Raising The Bar For Directors: Accountability And Liability In The IBC Framework

A. Introduction

Directorial liability is a critical pillar of corporate governance. Directors play a pivotal role in steering an organisation and are bound by responsibilities arising from statutory provisions, constitutional documents, and board mandates. With authority comes accountability, and a breach of this responsibility may subject directors to legal consequences.

The Companies Act, 2013 ("Companies Act") remains the cornerstone of corporate governance in India, setting out the duties, powers, and responsibilities of directors. While the Companies Act penalises fraudulent conduct intended to defraud creditors, it does not impose a direct statutory obligation on directors to mitigate losses to creditors in situations of financial distress. With the advent of the Insolvency and Bankruptcy Code in 2016 ("IBC") however, the legal landscape concerning director's liability has witnessed significant changes. Under the IBC, the directors may be held personally liable if their actions are deemed reckless, fraudulent or grossly negligent, leading to outstanding corporate debts.

This article examines the evolving contours of directors' liability under the IBC, analysing their duties, responsibilities, and the potential consequences of non-compliance.

B. Directors' Duties, Responsibilities, and Liabilities Under General Law

Under company law, directors occupy a quasi-fiduciary position, requiring them to maintain a degree of standard of care and uphold the trust¹ of the company while discharging its functions.². Section 166 of the Companies Act codifies this obligation by imposing duties of care, skill, and good faith. Directors are expected to exercise the level of care and diligence that a prudent individual with their knowledge and expertise would reasonably deploy. Breach of these duties attracts penalties, and wilful violation of material obligations may expose the "officer in default" to fines or imprisonment.

Judicial pronouncements have clarified that director liability under other statutes remains unaffected by insolvency proceedings. In the matter of P. Mohanraj v. Shah Bros. Ispat (P) Ltd.³, the Hon'ble Supreme Court has held that the director's liability under Section 141 of the Negotiable Instruments Act, 1881 remains unaffected by initiation of moratorium. Recently, it has been further clarified by the Hon'ble Apex Court in the matter of Ajay Kumar Radheyshyam Goenka v. Tourism Finance Corpn. of India Ltd.⁴, that dissolution of a company or approval of a resolution plan under the IBC does not absolve the personal penal liability of the directors of a company. Thus, statutory penalties imposed on directors operate independently of the IBC proceedings.

C. Additional Responsibilities Introduced by the IBC

The IBC has reshaped director liability by empowering insolvency professionals to scrutinise transactions executed in the period preceding insolvency. These changes are aimed at restoring the wealth of the company for the benefit of the company and its stakeholders.

1. Continuation of Avoidance Proceedings Post-Resolution

A significant development is the recognition that avoidance applications remain maintainable even after the approval of a resolution plan. In Madhavi Edible Bran Oils v. Immaneni Eswara Rao⁵, the National Company Law Appellate Tribunal ("NCLAT"), relying on the Delhi High Court's ruling in TATA Steel BSL Ltd. v. Venus Recruiter Private Limited⁶, held that applications for fraudulent or wrongful transactions could be still be prosecuted post-CIR Process. These rulings reinforce the position that directors cannot escape liability merely because a resolution plan has been approved, further emphasizing the need for diligence in financial management.

2. Personal Liability for Fraudulent and Wrongful Trading

Courts have increasingly held directors personally liable under Section 66 of the IBC for fraudulent and wrongful trading. Instances such as misrepresentation of financial statements, diversion of funds, and concealment of preferential transactions have been treated as fraudulent conduct. For instance, in Shibu Job Cheeran v. Ashok Velamur Seshadri⁷, the NCLAT held even non-executive directors liable for failing to exercise due diligence despite knowledge of insolvency risks. A similar position was taken by the NCLT Mumbai Bench in Vijendra Kumar Jain v. Nitin Ramchandra Jadhav⁸, where directors were held personally liable for wrongful trading and financial misrepresentation. These decisions are testament to the fact that courts are increasingly willing to hold directors accountable for financial misconduct under the IBC.

3. Duty to Prevent Losses to Creditors Under Section 66(2)

Section 66(2) of the IBC introduces a duty not previously found in the Companies Act: the obligation to take proactive steps to minimise losses to creditors when insolvency becomes reasonably foreseeable. The Section provides as below:

"66. Fraudulent trading or wrongful trading. –

...

(2) On an application made by a resolution professional during the corporate insolvency resolution process, the Adjudicating Authority may by an order direct that a director or partner of the corporate debtor, as the case may be, shall be liable to make such contribution to the assets of the corporate debtor as it may deem fit, if-

(a) before the insolvency commencement date, such director or partner knew or ought to have known that there was no reasonable prospect of avoiding the commencement of a corporate insolvency resolution process in respect of such corporate debtor; and

(b) such director or partner did not exercise due diligence in minimising the potential loss to the creditors of the corporate debtor."

The provision makes it clear that if directors fail to act despite knowledge (or deemed knowledge) of impending insolvency, the resolution professional may seek an order compelling them to contribute to the company's assets. Fraudulent transactions may also attract imprisonment of up to five years and fines up to INR 1 crore under Section 69 of the IBC.

This provision appears to be designed to address "wrongful or fraudulent trading" during the twilight phase—when the company's insolvency becomes imminent and its financial condition deteriorates.

