India: Duties To Be Discharged By Directors

Last Updated: 14 December 2011
Article by Siddharth Raja

Each Director has a fiduciary duty towards the company. All the powers entrusted to the Directors are only exercisable by them in this fiduciary capacity. The duties of Directors can be discussed under the following broad heads:

A. Fiduciary duties;

B. Common law duties;

C. Specific duties prescribed under the Companies Act;

D. Additional duties in case of a listed company; and

E. Other statutory duties.

A. Fiduciary Duties

A Director owes fiduciary duties towards the company, and not to individual shareholders, creditors (other than during winding up when their interest has to be taken care of) or fellow Directors. These generally consist of the following:

Good faith and bona fide Acts

Directors must act honestly, without negligence and in good faith in the bona fide best interests of the company. While applying this rule, Directors are not expected to act purely for the economic advantages of the company, disregarding the interests of the members, employees or creditors. The presumption is that a Director, acting within his or her authority, has acted in good faith, though the act may have been foolish or wrong, unless proved otherwise. The Courts usually refuse to substitute their judgment for the commercial judgment of the Director.

Proper use of powers

Directors must not exercise the powers conferred upon them for purposes different from those for which they were conferred. Notwithstanding that Directors have acted in honest belief for what they believe to be for the benefit of the company, they may nevertheless be liable for improper use of their powers, especially for purposes collateral to what they have been conferred for, for instance, furthering the Director's own interests or diluting the majority shareholding. A breach occurs when the dominant purpose of the act is improper.

Unfettered Discretion

Directors must not fetter their discretion for any reason whatsoever. They cannot validly contract or act pursuant to any arrangement either with one another or with third parties as to how they shall vote at board meetings or otherwise conduct themselves in the future. However, this does not include contracting to take further action to give effect to a contract entered into in a bona fide exercise of such discretion. Nominee Directors must be particularly careful not to act only in the interests of their nominators, but must act in the best interests of the company and of its shareholders as a whole.

Lack of Conflicting Interests

Directors must not, without the informed consent of the company, place themselves in a position in which their personal interests or duties to other persons are liable to conflict with their duties to the company or where there is a real and distinct possibility of conflict. This requirement covers the following aspects:

i. Directors have to make continuous disclosures of their interests in the various transactions of, and with, the company. A Director cannot enter into a contract with the company without its informed consent, even if there is no unfair advantage to be gained, or abuse of position, by such Director.

ii. Directors cannot use, without the consent of the company, the company's properties, opportunities or information for their own profit. In order to establish a breach of this duty, it must be shown: (1) that what the Directors did was so related to the affairs of the company that it can be said to have been done in the course of their management and in utilization of their opportunities and special knowledge as Directors, and (2) that what they did resulted in a profit to themselves. The English Courts, adopting a strict approach, have held directors to be in breach of this fiduciary duty, even if the opportunity was not one which would have been of use to the company. Indian courts generally follow this strict English law approach.

iii. Directors have a duty not to compete with the company, which is in many respects a corollary of the immediately preceding rule.

B. Common Law Duties

A Director is required to discharge certain common law duties towards the company, which generally consist of the following:

Duty to exercise reasonable skill and care

This rule consists of two elements:

i. an (objective) duty of care; and,

ii. a (subjective) duty to exercise skill.

Imposition of a duty of care on the Director does not necessarily require that a Director must be a professional. A comparison with a particular Director in the same position and how such particular Director reasonably ought to have acted is the question to be asked. Therefore, the question of what functions should be carried out by a Director will depend on factors such as type and size of the company; the sector in which it operates; the Director's own personal skill and experience; the Director's position and role in the company; and the remuneration of the Director.

Duty to act within the powers of the company

Directors must act within the powers of the company. They must ensure that they are familiar with the company's Memorandum and Articles and being 'insiders', they must ensure they act in accordance with these provisions, since breaching any of them might lead to strict liability even in the case of an understandable mistake. Their powers under the company's Memorandum and Articles must be exercised for proper purposes in the interests of the company.

Duty to exercise independent Judgment

Directors should not take decisions at the direction of others. Even while taking the advice of others, as and when required, they should exercise independent judgment in considering recommendations and suggestions made by advisors.

Duty of Supervision

The Directors have a duty to exercise supervision over the officers of the company to whom they delegate powers.

Duty of Confidentiality

The Directors have a duty of confidentiality towards the company and should not disclose or make use of confidential information relating to the company for any purposes, other than for the benefit of the company.

