India: Safeguarding The Interests Of Non-Executive Directors Nominated By PE Investors / VC Funds

Last Updated: 26 April 2018
Article by Iqbal Tahir Syed, Karan Ajitsaria and Gaurav Kapur

BACKGROUND

Being designated as a director in a company has a cascading effect with respect to exposure to liabilities under various legislations (including tax legislations like the Central Goods and Services Tax Act, 2017 (GST Act)). This issue becomes significant in view of the recent media reports on notices being served on some non-executive nominee directors, of private equity investors (PE), from the income tax department in connection with tax claims of investee companies.

Many PEs, by virtue of rights that they enjoy, under contractual arrangements with the promoters and investee companies, have a considerable say in the running of such companies. As a consequence, directors nominated by such PE investors (PE Directors), despite generally being non-executive directors, find it more difficult to absolve themselves when an investee company is in non-compliance of law, or is questioned by the tax office. The intention of this article is to briefly highlight the provisions under the GST Act that focus on the liabilities of directors of private limited companies; and what measures that PE Directors should generally adopt in order to safeguard their interests and avoid any undue liability.

GST ACT ON THE LIABILITIES OF DIRECTORS

Section 89 of the GST Act addresses the issue of liability of directors of a private limited company. It may be pertinent to note that this section overrides the Companies Act, 2013. The referred section states that if a private limited company does not pay its dues in relation to any supply of goods or services or both, for any period whatsoever, then, in such an event, the directors of such a company shall be jointly and severally liable for the dues of the company. It does not clearly classify which category of directors would be liable, and hence does not make any distinction so as to exclude any non-executive directors. While there are divergent views on this issue, the prevailing view is that there is no-carve out for non-executive directors (including PE Directors), as they also play a role in the running of companies. However, it is also important to note that only the directors who were holding office during such period when the tax was due will be held accountable and shall be made liable. Additionally, no liability will be triggered for any director (including the PE Director), if such director can prove that the non-payment by the company was due to reasons other than any negligence or breach of duty on his/ her part. It may be noted that Section 89 of the GST Act only applies in relation to unpaid dues of the company, and not for any personal penalty imposed on the directors under the GST Act. The particular director(s) will be responsible for their personal dues.

MEASURES TO SAFEGUARDS DIRECTOR'S INTEREST

In order to avoid/ mitigate any liability on the PE Directors, arising out of a non – compliance/ breach by the investee company under the GST Act, or any other legislation in force, it is recommended that the following measures be adopted by PEs in relation to their PE Directors:

1. Indemnification Provisions

Statutory Relief to Directors from Liabilities: Section 463(1) of the Companies Act, 2013 states that in proceedings brought against directors (including non-executive directors) for negligence; default; breach of duty; misfeasance or breach of trust, the court may relieve the directors from liability, either wholly or partly, depending on the circumstances of the case, and if such director has acted honestly and reasonably.

Indemnification under Companies Act, 2013: While Section 201 of the erstwhile Companies Act, 1956 had restricted a company from indemnifying the directors of the company, the Companies Act, 2013 does not have any such restriction and therefore, directors can now be indemnified by companies against liabilities.

Statutory Limitation on Indemnification: Indemnification can also be provided for in the company's articles of association (Companies Act, 2013 - Schedule I - Table-F - Clause 91). However, the indemnity will be enforceable only if it is against any liability incurred by a director in proceedings that have any of the following outcomes, namely: (a) judgment is given in the director's favour; or (b) the director is acquitted or discharged; or (c) it is determined that, although liable, the director acted honestly and reasonably and should be excused. As per the proviso to Section 463(1) of the Companies Act, 2013, a director cannot be indemnified against liability in civil or criminal proceedings for which he or she is found guilty.

In light of the above, it is advisable for PE Directors to be comprehensively indemnified (especially against contingent liabilities arising from tax related issues) jointly and severally by the investee company and its promoters, under the shareholder's agreement/ employment agreement, and also under the articles of association of the investee company.

