Corporate failures in the recent past such as Satyam, Sahara, Kingfisher brought out the fact that the Companies Act, 1956 (“1956 Act”) which existed over a period of 50 years was ineffective at handling some of the present day challenges of a growing industry and interests of increasing classes of sophisticated stakeholders. The Companies Act 2013 (“2013 Act”) has been enacted with a view to meeting the present day challenges of corporate governance arising from stakeholders’ expectations. The 2013 Act has ushered in a new era of corporate governance, by increasing the roles and responsibilities of the board, protecting shareholders' interests, bringing in a disclosure based regime and built in deterrence through self-regulation.
The 2013 Act has introduced several measures which have the effect of considerably enhancing the duties and liabilities of directors and imposition of stringent penal provisions in case of breach of any statutory provisions. While some of the requirements already existed for listed companies as part of the Listing Agreement, the new requirements under the 2013 Act apply to all companies. This article provides an insight on the duties and liabilities of the directors under the 2013 Act and the practical measures which may be adopted by them, for complying with these duties.
Meaning of the term “director”
The term “director” has been defined under Section 2 (34) of the 2013 Act to mean a director appointed to the board of a company.
The 2013 Act provides for different categories of directors, including, whole time directors, managing directors, independent directors, nominee directors, alternate directors and women directors.
The 2013 Act for the first time recognizes the concept of an independent director (though the Listing Agreement provided for the same). The term ‘independent director’ means a director other than a managing director or a whole time director or a nominee director and who fulfills certain other criteria (such as relevant expertise, experience, integrity etc) as provided under Section 149 of the 2013 Act.
Also, there is a new requirement under the 2013 Act to mandatorily appoint atleast one women director for certain categories of companies (being listed companies and certain categories of public unlisted companies).
Directors’ duties under Section 166
The 2013 Act has now codified directors’ duties (similar to the UK Companies Act) under Section 166. The provisions of this Section apply to all categories of directors, including independent directors.
Section 166 of the 2013 Act stipulates the following:
Subject to the provisions of this Act, a director of a company shall act in accordance with the articles of a company.
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.
A director of a company shall exercise his duties with due and reasonable care, skill and diligence and shall exercise independent judgment.
A director of a company shall not involve in a situation in which he may have a direct or indirect interest that conflicts, or possibly may conflict, with the interest of the company.
A director of a company shall not achieve or attempt to achieve any undue gain or advantage either to himself or to his relatives, partners or associates and if such director is found guilty of making any undue gain, he shall be liable to pay an amount equal to that gain of the company.
A director of a company shall not assign his office and any assignment so made shall be void.
The duties set out in this Section are not exhaustive. Apart from the duties set out in Section 166, directors are also responsible for various obligations provided under other Sections of the 2013 Act. For example:
The board needs to lay the financial statements for approval and adoption at the annual general meeting of the shareholders (Section 129);
The directors are responsible for devising proper systems to ensure compliance with the provisions of all applicable laws and to ensure that such systems are adequate and are operating effectively (Section 134);
Director needs to ensure that the company complies with obligations relating to corporate social responsibility provided under Section 135;
The board is responsible for appointing first auditors (Section 139);
A director needs to disclose his interest in a contract with the company (Section 184);
A director is prohibited from engaging in forward dealing of securities (Section 194);
The board is responsible for appointment of whole time key managerial personnel (Section 203);
The directors are responsible for issuance of notice ad holding of board meetings and general meetings etc.
Reiteration of common law principles
The duties which have been listed in Section 166 are essentially codification of the existing equitable and common law principles of the fiduciary duties of directors. These duties have been already laid down by the courts in several of its judgments under the 1956 Act.
The purpose of codification seems to provide all directors with access and to enable them to understand their basic duties easily.
The scope of duties under Section 166 is reliant on subjective tests and could be open to wide debate. The courts will need to refer to standards laid down by the various judgments delivered under the 1956 Act, when determining whether or not a breach of duty has occurred. Accordingly, the courts will need to rely on ‘reasonability test’ and will need to consider the facts and circumstances of each case, whilst pronouncing judgment.
Balancing conflict of interests
Under the 1956 Act, a director’s primary duties were to the company and its shareholders. Although employees and creditors interests were recognized in matters pertaining to insolvency, but the law was settled that a director should primarily act in the best interests of all shareholders. With the 2013 Act, there is an attempt to shift the focus for directors from looking solely at shareholders’ interests to taking account interests of other stakeholders as well. Though the idea may seem convincing from a corporate governance perspective, several practical difficulties could arise. For example, no guidelines for order of preference have been provided and accordingly, it is not clear whose interests should take precedence in case of conflicting interests. Thus, in such situations, would it be prudent for a director to act in the interest of employees ignoring the interests of the shareholders?
Also, since the 2013 Act also requires the director to take into account environmental and community concerns, will an interpretation that a director who is on the board of a tobacco company or cigarette manufacturing company is in breach of the provisions of the 2013 Act right from day one, hold good?
