Comments on Disclosure of Interest by Directors

BACKGROUND

The disclosure of interest by a director is a statutory duty arising out of distinctive position held by him. Such position does pose some ambiguity. It is very well possible that in the first instance even a director may not be able to give a clear reply about his legal position.

There exist well established judicial precedents as well laws that the directors have fiduciary obligations and also duties to act reasonably and in the best interests of the companies where they hold such positions. Their duties emanate due to holding positions which may be synonymous to they being agents as well as trustees of their companies.    

The Companies Act 2013 {new Act 2013} for the first time has laid down the duties of directors in unequivocal terms in section 166 in contrast to erstwhile Companies Act 1956. Before the enactment of section 166 aforesaid, there had already been plethora of judicial decisions pronounced over decades, laying down many fiduciary obligations and duties of directors as precedent laws. Such duties include director’s functioning honestly and in good faith, with care and diligence, his regularity in attending board meetings, not to delegate his functions and authorities which he is mandated to carry out and his disclosure of interest to the company to avoid conflict of interest. Section 166 has reflected the judicial precedents and more.

DUTY OF DISCLOSURE OF INTEREST BY DIRECTORS UNDER SECTION 184 OF THE COMPANIES ACT 2013

• The contour of position and duties of Directors being clearly laid down, the legal position of disclosure of interest by them is discussed hereinafter.

• It is of prime importance that for ensuring proper functioning, a director should be disinterested in the transactions of the company or otherwise it is natural that his personal interest is likely to prevail. {Ref. case: Jackson, The Wisdom of Supreme Court , 417 -18 {1962}.

• The first step in this regard is the disclosure of interest by the director. It was held in the case of Coltness Iron Co , Re, 1951, SC 476 {Scotland} that the interest to be disclosed is that which in business sense might be regarded as influencing judgement; the essence of the matter being that any kind of personal interest which is material in the sense of not be insignificant must be revealed.

• In the case of Public Prosecutor v. T P Khaitan AIR 1957 Mad 4 it was held that the arrangement hit by sections is one in which the director has a personal interest conflicting with his duties towards the company and does not cover any case where there is no personal interest involved.

• In another case it was also held that interest could be other than personal interest and not necessarily confined to pecuniary interest. {Ref  case; Fateh Chand Kad v. Hindsons {Patiala} Ltd {1957} 27 Com cases 340}.

• Interestingly in the case of Mukkattukara Catholic Company Ltd v. M V. Thomas {1995} 6 SCL 135 it was held in respect of sections 299 & 300 of the erstwhile Companies Act 1956 that the word “interest” means personal interest and not official or other interest. However it is also not limited to financial interest only and may arise out of fiduciary duties or closeness of relationship        
  

DISCLOSURE & TIMING

The sub section {1} of section 184 deals with the disclosure of interest to be made by the director. It lays down that every director is under an obligation to make disclosure of his:-

{a} concern, or

{b} interest,

in any of the following entities:-

1. company or companies or
2. bodies corporate, or
3. firms, or
4. other association of individuals.

Pertinently the concern or interest shall also include his shareholding.

The disclosure shall be made in such a manner as may be prescribed by the Central Government. {Already prescribed under Rule 9 of the Companies (Meetings of Board & its Powers) Rules 2014} The timing of the disclosure, however, has been stipulated in the sub section itself. Thus the disclosure shall be made:-

1. at the first meeting of the Board of Directors in which he participates as a director,  and
2. thereafter at the first meeting of the Board held in every financial year, or
3. whenever there is any change in the disclosures already made, then at the first Board meeting held after such change.

The first and foremost requirement is that the director should have concern or interest in any one or more of the entities where-after he is to disclose only at the board meetings as have been laid down. The terms “concern” or “interest” have not been defined although the term “interested director” have been defined in Section 2 {49}.

Pertinently mere disclosure of interest is not sufficient but the nature of concern or interest has to be disclosed. This was held in Turnbull v. West Riding Athletics Club Leeds Ltd 1894 WN4. This will adequately bring to light where the director has a conflict of his personal interest with that of his fiduciary duty as a director and protection of the company against such conflict.

The interest of the director may be direct or indirect, as laid down in next sub section.

DIRECTOR’S DIRECT/INDIRECT CONCERN/ INTEREST

The next sub section {2} of section 184 provides that every director who is in any way whether {a} directly, or {b} indirectly concerned or interested in the following:-

1) a contract or arrangement, or

2) a proposed contract or arrangement

which are {a} entered into, or {b} to be entered into by his company with certain specified entities, shall disclose the nature of his concern or interest at the Board meeting/s.

The use of the terms “in any way” “directly or indirectly” in the sub section is in line with the section 299 of the erstwhile Companies Act 1956, and denotes very wide coverage in all aspects.

The terms “concerned” or “interested” similarly have wide import. {Ref case: Firestone Tyre & Rubber Co .Ltd., v. Synthetics & Chemicals  Ltd., {1970} 2 Comp LJ  200}.

Moreover, it is clear that not only concluded contract or arrangement is covered but also the proposed ones.

The provisions of entering into contract / arrangement {transactions} with certain specified entities and disclosure requirements have been discussed hereinafter.

Transactions with Specified entities I

(A) Contract/ arrangement   with {1} a body corporate in which that director or he in association with any other director holds more than two per cent {2%} shareholding of that body corporate, or {2} that director is a promoter, manager, Chief Executive Officer {CEO} of that body corporate.

Interpretations

• The term “contract” would be governed by the Indian Contract Act 1872. The term “arrangement” has not been defined. This however has been used in various places in the Companies Act 2013. It appears here along with “contract” and in Chapter XV of the Companies Act 2013 relating to compromises, arrangements and amalgamations wherein arrangement includes a reorganisation of the company’s share capital. But this does not help in interpretation in this provision.   In any case “arrangement” should be read in a wider context comparable to “contract” the effect of which is to give rise to legal rights and liabilities.

