India: Codification Of Duties Of Directors Under The Companies Act 2013

Last Updated: 25 April 2018
Article by Ifla A

Introduction

While the rights, powers, and duties of Directors defined in the Articles of Association of the Company, a need was felt for legal clarity. Under the Companies Act 1956 (the Erstwhile Act), there were no explicit provisions regulating the duties of the directors of the Company. The J.J. Irani Committee report suggested that the duties of a Director should be "inclusive, and not exhaustive in view of the fact that no rule of universal application can be formulated as to the duties of the directors."

On the basis of the JJ Irani committee report, a specific provision governing the duties of directors was included in the Companies Act, 2013 (the Act), which applies to directors both individually as well as collectively to the Board. The section 166 of the Act has consolidated the law governing directors' duties making it more certain. Although this consolidation is not exhaustive, as certain duties of directors are still enumerated under other sections of the Act, for instance, Section 184 of the Act obliges a director to disclose his interest in a contract with the company, nonetheless, director's actions are benchmarked against responsibilities explicitly identified under section 166 which directors are expected to abide by, both individually and collectively as a Board.

General principles regarding duties of Directors:

A director of a company:

  1. shall, subject to the provisions of the Act, act in accordance with the articles of association of the company.
  2. should 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 interest of the company, its employees, the shareholders, the community and for the protection of the environment;
  3. shall exercise his duties with due and reasonable care, skill and diligence; shall exercise independent judgment.
  4. 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.
  5. 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 to the company.
  6. shall not assign his office and any assignment so made shall be void.

Classification of duties of directors

These duties can broadly be classified into two categories:

  1. Duty of care, skill and diligence & independent judgement:

The duty of care, skill and diligence require directors to devote the requisite time and attention to affairs of the company, pursue issues that may arise through "red flags" and make decisions that do not expose the company to unnecessary risks.

  1. Fiduciary duties:

Fiduciary duties, on the other hand, require the directors to put the interests of the company ahead of their own personal interests. The rules that prevent conflict of interest and self-dealing on the part of directors are integral to this set of duties.

Section 166 of the Act applies to directors of all types of companies. The aforementioned directors' duties extend to all categories of directors, including independent directors. However, in addition to Section 166, independent directors have to comply with the Code of Conduct under Schedule IV of the Act.

The Act necessitates a holistic approach to decision-making at the Board level. Codification of directors' duties forces directors into being more accountable and responsible towards the management of a company, thereby improving transparency and corporate governance standards.

Implications of the codification of directors' duties:

  1. Use of discretion: Exercise of discretion by a director ought to be well-founded and based on a thorough examination of all relevant facts.
  2. Full disclosure: Directors are likely to expect full disclosure of relevant information for basing their decision.
  3. Impact on nominee directors: A significant impact of section 166 (2) will be on the relationship between a nominee director and his nominating shareholder. Considering the statutory requirement for a director to act in the best interests of the members as a whole and to exercise independent judgment while deciding on a matter, a nominee director may find it difficult to harmonise his statutory, duties under section 166 with such instructions of his nominating shareholder, which most of the times are inconsistent with the interests of the company or a class of shareholders.

Non-adherence to section 166 of the Act

Breach of section 166 is an offense punishable by a fine for an amount not less than rupees one lakh but which may extend to rupees five lakh. However, where a director is guilty of making an undue gain, he will also be liable to pay to the company an amount equal to the gain.

Clarity of directors' duties may make it easier for shareholders to initiate a class action suit for a claim of damages against the company and/or its directors, if breach of directors' duties results in the management or conduct of the affairs of the company being run prejudicial to the interests of the company or its shareholders.

Conclusion

Given the liability of directors for non-compliance with their statutory duties, the following measures may be considered by a company and its Board:

  1. The directors should be given a thorough briefing on the statutory duties. The level of the briefing will vary depending on a director's familiarity with his duties but should be gradually subsumed into a company's induction process for all directors.
  2. Directors should adopt a balanced approach to decision making, and not act as a 'Dummy' director.
  3. If required, the board of directors should seek professional advice to understand the implications of a particular decision for making an informed decision' after considering all relevant factors.
  4. If the Board is of the view that there is a potential conflict between two provisions of Section 166. In such conflicting situations, perhaps it will also be appropriate for the Board to hear the views of each stakeholder and seek expert advice prior to deciding on a matter.
  5. Directors should attend as many Board meetings as possible so to ensure that they are fully briefed on developments affecting the company's business.
  6. A Nominations Committee may be constituted which should evaluate applications for directorships on an objective basis while ensuring that any new Board member, particularly an independent director, has the requisite skills and experience required for that particular position.
  7. Directors should consider on a regular basis whether a particular contractual arrangement or role performed by them can reasonably be regarded as likely to give rise to a conflict of interest. If it can be so regarded, the director concerned ought to make appropriate disclosures to the Board, in accordance with the articles of association of the company or provisions of the Act.
  8. The Company Secretary responsible for preparing Board related documents should be made aware of the requirements of Section 166 so that the Board is given adequate information, including of opinion of experts that may be relevant for an informed decision-making process.

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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