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A Brief Analysis of Liabilities of Directors under Companies Act through the lens of Judicial Pronouncements

Abstract

A company is regarded as an Artificial Entity, it thus needs competent people to run it. A group of such competent people is known as Directors. A Director’s responsibility is to manage the whole business of the company and thus he/she has indirect control over the aspects of the company. With great power comes great responsibility. The power vested in the Director to run a company paves a path for a director to commit fraud and derive undue gain. The investors thus become a victim of it. Post LPG reforms, the corporate structure of India had changed drastically. Since the legislation was not enough to cater to the need of the change, it opened gates for many directors/promoters to commit fraud. This gave rise to strict liabilities that were cast through a series of amendments brought in the Companies Act and through several judicial pronouncements given by the Appellate Court. This blog gives a brief analysis of Liabilities of Directors under the Companies Act, 2013 through the lens of Judicial Pronouncements.

Introduction

The term ‘company’ in itself is a vast concept. Even though a company is regarded as a separate legal entity it is an ‘Artificial Entity’ which does not have a brain of its own, This makes it necessary for any corporation to appoint someone on its behalf to carry out day to day functioning. Thus, the concept of a director comes into the picture. Under section 2(34) of the Companies Act, 2013 (“Act”), a director is a director who is appointed by the board of the company. Since the scope of the Director is very vast, it is very difficult to define a set role of a director. A director acts as an ‘Agent’ of a company because a company can’t act by itself, it can act only through a director. And though a company can hold property or any other assets under its name, the person in whom the legal ownership of the asset is vested is a director.[1]  

A director is an integral part of a company for the formulation of various policies for a company and hence they are vested with several duties and power under Act. But with great power comes great responsibility and thus a director could be held liable for non-performance of his/her duty. While, Companies Act, 1956 was formulated to regulate the working of directors, the corporate growth post LPG reforms saw several scandals like the Satyam Computers Scam, Kingfisher Scam and the Bhushan Steels Scam, etc, which raised several questions over the integrity of Directors. There was a dire need to bring rampant reforms in Corporate Governance to cope-up with the growing corporate sector in India. The Companies Act, 2013 which replaced the earlier act of 1956 brought certain changes to re-built the Governance structure of the Corporates.

Liabilities of Directors under Companies Act, 2013: A Critical Analysis

Since the advent of the Companies Act, 2013, there has been a pragmatic shift in the Corporate Governance of India. Many ineffective penalties have been replaced with new ones under the 2013 Act. It also cast several new duties and obligations upon the directors to make sure that the Corporate Governance is upheld.

Section 2(60) of the Act defines “Officers in Default” which states that the Directors shall be liable for any default done by the company[2]. Since a company is an empty sphere, action disregarded by law is done by a human being. This brought the fraudulent actions of the directors under the ambit of fraud.

The blog has been divided into two broad categories. Statutory and Non-Statutory Liability and Fiduciary and Vicarious Liability.

Statutory and Non-Statutory Liabilitiy

Where the statutory mandates the company to file various returns and statements from time to time, there are hundreds of compliances under the Act which need to be complied with and it shall be the director’s duty to comply with the same. This ensures a system of Checks on Companies to prevent fraud. Mainer times, Directors can furnish false reports/statements for unfair gains, this was primarily seen in the Satyam Computer Scam where Mr. Ramalinga Raju defrauded people for over Rs. 7000 crores by furnishing false statements.

On the other hand, Non-statutory liability arises out of the shareholders filing an application to the tribunal under section 241 if an act of the company is carried out in a way prejudicial to or oppressive to such shareholders. Since Company is merely an artificial entity, any act which causes prejudices to the shareholders is an act of directors. The members of the company can bring an action against any act of oppression or mismanagement of the company[3]. The term ‘members’ has a wide connotation while dealing with matters of Oppression and Mismanagement[4]. In Rajahmundry Electric Supply Corporation Ltd v. A Nageswara Rao[5] The shareholder brought an action against the directors for the gross mismanagement of the company. The Vice-Chairman of the Company drew a huge amount for personal benefits and gains while there were dues pending against the government and machineries were in a state of despair. The shareholders were powerless to do anything. The Court held that this amounts to mismanagement and appointed two administrators for managing the company. Similarly in Hemant D Vakil v RDI Print and Publishing (P) Ltd[6] It was held that when the directors have a motive to defraud the shareholders/members, it is sufficient enough data to establish mismanagement.

