Posted by: CS Shilpi Thapar
With the increasing stress on corporate governance the role of directors under the Companies Act, 1956 (the Act) has come into sharp focus. Though, a company enjoys an independent existence and is otherwise treated as “person” under the law, but being a legal person, it has to act through natural persons i.e. the directors, collectively referred to as the board of directors.
This principle of separate legal entity of the company was propounded by the “House Of Lords” in the case of Saloman v Saloman (1897). Since a company has no physical existence, it acts through the Board of Directors. The Directors are managerial persons and elected representatives of the shareholders. They individually and collectively hold the position of trust and have fiduciary duties towards the company, the shareholders and others.
Directors are agents of the Company in transactions they enter into on behalf of the Company, though they are not agents for individual shareholders or members. The Directors and shareholders are often the same people but they have distinct roles. Directors are officers of the company not employees, although they may have service agreements with company.
A director may be an employee, a servant or even a “worker” of the Company. He occupies the position of a trustee, though he is not a trustee in the strict sense in respect of the Company’s properties and funds.
Directors are known by a variety of names. All Directors have the same duties and responsibilities regardless of their title subject to certain exceptions.
In the corporate form of business organisation, the Board of Directors occupies a unique position. They are posed between the shareowners and executive management, on the one hand they guide, monitor and oversee the executive in their task of creation and maximisation of wealth on a sustainable basis within a value based framework and on the other hand, ensure that such created wealth is accounted for equitably among all shareholders, after meeting all legitimate dues and charges.
MEANING OF ‘DIRECTOR’ :
Section 2(13) of the Companies Act, 1956 defines a term director and states that ‘director’ includes any person occupying the position of director, by whatever name called.
The person can be director in a maximum 15 companies. Exclusions in computing the number (a) Private companies (other than subsidiaries of Public Company) (b) Unlimited Companies (c) Non Profit Association (d) Alternate Directorships.
In the ordinary sense a director is someone who administers, controls or directs something, one who supervises, controls or manages; a person elected by the shareholders of a company to direct company’s policies; person appointed or elected according to law, authorised to manage and direct the affairs of a company.
TYPES OF DIRECTORS:
1. Shadow or ‘Deemed director
2. Ordinary’ Director
3. Managing Director
4. Whole-time/Executive Director
5. Additional Director
6. Alternate Director
7. Professional Director
8. Nominee Director
9. Independent Director
LEGAL POSITION OF DIRECTORS:
1. Directors as Agents
2. Directors as Trustees
3. Directors as managing partners
DUTIES OF DIRECTORS
As per the Company law, directors of the company occupy a fiduciary position. This legal position is equally applicable to all types of directors.
Fiduciary Duties owed to the company
1. A duty to act honestly and in good faith
2. A duty not to make improper use of their position or information they receive
3. A duty to act for a proper and legitimate purpose
4. A duty to act with reasonable skill and care
5. A duty to act in the best interests of the company (and to the shareholders collectively)
6. A duty to avoid conflicts of interest (putting their own position ahead of the company)
7. A duty to disclose all material personal interests to the company.
Duties owed to third parties
1. A duty not to permit the company to trade whilst it is insolvent.
2. A duty to delegate their powers in a responsible manner.
3. A duty to ensure that all relevant information is notified Stock exchanges and government authorities if any.
4. Various duties under the Companies Act, 1956 relating to reporting, maintaining company registers and holding company meetings.
5. A duty to only pay dividends out of profits available for the purpose.
6. (Where the company is a trustee) a duty to ensure that the company is indemnified from the assets of the trust for any loss incurred while acting as trustee.
RESPONSIBILITIES OF DIRECTORS
The major responsibility of the Board of Directors is to direct the affairs of the company and to exercise such control that the wealth and wealth creating assets of the company are protected. Extensive board responsibilities are found in the Canadian Guidelines which identify five specific components of the board’s stewardship’s responsibilities as follows:
- Adoption of a strategic planning process
- Management of Risk
- Appointment , training and monitoring of senior management, including succession
- Effective communication and
- Ensuring the integrity of corporate internal control and management information systems.
