, before holding a non-executive director vicariously liable, the adjudicating authority should thoroughly satisfy itself of the active involvement of such directors in the contravention.

In fact precedent for such an approach already exists in Section 149(12) of the Companies Act.  Wherein, an independent director or a non-executive director shall be held liable, only for such acts which occurred with their knowledge that is attributable through the board processes. Further, pursuant to an MCA Circular, it was clarified that before serving notices to such directors, sufficient evidence must be collected to ascertain their knowledge. Further, it casts an obligation to ensure civil and criminal proceedings are not initiated unless sufficient evidence of their knowledge exists.  A more rigorous investigation before imposing liability would avoid litigation such as the ones that arose in Pankaj Gupta and Jaipur IPL Cricket.



This article analysed director's liability under FEMA. Section one examined corporate liability theories and the legal framework to identify the standard of involvement required for triggering director’s vicarious liability under FEMA. The second section addressed the concerning trend of implicating non-executive directors without a proper assessment of their involvement and highlighted the negative implications it may have on foreign investments in India. Ultimately the article concluded by proposing a revision in the adjudicating authority’s practice and the adoption of a more balanced approach.

Ryan Joseph is a 4th year BBA., LL.B. (Hons.) student at Jindal Global Law School, Sonipat.

[1] Eli Lederman, ‘Models for Imposing Corporate Criminal Liability: From Adaptation and Imitation Toward Aggregation and the Search for Self-Identity’ (2000) 4(1) Buffalo Criminal Law Review 641.

[2] Pankaj Gupta v Enforcement Directorate 2017 (349) ELT 633 (ATFE)

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