C. Specific Duties prescribed under the Companies Act

In addition to those already specified above, the Board, as against the individual Directors, is also required to discharge the following specific duties as prescribed under the Companies Act:

1. Administration and Compliance

Directors are vested with a number of administrative responsibilities in order to enable them to manage and administer the company. These administrative responsibilities include, amongst others, the following:

Filing returns with the Registrar of Companies

Directors must file a return of allotment of shares within thirty (30) days with the Registrar, stating the number and nominal amount of shares comprising the allotment, the names, addresses and occupations of the allottees, and the amount, if any, paid or due and payable on each share.

Convening Shareholders' Meetings

Directors must convene the different kinds of shareholders' meetings provided for in the Companies Act, within their stipulated periods.

For example:

  • A statutory meeting should be convened after one (1) month but within six (6) months from the date on which a public company is entitled to commence its business;
  • The first AGM should be convened within eighteen (18) months from the date of incorporation; and
  • An extraordinary general meeting must be convened by the Directors on a requisition by members holding at least ten percent (10%) of the paid up capital of the company.

Approval of Company's Documents

Directors must approve the balance sheet and profit and loss account of the company before it is signed on their behalf.

Audit Requirements

In cases of winding up or liquidation, the Directors must ensure that the books of account of the company are completed and audited up to the date of winding up order issued by the Company Court.

2. Restriction on Activities and Disclosure of Information

The Companies Act has prescribed and / or supplemented the common law duties with certain other obligations on Directors that relate to their position, including the following:

Declaration of Interest

Directors, who are concerned or interested in a proposed contract or arrangement with the company in any way, must disclose the nature of their concern or interest to the Board.

Receipt of Compensation

Directors must not receive, in connection with a transfer of property or shares of the company, any payment as compensation for loss of profit or in consideration for retirement from office. If they do so, they must hold such an amount in trust for the company.

Attending Board Meetings

Directors are under an obligation to attend the board meetings as prescribed by the Articles, or such as may be called by the chairman (if any) of the Board, otherwise any absenteeism for three (3) consecutive meetings or for a period of three (3) months, whichever is longer, without obtaining leave of absence, will result in that Director or Directors vacating their respective offices.

3. Duties during Voluntary Winding Up of a Company

The Directors must file the petition for winding up of the company (in a voluntary liquidation situation) before the relevant court. The Directors are also required to file a statement of the affairs prior to the voluntary winding up of the company, upon appointment of an official liquidator by the court. The following other duties are also required to be discharged, in connection with the winding up of the company:

Notice of resolution for Winding up

In the case of a voluntary winding up, the Directors must ensure publication of the notice of the resolution in the Official Gazette and a newspaper in circulation in the district where the registered office of the company is situated, within fourteen (14) days of the passing of such resolution.

Declaration

Where it is proposed to wind up a company voluntarily, the Directors of the company may at a meeting of the board, make a declaration verified by an affidavit, to the effect that they have made full inquiry into the affairs of the company, and as to the solvency of the company, i.e., the company has no debts, or that it will be able to pay its debts in full within such period not exceeding three (3) years from the commencement of the winding up as may be specified in the declaration.

Notice of appointment of Liquidators

Directors must give to the concerned Registrar of Companies a notice of the appointment of the liquidator of the company, so appointed by the company in the general meeting, and also give notice to such Registrar of Companies of the filling of any vacancy occurring in the office of such liquidator of the company.

Cease exercise of Powers

It is imperative for the Directors to cease exercising all powers of the Board, and likewise for the Managing or Whole-time Directors to cease exercise of such powers, except for the purpose of giving the notice of appointment of the liquidator mentioned in the immediately preceding paragraph.

Meeting of Creditors

In case of creditors' voluntary winding up, the Directors must cause a meeting of the creditors of the company to be called on the day or the next day on which general meeting is to be held and shall cause notices of the meeting to be sent to the creditors. At such creditors' meeting, the Directors must present a statement of the position of the company's affairs together with a list of creditors of the company and the estimated amount of such creditors' claims.

Filing Notice

The Directors must file the notice of any resolution passed at the creditors' meeting mentioned in the immediately preceding paragraph.

4. Duties During Involuntary Winding Up of a Company

In cases of involuntary winding up, the Directors must defend the Company in the winding up petition filed by a creditor or any other person recognized by the Companies Act. The requirement to file a statement of the affairs of the company by each of its directors, upon appointment of an official liquidator by the court, applies to involuntary winding up as well. In addition, the directors are also required to assist the official liquidator from time to time, by providing relevant information and assistance, in case of involuntary winding up of the company.