2. Directors and Officers Liability (D&OL) Insurance

Overview: D&OL Insurance safeguards past, present and future directors from any claim for damages arising from alleged/ actual wrongful acts of such directors. The coverage includes: (a) right to defend; (b) coverage for retired directors; (c) regulatory crisis response coverage; (d) special excess security for non-executive directors; (e) damage to reputation cover; etc.

Statutory Limitation on Insurance: It may be noted that as per Section 197(13) of the Companies Act, 2013, where any insurance is taken by a company on behalf of its managing director, whole-time director, etc. for indemnifying them against any liability in respect of any negligence, default, breach of duty/ trust, the premium paid on such insurance shall not be treated as part of the remuneration payable to any such personnel, provided, however, that if such person is proved to be guilty, the premium paid on such insurance shall be treated as part of their managerial remuneration.

Despite the statutory limitation on insurance provisions under the Companies Act, 2013, it may be noted that the D&OL Insurance is generally considered by PE investors as a pre-requisite for investing funds in the investee company. It is advisable for the PE investors to review the investee company's policies to ensure that the policies are adequate to protect their nominee/ non – executive directors. These insurance issues become particularly critical if the investee company does not have liquidity, in which case investee company would not be able to satisfy its indemnity obligations, and the investee company's insurance becomes critical.

3. Attending Board Meetings Regularly; Recording Dissenting Views

Overview: Under the provisions of Section 173(1) of the Companies Act, 2013, every company is required to hold a minimum of 4 (Four) board meetings in a year. Most of the business decisions made at a board meeting have a direct impact on the company, its board and its employees. Some decisions have an indirect effect, such as decisions regarding rules, regulations and financial operations. If a director is not regular in attending board meetings, then it is highly likely that such director is not observing and participating in the company's decision-making process, which may lead to neglect his/her duties to the company and exposure to undue liabilities.

In addition to attending board meetings regularly, for the reasons stated above, it is important for a PE Director to record his/ her dissenting views in the minutes of the board meetings on any agenda item discussed or any resolution passed. Such director must act honestly and with reasonable justifications. This will serve as an additional safeguard to such non-executive director in the event of any dispute, in relation to such agenda item/ resolution passed by the board of directors, arising in the future. Section 118(4)(b) of the Companies Act, 2013 also requires recording of names of the directors in the minutes book to specifically ascertain who dissented or not concurred with the resolutions passed by the board of directors. Also, it is advisable to peruse the agenda of the board meeting carefully and seek additional information, in writing, wherever necessary and report concerns about unethical behaviour, actual or suspected fraud or violation of the investee company's code of conduct.

4. Independent Audit

Overview: Under Section 143(2) of the Companies Act, 2013, auditors of a company are required to prepare an audit report on the basis of accounts examined by them.

Though, under the provisions of the Companies (Audit and Auditors) Rules, 2014, an auditor is required to report any fraud committed by a company to the Central Government/ Audit Committee, as the case may be, as a matter of abundant precaution, it is advisable for the PE Directors to have an independent audit right on the investee company. Such right, including its scope and duration, can be negotiated by the PE investor at the time of negotiating the shareholders agreement with the promoters and the investee company. The independent audit, in addition to the statutory audit requirements, will keep an additional check on the investee company on its financial transactions and/ or compliances. Needless to mention, such independent audit will be supported by way of a detail report setting out the irregularities of the investee company, if any, and suggested measures to rectify them.

5. Seeking Professional / Legal Advice

Seeking professional/ legal advice from reputed/ experienced lawyers/ independent auditors relating to issues pertaining to, inter alia, related party transactions, office of profit, loans to directors, appointment/ removal of directors and disclosure of interests by directors will significantly help the PE Directors to mitigate their liability and help them to reach a conclusive answer to their queries / concerns. In particular, in respect of related party transactions, it is strictly advisable for the nominee directors to exclude themselves from participation in transactions where there is a conflict of interest.

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.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Mondaq Sign Up
Gain free access to lawyers expertise from more than 250 countries.
 
Email Address
Company Name
Password
Confirm Password
Position
Industry
Mondaq Newsalert
Select Topics
Select Regions
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions