Duties & liabilities of director

0
920
Directors

Directorships are always susceptible to abuse. Here is a constant struggle to balance the personal and the company’s interest. As they are equipped with immense power by virtue of their position, it must not only be regulated in public interest but also for the protection of those who have invested and are the stakeholders. Sec 149(1) of companies act stipulates that the company should have a board of directors. ICA 2013 defines director under sec 2(34) as a director appointed to the board of directors. Majorly directors are categorized as:

Executive Directors

Whole Time Director

He is in whole time employment and looks after the overall functioning and management of the company.

Managing Director

He is the head of management who has substantial powers to control superintend and direct managerial affairs subject to the Board’s approval.

Non- Executive Directors

He is neither a Whole-time Director, Managing Director nor a nominee director.

Independent Directors

He is a non executive director with pecuniary relationship with the company, its promoters, senior management or affiliate companies, is not related to promoters or the senior management, and/or has not been an executive with the company in the three preceding financial years as defined in sec 149(6) and also as per clause 49 of the listing agreement,

Others

On the basis of the purpose of their appointment these further types of directors are recognized :

First Directors: Until directors are appointed in AGM, subscribers to MOA are the first directors.

Additional Directors: At the discretion of the board, additional directors can be appointed who will hold office until next AGM.

Alternate Director: Board may also appoint an alternate director who will act when the original director is not present for a minimum of 3 months, subject to the articles of the company.

Rotational Directors: These directors have to retire at the end of their tenure due to rotational retirement mandated as per companies act 2013.

Nominee Directors: These are appointed by certain shareholders in case of oppression and mismanagement in the company. However, their liability is not just restricted to such handful of shareholders but extends to all shareholders as a whole.

Residential Director:- These are the ones who have resided in India for at least 182 days in an immediately preceding year.[1]

Directors are pioneers of the institution they represent. They are accoladed with lots of powers and with power comes liability and duty too. Many of such powers, duties, liabilities have been codified into statute. The rest of them being developed by the courts over hundreds of years forming the common law rules and equitable principles applicable today.

General duties applicable worldwide

The duty of good faith

The directors should act in the best interest of the company, interest herein implies the interest of present and future members of the company, given the going concern principle. They should not exploit corporate opportunities to their own personal benefit resulting in secret profits.[2] The good faith would require that all the endeavours of the directors must be directed to the benefit of the company.[3]  Greatest good faith is expected in a discharge of their duties.[4] 

It has been held that men who are in complete control of a company’s business must not take the company’s interest at liberty as they are bound to protect the same.[5] Recently the Delaware Supreme Court ruled out to postulate the character of the duty of good faith wherein it was made clear that negligent conduct is different from conduct in bad faith because statutory provisions differentiate between the two. If the conduct is in absolute disregard with duties and responsibilities then it would constitute bad faith. Mere failure to act in good faith does not impose fiduciary liability, as it is a subsidiary element of duty of loyalty.[6]

Duty of care  

Director by virtue of his esteemed position should take utmost care and due diligence while working in the best interests of the company. However not more than what an ordinarily prudent man would have done can be expected out of him. The duty of care is uniform for all directors.[7] Such care need not be extraordinary in nature. This degree of care and skills shall vary with the nature of the business.[8] However, courts have extended relief where liability has been incurred even after acting in good faith. They are not to be held liable for mere errors of judgement.[9]         

Duty not to delegate 

As directors are agents of the company, they already have delegated a power which cant be delegated any further. They are bound by the maxim delegates non potest delegare.It is their skills and judgement on which shareholder rely and the same would get diluted when delegated but there are many exceptions where delegation is permitted subject to the company law and the articles of association. Subsequent to the delegation, if there is no suspicious activity, there is a presumption that affairs of the company are properly conducted.[10]

Duty to act honestly 

Directors hold the office of trust from where entails a duty to perform truly. Directors have an obligation to act with honesty since they hold a fiduciary position of trust.[11] They should be held liable for astraying from duties if that has culminated into frauds and losses.[12]

Sec 166 of companies act 2013 wherein various elements have been stated like:

How Director Shall Act

The law in subsection {1} stipulates that a director shall act according to the article of association of the company. Although this does not mandate any specific laying down of the duties if that is so, it will be a desirable provision.

