Fiduciary Duties of Directors

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Fiduciary Duties of Directors

Prior to the enactment of the Indian Companies act 2013, the codified law with regards to the fiduciary duties of directors was largely silent on the said aspect, except for Section 291 which contained the provision dealing with general powers of the board of directors. Duties of directors, hitherto, were largely laid down by courts by looking at common law principles. And although the law regarding this had evolved over time through judicial decisions, there was a great degree of uncertainty. The absence of statutory law coupled with the lack of cases on directors’ duties and liabilities, posed a problematic scenario. To alleviate this situation, an attempt has been made for the first time ever in India to codify the duties of directors through section 166 of the new Act.[1] India has thus emulated other common law jurisdictions, like the United Kingdom, through codification of directors’ duties.

The J.J. Irani Committee set up by the ministry of corporate affairs, recognized the importance of inclusion of duties of director into codified law.[2] The committee was all for the codifying general duties of directors such as; “duty of care and diligence”, “exercise of powers in good faith”, “duty to have regard to the best interest of the employees”, etc.[3] Section 166 as it reads today first featured in the Companies Bill, 2011.

The Interpretational Conundrum

Section 166(2) of the Act reads as follows:”A director of a company shall act in good faith in order to promote the objects of the company for the benefit of its members as a whole, and in the best interests of the company, its employees, the shareholders, the community and for the protection of environment.” The intention of the legislature in bringing stakeholders as varied as employees, shareholders, the community and even the environment is praiseworthy. However, this section does not render the directors accountable. Thus when a legislation provides for protection of the public, the provision is rendered irrelevant when the class to which it is sought to be applied is not easily recognized.[4] A close reading of the presents section allows us to conclude that it is a motley of easily identifiable elements like shareholders and employees along with vague groups like the community. Thus it would provide a cause of action to any person from the society giving rise to a problematic and absurd scenario.

The second issue involving interpretation relates to whether the director is expected to act in ‘good faith’ for the promotion of the objects of the company or should it also encompass other groups in the sub-section.[5]Thus if it is to be said that the criterion of ‘good faith’ is restricted only to the promotion of the objects of the company then the directors must act with the belief that what is done is subjectively correct. On the other hand, while considering the interests of other stakeholders, they should act objectively.[6] It is thus essential to consider the definition of the terms ‘good faith’ and ‘best interest’ so as to determine the duty owed by the director to the varied groups of stakeholders. The term “good faith” has been defined as a state of mind which includes honesty, faithfulness, observance of reasonable commercial standards and absence of intent to defraud, and is also called ‘bona fides’.[7] To act in the best interest is the duty of loyalty requiring decision making to be motivated by an intention to serve the best interests of all the relevant interest groups.[8] The duty of care requires directors to make decisions in an informed and deliberate manner[9] and to use reasonable prudence in performing their monitoring function.[10]

It is pertinent to take note of Lord Greene’s judgment in Stone v. Ritter[11] , which weighs good faith and best interest considerations so as to balance each other, as “Directors must exercise their discretion bona fide in what they consider and not what a court may consider –is in the best interests of the company.” While acting in the best interest, a director must carefully weigh commercial interests of the company on one hand while also taking into account the safeguarding of the interests of the stakeholders, on the other. While doing so, the director must ensure that his actions conform to the standards of those of a reasonably prudent person. The duty of good faith sets a higher standard than the best interest criterion.[12] The duty of care would not be considered to have been breached even if there has been negligence in the conduct provided that it is accorded protection by the ‘business judgment rule’ or ‘gross negligence standard’[13]. If in the course of the decision-making process, a gross negligent method has been adopted, the duty of care criterion would not be held to have been violated when the result is no better than it would have been if the proper care had been taken. Thus while selling a property to his company, a director would not be held to have violated the duty of loyalty even if he sells it at a price that is at the higher end of the market price spectrum. However, the rules shall not apply to a director’s conduct if it is shown that the duty of good faith has been violated. Thus for a director’s act in violation of the duty of good faith, it would not help even if the act has the approval of the board of the company.

