An overview of the fiduciary duties of Directors under Indian law.
Section 166 of the Companies Act, 2013 lays down the fiduciary duties of Directors. They owe these duties not to individual entities of the Company e.g.- shareholders, creditors, etc.; but solely to the Company. These are-
(i) Director should be acting in accordance with the Articles of Association.[1]
(ii) They should act in good faith so as to promote the objects of the Company and benefit of the Company, also in the best interests of stakeholders.[2]
(iii) While exercising their duties, reasonable care, skill, diligence, and independent judgement should be exercised.[3]
(iv) Directors should not get involved in an issue that directly or indirectly conflicts or may conflict with the interest of the company.[4]
(v) They should not achieve or attempt to achieve undue gain or advantage on a personal level. If found to have done so, the Director will have to pay to the Company the amount of undue gain made by them.[5]
(vi) A Director cannot assign the office held by them to another person; such a transfer will be void.[6]
(vii) If provisions of this section are contravened, a Director may be fined between Rs. 1 lack- Rs. 5 lacks.[7]
1) Let us consider the fiduciary duty of Directors to act in good faith– which is covered under section 166 (ii)- states that Directors must act honestly, without negligence and in good faith for the bona fide interests of the Company. When a legislation provides for protection of the public, the provision is rendered irrelevant when the class to which it is sought to be applied is not easily recognized. The second issue involving interpretation relates to whether the director is expected to act in ‘good faith’ for the promotion of the objects of the company or should it also encompass other groups in the sub-section.[8] To act in the best interest is the duty of loyalty requiring decision making to be motivated by an intention to serve the best interests of all the relevant interest groups.[9]The duty of care requires directors to make decisions in an informed and deliberate manner and to use reasonable prudence in performing their monitoring function[10]
In the Stone v. Ritter[11] judgement– good faith and best interest are used to balance each other. Directors need to exercise their jurisdiction to determine what a Court might consider and what they consider- is in the best interests of the Company. They also need to carefully weigh the commercial interests of the Company but also simultaneously aiming towards safeguarding the interests of stakeholders. While doing these activities the Director must keep in mind that their actions achieve the standard of a reasonably prudent person.
In the Dale & Carrington v. P.K. Prathapan[12]– the Company was being run by one person; Mr. Ramanujanam was maintaining minutes of the meeting only to comply with the statutory requirements. However, in actuality, he was recording the minutes in an arbitrary manner. It was evident that he allotted shares to himself to gain a greater control over the Company. As understood from section 166(ii), the acts and deeds of directors have to done in accordance with benefitting the Company. Further section 166(iii) states that the duty to act on behalf of the Company comes with certain expectations such as- utmost care, due diligence, good faith. Directors also have the duty to make an honest disclosure about matters relating to the Company. Hence, Directors owe a duty to issue shares only for a proper purpose.
2) Avoid conflict of interests under section 166(iv)-
Globe Motors v. Mehta Teja Singh[13]– this cases seems to blatantly signify the unfairness against the Company. It was a case of winding up of Globe Motors. There was an agreement between them and Teja Mehta Singh &Co. appointing the latter as distributors of company’s steel products. Some of the Directors showed interest in the Agreement therefore they did not take part in the discussion. The Court held that the Agreement was made in a manner so as to simply benefit the Directors. Even though they were well aware of the same they did not disclose this to the Company. Moreover, there was not even a single redeeming feature in the agreement for the Company. The Directors failed to put their personal greed aside and disclose this conflict of interest to the Company.
Rajeev Saumitra v. Neetu Singh & Ors.[14]– herein the defendant had incorporated two companies to compete with Paramount. In order to promote the companies incorporated by her she solicited the employees of Paramount; also made under use of goodwill and intellectual property of Paramount. Since she was a Director and a majority shareholder of Paramount, she had failed to disclose her conflict of interest. In fact she acted in bad faith so as to make personal undue gains at the cost of the interests of Paramount.
3) Fiduciary to act according to Proper Purpose under section 166-
Howard Smith Ltd. v. Ampol Petroleum Ltd. & Ors.[15]– As per AoA, issue of shares was under the control of directors, who could allot or dispose of the same to such persons on such terms and conditions as they deem fit–thus, issue of shares was clearly intra-vires the directors. However, directors’ power under AoA is a fiduciary power, and though formally valid, maybe attacked on the ground that it was not exercised for the purpose for which it was granted(i.e.,the ‘proper purpose’). Power conferred is to enable capital to be raised–if purpose was otherwise, the issue of shares becomes invalid. Purpose here was simply and solely to dilute majority voting power held by Ampol & Bulkships and disable positive veto right– such issue of shares purely to flip voting power has been condemned- particularly where it disables an existing majority from blocking votes(Dale & Carrington). Directors cannot use fiduciary powers over company’s shares to interfere with the company’s constitution–doing so is separate from and against their powers.
Eclairs Group Ltd. & Glengary Overseas Ltd. v. JKX & Oil & Gas PLC[16]– the purpose for which the Directors of JKX exercised their powers was not proper. As ‘purpose’ did not include influencing outcome of general resolutions which can be a consequence of a restriction notice but cannot be proper purpose.
Director to be viewed as an agent of the Company.