Acting In Good Faith and in Best Interest

The next subsection {2} provides that a director shall act in good faith. This encapsulates a great amount of subjectivity but at the same time should be seen from an ordinarily prudent man’s perspective. It has also been held that all efforts of directors must be directed towards benefiting the company.[13] Pertinently, a wide coverage has been made by usage of both the terms “members” as well as “shareholders”. “Members are those persons who agree in writing to become members and whose names are entered in the register of members or whose names are entered as beneficial owners”.[14]Necessarily it does not follow that all shareholders are members and vice versa.

Acting with Care, Skill & Independent Judgement

Subsection {3} goes on to lay down that the director shall exercise his duties with due and reasonable care. Although there is a great subjectivity involved here the touchstone for the same can be that of what a reasonable would do in given circumstances. Further, an exercise of the independent judgment indicates that there should be no external influence, he should have complete freedom to reach to his judgement.

No Conflict of Interest

The following subsection {4} stipulates that a director should avoid conflict of interest. This prescribes that a director should not get involved in such a situation where conflict may arise in his personal interest and the company’s interest. Whenever any such kind of situation arises, precedence should be given to the company’s interest over his personal interest.

No Undue Gain or Advantage

The provision of the subsection {5} stipulates that no personal benefit should be made out of the company’s business neither it should be accrued to director’s relatives, partners, associates.

This section also provides for disgorgement of gains as the intent behind this is that there should not be any loss to the company.

No Assignment

Subsection {6} prohibits the transfer of the office’s rights to another person. He cannot assign his office, and if done it shall be void.

Contravention

The last subsection {7} lays down the penal provisions where a director contravenes the section. Such director shall be punishable with fine which shall not be less than one lakh rupees but which may extend to five lakh rupees.[15] Although this attracts a penalty it does not ask for the vacation of office u/s 167 of Companies Act 2013.

Liabilities of Directors                                              

Along with duties, liabilities accompany, liabilities can also be statutory liabilities as provided in specific statutes, it can also be general duties which are applicable to all uniformly. They can be :

Liability to the Company

The liability of a director could arise in the following manner :

  • Breach of fiduciary duty: As the directors hold the office of trust along with power they are expected to exercise this power in the best interest of the company. Whenever there comes dishonesty in fulfilling this duty, there is a breach of fiduciary duty. There is always a possibility of a conflict of interests but should such a conflict arise the concerned director should make complete disclosure and try to obtain the confidence of stakeholders in the general meeting. If such is not a case then it shall be held as a breach of fiduciary duty and he will be liable for indemnification to the company.[16]It has been held that directors being the trustee have to deal with business and its property the way they treat their own personal property and interest.[17]
  • Ultra vires act: Directors have powers subject to Companies Act, Memorandum and Articles of association. Whenever they exceed these limits they are personally liable for the act being ultra vires. But if acts are intra-vires the company such acts can be subsequently ratified by the shareholders in the general meeting, otherwise, if a company suffers a loss on ultra-vires acts of its directors, the company can claim such loss from the directors.[18]
  • Negligence: As long as the Directors exercise reasonable care and due diligence, they are fulfilling their duties to the company. But as soon as there is the failure to exercise such care and precaution they are deemed to be negligent in their conduct and are personally liable for the consequent damages. However, the error of judgement will not be deemed as negligence.[19] “Business runs on a going concern, which will not be possible if people doubt every step of the trust holders or office holders.”[20]
  • Mala fide acts:  Directors are the trustees for the money and property of the company. They hold an office of trust and if they misuse their powers they will be liable for breach of trust and may be required indemnify the losses incurred due to.they need to make regular disclosures on their profits, if any, earned in course of the performance of duties. Director can also be held liable for misconduct, provided it is not willful.  

Liability to third parties 

The directors as agents of the company are not most of the times personally liable to third parties for any transaction entered on behalf of the company. Their acts bind the company to third parties. Generally, the rule is that wherever an agent, in a principal- agency concept liable, directors would be liable. They can be held personally liable only in exceptional circumstances  when they contract in a personal capacity, or when the principal is not disclosed, or when it is a pre-incorporation contract or when the contract is ultra vires the company and is not ratified subsequently

Positioning  Directors duty in International Paradigm

Different countries have adopted different approaches to addressing the conundrum of duties and liabilities of Directors. In the UK directors are given full discretion to run the companies. Essentially directors are here deemed to have contractual powers according to which they can enter into any profitable contract that they deem fit for the company. Thus they act in the capacity of agents whereas, in the US, directors are neither “agents” of the corporation nor of the shareholders. They have a fiduciary relationship according to which they have to manage the corporation.

