Director's Duties and Legal Obligations : A Case Study.

   This article is written by Adwitiyo Raha, Amity University, Kolkata, LL.M, during his internship at LeDroit India.

Key Words : Director, Duties of Directors, Fiduciary Duty, Criminal Liabilities of Directors, Corporate Social Responsibility, Corporate Governance.

Abstract

Directors of a company play a crucial role in ensuring sound corporate governance and maintenance of ethical business practices. They play a crucial  role in the company’s management along with decision making procedures. “The Companies Act, 2013, entrusts directors with fiduciary duties, statutory obligations, and legal liabilities to protect the interests of creditors, shareholders and other stakeholders of the company”. (The Institute of Company Secretaries of  India, 2014). This article delves into the statutory framework that governs the duties of  the directors, emphasizing their responsibility to act in “good faith, exercise due diligence, and avoid conflicts of interest.” By analyzing judicial interpretations and case laws, the article seeks to offer an in-depth understanding of the legal duties of directors.

Introduction

“Director” is defined in Section 2(34) of the Companies Act, 2013. As per Section 2(34) a director means “director appointed by the board”. “The legal position of the directors of the company is related to different attributes. They act as trustees for assets and properties of the company, as agents on behalf of the company and as managing officers who enjoy the vast power of management by provisions set out in the memorandum of association (MoA) and article of association (AoA) of the company.” (Company Administration, n.d., p. 1). Only individuals can be appointed as directors, neither a body corporate nor a firm can be appointed as director of a company.

Board of Directors

The directors of the company are collectively called the “Board of directors” who are collectively responsible to act to promote the goal and objectives of the company. “A public company must have a minimum number of three directors, in case of a private company a minimum of two directors and one director in case of a one-person company. The maximum limit on the number of directors for every company is fifteen. However, A company may appoint more than fifteen directors after passing a special resolution.” (COMPANY ADMINISTRATION, n.d.-b)

Types of Directors

The Companies Act, 2013 recognises the following types of directors : 

1. Executive Director : Defined in Section 2 (94) of the Companies Act, 2013, an executive director is a full time employee of the company. They are responsible for operations of the company and participate in decision making.

2. Managing Director :  According to Section 2(54) of the Companies Act, 2013 a managing director has significant authority over the company’s management.

He is appointed by : 

• “By the articles of the company
• By an agreement with the company
• By a resolution passed in the general meeting
• By the company’s Board of Directors.” (Saxena, 2024)

3. Independent Directors : An independent director of a company, means “a director other than a managing director or a whole-time director or a nominee director, who is in the opinion of the Board of Directors, a person of integrity and possesses relevant expertise and experience and who is not a promoter of the company or its holding, subsidiary or associate company, nor related to promoters or directors in the company, its holding, subsidiary or associate company.” (The Institute of Cost Accountants of India, 2013b)

4. Small Shareholder Director : Small shareholders may have one director elected by them to the Board of Directors to represent their interest. Explanation proviso to Section 151 of the Companies Act, 2013 defines small shareholder as a shareholder holding shares of nominal value of not more than twenty thousand rupees or such other sum as may be prescribed in the company’s memorandum of association (MoA). (“BUSINESS ENVIRONMENT AND LAW,” n.d.)

5. Nominee Director : According to Section 161(3), “subject to the articles of a company, the Board of Directors of the company may appoint any person as a director who is nominated by any institution.” (Kanchi, 2015). It may be a financial institution such as a bank or by the creditors or an individual who is nominated “by the Central Government or the State Government by virtue of its shareholding in a Government Company.” (The Institute of Company Secretaries of  India, 2014).