The responsibilities under The Companies Act, 1956 includes:
- Keeping proper book of accounts and preparing annual accounts and director’s report for presentation to the company’s shareholders;
- Filing of accounts and returns annually with the Registrar of Companies, Income Tax departments and other statutory departments;
- Filing of various resolutions with Registrar of Companies and seeking approvals from The Registrar of Companies, Company Law Board, Central Government and High Court.
- Informing The Registrar of Companies of the appointment or retirement of any director or the company secretary or of any change in the situation of the company’s registered office and of many other events including allotments of shares;
- Appointing auditors;
- Calling and holding Annual General Meetings each year, at which the annual accounts are presented and;
- Making sure that the company acts strictly in accordance with the powers and rules set out in its memorandum and articles of association.
- Section 217 of The Companies Act,1956 specifies the contents of Board Report to be attached to the Balance Sheet of the company which includes Director’s Responsibility Statement:
- That in the preparation of the annual accounts, the applicable accounting standards had been followed along with proper explanation relating to material departures;
- That the directors had selected such accounting policies and applied them consistently and made judgements and estimates that are reasonable and prudent so as to give a true and fair view of the state of affairs of the company at the end of financial year and of the profit or loss of the company for that period;
- That the directors had taken proper and sufficient care for the maintenance of adequate accounting records in accordance with the provisions of the Act for safe guarding the assets of the company and for preventing and detecting fraud and other irregularities;
- That the directors had prepared the annual accounts on a going concern basis.
POWERS OF DIRECTORS:
The Directors has power to do everything that a company subject to-
- Provisions of The Companies Act,1956(The Act)
- Provisions of Memorandum and Articles of Association of the Company
- Shareholder’s approval wherever required.
LIABILITIES OF DIRECTORS:
The Court, relying on Sections 5 and 291 read with clauses (24), (26), (30), (31) and (45) of Section 2 of the Companies Act, 1956, lists the categories of persons who under the Companies Act can be considered as persons who are responsible to the company for the conduct of the business of the company as well termed as “Officer in default”. They are:
(a) the managing director/s;
(b) the whole-time director/s;
(c) the manager;
(d) the secretary;
(e) any person in accordance with whose directions or instructions the Board of directors of the company is accustomed to act;
(g) where any company does not have any of the officers specified in clauses (a) to (c), any director or directors who may be specified by the Board in this behalf or where no director is so specified, all the directors.
In Sec 5, there is no specific mention of Independent Directors or Nominee Directors. Independent directors are treated as officer in default only where the company does not have a whole time director, or no specific director is charged with a particular compliance. Other sections such as Sec 267-269, 292, 292A, 309(4) applicable only to whole time directors.
Personal Liability of Directors:
The following provisions of the Companies Act, 1956 provide that the Members or the Directors/nominee Directors of a company will be personally liable if:
(1) A company carries on business for more than six months after the number of its members has been reduced below seven in the case of a public company and two in the case of a private company. Every person who was a member of the company during the time when it carried on business after those six months and who was aware of this fact, shall be severally liable for all debts contracted after six months,
(2) The application money of those applicants to whom no shares has been allotted is not repaid within 130 days of the date of issue of the prospectus, then the Directors shall be jointly and severally liable to repay that money with the prescribed interest,
(3) An officer of the company or any other person acts on its behalf and enters into a contract or signs a negotiable instrument without fully writing the name of the company, then such officer or person shall be personally liable,
(4) The court refuses to treat the subsidiary company as a separate entity and instead treat it as only a branch of the holding company,
(5) In the course of winding up of the company, it appears that the business of the company has been carried on with intent to defraud the creditors of the company or any other person or for any fraudulent purpose, al those who were aware of such fraud shall be personally liable without any limitation of liability.
Penalties for breach of duty:
Personal actions against a director can be initiated by any of the following:
- the shareholders collectively
- the company (ie. the board of directors)
- a liquidator of the company
- another director
- an employee
- a competitor
- the government (for breach of legislation, such as environmental protection legislation)
- a third party (for negligent actions leading to loss)
- a creditor.
