Directors are sine qua non for the functioning of a company. Assuming positions of power mandates the director to conduct the affairs of the company in good faith. In the erstwhile Companies Act of 1956 the duties of directors were only briefly stated in S.291. All cases in relation to duty of a director were adjudged on principles of common law and equity. The dearth of a codified set of duties created uncertainty and scope to circumvent the law. Upon the recommendations of J.J Irani Committee, S.166 was incorporated into the Companies Act, 2013 to statutorily lock the duties of a director. However, S.166 posits the general duties owed by a director, it makes no explicit mention of the term ‘fiduciary duty’. Our understanding has developed from a series of cases, as discussed further below.
1. Origin of Fiduciary Duty
The concept of fiduciary duty stems from the notion of acting in good faith. Between two persons one is bound to protect the interests of the other and if the former availing of that relationship makes an unjust enrichment or unjust benefit derived from another, it is against the ethos of fiduciary duty. [1] The fiduciary duty of a director is considered analogous to the duties owed to a beneficiary by a trustee. Being trustees, the directors are bound to act in the best interests of their beneficiary, that is, the company or its stakeholders. This comparison dates to the English case of Percival v Wright [2], wherein it was held that the director shares a twofold relationship with the company, that of agency and trusteeship. This position was further reiterated in Indian jurisprudence in Globe Motors Ltd. vs Mehta Teja Singh where it was opined that the fiduciary duties of directors are basically the same as those of other trustees and they are expected to display the utmost good faith towards the company whether their dealings are with the company or on behalf of the company. [3]
2. Fiduciary duty under Indian law
2.1 To whom is the duty owed?
The general rule is that no fiduciary relationship is to be imputed between a director and shareholder, it only extends to the company. This principle carved out in Percival is considered good law even today and has been reiterated in multiple English cases [4]. In Indian jurisprudence, while it is generally accepted that directors bear no fiduciary obligation to shareholders, such obligation is attracted in special and exceptional circumstances.
The case of Sangramsing P. Gaekwad [5] is an authoritative text to understand the fiduciary duties of a director’s vis a vis the company and shareholders. The court relied upon a variety of cases to conclude that under special circumstances, such as, directors placing the onus upon themselves to advice the shareholders [6], in case of takeover of bid [7] , usage of powers for extraneous purposes[8], when tenets of agency such as trust, confidentiality and loyalty arise [9], when additional shares are acquired to benefit the company and in the process directors make a pecuniary gain with an ulterior motive[10], a digression can be made from the settled position of law which recognizes fiduciary duty of a director only in context of the company. In Percival, the term ‘ordinarily’ was used, and it would not be cogent to extend that to special circumstances. Thus, the court created an exception of special circumstance/special arrangement to the Percival rule.
An important distinction was made in relation to the fiduciary duty of directors regarding property and funds of the company and the duty of directors to shareholders as sellers of shares. [11] (Verma, 2014) These are distinct duties and cannot be conflated. Nevertheless, shareholders may seek remedy in the presence of special circumstances which give rise to a fiduciary relationship in a director vis a vis shareholder.
In my analysis, the judgement recognizes that it implausible to establish a law that will have universal application in determining fiduciary duties of a director. Such an observation is made more pertinent considering evolving economies, increasing number of scandals and cases of oppression and mismanagement. It would be remiss to apply a rigid principle without accounting for differing facts and circumstances of each case. The power of the judgement lies in its creation of the exception which provides minority stakeholders and other vulnerable groups with the opportunity to avail remedy.
2.2 Fiduciary duty to avoid conflict
Directors are often in a position that enables them to gain pecuniary benefit at the expense of the company or shareholders. By precedent, it has been established that in such circumstance’s directors are bound to disregard their own private interests whenever a regard to them conflicts with the proper discharge of their duties as directors.[12] This principle was explored in the case Globe Motors Ltd. vs Mehta Teja Singh [13] and the court decisively held that the agreement entered into by the directors of the company was in a fiduciary capacity and since the directors acted in their personal interest as opposed to the interest of the company, such agreement was liable to be vitiated.
In Rajeev Saumitra v Neetu Singh & Ors[14], after the incorporation of S.166 into the Companies Act, 2013 the Delhi High Court deliberated upon aforesaid section and expanded the current understanding of shareholders’ obligations. The plaintiff and defendant were 50% shareholders each in a coaching company and were directors. The defendant created two other businesses engaged in coaching as well and to benefit her other creations she unduly utilized the resources of prior coaching company. Since she was a director holding 50% shares, she was entitled to block any applications initiating proceedings against her. Therefore, the defendant filed a suit for breach of duties under S.166. Establishing two competing businesses while holding directorship was held as a breach of fiduciary duty owed to the company as the affairs of the company were to be dealt with loyalty and good faith and avoidance of conflict of duty and self-interest. [15] Further, the court opined that consequences are to follow if a director places herself in a position where her personal interest is liable to conflict with the duties owed to the company. In this manner, the avoidance of conflict has been read into the fiduciary duties of a shareholder.