Duties of Directors

The Companies Act, 2013 provide for the following duties of the directors : 

1. Fiduciary Duties  : “Section 166 of the Companies Act, 2013, provides for the fiduciary duties of the directors of a company.” (The Institute of Company Secretaries of  India, 2014). These are : 

•  Directors should act in good faith and in the best interest of the company and its stakeholders including creditors and shareholders.
•  Directors are required to promote the goals and the objectives of the companies.
•  Directors are required to carry out their duty with due care, skill and diligence. They shall exercise their judgment independently.
• Directors must refrain from intervening when their interests, whether direct or indirect, conflict with those of the company 
• Directors should not try to obtain any unfair advantage either for himself or for his relatives, partners or associates.
• Directors cannot assign their office or duties to another individual.
• Directors are required to act in accordance with the company’s  Article of Association (AoA).

2. Duty to Disclose Interest : Section 184 (1) of the Companies Act, 2013, provides that directors are required to disclose their interest or concern in other companies, firms or associations.

             This disclosure must be made at : 

• The first board meeting they have attended as directors of the company.
• “The first board meeting of every financial year.
• The first board meeting held, after the change in their interest or concern.” (Kothari, n.d.).

         According to Section 184 (2) of the Companies Act, 2013, a director of a company is required to disclose about their direct or indirect interest with a Body Corporate where they hold more than 2% shareholdings or is a promoter, manager or CEO of that Body Corporate with the which the aforementioned company intends to enter into a contract.

3.  Duty to Ensure Compliance with Corporate Social Responsibility : Companies with a net worth of INR 500 Cr., a turnover of INR 1000 Cr., or a net profit of INR 5 Cr. in the previous fiscal year are required by Section 135 of the Companies Act, 2013 to engage in initiatives that promote social, economic, and environmental development. These companies must establish a Corporate Social Responsibility Committee with three directors, one of whom must be an independent director, to ensure compliance with Section 135 of the Companies Act 

Liabilities of Directors

1. Punishment for Fraud : The Companies Act of 2013 addresses penalties for fraud in Section 447.  Fraud is defined in the Explanation to the Section as an act of omission or concealment of any material fact or abuse of position with the intention of deceiving, gaining an undue advantage, or harming the interests of the company, its shareholders, creditors, or any other person. This Section also applies to a company’s directors If the fraud is worth of INR 10,00,000 or 1% of the turnover of the company (whichever is lower) then according to this Section, then the person guilty of fraud shall be punishable with imprisonment for a term which shall not be less than six months and shall also be liable to fine which shall not be less than the amount involved in the fraud and may extend to three times of such amount. If the fraud in question involves public interest then the term of imprisonment shall not be less than three years.” (Bhat & Singh, 2020)
2. Punishment for False Statement : Section 448 of the Companies Act, 2013, pertains to any person, including the directors of a company, who is found to have made or circulated false statements, reports or accounts, either knowingly or recklessly, with the intent to deceive or defraud the stakeholders including the shareholders and creditors or any other person associated with the company. Anyone found guilty under this section faces a minimum fine of INR 50,000 but a maximum fine of INR 1 lakh, as well as a maximum sentence of two years in prison.  Prosecution under Section 448 of the Companies Act, 2013, requires prior approval of the Central Government
3. Punishment for Failure to keep Books of Accounts : Section 128 of the Companies Act, 2013 makes the maintenance of books of accounts by a company as mandatory. Section 128 (1) states that every company shall prepare and maintain books of accounts which shall include financial statements for every year at its registered office. This ensures a true and fair view of the company’s state of affairs and including that of its branches. Section 128 (6) states that if the managing director or the executive director incharge of finance, who are put in charge by the Board of Directors to ensure compliance with this Section shall be punishable with fine of not less than INR 50,000 but which may extend to INR 5 lakhs.
4. Punishment if Financial Statement do not Comply with Accounting Standards : Section 129 (7) states that if the financial statement of the company do not comply with accounting standards then the managing director and executive director in charge of finance, the Chief Officer or any other person (The Institute of Cost Accountants of India, 2013) who is put in charge by the Board of Directors to ensure compliance with Section 129 of the Companies Act, 2013 shall be punishable with imprisonment for term which may extend to one year or with fine which shall not be less than INR 50,000 but may extend to INR 5 lakhs.(Aayog et al., 2021)
5.  Punishment for Failure to Disclose Interest : : Section 184 (1) of the Companies Act, 2013, provides that directors are required to disclose their interest or concern in other companies, firms or associations.

