Recovery Against Directors of Companies in Liquidation (Section 88)

Recovery Against Directors of Companies in Liquidation (Section 88)

1. The Core Dispute: Vicarious Liability vs. Liquidation Control

The Revenue initiated recovery proceedings against the individual directors of a company undergoing liquidation by attaching their personal bank accounts. The demand pertained to arrears of interest and penalty that remained unpaid after the principal tax amount was recovered from the company’s electronic credit ledger.

• Directors’ Argument: They were no longer in control of the company’s affairs, as a Liquidator had been appointed. They contended that under the Insolvency and Bankruptcy Code (IBC) and GST law, recovery should be sought through the liquidation process, not directly from their personal assets.

• Revenue’s Stand: The department invoked the principle of vicarious liability, claiming that directors are jointly and severally liable for the company’s dues if they cannot be recovered from the entity itself.

2. Legal Analysis: Section 88 and Procedural Safeguards

The Court examined the boundaries of Section 88, which governs the liability of directors when a company is in liquidation.

I. Prerequisites for Director Liability

Under Section 88(3), directors of a private company are personally liable only if:

1. The tax, interest, or penalty cannot be recovered from the company.

2. The non-recovery is attributable to gross neglect, misfeasance, or breach of duty on the part of the director.

II. The Role of the Liquidator

Once a liquidator is appointed, the company’s assets are no longer under the directors’ management. The Revenue’s primary course of action is to file a claim with the Liquidator (Official Liquidator or IRP).

• The Ruling: Recovery cannot be initiated against directors until it is definitively established by the Liquidator that the company’s assets are insufficient to cover the dues.

3. The Ruling: Quashing of Bank Attachment

The Court held that the attachment of the directors’ personal bank accounts was premature and unjustified.

• Recovery from Credit Ledger: Since the principal tax had already been recovered from the company’s ledger, the pursuit of interest and penalty from the directors’ personal funds—while the company was still in the hands of a liquidator—lacked legal basis.

• Natural Justice: The directors were not given an opportunity to prove that the non-payment was not due to their negligence.

• Outcome: The attachment orders were ordered to be vacated. The directors were granted liberty to file applications to officially extricate themselves from the liability.

Key Takeaways for Directors

1. Not an Automatic Liability: Director liability is a “secondary” recovery measure. The department must first exhaust the “primary” remedy of claiming against the company’s assets in liquidation.

2. Burden of Proof: If the department attempts recovery, the burden is on the director to prove they acted with due diligence and that the company’s failure to pay was beyond their personal control.

3. Writ Remedy: If your personal accounts are frozen for a company’s GST dues during liquidation, you can challenge the action as a “draconian measure” that bypasses the IBC and Section 88 procedural safeguards.