Are you a director?
At a recent summit on corporate governance, Securities and Exchange Board of India (Sebi) chairman M. Damodaran observed that the boardroom can be seen as the centre -stage of corporate governance, defining the performance of the company. Most of us would agree with the Sebi chairman that a director should not merely “grace” a board meeting, but participate actively in the affairs of the company. However, while playing an active role in the affairs of the company, a director also needs to be fully aware of his duties under law. Broadly speaking, the duties of a director of an Indian company can be classified as fiduciary duties, duties arising in his capacity as an agent of the firm, and statutory duties.
As their fiduciary duty, directors are expected to display good faith towards the company, in their dealings with, or on behalf of, the company. They are liable as trustees for breach of trust if they misapply the funds or commit breach of by-laws (Albert Judah Judah vs Ramapada Gupta, AIR 1959 Cal 715). The said fiduciary duties are, however, owed to the company and the company alone and not to shareholders.
Illustration: Jayachandran/ Mint
Nevertheless, such a duty may arise to shareholders in exceptional circumstances—in cases where the directors are authorized by the shareholders to negotiate, on their behalf, for the sale of their shares or for negotiating with a potential takeover bidder, and so on. This duty is most likely to arise in cases where the directors are advising the shareholders on how to deal with their shares in the company. In this regard, it is important to point out that an obvious, but often less respected, breach of fiduciary duty is that of competing with the company. Therefore, unless the company has specifically consented to the director being associated with a rival company and such director subordinates his personal interests to those of the company, this remains a breach of fiduciary duties by the director.
In addition to his fiduciary duties, a director of a company should also, as an agent of the company, display utmost care, skill and diligence in the exercise of his powers and functions on behalf of the company.
Directors of a company are special agents of the company and their powers are only as vested in them by the Companies Act, 1956, and the memorandum and articles of association of the company. While the principles of agency do apply to a large extent in their relationship with the company, a director has to use only such skill as may reasonably be expected from a person of his knowledge and experience. He is not an insurer of the success of the company. The directors will, therefore, not be held to be liable if they act honestly for the benefit of the company, and within their powers and with such care as is reasonably expected of them, having regard to their knowledge and experience. The directors are also not bound to bring any special qualifications into their office. In practical terms, it is difficult to provide a precise description of the standard of care and diligence which is expected. Reference for a decision by the courts in such cases is often based on the nature and size of the company, and is ascertained on the facts of each case.
Several statutes set out certain duties of directors. The Companies Act itself has provisions under which a director has a personal civil liability for the acts and omissions specified in those provisions. Furthermore, almost all modern Indian statutes that deal with environmental, industrial, economic and other welfare issues include a section which defines the vicarious liability of directors for offences committed by the companies of which they are directors. In addition, directors of a listed company are required to carry out the obligations under, among others, the Sebi (Substantial Acquisition of Shares and Takeover) Regulations, 1997, and the Sebi (Insider Trading) Regulations, 1992.
In the ordinary course of things, directors, being agents, are entitled to an indemnity under section 223 of the Contract Act, 1872, in respect of all liabilities incurred in managing the business of the company in good faith.
However, section 201 of the Act states that any provision indemnifying any officer of the company, or any person employed by the company, against any liability, which by virtue of any rule of law would otherwise attach to him in respect of any negligence, default, misfeasance, breach of duty or breach of trust, will be invalid. Nonetheless, a company may indemnify any such officer against any liability incurred by him in defending any proceedings, whether civil or criminal, in which the judgement is given in his favour.
Further, a company is permitted to insure itself against a liability which may be incurred by it because of any act or omission of a director or officer. For the same reason, a director or officer may lawfully take out an insurance policy to protect himself against such potential liability and it is lawful for the company to pay the premium on such policy.
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This column is contributed by Dakhs Trivedi of AZB & Partners, Advocates & Solicitors.