Director carrying competing business breaches fiduciary duty: Through a case analysis on Rajeev Saumitra Vs Neetu Singh & Ors.
Introduction
A company is a distinct legal entity, being a creature of law, while the directors are responsible for the governance and management of the company and thereby hold a fiduciary role; hence, they are regarded as trustees, representatives, and agents of a corporate entity. The Companies Act of 1956 provided a basic outline of the duties of a director u/s 291, which required a comprehensive framework that led to reliance on common law and equitable principles, resulting in ambiguity and potential legal loopholes. To address this, Section 166 of the Companies Act 2013 was introduced following the recommendations of the Dr. J.J. Irani Committee on Company Law (2005), laying out statutory director obligations. Despite this, the section broadly defines director responsibilities without explicitly detailing what constitutes a “fiduciary duty.”
Fiduciary Duty in India
The principle of fiduciary duty has its basis in the theory of good faith. Between two individuals, one must safeguard the other’s interests, and if the former’s use of such a relationship generates an unjust benefit or unjust enrichment obtained from another.
In the case of Global Motors Ltd. v. Mehta Singh the dual role of directors with the company i.e. as trustee and agent was reiterated. It is clear that, even though the term “fiduciary capacity” is not well defined, it denotes a relationship similar to that which exists between a trustee and the beneficiaries of a trust. The phrase covers a wider range of circumstances, including those in which parties are positioned in accordance with mutual trust, confidence, and good faith.
In the case of Sangramsinh Gaekwad & Ors. v. Shantadevi P. Gaekwad (Dead) thr. Lrs. & Ors the Supreme Court held directors are not required by fiduciary law to advise current shareholders on how best to sell their shares. This is so because directors are not typically considered to be the agents of their shareholders and are not charged with managing their shares. However, the Court stressed that directors must behave in good faith and refrain from any deliberate or careless deception or fraud if they freely provide advice to current shareholders.
The interest of the company shall be given the priority when there is a conflict between the interests of the company and shareholders, and their obligation shall be to protect the assets and finances of the company.
Parties to the dispute
Plaintiff: Rajeev Saumitra
Defendant(s): Neetu Singh
M/s Paramount Coaching Centre Pvt. Ltd
M/s K.D. Campus Pvt. Ltd
In the case of Rajeev Saumitra Vs Neetu Singh & Ors. 2016 SCC OnLine Del 512 the plaintiff and the defendants were shareholders in Paramount Coaching Centre Pvt. Ltd (hereinafter “Paramount”), each of them holding 50% of the share capital, thereby serving as the directors of the company. The defendant, Neetu Singh, established two different companies that were directly competing with Paramount; consequently, she approached several employees and subsisting employees of Paramount to promote and upgrade her freshly formed companies, thereby swaying Paramount’s goodwill and intellectual property. As the director and the shareholder of the company, it was her prime responsibility to act in good faith for the benefit of the company. As the director, the defendant was also able to occlude any resolution passed by Paramount to take any action against her. In light of these circumstances, the Plaintiff was compelled to file a subordinate suit against the defendant for violating Section 166 of the Companies Act 2013.
Issues involved: Whether Defendant No.1 breached her fiduciary duty u/s 166 of CA 2013 by starting a competing business while still serving as a director in Paramount?
Whether there was a conflict of interest and obligation of director u/s 166 of the CA 2013?
Statutory rules
Section 166 of the Companies Act, 2013, under sub-section (2) of this section, a director of a company is required to act in good faith to further the company’s goals for the benefit of all of its members. He must also act in the company’s best interest and of its shareholders, workers, community, and the environment.
Section 397 of the Companies Act, 2013 Purview of the company law board under the Companies Act, according to Section 397 of the said Act, is a simultaneous ward that might be practiced by common courts where charges relating to mistreatment and botch share the character of a common question.
Section 88 of the Indian Trust Act, 1882- Advantages gained by fiduciary- Where a Trustee, Executor, Partner, Agent, Director of a Company, Legal Advisor, or other person bound in a fiduciary character to protect the interests of another person, by availing himself of his character, Gains for himself any pecuniary advantage, or where any personal bound enters into any dealings under circumstances in which his interests are or may be, adverse to those of such other person and thereby gains for himself a pecuniary advantage, Ø he must hold for the benefit of such other person the advantage so gained.
