Unlocking Transparency: A Deep Dive into Directors Disclosure of Interest [Section 184 of Companies Act, 2013]

Unlocking Transparency: A Deep Dive into Directors Disclosure of Interest [Section 184 of Companies Act, 2013]

In this article we are delving into the intricacies of Section 184 of the Companies Act, 2013 particularly focusing on the disclosure of interest by directors regarding contracts or arrangements in which they are interested. This provision is crucial in ensuring transparency and preventing conflicts of interest that might adversely affect the decisions made by the Board of Directors.

Historical Background and Evolution

Before the enactment of the Companies Act, 2013 similar provisions were present in the Companies Act, 1956 particularly under Section 299 and Section 300 which dealt with the disclosure of personal interests and restrictions on participating in discussions and voting in matters where directors had a potential conflict of interest.

The Companies Act, 2013 (“the Act”) was a comprehensive overhaul aimed at improving Corporate Governance and Accountability in response to various corporate scandals and the changing business environment in India. Section 184 of the Act was introduced to enhance the scope and effectiveness of the regulation concerning the disclosure of interests by Directors.

Object of disclosure of interest:

Section 184 of the Companies Act, 2013 is like a tool that helps the Board members understands their responsibilities to both the Company and its shareholders. The directors are in a position of trustees under the Act and they have a fiduciary relation towards the Company and its shareholders so as to ascertain whether he is acting for his own benefit or in any way prejudice to the interest of the Company.

This provision is like a compass helping directors navigate tricky situations where their personal interests might clash with their duties to the Company.

Understanding Key Terms used in Section 184 of the Act:

Before delving into the intricacies of the Section 184 of the Companies Act, 2013, it’s crucial to grasp the fundamental terms used within the provision. These terms lay the groundwork for a comprehensive understanding, shedding light on the legislative intent behind the provision.

Disclosure

In essence disclosure is about sharing vital information. Within the framework of Section 184 of the Companies Act, 2013, it entails directors informing the company if they or their relatives have any stakes in contracts or deals the Company is involved in. This transparency is pivotal as it helps identify any potential conflicts of interest. By openly disclosing their interests, directors demonstrate their integrity and commitment to prioritizing the company’s welfare. It’s like being honest about important details to make sure everything is fair and clear for everyone.

“Concern”

It refers to any involvement, connection or association that a director may have with another Company or entity. It could include various types of relationships such as ownership, employment or partnership.

When a director is described as “concerned” regarding a contract or arrangement, it typically implies the director has a connection or involvement with the contract either directly or indirectly. This involvement may not necessarily imply a personal interest or benefit to the director but rather signifies their association with the contract or arrangement due to their role or relationship within the Company or with other entities.

Example:

Suppose for Company ABC Ltd, Mr. X serves as a Director, is considering to purchase the equipments from another Company PQR Ltd. If X’s brother in law is the CEO of the Company PQR Ltd, Mr. X would be considered “concerned” with the contract due to his familial relationship with the CEO. However Mr. X connection to the contract is indirect as he doesn’t stand to gain or lose personally from the contract but his association with his brother-in-law makes him “concerned” with the arrangement.

“Interest”

An “interest” denotes a financial or personal stake that a director holds in another company or entity. It encompasses any direct or indirect involvement that may influence the director’s decision making.

When a director is “interested” in a contract or arrangement, it suggests that the Director stand to gain or lose something personally as a result of the contract whether its financial , professional or related to other benefits accruing to the director directly or indirectly from the contract or arrangement.

Example:

In the above example, suppose ABC Ltd is considering a contract with PQR Ltd in which its Director Mr. X owns significant number of shares in PQR Ltd. Here Mr. X would be considered interested in the contract. In this case Mr. X personal financial interest is directly tied to the success of the contract between Company ABC Ltd and Company PQR Ltd, making him “interested” in the arrangement.

Now the term direct or indirect concern needs to be distinguished for understanding the nature and extent of one’s involvement or connection to the contract.

Directly Concerned or Interested:

• Direct Concern :

A director is directly concerned if they have a personal stake, involvement or connection to the contract or arrangement. This could include being a party to the contract, having a financial interest in the subject matter of the contract or holding a position within an organization involved in the contract.