D. Additional Duties in case of a Listed Company

In case of a listed company, SEBI prescribes the following additional duties:

Declaration of Pecuniary Relationships

All pecuniary relationships and transactions of the non-executive Director vis-àvis the company shall be disclosed in the annual report of the company. The nonexecutive Directors must disclose their shareholding (either held directly or for other persons on a beneficial basis) in the company in which they are proposed to be appointed as Director. Such disclosure shall be made prior to his appointment in a general meeting called for his appointment.

Declaration of Material Contracts

SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009 require that the prospectus with respect to an initial public offering (IPO), or further public offer, shall disclose the dates, parties to, and general nature of the contacts appointing or fixing the remuneration of a Director within or more than two (2) years before the date of the prospectus. The company also needs to disclose the dates, parties to, general nature of every material contract not being in the ordinary course of business entered into more than two (2) years before the date of the prospectus.

E. Other Important Duties

Duties under Foreign Exchange Management Act

The Foreign Exchange Management Act, 1999, and the regulations issued thereunder, provide the legal framework for any transaction between an Indian entity and a foreign entity. It specifies that in case of contravention of any of its provisions or any rule, direction or order thereunder by a company, the person who at the time of the contravention was in charge of and was responsible to the company for the conduct of the business of the company shall be deemed to be guilty of the provisions and shall be liable to be proceeded against.

If the offence is committed with the consent or connivance of, or is attributable to the neglect of the Director, such Director shall be deemed to be guilty and liable to be proceeded against. For example: under the Foreign Exchange Management (Transfer or Issue of Securities by a Person Outside India) Regulations, 2000, a foreign entity can invest in an Indian company that undertakes activities in the construction-development of real estate sector, by way of Foreign Direct Investment, without requiring any approvals. However such investment by the foreign entity is subject to certain guidelines prescribed in that Regulation. Non-compliance of such conditions would be a contravention and any person being a Director of such company contravening those conditions can be found guilty.

Duties under the Negotiable Instruments Act

Under the Negotiable Instruments Act, 1881, if a company issues, and later dishonours a cheque which was presented for discharge of debt or other liability, every person who at the time of such dishonor was in charge of overall control of the day-to-day business of the company (both under law and as a matter of fact), shall be deemed to be guilty of the offence and shall be liable to be proceeded against. If the offence is committed with the consent or connivance of, or is attributable to the neglect of the Director, such Director shall be deemed to be guilty and liable to be proceeded against.

However, if such person has been appointed as a Director by virtue of his holding in any office or employment in the central government or state government or a financial corporation owned or controlled by the state or the central government, he shall not be liable for prosecution.

Duties under the Competition Act

The Competition Act, 2002 prescribes certain specific duties to be discharged by Directors.

1. Combination: The Competition Act, 2002, imposes certain limits to be examined, and adhered to, by Directors and requires that the merger or amalgamation or acquisition does not amount to a resultant enterprise being a combination.

2. Duty to file report with Commission: Directors must show that such a combination under the Competition Act, 2002, is not likely to cause an appreciable adverse effect on competition within the relevant market in India, if the assets or the turnover of the newly created or remaining company amounts to a combination by exceeding the prescribed limits. Therefore, it is the duty of the Director under this legislation, to give notice to the Competition Commission, in the form as may be specified and the fee which may be determined, by regulations, disclosing the details of the proposed combination, within seven (7) days of the company's approval of the merger or amalgamation proposal. The Commission shall then conduct such investigations, inquiries and pass any orders. No combination shall come into effect until two hundred and ten (210) days have passed from the day on which the notice has been given to the Commission or the Commission has passed orders, whichever is earlier.

Duties under Labour Laws

In legislations such as the Employees' Provident Funds and Miscellaneous Provisions Act, 1952 and the Payment of Gratuity Act, 1972, the term 'employer' with respect to any establishment (in cases other than a factory), means the person who, or the authority which, has the ultimate control over the affairs of the establishment. Where the said affairs are entrusted to a Manager or a Managing Director, such Manager or Managing Director is considered the 'employer'.

However, this liability is not one imposed on all Directors or Managers uniformly; it is only imposed on those Directors or Managers who are in overall control of the affairs of the company (this implies control over the day-to-day affairs of the company). Those Directors who are only in control of certain aspects, or are aware of the policy of the company, but are not in charge of it, would not be held liable.

The Managing Director or the Manager, will, in his capacity as the 'employer', have the duty to ensure welfare of the employees. He will also be responsible to make necessary statutory registrations or contributions, as applicable, from time to time.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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