4. Proceedings Continue Post-CIR Process

In Kapil Wadhawan v. Piramal Capital & Housing Finance Ltd.⁹, the NCLAT upheld the validity of a clause in the resolution plan which provided that the successful resolution applicant would pursue the avoidance applications filed by the administrator even after the approval of the resolution plan, confirming that proceedings against directors persist beyond the completion of CIR Process.

D. Practical Impact of Enhanced Scrutiny

While the IBC significantly heightens director accountability – inter alia holding the directors personally liable if they are found to have acted recklessly, fraudulently, or with gross negligence, a major challenge arises in adjudicating questions of intention and knowledge—elements that typically require a trial-like process. Given the summary nature of IBC proceedings, determining knowledge becomes complex. To ascertain if the directors have 'knowingly' carried on the operations of the company in a manner which does not aid the prospects of meeting the debts of the company, there has to be credible evidence which could indicate the knowledge, intent and motive of the directors in question.

Further, available data suggests limited success in clawback proceedings. As of June 2023, only 200 of 947 avoidance applications had been disposed of, with an overall recovery rate of just 11%—most of which stemmed from a single CIR Process (Jaypee Infratech Ltd.¹⁰). One contributing factor is the inconclusive nature of forensic audit reports, which often classify transactions as "potentially" fraudulent rather than providing definitive findings.

In one instance, the NCLT dismissed an application under Section 66 where the forensic report merely identified "potentially fraudulent" transactions, holding that failed business decisions cannot be equated with fraud absent clear evidence of intent to defraud or actual diversion of funds¹¹. The NCLT observed that the erstwhile management of a company cannot be called in question under Section 66 of the IBC for the failed business decisions causing losses to the company. In the absence of any credible proof of siphoning or diversion of funds, an application under Section 66 was dismissed by the NCLT.

E. Mitigating Liability Through Robust Corporate Governance

In the preceding paragraphs, we have discussed that if the directors are found liable under the IBC, they can face civil penalties, including compensation for losses suffered by creditors and the company. These penalties aim to compensate the financial position of the company. In severe cases involving intentional misconduct or fraud, directors can face criminal charges, leading to fines or imprisonment.¹² These consequences underscore the importance of ethical conduct.

Given the heightened scrutiny under IBC, directors must adopt proactive governance practices to mitigate liability risks:

• Strengthen internal controls through transparent reporting, whistleblower mechanisms, and robust risk-assessment frameworks.
• Ensure accurate and timely financial disclosures to avoid allegations of concealment or misrepresentation.
• Record dissent explicitly in board minutes to demonstrate due diligence and protect against personal liability.
• Avoid related-party and non-arm's-length transactions, especially during financial distress.
• Engage with creditors transparently, reducing information asymmetry and the likelihood of transactions being viewed as fraudulent.
• Evaluate insolvency risks in real time and, when warranted, consider voluntary initiation of CIR Process under Section 10 to prevent further deterioration.
• Resist pressure from promoters or majority shareholders to approve decisions that may worsen the company's financial distress.

These measures not only protect directors but also contribute to organisational integrity and stakeholder confidence.

F. Conclusion

IBC has transformed the landscape of director's liability, imposing greater responsibility and scrutiny on directors, particularly during periods of financial distress. Directors are expected to exercise heightened diligence to ensure that their actions do not exacerbate the company's insolvency risk. Transparent communication with creditors and shareholders, timely disclosures, and ethical decision-making are essential to safeguard both the company and its directors from allegations of fraudulent or wrongful trading.

While the enhanced framework strengthens corporate governance, it is equally important to maintain a balance—protecting directors from frivolous claims while ensuring accountability for genuine misconduct. Ultimately, IBC reinforces the principle that directors serve not only shareholders but all stakeholders, including creditors, employees, and the broader financial ecosystem.

Footnotes

1. Chevalier I.I. Iyyappan v. Dharmodayan Co., Trichur, AIR 1966 SC 1017

2. Albert Judah Judah v. Ramapada Gupta, (1960) 30 Com Cases 582 : AIR 1959 Cal 715: "It is clear that the directors are trustees in a very limited sense. They are liable as trustees for breach of trust, if they misapplied the funds or committed breach of bye-laws. Their position differs considerably from ordinary trustees..."

3. (2021) 6 SCC 258

4. 2023 SCC OnLine SC 266

5. (Company Appeal (AT) (CH) (Ins) No.388/2022)

6. (LPA 37/2021)

7. (Company Appeal (AT) (CH) (Ins.) No. 350 of 2021)

8. Interlocutory Application No. 677 of 2023 in CP (IB) No. 1023 of 2021

9. CA (AT) (Ins.) No. 437 of 2023.

10. The Quarterly Newsletter of the Insolvency and Bankruptcy Board of India, April-June 2023, Volume 27 accessible at: https://ibbi.gov.in/uploads/publication/0d26415640ac24dab79ebdcbc11a64a8.pdf

11. Mr. Venkatesan Sankaranarayanan, the RP for RTIL Ltd. Vs. Mr. Nitin Shambhukumar Kasliwal & Others, M.A. 05 of 2019 in C.P. No. 382/I&B/MB/2018, Order dated 29 November 2021 at para 2.1

12. Under the Companies Act and IBC, there are several offences wherein fine and imprisonment is prescribed as sentence.

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.