             This disclosure must be made at : 

• The first board meeting they have attended as directors of the company.
• “The first board meeting of every financial year.
• The first board meeting held, after the change in their interest or concern.” (Kothari, n.d.)

         According to Section 184 (2) of the Companies Act, 2013, a director of a company is required to disclose about their direct or indirect interest with a Body Corporate where they hold more than 2% shareholdings or is a promoter, manager or CEO of that Body Corporate with the which the aforementioned company intends to enter into a contract.

If a director fails to inform about such interest then as per Section 184 (4) of the Companies Act, 2013 shall be liable to a penalty of INR. 1 lakhs. 

Case Laws

Percival v Wright (1902)

1. Facts: 

Some directors of Nixon’s Navigation Co. bought the shares at £12.10s a share, which was based on independent valuation, after shareholders wanted to sell their shares and asked the secretary of the company to find buyers 

“Subsequently, it was revealed that the directors had been negotiating to sell the entire company, which would have increased the value of the shares significantly had the sale been completed. The plaintiff shareholder sued, alleging:

• Directors typically do not owe fiduciary duties to individual shareholders, but in this case, they were in a position of trustees for the sale due to the imminent sale of the company.
• The failure to disclose the ongoing negotiations constituted a breach of fiduciary duty.” (Heyes, 2024b).

Judgement

The claim was dismissed by the The House of Lords. Swinfen Eady J. held that the fiduciary duties of the directors were towards the company itself and not to individual shareholders. 

2. Tata Consultancy Services Limited v. Cyrus Investments Pvt. Ltd. (2021)

Facts : 

   Cyrus Mistry was fired as Executive Chairman of Tata Sons by the board of the Tata Group in 2016. Under the Companies Act of 2013, Mistry’s investment company, Cyrus Investments Pvt. Ltd., accused the Tata Sons board, headed by Ratan Tata, of oppression and mismanagement, alleging that the board behaved arbitrarily and in violation of its fiduciary obligations. The decision of the National Company Law Tribunal (NCLT), which ruled in favour of the Tata Sons. was challenged before the National Company Law Appellate Tribunal (NCLAT). The NCLAT ruling in favour of Mistry, ordered the reinstatement of him.  Tata Sons challenged this decision before the Supreme Court.

Judgement

 The Supreme Court overruled the NCLAT’s decision and ruled in favour of the Tata Sons. It held that Boards action was in compliance with the Companies Act, 2013. The Supreme Court further observed that “The fact that the removal of Cyrus Mistry was only from the Executive Chairmanship and not the Directorship of the company as on the date of filing of the petition and the fact that in law, even the removal from Directorship can never be held to be an oppressive or prejudicial conduct was sufficient to throw the petition under Section 241 of Companies Act, 2013 out, especially since NCLAT choose not to interfere with the findings of fact on certain business decisions.” The Supreme Court has further reiterated that the fiduciary duties of directors are to do what is  best for the company as a whole and not as to what is best for one of the shareholders. It held  that the Tata Sons’ board had exercised business judgment in removing Mistry and this was consistent with principles of sound corporate governance. 

Conclusion

Under the Companies Act, 2013, the role of directors is crucial in ensuring sound corporate  governance and protecting the interests of stakeholders. The duties and legal obligations specified for them in the Act are  meant to ensure that company operations are carried out with transparency, accountability, and ethical standards.  Non-compliance with these duties can attract severe legal consequences, which could be civil or criminal in nature.  Consequently, directors are required to fulfil their legal and fiduciary duties to ensure the long-term success of  the company.