Analysis
In the present case, the plaintiff argued that Neetu Singh, the director of Paramount, started a competing business (K.D. Grounds Pvt. Ltd), thereby exploiting the goodwill and resources by promoting it through the socials and branding of Paramount and hence breached the fiduciary duty under Section 166 of the CA 2013, the plaintiff had stated that the competing business started by her started creating confusion among the public and the existing clients as they believed that both the business were affiliated. Further, Defendant No.1 used the sub-title “another venture by Neetu Singh, founder/director of Paramount.” That means the customers were misled into thinking of a new venture to be part of Paramount. Hence, she holds liability for diversion in the profits of the business of Paramount since she also denied transferring the profits made by K.D. Grounds. Further, the plaintiff argued that since she never formally resigned from the directorship before starting K.D.Grounds Pvt. Ltd. Hence, issues regarding equity dilution, profit, and shareholding allocation were raised. The relief sought by the plaintiff was that Defendant No.1 should pay back the profits and an injunction to restrain Defendant No.1 and No. 2 from her business to prevent using the goodwill and Paramount’s resources.
The Defendants argued that the plaintiff has been making unilateral decisions concerning the management of the company without the approval of the Board, that Defendant No.1 was physically prevented from entering the premises and participating in the company’s affairs, and that there had been an embezzlement of Rs 47 lakhs by the plaintiff. Further, there was a deadlock since both parties held 50% shares, and the plaintiff had made the operations impossible. She stated that Section 166 of the Companies Act, 2013, Section 88 of the Indian Trusts Act, and Section 16 of the Partnership Act do not bar her from engaging in a similar business after being excluded from company affairs. The relief sought by the defendant u/s 397 and 398 of the Companies Act, 1956 and indicates that the financial mismanagement warrants the winding up of the company.
The Delhi HC highlighted in the judgment that “DIRECTOR CARRYING COMPETING BUSINESS BREACHES ‘FIDUCIARY DUTY’”. It held that u/s 166 of the CA 2013, the defendant had breached a fiduciary duty by starting a competing business, thereby restraining her from using the trademark of ‘Paramount’ and further held that “She has not exercised her duty with due & reasonable care, diligence &she was involved in the situation in which there was a direct interest that conflicted with co.’s interest, in order to gain an advantage by herself and her relatives….. Being the Director, wife is guilty of making undue gain, and she is also guilty of carrying out the competing business of co.” Further, it highlighted that “Sec. 166 is akin to the common law right”. In case a director violates the duties prescribed in Sec. 166, the cause of action accrues in favor of the company.
Conclusion and Critical Comments
Earlier, the director’s responsibilities were molded by decisions by courts since Company Law had a deficit of detailed guidance on the duties of directors; these duties were general in nature with the obligation to perform tasks with reasonable skill and care, to act honestly and fairly. Consequently, the legal framework became stringent and clearly defined the duties towards the company, its shareholders, and other stakeholders, as seen in the present Companies Act 2013. India has inculcated it through common law jurisdictions like the UK to broaden the principles into specific director responsibilities. Venturing into a new territory of corporate governance, the court emphasized the need for caution. Additionally, the prohibition on directors competing with the company in which they are directors deserves closer scrutiny. It is unclear whether the same degree of scrutiny applies to nominees or departing directors. The court ruling is that a nominee director can be held liable for contravention of duties under Section 166 of the Companies Act. Nonetheless, the law provides that a nominee director may act as per instructions from the nominator if they genuinely assume that the nominator’s and company’s interests are aligned.
References
Afsharipour, A., The Promise and Challenges of India’s Corporate Governance Reforms, retrieved from http://ssrn.com/abstract=1640249
Afsharipour, A., Corporate Governance Convergence: Lessons from the Indian Experience (2009), retrieved from http://ssrn.com/abstract=1413859
Balasubramanian,N., Black,B.S.,and Khanna,V., Firm-Level Corporate Governance in Emerging Markets: A Case Study of India (2009), European Corporate Governance Institute,retrievedfromhttp://ssrn.com/abstract=992529
Balakrishnan, R., What is stored in the draft Companies Bill 2009- Relating to accounts and audit retrieved from http://www.taxmann.com/taxmannflashes/flashart9-2-10_15.htm.
Government of India, “Dr. J.J. Irani Committee report on company law, 2005” Chapter IV para 36.6, Chapter V para 1. (Ministry of Company Affairs).
Rajeev Saumitra Vs Neetu Singh 2016 SCC OnLine Del 512
Sangramsinh P. Gaekwad v. Shantadevi P. Gaekwad (Dead) thr. Lrs., MANU/SC/0052/2005.
The Companies Act, 2013 (https://www.indiacode.nic.in/handle/123456789/2114)
The Indian Trusts Act, 1882 (https://www.indiacode.nic.in/bitstream/123456789/2327/3/A1882-02.pdf)
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