• Direct Interest

A Director is directly interested if their personal interests are directly affected by the outcome of the contract. This could include financial gain or loss, personal benefits or potential conflicts with their other roles or responsibilities.

Example: If a director owns shares in a company that is a party to the contract or if the contract directly impacts their personal finances or assets, they would be directly concerned or interested.

Indirectly Concerned or Interested:

• Indirect Concern :

A Director is indirectly concerned if their concern or connection to the contract is not immediate or direct but is related to their association with another entity or individual involved in the contract. This could include being affiliated with a company, organization or individual that has a direct involvement in the contract.

• Indirect Interest :

A Director is indirectly interested if their interests are affected indirectly through their relationship with another entity or individual involved in the contract. This could include familial relationships, business associations or financial connections that create potential conflicts of interest.

Example: If a director’s relative or business partner is a party to the contract or if the contract indirectly impacts their interests through their association with another entity, they would be considered indirectly concerned or interested.

Types of personal interests of a director

A Director may have in a contract or arrangement the following types of interests:

1. Financial Interest :

A financial interest involves the potential for the Director to gain or lose financially as a result of the contract or arrangement. This could include direct financial gains such as profits. Dividends or bonuses or financial losses such as liabilities or obligations.

Example: A Company XYZ Ltd in which Mr.R is a Director is considering a contract to lease office space from a property owned by Mr. R. In this scenario Mr. R has a financial interest in the contract because he stands to gain financially through rental income from Company. Similarly if Mr. R’s spouse own shares in a company that is a party to the contract then also it would be considered as R’s financial interest is involved.

2. Professional Interest :

A Professional interest involves the potential for the director to benefit professionally or advance their career as a result of the contract or arrangement. This could include opportunities for career advancement, recognition or networking.

Example: Let’s consider a Company ABC Ltd wherein Mr. M is a director. The Company is considering a contract with a consulting Firm to provide advisory services. If M’s consulting firm is one of the candidates for the contract, Mr. M has a professional interest in the arrangement. Mr. M may benefit professionally by securing the contract for his consulting firm which could enhance his reputation and career prospects.

3. Other Benefits :

Other benefits refer to non-financial or non-professional advantages that the director may derive from the contract or arrangement. These benefits could include personal relationships, social connections or favors.

Example: A company MNP Ltd where Mr. X is a director is considering a contract with a vendor for IT services. If Mr. X’s close friend is the CEO of the vendor company and Mr. X expects preferential treatment or favors from the CEO outside of the business realm due to their personal relationship. Mr. X has an interest in the contract beyond financial or professional considerations.

A Director’s personal interest in a contract or arrangement can manifest in various forms including financial, professional or other benefits derived directly or indirectly from the contract. It’s essential for Directors to recognize and disclose these interests transparently to ensure accountability and maintain integrity in corporate decision making.

Language of Bare Act:

Section 184 of the Companies Act, 2013 reads as follows:

Disclosure of interest by Director

(1) Every  director shall at the first meeting of the Board in which he participates as a director and thereafter at the first meeting of the Board in every financial year or whenever there is any change in the disclosures already made, then at the first Board meeting held after such change, disclose his concern or interest in any company or companies or bodies corporate, firms, or other association of individuals which shall include the shareholding, in such manner as may be prescribed.

Explanation:

The Clause essentially mandates that every director of Company must disclose any involvement or interest they have in other Companies, Body Corporates, Partnerships or similar entities along with their shareholding. This disclosure needs to be made at the first board meeting they attend as a director and then annually at the first board meeting of each financial year.

If there are any changes to their interests throughout the year, they must disclose these changes at the next Board Meeting following the change. This ensures that the Board is informed promptly of any modifications to the director’s interests.

The method or format of disclosure is prescribed under Rule 9 of The Companies (Meetings of Board and its Powers) Rules, 2014 in Form MBP-1.

Proposed Changes for Disclosure Requirements:

There are some potential changes for which a director would need to update their disclosure under Section 184 of the Companies Act, 2013:

⇒ Change in Shareholding :

Any increase or decrease in the director’s shareholding in a company or companies would require disclosure. This could include buying or selling shares, exercising stock options or receiving through bonus or grants.