Directors owe duties of care and loyalty to their corporation. They also owe a duty of absolute loyalty and utmost good faith. Prime difference between US & UK law is that in the latter  the duty  is owed as a whole to the corporation instead of owing it directly to the shareholders However, an in-depth analysis shows that the duty of directors duties in the UK is basically a duty to their shareholders, but the way of interpretation has brought this difference. The duty herein is owed to shareholders as a body and not to individual shareholders[21] which is well evident now in sec 170 of their companies act 2006 On the other hand as far as the duty of loyalty is concerned, directors have acted in the best interest of their company accompanies with good faith. Although this case is considered to be a good law and followed throughout the same has been dissented within subsequent cases wherein it was held that in circumstances where a shareholder has solely relied on the director’s guidance, a director may owe a greater duty to an individual shareholder.[22]

The American business judgement rule focuses more on procedure than on result whereas in U.K there is an objective test to determine bad faith or good faith transactions. It’s only incomplete irrationality that directors are made liable for business decisions in America.

Finally, U.K jurisprudence requires that directors should act in such a manner that there exists no conflict of interests and also no personal advantage could be taken by virtue of their position. Here the defence of business judgement rule is ineffective when there is a violation of the duty of loyalty. They are better known here by the name of ‘The no- conflict rule’  and ‘The no-profit rule’ respectively.

Critical analysis of sec 166

Codified duties of directors is not a new concept. Its been since long that countries like the UK, Singapore have done codification. .Section 170 of the English Companies Act stipulates that the director’s duties are directed towards the company. The Indian Act fails to provide such clarity, due to which there still remains confusion as to whom the directors own such duties primarily, company or the shareholders.

Companies Act 2013 is a revolution in corporate law development in India. The legislature, through this, has tried to bring the Indian corporate law in International paradigm. Although the inclusion of diverse groups makes it a bit complex still the efforts to serve the interest of stakeholders and society at large is applaudable. The major cause of concern is the unaccountability of directors due to differences in interests. Moreover, there is an immediate need to demarcate the duties owed to the company against that of stakeholders. There must be harmonious construction between commercial considerations of the company and the interests of stakeholders. Thus the courts have been left to strike such a balance so as to reconcile the differences in two extremes.

Also, it becomes pertinent to define good faith and best interest in order to gauge the difference between the two. Good faith is “bona fide state of mind which includes honesty, faithfulness, observance of reasonable commercial standards and absence of intent to defraud”. Best Interest, on the other hand, involves the duty of loyalty with an intention to equitably serve the best interests of all concerned.  

In Stone v. Ritter[23]it was held that directors must exercise their prudence in carrying out the company’s operations, regardless of what the court may consider the best interest. Directors should ordinarily balance out commercial interest and shareholder’s interest on the scale of an ordinarily prudent person. The duty of good faith somehow acquires higher precedence than the best interest due to the additional element of ‘belief’. It sets a higher benchmark as a director acting in violation of good faith could not be saved by ‘business judgement rule’ even if the act has the approval of the board of the company. 

There is a lot of objectivity involved in the best interest criterion. The ‘good faith standard’ places itself on a higher platform as it includes belief too. Since the verbatim of section 166 of Companies Act 2013 does not create a hierarchy between various groups, priority selection creates an enigma. Sometimes maximization of profit may not go hand in hand with environmental interest. Reconciliation of such interest poses serious problems and at such times, the director must take into consideration of all stakeholders and discharge his duty of acting in good faith, to arrive at a decision.

The mentioning of the term ‘company’  twice in section 166(2) evidently suggests that the director owes a duty of good faith read with best interest criterion. A distinction between the two terms could have been presumed had the term not been used in the second part. This results in a conclusion that the legislature intends to put interests of the company, as a whole, over other stakeholders.

Conclusion

Companies, by their very nature, incapable of acting on its own despite having a separate legal entity. This is where comes the role of directors who are akin to the company’s guardians. In acting in such a capacity they are expected to work in the best interest of the company and its shareholders and not in their personal interest- contra naturam suam.

This conflict of interest creates myriad conundrums leading to various interpretations. In light of the same, there emerges an immediate need to analyse the duties and liabilities of directors apropos American and British jurisprudence. Under custom-based law rules and even-handed standards, executive’s obligations are to a great extent gotten from the law of office and trusts (i.e., set of authoritative, semi-legally binding and non-legally binding trustee associations with the Organization). Under the law of office, obligations of aptitude, care and persistence are forced on executives. Then again, the law of trusts force trustee obligations on chiefs. As needs are, directors are the trustees of the organization’s cash and property, and furthermore, go about as specialists in the exchange which they go into in the interest of the organization. Executives are at risk as trustees for rupture of trust, on the off chance that they twisted the assets or submitted break of byelaws of the organization. 