The best interest criterion is an objective standard. The ‘good faith standard’ sets a higher benchmark than the ‘best interest criterion’ as the additional aspect of ‘belief’ must be taken into consideration. Thus, taking a look at the various groups having an interest in the fiduciary role of the director, evinced in Section 166(2), it is evident that it represents a motley. Since the language of sub-section does not create a hierarchy between various groups, giving preference to the interests of one group over the other becomes problematic. Thus generating maximum profit for the company while might not go hand in hand with the interest of the environment or the community. Thus, reconciling the interests of all these stakeholders, at times, poses a conundrum. At such times, the director must first discharge his duty of acting in good faith, and objectively consider the interests of the various stakeholders and arrive at a decision.

The term ‘company’ finds mention twice in sub-section 2 of Section 166. This indicates that that the director owes the duty of good faith to the company while also acting in its best interests. If the said term was opted to not be used in the second part, it could have been said that there was a distinction that was sought to be made between the two duties. Thus the wordings of the sub-section coupled with the placement of the term ‘company’ is sufficient to conclude that the legislature has sought to provide primacy to the interests of the company, as a whole, over other stakeholders. While considering the question of conflict between the interests of the company and that of the environment, the court in R(on the application of People and Planet) v. H.M. Treasury[14] that it would be inappropriate for it to impose on the board, their own policy to reconcile the interests of the company while taking into account environmental and human rights consideration.

Comparative Analysis

The codification of the duties of the directors is not a novel concept. Common law jurisdictions, including but not limited to, the U.K. and Singapore, has taken steps towards codification. Notable differences, however, can be made out in the process so completed. With respect to enforceability, Section 166(7) provides for a liability to be imposed for failure to abide by the provisions of Section 166. However, the problem of lack of clarity as to how it is to be enforced remains. By virtue of Section 170, the English Companies Act makes it clear that the director owes his duty to the company. The Indian Act fails to provide such an express provision. Moreover, the Indian Companies Act fails to include a provision for providing for the applicability of common law even after codification. The counterpart statutes in other jurisdiction such as Singapore and U.K. do provide for the application of common law even after codification. This is evident from relevant portions of the codified law relating to directors’ duties that are reproduced below:

Section 170(4) of the U.K. Companies Act, 2006

 The general duties shall be interpreted and applied in the same way as common law rules or equitable principles, and regard shall be had to the corresponding common law rules and equitable principles in interpreting and applying the general duties.

Section 157(4) of the Singapore Companies Act

This section is in addition to and not in derogation of any other written law or rule of law relating to the duty or liability of directors or officers of a company.

Thus upon examination of the statutes making provisions for directors’ duties, it is evident that they remain in contrast to Section 166, as the latter makes no provision for the preservation of common law.

Conclusion

The introduction of the Companies Act 2013 is indeed a positive step towards the development of company law jurisprudence in India. The legislature, through this, has tried to make a conscious effort to bring the law in India in line with internationally accepted practices. Through Section 166(2) the legislature, apart from codifying directors’ duties has also tried to protect the interests of the stakeholders. Although this is a bit problematic due to the inclusion of diverse groups, it is still appreciable. The risk of the director being left accountable to none due to differences in interests is a cause of concern. Moreover, there is also the problem of provisions not being enforced due to lack of enforcement mechanism. Also, it is essential that the Courts now provide a clear picture with respect to the duty owed to the company against that owed to other stakeholders. Harmony must be sought to be struck between commercial considerations of the company and the interests of stakeholders. Thus the courts have been left with the unenviable task of striking such a balance as to find a middle path in reconciling the two extremes.

Frequently Asked Questions:

  • What are the fiduciary duties of Directors?