⇒ Change in Directorship :

If the director assumes a new directorship or resigns from a directorship in another company or companies, they would need to update their disclosure to reflect this change.

⇒ Change in Business interests :

Any new business interests or investments acquired by the director would require disclosure. This could include starting a new business venture, investing in a startup or partnership, or acquiring ownership in a different type of asset such as real estate or intellectual property.

⇒ Change in Legal or Financial Obligations :

If the Director enters into new contracts agreements, loans or financial arrangements that could impact their interests in other companies or businesses, they would need to disclose these changes. This could involve taking on debt, guaranteeing loans or entering into partnerships that affect their financial interests.

⇒ Change in Relationships or Affiliations :

Any changes in the director’s relationships or affiliations with other individuals or other entities that could affect their interests in companies or businesses would require disclosure. This could include change in family relationships, partnerships or associations with other organizations.

⇒ Change in Positions or Roles :

If the director assumes new positions or roles within their existing businesses or organizations that could impact their interests, they would need to update their disclosure. This could involve taking on executive roles, advisory positions or leadership responsibilities that affect their involvement in other companies.

The key is to ensure that any changes in the director’s interest or relationships that could potentially create conflicts of interest are transparently disclosed to the Board and recorded in accordance with legal requirements.

Example:

A Company XYZ Ltd a manufacturing Company has Mr. P its director and the Company is considering to contract with PQR Ltd a software development company in which Mr. P owns share.

The implications of Section 184 will be as follows:

I. Initial Disclosure :

At the first Board Meeting of XYZ Ltd Mr. P after being appointed as a Director, he discloses his interest in PQR Ltd providing details about his shareholding in software development company to the board.

II. Annual Disclosure

In compliance with Section 184 at the first board meeting of XYZ Ltd held after start of every financial year, Mr. P reiterates his interest in PQR Ltd. He confirms the details of his shareholding in the software development company for the current financial year.

III. Disclosure of Changes :

During the Financial Year Mr. P acquire additional shares in PQR Ltd. Thereby increases his shareholding. As per Section 184, Mr. P is required to disclose this change in his interest at the first board meeting of XYZ Ltd held after this change occurs.

IV. Updated Disclosure :

At the subsequent board meeting of XYZ Ltd, Mr. P updates the Board about his increased shareholding in PQR Ltd. He provides details about his additional shares he has acquired since his last disclosure.

In this example Mr. P as a director of XYZ Ltd., fulfills his obligation under Section 184 of the Companies Act,2013, by disclosing his interest in PQR Ltd. at the appropriate times-initially when he joins the board, annually at the start of each financial year and whenever there is a change in his disclosures. This ensures transparency and enables the Board of XYZ Ltd. to monitor and manage any potential conflicts of interest that may arise due to Mr. P’s involvement in PQR Ltd.

(2) Every director  of a company who is in any way, whether directly or indirectly, concerned or interested in a contract or arrangement or proposed contract or arrangement entered into or to be entered into—

(a) with a body corporate in which such director or such director  in association with any other director, holds more than two per cent. shareholding of that body corporate, or is a promoter, manager, Chief Executive Officer of that body corporate; or

(b) with a firm or other entity in which, such director is a partner, owner or member, as the case may be, shall disclose the nature of his concern or interest at the meeting of the Board in which the contract or arrangement is discussed and shall not participate in such meeting:

Provided that where any director who is not so concerned or interested at the time of entering into such contract or arrangement, he shall, if he becomes concerned or interested after the contract or arrangement is entered into, disclose his concern or interest forthwith when he becomes concerned or interested or at the first meeting of the Board held after he becomes so concerned or interested.

Explanation:

This provision outlines the disclosure requirements upon directors of a Company when their company engages (or to be engaged ) in contracts or arrangements with other entities and the director of a Company has any sort of involvement or interest in such other entities.

1. Shareholding interest :

If a director either individually or in association with other directors holds more than two percent of the shares in another company with which the Company wishes to enter into or to be entered into a contract or arrangement then the Director must disclose the nature of their interest or concern at the Board Meeting during which the conract or arrangement is under discussion.

