India: Liabilities Of Directors; Persons Who Can Bring Actions Against The Directors

Last Updated: 21 November 2011

Directors can be held liable both jointly and collectively, for any and every act, commission or omission which is prejudicial to the interests of the company and violates any of the duties to be discharged by them.

A. Director's personal liability

As a general rule, since the company and its Director are separate entities, the Director has no personal liability on behalf of the company. However, under certain circumstances, a Director may be held liable on behalf of the company. These circumstances are:

Liability for Tax

Under the Income Tax Act, 1961, where any tax due from a private company in respect of any income of any previous year cannot be recovered from such private company, then, every person who was a Director of such private company at any time during the relevant previous year is liable, jointly and severally, for the payment of such tax. A Director (including any past Director but only for the duration when he was in office) can, however, escape such liability if he or she proves that the non-recovery of such tax cannot be attributed to any gross neglect, misfeasance or breach of duty on his or her part in relation to the affairs of such private company.

Under the Central Sales Tax Act and certain state Sales Tax laws, liability may be fastened on Directors of a company, which is wound up, for recovery of sales taxes due from such liquidated company.

Debts of the Company

Generally, a Director is not personally liable for any debt of the company unless fraud on the part of such Director can be established.

Liability for company's Contracts

A Director is, generally, not liable for any contract entered into by the company, unless expressly provided for, or fraud on the part of such Director can be established.

Refund of Share application Money

A Director is personally liable along with the company to repay the share application or excess share application money, as the case may be, if the same is not repaid within the stipulated time limit.

Liability to pay for qualification shares

If the Director has not acquired his or her qualification shares within the prescribed time period and the company goes into liquidation the day after this period expires, the Director will be called upon by the Official liquidator to pay for the shares he or she was supposed to have purchased.

Mis-statement in the Prospectus

Civil liability can be imposed on a Director for any untrue statement in the prospectus of a public company if he or she is a Director at the time of the issue of the prospectus, unless he or she proves that he or she withdrew consent before the issue of the prospectus or that it was issued without his or her authority or consent or without his or her knowledge or that, once he or she came to know of the untrue statement, he or she withdrew consent and gave reasonable public notice of the same, or proves that he or she believed the impugned statements to be true.

Fraudulent Conduct of Business

A Director may be held personally responsible, without any limitation of liability, for all or any of the debts or other liabilities of the company if he or she was knowingly party to the fraudulent carrying on of business.

Unlimited Liability

The liability of any or all of the Directors of a limited company can be unlimited if so provided by the Memorandum, or can be so done if approved by a special resolution as authorized by the Articles.

B. Criminal Liability

Dishonoured Cheques

The Director signing a cheque which is dishonoured so as to constitute an offence under the Negotiable Instruments Act, 1881, can be prosecuted along with the company.

Mis-statement in the Prospectus

The Companies Act imposes criminal liability on any person who was responsible for a mis-statement in the prospectus of a public company.

Offences under the Income Tax Act

An offence committed by a company under the Income Tax Act, 1961 is attributed to the persons who were responsible for and in charge of the business of such company.

Offences under Labour Laws

An offence committed by a company under the various labour legislations (specifically in case of Employees Provident Funds and Miscellaneous Provisions Act, 1952 and Factories Act, 1948) is attributed to the persons who were responsible for and had control over the affairs of the company. Hence, Directors would be personally liable for offences committed by a company under the relevant labour legislations. However, this liability is not one imposed on all Directors uniformly; it is only imposed on such Directors 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 not in overall charge of the company, but 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.

C. Lifting of Corporate Veil

A company is an independent entity and, as a general rule, the Director of the company is not liable for any offence or, breach or liability of the company. However, in certain cases, the common law doctrine of 'lifting the corporate veil' is utilized to impose penalty on the person, or persons, controlling in reality the actions of the company (such as, Directors) and certain statutes impose liability on such person or persons in charge of, or responsible to, the company for the conduct of its business.

Lifting the veil under the Companies Act

If, in the course of winding up, it appears that any business of the company has been carried on with an intent to defraud the creditors of the company or any other person, or for any fraudulent purpose, the persons who were knowingly parties to the carrying on of the business in such fraudulent manner shall be personally responsible without any limitation of liability, for all or any of the debts or other liabilities of the company as the court may direct.

Lifting of Veil as recognized by courts

The scope of this principle as applied by Indian courts is broad and largely dependent on the facts of an individual case. The corporate veil may be lifted where:

  1. a statute itself contemplates this;
  2. where fraud or improper conduct is intended to be prevented;
  3. where a taxing statute or a beneficial statute is sought to be evaded; or
  4. where associated companies are inextricably connected as to be, in reality, part of one concern.

The nature of the impugned conduct, the involvement of the public interest and the effect on the affected parties are all relevant considerations while determining whether or not to lift the corporate veil.

The court has, in one instance, lifted the corporate veil and recognized an individual as having acted on behalf of the company, who had resigned from the Board of a company and had ceased to be member of the company.

D. Derivative Action Suits against Directors

Courts will not, generally, interfere at the instance of the shareholders with the management of a company by its Directors, so long as they are acting within the powers conferred on them by the Articles, except in cases of derivative actions as explained below.

What is a Derivative Action?

Derivative action is defined as an action by one or more shareholders of a company where the cause of action is vested in the company and relief is accordingly sought on its behalf. Since the company has a distinct legal personality with its own rights and liabilities which are different from those personal rights of individual shareholders, this action is brought by a shareholder not to enforce his or her own personal rights but, rather, the rights and liabilities of the company on its behalf and for the benefit of the company; which the company cannot itself do, as it is controlled by the 'wrong-doers'.