Further, this provision would also have a significant impact on nominee directors. In exercising their fiduciary duties, nominee directors often seek instructions from the appointing shareholder in relation to decisions that need to be taken, for example, the manner in which to vote during a particular resolution. It would be difficult for a nominee director to act where the instructions of his nominating shareholder run inconsistent with the interests of a class of stakeholders.
Such practical situations would make balancing act difficult for directors. To minimize risks, the board should consider seeking inputs from its different categories of stakeholders to identify what stakeholders believe may be an appropriate course of action.
Apart from the duties mentioned above, which are applicable to all directors, independent directors are also additionally required to comply with code of conduct specified under Schedule IV of the 2013 Act.
The Schedule has stipulated 13 (thirteen) different duties to be performed by an independent director. Some of these duties include:
Regularly updating and refreshing the skills, knowledge and familiarity with the company.
Strive to attend and participate actively in all meetings of the Board and the committees and general meetings.
Keeping well informed about the company and the external environment in which it operates.
Not to unfairly obstruct the functioning of a proper board or committee.
To pay sufficient attention and ensure that adequate deliberations are held before approving related party transactions and assure himself that the same are in the interest of the company.
To ensure that the company has an adequate and functional vigil mechanism and also to ensure that the interests of a person who uses such mechanism are not prejudicially affected on account of such use.
Not to disclose confidential information, including commercial secrets, technologies, unpublished price sensitive information, etc., unless such disclosure is expressly approved by the board or is required by law.
Apart from the duties, the Code also covers other aspects, such as it provides guidelines for professional conduct, role and functions of independent directors, manner of appointment, reappointment, resignation/removal, need for separate meetings of independent directors and evaluation of independent directors by the entire board.
As seen from the above, various duties and responsibilities have been cast on independent directors, including protecting interests of minority shareholders, harmonizing conflict of interests of stakeholders, acting as a mediator in cases of conflicting interests etc considering the importance of their role from a corporate governance perspective.
Concept of ‘officer in default’
As provided under the 1956 Act, the definition of the term “officer in default” includes directors. Various penal provisions in the 2013 Act, which seek to penalize a company’s officers would accordingly include company’s directors and charge them for offences committed under the Act.
The term “officer who is in default” has been defined under Section 2 (60) of the 2013 Act as:
“officer who is in default for the purposes of any provision in this Act which enacts that an officer of the company who is in default shall be liable to any penalty or punishment by way of imprisonment, fine or otherwise, means any of the following officers of a company, namely –
(vi) every director, in respect of a contravention of any of the provisions of this Act, who is aware of such contravention by virtue of the receipt by him of any proceedings of the board or participation in such proceedings without objecting to the same, or where such contravention has taken place with his consent or connivance.”
It is pertinent to note here that the term ‘officer in default’ now seeks to implicate every director (including nominee director) who is aware of the contravention. He need not even participate in any meetings of the board, but if the information as to a contravention is contained in any of the proceedings of the board received by him, he is deemed liable. Also, in view of the aforesaid provisions, a director needs to ensure that any objection raised by him at a board meeting is duly recorded in the minutes.
Liability of directors
Contravention of provisions of Section 166 (relating to codified duties) is punishable with a fine which shall not be less than Rs 1 Lakh but which may extend to Rs 5 lakhs.
Further, penal provisions throughout the 2013 Act have been made more stringent and provide for increased penalties as compared to the 1956 Act. On an average, the minimum amount of fine that is imposed under certain Sections is Rs 25,000 which in certain cases extends to Rs 25 crores or even more. Set out below is the list of few contraventions, where the penalties are Rs 1 crore or more:
Violation of provisions relating to not-for-profit companies (Section 8);
Violation of provisions relating to subscription of securities on private placement (Section 42);
Issue of duplicate share certificates with an intent to defraud (Section 46 (5));
Failure to repay deposits within specified time (Section 74 (3));
Contravention of provisions relating to insider trading (Section 195 (2)).
Apart from monetary penalties, certain offences even attract imprisonment. Most of the offences leading to imprisonment under the 2013 Act are non-cognizable (that is would need warrant to arrest) but there are certain serious offences which are cognizable in nature and would not require a warrant to arrest. These offences are mainly connected to fraud or intent to defraud. Some of such offences are listed below:
Furnishing of any false or incorrect particulars of any information or suppressing any material information in any of the documents filed with the Registrar of Companies in relation to the registration of a company (Section 7 (6);
Including in the prospectus any statement which is untrue or misleading in form or context in which it is included or where any inclusion or omission of any matter is likely to mislead (Section 34);
Fraudulently inducing persons to invest any money (Section 36);
Default under Section 56 relating to transfer and transmission of shares with an intent to defraud;
Offences relating to reduction of share capital (Section 66).