This disclosure is essential to ensure transparency and integrity in corporate dealings.

Examples :

I. Suppose Mr. Shyam is a director of Company X Ltd and also owns 5% of the Equity shares in Company Y Ltd which is a supplier to Company X Ltd. When X Ltd. discusses entering into a new contract with Company Y Ltd. for the supply of raw materials, Mr. Shyam must disclose his shareholding in Company Y and refrain from participating in the meeting’s discussion on this contract.

II. A and Mr. B the Directors of ABC Ltd individually holds 1.5 % and 1.8% of the shares in PQR Ltd and the Company ABC Ltd is considering entering into a contract with PQR Ltd. then both the directors Mr. A and Mr. B must disclose their collective shareholding to ABC Ltd and abstain from participating in the decision making process to avoid any conflicts of interest.

2. Positional Influence :

The provision also covers situations where a director holds a position as a Promoter, Manager or Chief Executive Officer (CEO) of the body corporate with which the contract or arrangement is proposed and is applicable irrespective of the Shareholding percentage.

Promoters, Managers and CEO’s hold influential positions within a Company and may have the ability to shape its decisions and actions. Their involvement in contracts or arrangements with their own company or related entities could raise concerns about their conflicts of interest.

Including these roles in the provision ensures that directors who hold such positions are subject to the same disclosure requirements as those who hold significant shareholdings, thereby promoting transparency and accountability in Corporate Governance.

Examples :

I. Mr. X is a director of Company PQR Ltd and also the promoter and CEO of Company ABC Ltd. Company PQR is considering a contract with Company ABC Ltd. for the purchase of software solutions, thus in this case Mr. X being the promoter and CEO of ABC Ltd is required to disclose his interest to PQR Ltd for the contract to be entered with ABC Ltd. and also refrain from participating in the decision making process regarding the contract.

Disclosure requirement :

The concerned Director/(s) must disclose his/her nature of interest or concern at the Board meeting during which the contract or arrangement is under discussion.

This disclosure is essential to ensure transparency and integrity in corporate dealings.

Non-Participation :

Additionally the director must refrain from participating in the meeting where the contract or arrangement is being deliberated upon. This abstention ensures that the decisions made are not influenced by personal interests, maintaining the integrity of the decision making process.

Timely Disclosure :

If a director was not initially involved or interested in the contract or arrangement but later becomes so, then he is obligated to disclose his interest promptly either immediately upon becoming concerned or interested or at the first board meeting held after becoming aware of their interest.

Example :

Suppose Mr. B of Company ABC Ltd initially had no involvement or interest in a contract between Company ABC Ltd and XYZ Ltd. However the spouse of Mr. B becomes a significant shareholder in Company XYZ Ltd. after the contract is finalized. In this case Mr. B must promptly disclose their new interest in the contract with Company XYZ Ltd. at the next board meeting held after becoming aware of their spouse’s shareholding in Company XYZ Ltd.

Exception for Private Companies :

[Notification dated 05^th June ,2015]

♦ In the case of Private Companies, the interested director may participate in the meeting after disclosing their interest.

♦ This exception applies to Private Companies that have not defaulted in filing of financial statements or annual returns with the registrar.

Application to Section 8 Companies :

[Notification dated 05^th June ,2015]

♦ The disclosure requirements apply to Section 8 Companies, if the transaction with reference to Section 188 exceeds Rupees One Lakh based on the terms and conditions of the contract or arrangement.

Application to Specified IFSC Public Company :

[Notification dated 04t^h January ,2017]

♦ The disclosure requirements apply to Specified IFSC Public Companies with the exception that interested director may participate in such meeting provided the disclosure of his interest is made by the concerned director either prior to or at the meeting.

(3) A contract or arrangement entered into by the company without disclosure

under sub-section (2) or with participation by a director who is concerned or interested in any way, directly or indirectly, in the contract or arrangement, shall be voidable at the option of the company.

Explanation :

This provision stipulates that any contract or arrangement entered into by the Company without the disclosure by a concerned or interested director as outlined in sub-section (2) or with the participation of such Director, such contract or arrangement is deemed voidable at the option of the Company.

Voidability of Contracts :

♦ It means that the contract is not automatically invalidated but can be rescinded or annulled at the discretion of the Company.