Fiduciary and Vicarious Liability

The Fiduciary Liability of the Directors can be seen under section 166 of the Act. The Section sets out detailed duties of the Directors, violation of which can attract a fine of Rs. 1 lakh which may extend to Rs. 5 lakhs[7]. The general duties of the director are to act according to the AOA, not using the office for personal gain, should not get involved in transactions in which he may have a direct or indirect interest, etc[8]. One of the key sub-clauses is u/s 166 is to exercise his/her duty with due care, diligence, and independent judgement. The Act of 2013 brought the said amendment which has given a wide implementation of director’s duties. This establishes a Fiduciary Duty upon a Director to work according to the provisions of the Act and thus a director can be held liable for breach of trust. In Bank of Poona Ltd. v. Narayandas Shriman Somani[9] The Court held that “Greatest good faith is expected in the discharge of their duties”. While powers entrusted upon the directors are “Power in Trust” and therefore it shall not be used for personal gain. In Cook v. Deeks[10] When the director in pursuant to his voting power by holding shares, diverted the contract for his personal benefit, it was held that, since he possesses a fiduciary duty towards the company, he cannot use his voting power for personal gains over companies gains.

On the other hand, Vicarious Liability arises when the Director is acting on behalf of a Company. In simple terms, Vicarious Liability makes the principal liable for the acts of the Agent. The Act has entrusted certain powers under section 179 to the Board of Directors which makes them Vicariously Liable to the Company[11]. Since the term Board of Director is used under the said provisions, there is no distinction between any type of directors whatsoever. One of the most important jurisprudence on this behalf was pronounced by the Supreme Court in Iridium India Telecom v. Motorola Inc.[12] The case revolved around the criminal liability of directors of Motorola Inc defrauding Iridium by making a false promise about the technology sold to them. Even though the suit was brought against Motorola Inc, the Supreme Court took the aid of English Jurisprudence and held that, since Motorola Inc is an artificial entity that can’t defraud anyone, it is the directors who are criminally liable for fraud and cheating under the provisions of Indian Penal Code, 1860.

Similarly, the Supreme Court in Sunil Bharti Mittal v. Central Bureau of Investigation[13]. The supreme court clarified the stand of alter ego. The Court stated that, under the principle of alter ego, Directors can be held liable for the actions of the company only if it is proven that there was a criminal intention of such directors to commit fraud and cheating under the name of the company.

Conclusion

The Jurisprudence of Corporate Governance is constantly evolving to meet up the new challenges in the Corporate Sectors of India. The Act of 2013 was crucial in bringing pragmatic changes to the Liabilities and Defences of the directors.  Section 8.31 of The Model Business Corporation Act which is adopted by many states in the USA, presumes the director to be innocent until proven guilty, this mitigates the risks of directors’ liabilities to the company[14]. The said provision is not expressly provided in the Companies Act, 2013 which might not provide for sufficient defences to the directors while carrying out their duties towards the company.  


[1] Dr. G.K Kapoor and Dr. Sanjay Dhamija, Company Law and Practice (24th edn. Taxmann 2019).

[2] Companies Act, 2013 § 2(60).

[3] Companies Act, 2013 § 244.

[4] Avtar Singh, Company Law (17 edn. EBC 2018).

[5] Rajahmundry Electric Supply Corporation Ltd v A Nageswara Rao AIR 1956 SC 213.

[6] Hemant D Vakil v RDI Print and Publishing (P) Ltd MANU/CL/0026/1995.

[7] Companies Act, 2013 § 166(7).

[8] Companies Act, 2013 § 166.

[9] Bank of Poona Ltd. v. Narayandas Shriman Somani AIR 1961 Bom 252.

[10] Cook v. Deeks (1916) 1 AC 554.

[11] Companies Act, 2013 § 179.

[12] Iridium India Telecom v. Motorola Inc. (2011) 1 SCC 74.

[13] Sunil Bharti Mittal v. Central Bureau of InvestigationAIR 2015 SC 923.

[14] Model Business Corporation Act  § 8.31.

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