In order to be classified as a derivative action, the following aspects must be satisfied:

  • It must be brought in a representative form, even though it is the company, rather than the other shareholders, whom the person initiating the legal action / proceedings seeks to represent. Thus, by implication, all the other shareholders are bound by the result of the action.
  • Although the action is brought on behalf of the company, the company appears as a defendant, so that the action takes the form of a representative action by the initiating shareholder on behalf of himself and all the other shareholders (other than the alleged 'wrong-doers'), against the alleged 'wrong-doers' (who are, in fact, in control of the company) and the company. Derivative claims may be brought by a shareholder or shareholders in the following instances, as described below.

Ultra Vires

A shareholder may bring an action against the company and its Directors in respect of matters which are ultra vires the Memorandum or the Articles of the company and which no majority shareholders can sanction. For example, Directors of the company sanctioning an action that is contrary to the objects of the company.

Fraud on Minority

Directors and the company would also be liable if the conduct of the majority of the shareholders constitutes a "fraud on minority", i.e., a discriminatory action. For example, where the shareholders have passed a special resolution with an effect of discriminating between the majority shareholders and minority shareholders, so as to give the former an advantage of which the latter were deprived.

Required Resolution

Certain actions of the company can be approved only by passing a special resolution at a general meeting of shareholders. If the majority seek to circumvent this legal requirement and pass only an ordinary resolution, or do not pass such a special resolution in the manner required by law, any member or members can bring an action to restrain the majority.

To safeguard Interests of the Company

For instance, an obvious wrong may have been done to the company by the Directors, but because of the control of such Directors on the majority shareholders, such shareholders may not permit an action to be brought against the 'wrong-doer' Directors. Therefore, to safeguard the interests of the company, any member or members may bring a derivative action.

Individual Membership Rights

As a general rule, personal rights per se are not to be enforced through derivative actions; however, some exceptions have been recognized. These exceptions often arise in cases of rights that have been conferred upon the shareholders by the Companies Act itself or the respective Articles (commonly known as "individual membership rights"). For example, the right to vote, the right to have one's vote recorded, or the right to be nominated as a candidate for the post of a Director during the election of Directors at a general meeting of the shareholders. Prevention of Oppression and Mis-management A representative action may be brought for prevention of oppression and mismanagement, which are cases where the majority acts in a manner that oppresses the minority; or where the affairs of the company are being conducted in a manner prejudicial to public interests or oppressive to any member(s) or in a manner prejudicial to the interests of the company including an adverse material change in the management or control of the company. Since these proceedings are initiated for the benefit of the company, it can be considered a form of derivative action and find specific place in the scheme of the Indian company law under the Companies Act. In order to obtain relief, the Company Law Board can be approached by:

  1. Not less than one hundred (100) shareholders, or not less than one-tenth of the total number of members; or
  2. Members holding not less than one-tenth of the issued shares capital of the company, provided all the dues on the shares have been paid by the applicants.

E. Other Actions against Directors

Actions can be brought against a Director for failure to discharge his or her duties. The following persons shall have the locus standi to bring such actions or proceedings against the Directors:

Company

As a general rule, Directors owe their duties to the company alone and would not generally owe their duties to the company's shareholders, subsidiaries or holding companies (or, indeed, even the company's creditors). In practice, such claims would, unless a company is insolvent, most likely arise as a result of a takeover or after the make-up of the board has significantly changed for some other reason. There is also a possibility of claims being brought by the company against other third parties, in particular, auditors, who may be joined with Directors in proceedings, considering their contribution to the Directors' breach (if at all) of their duties to the company.

Liquidators, Creditors and Contributories / Members, following Winding up, Reconstruction, Compromise and Arrangement

The claims may arise because all has not been well with the company and that certain decisions were taken by Director / Directors who need to be held accountable for that decision. Normally, such claims relate to the fraudulent conduct of business when a company is in the course of winding up. These claims will arise when the company continues to carry on business and incur debts at a time when there is, to the knowledge of the Directors, no reasonable prospect of the creditors ever receiving payment of those debts. The Directors are personally liable in such a case for such debts of the company.

Claims may arise against Directors to furnish such information particularly stating material interests of the Directors or Managing Director of the company, whether in their capacity as such or as members or creditors of the company or otherwise. This is instrumental in gauging the effect of those interests on the compromise or arrangements so proposed. The Directors also owe a duty to the Official liquidator, where a winding up order has been made by the High Court, to submit and verify a statement as to the affairs of the company.

In all the aforementioned cases it is unlikely that such claims will be brought by the creditors or members and are in practice brought by a Official liquidator (duly appointed by the members or creditors or High Court) in the name of the company.

SEBI

In the case of listed companies, SEBI may proceed against the Director(s) where the Directors of a listed public company fail to make certain disclosures as stipulated under the SEBI (Acquisition of Shares & Takeovers) Regulations, 1997 and SEBI (Prohibition of Insider Trading) Regulations, 1992, in respect of their shareholdings in the company.

F. Indemnifying Directors

Indemnification

The Companies Act restricts the ability of a company to indemnify its Directors and officers against losses. Any provision contained in the Articles or any other agreement, to provide indemnity on account of their negligence, default, misfeasance and breach of duty or trust is void. However, such indemnity will be enforceable if it is against any liability incurred by such Director or officer in defending any proceedings in which judgment is given in his favour or in which he is acquitted or discharged or where it is determined that, although liable, he acted honestly and reasonably and should be excused. The Companies Act, however, does not prevent a company from taking an insurance policy for its own protection against loss caused to it by its Directors. Further, the Director can take out a policy to recompensate the loss he suffers because of his liability to the company. The premium for such policy may be paid by the company itself.

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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