♦ This provision underscores the importance of disclosure and the avoidance of conflicts of interest in corporate transactions. It serves to safeguard the company’s interests and upholds ethical standards in corporate governance.

Consequences of Voidability :

♦ If a contract is declared voidable, the Company has the option to rescind or annul the contract effectively nullifying its legal effect.

♦ This action protects the company from potential harm or losses resulting from undisclosed conflicts of interest or improper participation by directors.

Examples :

a) Undisclosed Conflicts of Interest :

The director Mr. A of Company ABC Ltd enters into a contract with Company DEF Ltd for the purchase of goods without disclosing that he is a significant shareholder in Company DEF Ltd. Subsequently it is discovered that the director Mr. A had a conflict of interest in the transaction. The Company ABC Ltd. has the option to declare the contract voidable and rescind it, protecting its interests.

b) Improper Participation by a Director :

The director Mr. B of Company ABC Ltd , who has a personal interest in a supplier, actively participates in negotiations and approves a contract with that supplier without disclosing their conflict of interest. Upon discovery of Mr. B’s improper participation, Company ABC Ltd may choose to declare the contract voidable and annul it safeguarding the integrity of the procurement process.

(4) If a director of the company contravenes the provisions of sub-section (1) or sub-section (2), such director shall be liable to a penalty of one lakh rupees

Explanation :

Where a director of a Company fails to comply with the requirements specified in sub-section (1) or (2) then he shall be liable to a penalty of One Lakh rupees.

Example :

Mr. A , a director of Company ABC Ltd fails to disclose his interest in a contract with the Company XYZ Ltd. as required under sub-section (1) and (2) of Section 184 of the Act. Upon investigation it is determined that Mr. A contravened the provision. As a result Mr. A is liable to pay the penalty of One Lakh rupees for the violation.

(5) Nothing in this section—

(a) 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;

(b) shall apply to any contract or arrangement entered into or to be entered into between two companies where any of the Directors of the one company or two or more of them together holds or hold not more than two per cent. of the paid-up share capital in the other company or the body corporate.

Explanation :

a) This sub-section recognizes that there may be existing legal principles or rules that impose limitations restrictions on a director of a Company from having any concern or interest in any contract or arrangement with the Company.

Such rules could be derived from Common Law, Statutory Law or the Company’s Articles of Association.

The provision ensures that the application of this section does not override or conflict with any such pre-existing legal restrictions.

Example :

If there exists a legal provision in the Articles of Association that prohibits Directors from engaging in contracts with the Company in which they have personal interest, this provision ensures that such a rule remain in force and is not overridden by the regulations outlined in this section.

b) The Clause to this sub-section exempts certain contracts or arrangements from the disclosure requirements outlined in the section. Specifically the contracts between two Companies are exempted if they are doing business together and the directors of one Company collectively own less than two percent of the other Company’s shares, then these rules don’t apply.

Example :

Let’s say Company A and Company B are working together on a project. If the directors of Company A together own less than two percent of the Company B’s Shares, the contract between Company A and Company B is exempt from the disclosure requirements outlined in this section.

Conclusion: Directors’ disclosure of interest, as mandated by Section 184 of the Companies Act, 2013, is a cornerstone of corporate governance, fostering transparency and accountability. By understanding the legal provisions, key terms, and implications, companies can uphold integrity in their operations and mitigate conflicts of interest, ensuring fair and ethical decision-making processes.

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Disclaimer : This editorial is based on the current information and relevant provisions. While efforts has been made to ensure accuracy and completeness, no responsibility is assumed for any inaccuracies or omissions. Users are advised to refer to applicable laws and regulations for confirmation and seek professional advice where necessary. The information provided in this document is for general informational purposes only and does not constitute any professional advice. It may not cover all legal or regulatory requirements and may be subject to change without notice. The author disclaims any liability for the consequences of reliance on the information provided herein. Readers are encouraged to verify data from reliable sources before taking any action based on the information contained herein.

The author of this editorial is a distinguished Company Secretary of Fortuna Group, a leading Real Estate Group based in Lucknow. For any inquiries or further information the author can be contacted at [email protected].