2.3 Fiduciary duty to act bonafide
In the case, Dale and Carrington v Prathapan & Ors[16]. litigation centered around the control and management of a company in which the parties were shareholders. Additional equity shares were issued in favor of the Managing Director which rendered the respondent from a majority shareholder to a minority shareholder. The court then had to decide whether such act was a bonafide act in the interests of the company.
A variety of precedents were cited by the court to conclude that the directors, within their powers are vested with the ability to issue and acquire shares to raise capital if such act is motivated by bonafide interests. If they receive an incidental profit or gain from such exercise it would not attract consequences, due to being performed under the belief of good faith. However, if such act is spearheaded by improper motives the directors are liable for breach of fiduciary duty.[17] The court observed that the bona fide test in other jurisdictions has been extended to ‘proper purpose rule’ which vitiates issuance of shares made even under bonafide belief, if such act was not for a proper purpose.
In conclusion, an exercise of power by the directors in the matter of allotment of shares, if made mala fide and in their own interest and not in the interest of the company, will be invalid even though the allotment may result incidentally in some benefit to the company. [18] Therefore, to pass the muster of good faith the action of directors must not be tainted by ulterior motives.
3. Conclusion and Analysis
With the growing complexity of the commercial world, the scope of director’s responsibility is expanding and with it, the compass of fiduciary duty is also evolving. [19] (Jenna 2009) Prior to enactment of S.166, the court endeavoured to postulate a meaning in conformity with principles of equity and good faith. The revised Act incorporates similar principles in S.166 and identifies ‘’officers in default’’ defined under S.2(60)[20]. Inserting S.2(60) illustrates the commitment of the statute in protecting parties who have been wronged and acts a deterrent from committing such wrongs as contravention of provisions attracts penalty or punishment. However, independent directors and non-executive directors are saved from being ‘’officers in default’’ under S.149(12).
The strongest critique of S.166 lies in its weak protection of the rights of non-shareholders, i.e., stakeholders such as suppliers, customers etc. S.166(2)[21] ostensibly appears to address this issue, but difficulties in implementing the section defeat the purpose, rendering stakeholders with no remedy in case of breach of duty by directors. The primacy given to shareholders is evident in the existing remedies of derivative action and class action suits, from which stakeholders are excluded.
[1] Sangramsinh P. Gaekwad and Ors. vs. Shantadevi P. Gaekwad (Dead) thr. Lrs. and Ors (2005)11SCC314
[2] Pericval v Wright [1902 (2) Ch. 421]
[3] Globe Motors Ltd. vs Mehta Teja Singh (1984 55 Comp Cas 445 Delhi) para.7
[4] For example, in Peskin v Anderson, it was held that directors do not owe a general duty to shareholders. However, a duty may arise if a special relationship is established between the directors and shareholders.
[5] Supra at 2.
[6] Dawson International PLC v Coats Patons PLC (1980 SLT 854)
[7] Gelting vs. Kilner, 1972 (1) All ER 1166
[8] Piercy v. S. Mills & Company Ltd. [1920] 1 Ch 77
[9] Peskin and Another Vs. Anderson and Others [2001] 1 BCLC 372
[10] Needle Industries (India) v. Needle Industries Newey (India) Holding Ltd 1981 AIR 1298, 1981 SCR (3) 698
[11] Verma, V. K. (2014, December 22). Indiancaselaws.wordpress. Retrieved from https://indiancaselaws.wordpress.com/2014/12/22/do-directors-owe-fiduciary-duty-to-shareholders/#_ftn11
[12] Imperial Mercantile Cradit. Assn. v. Coleman (1873) L.R.6 H.L. 189)
[13] Supra at 4.
[14] Decided on January 27, 2016 by the Delhi High Court in I.A. NO. 17545 OF 2015 and CS (OS) NO. 2528 OF 2015.
[15] The court took the help of Foster v. Bryant, (2007 EWCA Civ. 200) to arrive at this conclusion.
[16] Dale and Carrington v. Prathapan & Ors. (2005 )1SCC 212
[17] Needle Industries (India) Ltd. and Ors. v Needle Industries Newey (India) Holding Ltd. and Ors [(1981) 3 SCR 689]
[18] The Tea Brokers (P) Ltd. and Others v. Hemendra Prosad Barooah, (1998) 5 Company Law Journal 463
[19] Narayan, Jenna, A Duty Owed – Discussing a Director’s Fiduciary Liability (October 5, 2009). http://dx.doi.org/10.2139/ssrn.1483051
[20] As per the definition, even if a director is not overtly responsible for contravention, if he had knowledge of such contravention, or contravention was committed with his consent, he is liable for penalty or punishment.
[21] S.166 (2) : A director of a company shall act in good faith in order 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 environment.
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