- Where a director is found guilty of a breach of duty, he may be liable in damages to the party
- Who suffered the loss.
- In addition the Companies Act, 1956 imposes penalties for breaches of certain duties. These include fines, imprisonment and disqualification as a director.
Director’s liability arises because of their position as agents or officers of the Company as also for being in the position of trustees or having fiduciary relation with the Company or its shareholders.
Some of these liabilities are in contract, some are in tort, some are under the criminal law and others are statutory, i.e., under the companies Act, 1956 and other laws. The courts have, in deciding the liability of Directors, taken into consideration a director’s position as a whole.
In R.K. Dalmia and others v. The Delhi Administration it was held that “A director will be personally liable on a company contract when he has accepted personal liability either expressly or impliedly. Directors are the agents or the trustees of a Company.”
Pre- Incorporation Liability- A Company cannot make a contract before it is incorporated because, before incorporation, it has no legal existence. Therefore, a Company after incorporation cannot ratify a contract previously made. It must make a fresh contract. But, those who act on behalf of the unincorporated company may find themselves personally liable.
Liability of Directors for Torts of the company: –
Directors as such are not liable for the torts or civil wrongs of their company. To make a person liable for a tort, e.g. for negligence, trespass, nuisance or defamation it must be shown that he was himself the wrongdoer or that he was the employer or principal of the wrongdoer in relation to the act complained of, or that the tort was committed on his instructions.
Civil Liability to the Company- Director’s liability to the Company may arise where:
(1) the directors are guilty of negligence, (2)the directors committed breach of trust, (3) there has been misfeasance and (4) the director has acted ultra vires and the funds of the company have been applied for such an act.
A director is required to act honestly and diligently applying his mind and discharging his duties as a man of prudence of his ability and knowledge would do. It has been explained in the duties of directors as to what is standard or due care and diligence expected from him as explained by Justice Romer in Re City Aquintable Fire Insurance Company.
The director is criminal liable for the following violations as per The Companies Act, 1956:
- Section 44(4) – Filing of prospectus containing untrue statements-two years imprisonment and /or fine up to Rs.50000;
- Section 58A(6)(b)- Inviting deposits in contravention of the rules or manner or conditions- five years imprisonment and fine.
- Section 58A(10)- Failure to repay deposits as ordered by the CLB- Three years imprisonment.
- Section 63- Criminal liability for misstatement in prospectus- Imprisonment up to 2 years or fine up to Rs. 50000 or both.
- Section 68- Fraudulently, inducing persons to invest money. Imprisonment up to 5 years, or fine Rs.100000.
- Section 73- Failure to repay excess application money-imprisonment up to one year and fine up to Rs.50000.
- Section 105- Concealing name of creditor- Imprisonment up to one year or fine or both.
- Section 202(1)- Undischarged insolvent acting as director imprisonment up to 2 years or fine up to Rs.50000 or both.
- Section 207- Default in distributing dividends- imprisonment up to 3 years and fine up to Rs.1000 for every day.
- Section 209A- Failure to assist Registrar or any officer so authorised by the Central Government in inspection of books of accounts, etc- imprisonment up to one year and fine not less than Rs.50000.
- Section 210(5) – Failure to lay balance sheet etc. at annual general meeting-imprisonment up to six months or fine up to Rs.10000 or both.
- Section 211(8) – Failure to comply section 211 regarding form of balance sheet and matters to be stated-imprisonment up to six months or fine up to 10000.
- Section 217(5)- Failure to attach balance sheet a report of board imprisonment upto six months for each offence or fine up to Rs.20000 or both.
- Section 221(4) – Failure to supply information to auditor-imprisonment up to six months, or fine up to Rs.50000 or both.
- Section 250(9)- Improper issue of shares-imprisonment up to six months or fine up to Rs.50000 or both.
- Section 293A(5)- Contribution to political parties in contravention of section 293A- three years imprisonment and fine.
- Section 295(4)- Grant of loan to directors-Simple imprisonment upto six months or fine up to Rs.50000.
