CONCEPT OF DIRECTORS’ LIABILITY IN INDIA

Background:

The Companies Act 2013 (“Act”) was recently enacted to meet the modern-day corporate governance challenges arising from stakeholders’ expectations. This note provides an insight into the duties and liabilities of the directors under the Act and the practical measures they may adopt to comply with these duties.

Meaning of the term “Director.”

The term “director” has been defined under Section 2(34) of the Act as a director appointed to the company’s board. The Act provides for different categories of directors, such as whole-time directors, managing directors, independent directors, nominee directors, alternate directors, and women directors.

Concept of “officer in default”

The Act attributes the liability on the ‘officer in default’, which may include the directors. The Act introduced the concept of the “officer who is in default”, and most of the sections prescribing a penalty for non-compliance hold the ‘officer in default’ liable for such a penalty. The term is defined in section 2(60) of the Act as under:

Section 2(60) of the Act: “officer who is in default”, for any provision in this Act which enacts that an officer of the company who is in default shall be liable to any penalty or punishment by way of imprisonment, fine or otherwise, means any of the following officers of a company, namely: —

  • whole-time director;
  • key managerial personnel (KMP);
  • where there is no key managerial personnel, such director or directors as specified by the Board in this behalf and who has or have given his or their consent in writing to the Board to such specification, or all the directors if no director is so specified;
  • any person who, under the immediate authority of the Board or any key managerial personnel, is charged with any responsibility including maintenance, filing or distribution of accounts or records, authorizes, actively participates in, knowingly permits, or knowingly fails to take active steps to prevent, any default;
  • any person in accordance with whose advice, directions or instructions the Board of Directors of the company is accustomed to act, other than a person who gives advice to the Board in a professional capacity;
  • every director, in respect of a contravention of any of the provisions of this Act, who is aware of such contravention by virtue of the receipt by him of any proceedings of the Board or participation in such proceedings without objecting to the same, or where such contravention had taken place with his consent or connivance;
  • in respect of the issue or transfer of any shares of a company, the share transfer agents, registrars and merchant bankers to the issue or transfer;

Notably [refer point (vi)], the directors of the company who are not responsible for the day-to-day management of the affairs of the company can be held liable only in those cases where the default or the contravention of the provisions of the Act 2013 have occurred with the knowledge of such director, attributable through the board processes.

Directors’ duties under Section 166[1]

Besides the liabilities, the Act codifies directors’ duties and the relevant provisions of the Act, which apply to all categories of directors, including independent directors. These include acting in accordance with the articles of a company, acting in good faith to promote the objects of the company for the benefit of its members as a whole, and in the best interests of the company, its employees, the shareholders, the community and for the protection of the environment, avoid situations in which he may have a direct or indirect interest that conflicts, or possibly may conflict, with the interest of the company and so on shall be void.

Directors’ liabilities, in general

  1. Contractual Liability: Directors are bound to use fair and reasonable diligence in discharging their duties to act honestly and with such care as is reasonably expected from them, regarding their knowledge and experience.
  • Express and implied liability arises when a director has personally guaranteed the performance of a contract. Implied liability will arise when a director signs a contract for the Company or mentions the name but fails to add the vital word “limited” or its abbreviation. This rule rests on the ordinary principle of agency that where an agent enters into a contract without disclosing that he is acting as an agent he accepts personal liability.
  • Pre- Incorporation Liability: A Company cannot make a contract before it is incorporated because, before incorporation, it has no legal existence. Therefore, a Company, after incorporation, cannot ratify a contract previously made. It must make a fresh contract. But those who act on behalf of the unincorporated company may find themselves personally liable.
  • Tax Liability: As per the Indian tax laws, when any private company is wound up and the tax assessed cannot be recovered, then every person who was a private company director shall be jointly and severally liable for the payment of such tax.
  • Apart from the Act, several other statutes, such as the Negotiable Instruments Act, and Consumer Protection Act, lay down increased liabilities on directors.

Class action remedy

The company can initiate legal action against directors if they breach their duties. The Act has also introduced the novel concept of ‘class action suits’ under the Act. Under this concept, a group of shareholders (constituting a minimum of 100 shareholders or such minimum percentage of total shareholders as may be prescribed) can bring an action on behalf of all affected parties, against the company and/or its directors, for any fraudulent or wrongful act or omission of conduct on its/their part. Further, the Act proposes to set up a National Company Law Tribunal, which is expected to provide a speedier and more efficient remedy.

[1] Contravention of provisions of Section 166 (relating to codified duties) is punishable with a fine which shall not be less than Rs.1 Lakh but which may extend to Rs.5 Lakhs.

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