A company acts as a legal entity. However, it requires the assistance of human agency. Therefore, a company acts through directors who are essentially elected representatives of shareholders and make decisions for their benefit. By the basic definition, an agent is someone who acts on behalf of the principal; thereby ensuring that the third party can hold only the principal and not the agent liable for any wrong. Hence, directors do act as agents as they act on behalf of the Company and cannot be held personally liable for Company’s default.
1) Tristar Consultants v. Vcustomer Services India Pvt. Ltd. and Ors.[17]: Dinesh Mirchandani was acting as the sole proprietor of Tristar Consultants. The Defendant and Plaintiff firms had agreed that the Plaintiff firm was to recommend suitable candidates to the former on the basis of criterion discussed by them and conducting an interview. However, this agreement was cancelled by the Defendants. After this, there was an exchange of correspondence between the Plaintiff and Mr. Sanjay Kumar- the director of Defendant firm. On behalf of Defendant firm, Mr. Kumar agreed to pay professional fee and expenses incurred by the petitioner. Alleging that the said agreement was not honoured, suit was filed seeking recovery of Rs. 17.61 lacks.[18] The contention herein was whether the suit claiming personal liability of Mr. Kumar would be justified despite the fact that he was simply acting as an agent of Defendant.
The Judgement held that Directors act as agents of Company and the latter acts through the former. It also states that Directors have been defined as Company’s agents since they act in a fiduciary manner vis-à-vis the Company. They also perform acts and duties for the benefit of the company. However, Directors are only agents of the Company to the extent they have been given the authority to certain acts on behalf of it. Here, the Court held that Mr. Kumar was acting in his capacity as the agent/Director of Defendant firm. Hence, he was not liable in his personal capacity. The petition was dismissed.
2) Ferguson v. Wilson[19]: Mr. George Ferguson held the position of a Promoter and a Director of the Washoe United Consolidated Gold and Silver Mining Company Ltd. A Resolution of Promoters was passed thereby accepting advances from Promoters, and stating that advances with interest are to be repaid. This Resolution also gave Promoters the option of converting any unpaid amount into shares of the Company. Mr. Ferguson advanced 700 Pounds. The Directors decided to repay these advances. However, instead of repayment he wanted shares in lieu of his advance. He proposed that the unallocated shares should be disposed off only with the assent of shareholders. But this Resolution failed. The Directors continued to allocate shares without consideration for the share claimed by Mr. Ferguson. He eventually filed a petition against Directors claiming entitlement to 700 shares.
The question that arose here was the nature of the contract and the parties to the same. There arose a contract between Mr. Ferguson and the Company. The relationship between Directors and a Company is that of a simple principal-agent one. The petition filed against Directors could not be pursued. Directors are mere agents of the Company. Further, the Judgement stated that when an agent is liable naturally directors would also be liable; but when the liability is solely attached to the principal, it’s only the liability of the Company.
3) Walchandnagar Industries v. Ratanchand[20]: this judgement widened the scope of a director’s role as an agent. It is a Director’s duty to disclose interest to the company. It’s also their duty to ensure that there isn’t a conflict of interest between their personal interests in the role of an agent of the company and in the principal’s interests i.e. the Company.
4) Allen v. Hyatt[21]: in the eyes of law, directors are in the position of agents of the company and therefore have certain consequent duties. Hence, just like the general rule states- every director acting as an agent needs to disclose their personal interests (if any) during the course of a transaction, so as to avoid conflict of interest. As a corollary this means that where there is conflict of interest, there are probabilities that the interest of the director may prevail over that of the company which may be detrimental to the company.
Directors act as agents of the Company and therefore cannot be personally held liable when the issues at hand are attached to the principal i.e. the Company. When the case is solely leading to the liability of the principal, agents cannot automatically also be dragged in. The Directors as agents not only derive their authority from the Company but also from the Companies Act. However, there are certain roles and duties that need to be followed by the agents, so as to ensure that they don’t misuse their power to benefit themselves or to get away by thrusting the whole liability on the Company.
[1] Companies Act, 2013, Section 166 (1)
[2] Companies Act, 2013, Section 166 (2)
[3] Companies Act, 2013, Section 166 (3)
[4] Companies Act, 2013, Section 166 (4)
[5] Companies Act, 2013, Section 166 (5)
[6] Companies Act, 2013, Section 166 (6)
[7] Companies Act, 2013, Section 166 (7)
[8] Naniwadekar, Mihir and Varottil, Umakanth, The Stakeholder Approach Towards Directors’ Duties Under Indian Company Law: A Comparative Analysis (11 August 2016). NUS – Centre for Law & Business Working Paper No. 16/03; NUS Law Working Paper No. 2016/006. Available at SSRN: http://ssrn.com/abstract=2822109 (last visited 16 March 2016).
[9] Smith v. Van Gorkom, 488 A.2d 858, 872 (Del 1985)
[10] Raje, S., 2020. Fiduciary Duties Of Directors – Law Times Journal. [online] Law Times Journal. Available at: <http://lawtimesjournal.in/fiduciary-duties-directors/> [Accessed 10 June 2020].
[11] 911 A.2d 362, 369 (Del 2006).
[12] AIR2005SC1624
[13] [1984]55CompCas445(Delhi)
[14] [2016]134C LA450(Delhi)
[15] [1974] AC 821
[16] UKSC 71
[17] AIR2007Delhi157
[18] AIR2007Delhi157
[19] (1866) LR 2 Ch LR 77
[20] AIR 1953 Bom 285
[21] {1914} 30 TLR 444
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