- Section 308(3)- Failure to disclose shareholdings-imprisonment upto two years or fine up to Rs.50000 or both.
- Section 372A- Giving loans to other bodies corporate in excess of the limits prescribed under section 372A-imprisonment up to 2 years or fine up to Rs.50000.
- Section 407(2)- Acting as director after removal by Court- imprisonment upto one year, or fine up to Rs. 50000 or both.\
Section 488(3)- False declaration of company’s solvency – imprisonment upto six months or fine up to Rs.50000 or both.
Under Section 179 of the Income Tax Act 1961, when any private company is wound up and the tax assessed cannot be recovered, then every person who was a director of the private company shall be jointly and severely be liable for the payment of such tax.
Directors with unlimited liability:-
The liability of the directors like the shareholders is limited to the extent of the shares held by them remaining unpaid. A limited liability can make the liability of any or all of its directors unlimited. A provision to this effect has to be contained in the Memorandum. that a person who becomes director after incorporation of such a clause will have unlimited liability.
RISK MANAGEMENT FOR DIRECTORS
Protection from liability
There are several ways in which a director can protect himself from liability:
- Directors will not be held liable where they have made a business judgement in good faith for a proper purpose and rationally believed it to be in the best interests of the company.
- Directors are allowed to rely on advice or information from experts as long as they believe on reasonable grounds that the person relied on is reliable and competent.
- Directors should put compliance plans in place to ensure that the company complies with all relevant legislation.
- Directors should ensure that D&O (Directors & Officers) insurance is in place in relation to their appointment. The premiums for this insurance can be paid by the company, and the cover may protect against breaches of duty by the directors.
- Directors should also ensure that a Deed of Indemnity is entered into with the company.
- These deeds provide that the company indemnifies the director against any liabilities and costs incurred by him acting properly in his capacity as a director of the company.
- If a problem comes to the attention of a director, he should convene a board meeting immediately to discuss the matter, and if necessary seek legal advice.
A director and officer is duly diligent if they have taken all following reasonable steps to prevent the occurrence of an event:
1. Always attend meetings.
2. Insist that all material be available well in advance of meeting especially when there will be a vote on a particular issue.
3. Obtain written advice on all legislation and guidelines that are relevant to the activities or the organization.
4. Always review and read documents, legislation and so forth prior to meetings.
5. Insist on written opinions from legal and other professionals on any important decision.
6. Periodically or on major issues where regular counsel or advisors have provided advice, insist on independent outside counsel or advisors for a fresh perspective.
7. Review all opinions given by professional consultants.
8. Review the minutes of all meetings and insist that they be accurate.
9. Keep your own notes.
10. Ensure that your dissent is recorded even if this means sending a registered letter to the board.
11. Review the company’s objects and bylaws.
12. Review all internal controls especially with respect to cheque signing and contract execution.
13. Encourage the development of a directors manual.
14. Know what trust property or accounts the company holds.
15. Keep information about the company confidential.
16. Avoid even the appearance of a conflict of interest.
17. Ensure that the Articles of Association/ bylaws provide for the indemnification of directors.
18. Ensure that the committees and management report to the board.
19. Ensure that the company acquires and maintains officers and directors indemnity insurance coverage.
The Directors are expected to be knowledgeable man with adequate skill and expertise but to ensure early contribution and to build their knowledge about particular organization proper training on risk management strategies of the organization is necessary. They should be properly made aware of the standing of the particular company in the market, future planning for growth, new products and service going to be introduced.
One important aspect, which hinders the effectiveness of directors especially independent, is the non availability of information. Many a times, such directors do not have free access to information required to accomplish their role in monitoring and controlling the activities of the companies they are representing. It should be realized that the professionalism of such directors will help them to increase overall value of the business by looking at the business independently from the family. This change of attitude is very vital for achieving excellence, as attitude determines altitude.
Also there has been a considerable change in the attitude of the corporate management in recent times and they are coming forward to implement good corporate governance practices, realizing their importance.
Paper submitted to Institute of Directors, April,2010- Ms. Shilpi Thapar