• In the case of Seth Mohanlal v Grain Chambers Ltd, AIR 1959 All 276 it was held that the word contract or arrangement is intended to cover transactions in which a director acquires some right or incurs some liability “qua” director, as a result of it.

• The term “association” has not been defined and should be understood in common parlance to mean some controlling connections between the directors which could arise out of blood relations or otherwise. Interestingly if a relative of a director or such relative in association with any other director hold/s more than 2% shareholding, the said director will not be covered herein.

• The term “body corporate” has been used here instead of the term ‘company”. The body corporate has been defined in Section 2{11} of the Companies Act 2013 to include a company incorporated outside India, thereby widening the coverage of the disclosure requirements.

• The use of the term “shareholding” has widened the coverage to take into account equity or preference shares. The word “share”  has been defined in Section 2{84}  to mean a share in the share capital of the company and includes stock. Notably the term “securities” in terms of section 2{81} has not been used here otherwise  very wide coverage would have happened  as the definition of “securities” in section 2 {h} of the Securities Contracts {Regulation} Act 1956 would have been invoked.

• It may be significant to note here that if the concerned director of the company is a promoter , manager or CEO of  the other body corporate , then there is no need for holding any shares in that body corporate to invoke these provisions .     
  

Transactions with Specified entities II

(B) Contract/ Arrangement   with a firm or other entity in which, such director is a partner, owner or member, as the case may be.

The term “firm” mentioned here ostensibly denotes a partnership firm under the Partnership Act 1932, but the term “other entity” is meant to widen the coverage of this provision. Such entities could be a Society, Hindu Undivided family or a sole propriety concern. Here only the director is covered and not his relatives for invocation of these provisions.

Disclosure at the Board meeting/ voting/ quorum

• This sub section {2} further mandates that the director shall disclose the nature of his concern or interest at the meeting of the Board of Directors in which the contract or arrangement is discussed. He is however, not permitted to participate in such meeting. Consequently he cannot vote which is to ensure that he will not be allowed to influence and swing the decision process at the board proceedings in his favour.

• It may be worth noting here that in case the transaction is with a related party he cannot be present at the Board meeting in terms of Rule 15{2} of the Companies {Meetings of Board and its Powers} Rules 2104. Since the transaction envisaged in this section will generally constitute with related party it appears irrational that where a director cannot be present in the meeting what is the further need to prohibit him to participate in that meeting. Moreover, in terms of section 174{3} of the Companies Act 2013 he shall be an interested director for which his presence shall not be counted for quorum. But then, where he cannot be present in the meeting in terms of said Rule 15{2} for his related party transaction, what is the further need to provide that he is not counted for quorum.

Subsequent concern/interest.

This sub section also stipulates by way of proviso that where any director who is not so concerned or interested at the time of entering into such contract or arrangement, but subsequently if he becomes concerned or interested after the contract or arrangement is entered into, he is required to disclose his concern or interest, forthwith, when he becomes concerned or interested. It appears that he needs to generally disclose to the company. Alternatively he needs to disclose at the first meeting of the Board held after he becomes so concerned or interested.

VOIDABLE AT OPTION OF COMPANY

The next sub section {3} provides for a situation where there is non compliance of subsection {2} with regard to disclosure by the interested director or where there is participation by the interested director in the  contract or arrangement in which he is interested. It lays down that a contract or arrangement entered into by the company with such non compliance shall be voidable at the option of the company. In such a situation the company has the option to either avoid the said contract or arrangement or confirm and validate it.  { Ref case: Amritsar Rayon & Silk Mills Ltd v. Amirchand Saideh {1988} 64 Comp cases 762 { P & H}.

CONTRAVENTION

• This penultimate sub section {4} stipulates about contravention. If the director contravenes the provisions of sub-section (1) or subsection (2), he shall be punishable with imprisonment for a term which may extend to one year or with fine which shall not be less than fifty thousand rupees but which may extend to one lakh rupees, or with both. This sub section makes it clear that the onus of compliance is on the director and for any contravention he is liable. As far as the company is concerned there is no liability and it has the option to validate the offending contract or arrangement in terms of sub section {3}. In case it does not validate the same, the contract or arrangement, becoming invalid thereby, cannot be proceeded with.

• Noteworthy is the position that as per section 167{1}{c} of the new Act 2013 a contravention shall result in office of the concerned director becoming vacant.

EXEMPTIONS

As per clause {a} of last sub section {5} , no provision of this Section shall be taken to prejudice the operation of any rule of law restricting a director of a company from having any concern or interest in any contract or arrangement with the company. Hence a director cannot argue that by complying with this Section he can by-pass any other law which also restricts him in this regard.

This clause {b} states that nothing in this Section shall apply to any contract or arrangement entered into or to be entered into between two companies:-

1. where any of the directors of the one company or  two or more of them together
2. hold/s not more than two per cent {2%} of the paid-up share capital in the other company.

This exemption is in line with section 299 {6} of the erstwhile Companies Act and is the touch stone as to whether this Section 184 applies or not.

But this is only limited to contract or arrangement between two companies only, and, shareholdings of the directors are merely taken into account and not shareholding of their relatives or other entities. This could be a loophole giving unintended exemptions where although the shareholdings of concerned directors are below the threshold limit but their relatives’/ entities’ shareholdings are beyond the said limit; still the exemption is available.

CONCLUSION

Disclosure of interest by directors can be termed as the most critical commencement of the process of carrying out of statutory duties by them and goes a long way in establishing corporate governance by avoiding conflict of interest. It should be followed by all directors at all times in letter and spirit.