Fiduciary duties of a director refer to the highest degree of care which is expected from the person who has the power, i.e. director. That is the powers which he holds with himself shall be used in a useful manner, and not for making his own profit. However different places have different fiduciary duties criterion expected from directors. Some common duties of directors are:

a. Loyalty:

The directors of the company are expected to take decisions, which are valuable or profitable for others and not for themselves.

b. Duty of care

Directors are expected to be careful while taking any decision or giving consent to it. As they are the supreme power to exercise, therefore there is no scope for conflicts which may sometimes help in giving a decision, there it is expected from directors to take a decision with care.

c. The duty of disclosure:

As the directors of Public Company is obliged to disclose all the information to the shareholders. This disclosure allows the shareholders to vote as well as to sue if the information so disclosed are wrong. Therefore, the directors are expected to disclose the information with full care.

d. Duty to be more precautions:

Directors are expected to be more precautious. As they are superior to all, they are expected to be more precautious as even the smallest mistake can be at the question of their job. So its better be more precautions for the decisions.

  • What are the fiduciary duties of Directors towards there shareholders?

Shareholders are those individuals or groups of people who own one or more shares of the company. They are the one who plays important role in the company, and therefore the directors own duties towards them. The most common and compulsory duty which directors own are of being loyal towards their shareholders and should always make sure that the decisions so taken works profitably for the company and shareholders and not for themselves.

  • What are the fiduciary duties of directors after resignation?

As such the duty of director ends as soon as he leaves the office or gives his resignation, but there are certain duties which he owns towards the company. Like duty not to misappropriate with the companies opportunities which he has acquired at the time of his employment, that is whatever he should not misappropriate with any profit or any other thing which he has acquired in the name of the company for his own personal or economic benefit. Another duty which he owns is not to disclose any confidential information which he has at the time before his resignation. Moreover, he should also not misuse his position which he acquires when he was the part of the company.

  • What are the duties which the directors own in comparing it other country laws?

The fiduciary duties which they own are the same in all countries, but there are different laws which are binding. Like the directors in the UK unlike in the USA have a duty of care and loyalty towards their corporation, along with duty of utmost good faith an absolute loyalty. In comparison with other country, US laws are more attractive as their board of directors is governed by the State Corporate Statute, whereas in countries like the UK it is governed solely by Companies Act, 2006. Therefore every State has there own laws for the duty, but among all other duties of directors, one of the most important duties which the director own is of the Fiduciary Duty towards corporations.

Quality Check – Ankita Jha

Edited & Published by –  Sakshi Raje


[References]

[1] A Guide to Board Evaluation, The Companies Act, 2013 Series, ICSI Available at https://www.icsi.edu/portals/0/guide_to_board.pdf

[2] Report of the Expert Committee on Company Law, May 2005 (‘Irani Committee’): (2006) 1 Comp LJ 25 (Journal)

[3] Report of the Expert Committee on Company Law, May 2005 Part 3, para 18.3, p 44

[4] W. E Peel & J.Goudkamp, Winfield & Jolowicz Torts, 19th Edn. 2014 p 211

[5] Naniwadekar, Mihir and Varottil, Umakanth, The Stakeholder Approach Towards Directors’ Duties Under Indian Company Law: A Comparative Analysis (11 August 2016). NUS – Centre for Law & Business Working Paper No. 16/03; NUS Law Working Paper No. 2016/006. Available at SSRN: http://ssrn.com/abstract=2822109 (last visited 16 March 2016).

[6] Ibid

[7] Black’s Law Dictionary 713 (8th Ed. 2004).

[8] Smith v Van Gorkom, 488 A.2d 858, 872 (Del 1985)

[9] Ibid

[10] Stone v Ritter, 911 A.2d 362, 369 (Del 2006).

[11] 911 A.2d 362, 369 (Del 2006).

[12] Melvin A. Eisenberg, The Duty of Good Faith in Corporate Law, 31 Del. J. Corp. L. 1 (2006), Available

at http://scholarship.law.berkeley.edu/facpubs/737 at page 29 (last visited 11 March 2017).

[13] Ibid.

[14] R. (on the application of People & Planet) v HM Treasury (2009) EWHC 3020 (Admin).