A director is relied upon to play out his obligations as a sensibly persevering individual having the information, ability and experience both of an individual completing that director’s capacity also, and of that individual himself. An executive, along these lines, assume different jobs in the organization, let it be of a specialist, a representative (when designated on the rolls of the organization), an officer and additionally a trustee of the Organization. Thereby wide interpretation needs to be given so as to include each and every dimension of this duty.

Frequently Asked Questions(FAQ’S)

1. Why is there a need for including duties of directors in statutes?

They were an instant need to define them to bring objectivity. This will give less discretion to the courts to decide whether there is a breach or not, rather they will have to decide it according to the set criteria.

2. What is the role of directors in a company?

The board of directors‘ key purpose is to ensure the company’s prosperity by collectively directing the company’s affairs, whilst meeting the appropriate interests of its shareholders and stakeholders

3. What were the duties of directors in companies act 1956?

  • The duty of good faith
  • The duty of reasonable care
  • Duty to attend board meetings
  • The duty of personal attendance
  • Duty to disclose interest

4. Whether directors share a fiduciary relationship with co. in India? 

Yes, Fiduciary Duty of Good Faith and Fair Dealing. This fiduciary duty is closely aligned with the duties of care, loyalty, and obedience. Under this duty, officers and directors must act with honestygood faith, and fairness when handling corporate obligations

5. What is the consequence of the non-performance of directors duties? 

If a director of the company contravenes the provisions of this section such the director shall be punishable with fine which shall not be less than one lakh rupees but which may extend to five lakh rupee.

Edited by – Sakshi Agarwal

Approved & Published – Sakshi Raje

Reference

[1] Section 149(3) of Companies Act,2013.

[2] Cook v. Deeks {1916} 1 AC 554

[3] Bank of Poona Ltd v. Narayandas, AIR 1961 Bom 252 at 253

[4] Turner Morrison & Co v Shalimar Tar Products {1980} 50 Comp Cas 296 Cal.

[5] Supra, at 1.

[6] Stone v. Ritter 911 A.2d 362 (Del. 2006).  

[7] Jorchester Finance Co Ltd v. Stebbing 1989 BCLC 498 Ch D

[8] In re city fire insurance, City Equitable Insurance Co, (1925) Ch 407

[9] Lagunas nitrate co. vs lagunas nitrate syndicate [1899] 2Ch.392 (p.428, C.A.)

[10] Ganesan v. Brahamaya & Co {1946} Comp LJ 262 Mad                             

[11] York and North Midland Railway Co v Hudson (1853) 61 Beav 485: 22 LJ Ch 529

[12] Official Liquidator v. P.A. Tendulkar {1973} 43 Com cases 382

[13] Turner Morrison & Co v. Shalimar Tar Products 1980 50 CompCas 296 Cal.

[14] Section 2 {55} of the Companies Act 2013.

[15] Section 166(7) of Companies Act 2013.

[16] In P. K. Nedungandi v. Malayalee Bank Ltd  A I R (1971) SC 829.

[17] Fleming Spinning and Weaving Co Ltd v. Naik 9 Bom. 374.

[18] Aggarwal V.S The Company Directors (1983).

[19] Re Brazil Rubber plantations and Estates Ltd, (1911) 1 Ch.425

[20] Dovey v. Cory [1901] AC 477.

[21] Percival v Wright [1902] 2 Ch 401.

[22] Coleman v Myers [1977] 2 NZLR 225[2] ; Peskin v Anderson [2001] BCLC 372[3]. 

[23] 911 A.2d 362 (Del. 2006).

Previous articleOppression & Mismanagement
Next articleSignificant Beneficial Ownership
Shipra Sayal
I am Shipra Sayal from Nirma University, Institute of Law pursuing B.Com LLB (Hons.) Corporate law, Company law and Securities law form part of my core interest area. I love to keep myself updated with news, law and politics. I participate in Moots and Trial Advocacy competitions. My leisure time activities are playing badminton and cricket. I also enjoy watching sci-fi series and movies. I love to read, write and research as this helps a lot in shaping one’s personality and honing skills. I believe in smart work and efficient time management to get success at any work