The company has the right to initiate legal action against directors, in case of breach of their duties. Apart from this, the 2013 Act has also introduced the novel concept of ‘class action suits’ under Section 245. Under this concept, a group of shareholders (constituting a minimum of 100 shareholders or such minimum percentage of total shareholders as may be prescribed) can bring an action on behalf of all affected parties, against the company and/or its directors, for any fraudulent or wrongful act or omission of conduct on its/their part. Further, the 2013 Act proposes to set up a National Company Law Tribunal which is expected to provide speedier and more efficient remedy.
Apart from the 2013 Act, there are several other statutes, such as Negotiable Instruments Act, Consumer Protection Act, which lay down increased liabilities on directors. In case of default on the part of the Company, there are several instances where the complainant as a strategy, would make all the directors party to the suit, to put pressure on the company. Once a director is made a party, he will have to go through the time consuming and cumbersome court procedures to prove his innocence. This will no doubt cause lots of hardship and inconvenience to an innocent director.
Exemptions for independent directors
Section 149(12) of the 2013 Act, inter-alia, states that notwithstanding anything contained in this Act an independent director shall be held liable, only in respect of such acts of omission or commission by a company which had occurred with his knowledge, attributable through Board processes, and with his consent or connivance or where he had not acted diligently. This carve out has been provided to independent directors considering the limited degree or involvement of an independent director in the day to day affairs of the company.
The term ‘attributable through Board processes’ would normally be interpreted to mean that a director would be deemed to have knowledge of all matters that are taken at the board level. However, the term is not clearly defined and accordingly would be open to judicial interpretation and uncertainties. Further, the term ‘knowledge’ is also subjective and would be open to judicial interpretation.
Since now the Act would hold independent directors for any action taken with their consent, it would be extremely important for independent directors to be extremely cautious when it comes to giving consent to any proposal. Else, they will have to be prepared to face the consequences of their actions.
Further, although, the law is attempting to limit the scope of offences in respect of independent directors, at the time of prosecution, all directors irrespective of their category are issued summons. Thereafter, the burden of proof lies on the independent director to prove that he was diligent in the discharge of his duties and that he had acted in a bona fide manner. However, till such a conclusion is drawn, the independent director suffers a lot of inconvenience and embarrassment.
Considering the importance attached to their role, it is important that independent directors act in a more proactive manner, attend board meetings regularly and question all decisions which appear inappropriate.
The 2013 Act has endowed directors with enhanced duties and liabilities, to make them more accountable and be personally liable in case of wrongs committed by them.
Considering the stringent penal provisions imposed even for not so grave non-compliances, it is necessary that directors adopt an extra cautious approach. They will need to ensure that they always act in the best interest of all stakeholders. Even a slight laxity on their part may be a good reason to put them behind bars. Here are some of practical recommendations which directors may find useful, whilst discharging their duties:
All directors (including independent directors) need to attend as many board meetings as possible to ensure that they are fully aware of the company’s business. For improving attendance, they may consider proposing that the company should at the beginning of each year, tentatively set up agreed dates, timings and venues for meetings of the board and committees (except in exceptional circumstances).
Directors should read all necessary papers and relevant background information made available to them for meetings to enable their meaningful participation and contribution.
Directors must ensure that any questions raised by them in a board meeting or any dissent expressed is properly recorded in the minutes of the meeting so as to provide prima facie evidence, in case the role of the director is questioned at any time.
Directors (especially new directors) need to ensure that they receive appropriate training on governance and directors’ legal duties.
Directors need to ensure that they take legal advice, in cases of doubt.
Directors need to ensure that they have obtained directors’ and officers’ liability insurance to provide them with some degree of comfort.
Becoming a company director has become a very serious business and should not be undertaken lightly or unadvisedly. If you are invited to become a company director or are already a director, it is very important that you understand your duties and responsibilities and the potential consequences of their breach.
Views of the authors are personal, and should not be considered as views of Khaitan & Co.
Rabindra Jhunjhunwala, email@example.com
Rabindra Jhunjhunwala is a Partner at Khaitan & Co, Mumbai office. He specialises in domestic and cross border mergers and acquisitions, private equity investments, transactional documentation work and advises on all aspects of foreign investments (both inbound and outbound) and regulatory approvals. He has advised several multinationals and Indian companies on complex and big-ticket M&A transactions.
Rabindra has been acknowledged for his experience and expertise and been recommended by several leading publications including IFLR, Asialaw, Chambers and Partners, Legal 500 and PLC Which Lawyer? for Corporate/M&A work. Meritas, an international alliance of law firms, also honoured Rabindra in April 2009 for his distinguished service to the organisation.
Stuti Galiya, firstname.lastname@example.org
Stuti Galiya is a Senior Associate at Khaitan & Co, Mumbai office. Her primary areas of practice include mergers & acquisitions, joint ventures, private equity investments, foreign investments, technology collaborations, financial services and related regulations, commercial contracts, real estate, employment and general corporate laws.