DUTIES AND LIABILITIES OF NON-EXECUTIVE DIRECTORS

THIS ARTICLE WAS WRITTEN BY SHIRSH RAJ, A STUDENT OF CHRIST, BENGALURU.

ABSTRACT

This research paper seeks to explore the duties and liabilities of non-executive directors of a company, and the difference with that of executive directors of the company who have control over the day to day functioning of the company.

Non-executive directors are those directors who do not have control over the day to day functioning of the company. They are usually directors such as Independent Directors, Nominee Directors, etc. With the need for, the expertise of such directors on the board, these non-executive directors have become extremely crucial for the effective functioning of the company. But these types of directors have begun to shy away from becoming such non-executive directors of companies because the liability of the these non-executive directors remain the same as that of the executive directors, even though they have not been involved in the functioning of the company.

Therefore, this paper will explore with the help of case law and the Companies Act, 1956 and Companies Act, 2013 the various methods in which the liability of such directors can be reduced.

INTRODUCTION

Since the emergence of various corporate scandals in India over the past few years, there has been much attention and debate on the role of company Directors. There has been a lot of focus on independent Directors (and also, on nominee Directors). In particular, with India emerging as a preferred investment destination, there has understandably been a need to clarify the responsibilities of nominee Directors. As covered in this Note, the principles to determine the liabilities of Directors are, in large measure, common to all Directors, varying in degree depending on their respective roles and involvement in the company’s affairs. Company law has known directorial duties and liabilities for decades and the principles of such obligations have been distilled for many years. To illustrate, the Supreme Court of India, while considering who is said to be responsible for the conduct of a company’s business, especially the role of non-executive Directors, had this to say in 1973[1]; words that are of no less relevance today:

“It is certainly a question of fact….whether a director….had acted reasonably as well as honestly and with due diligence….A director may be shown to be so placed and to have been so closely and so long associated personally with the management of the company that he will be deemed to be not merely cognizant of, but liable for, fraud in the conduct of the business of a company even though no specific act of dishonesty is proved against him personally. He cannot shut his eyes to what must be obvious to everyone who examines the affairs of the company even superficially.”

CONCEPT OF NON-EXECUTIVE DIRECTORS

Of the two kinds of directors that exist statutorily[2],Executive directors can either be a Whole-time Director of the company, one who devotes his whole time of working hours to the company and has a significant amount of personal interest in the company as his source of income; or a Managing Director, one who is employed by the company as such and has substantial powers of management over the affairs of the company subject to the superintendence, direction and control of the Board.[3]

However, a member of a company’s board of directors who is not part of the executive team is a non-executive director; also called external director, independent director and outside director.A non-executive director (NED) typically does not engage in the day-to-day management of the organization, but is involved in policy making and planning exercises. In addition, non-executive directors’ responsibilities include the monitoring of the executive directors, and to act in the interest of any stakeholders.

Non-executive director is neither a Whole-time Director nor a Managing Director. For the purposes of corporate governance, the Board of Directors of the company shall have an optimum combination of executive and non-executive directors with not less than fifty percent of the Board of Directors comprising of non-executive directors.[4]

Essentially the role of a non-executive director is to provide what could be called a “creative contribution”[5] to the board of directors by giving objective criticism and advice. Today it is widely accepted that non-executive directors have an important contribution to make to the effective running of many companies, as well as its economy and the world at large. The non –executive directors should bring an independent judgment to bear on issues of strategy, performance and resources including key appointments and standards of conduct.[6]

All directors should be capable of seeing company and business issues in a broad perspective. However, non-executive directors are generally chosen because they have a breadth of experience, are of an appropriate caliber and have particular personal qualities. Additionally, they may have specialist knowledge that will help provide the board with useful insights or, perhaps, key contacts in related to the industries.

Of genuine importance is their independence from the management of the company and any of its “interested parties”. This means they can bring a degree of objectivity to the board’s deliberations and play a valuable role in monitoring management decisions.

Non-executive directors may have an inherent conflict if it is the intention of the majority or sole shareholder that they represent their or its interests. In such a case they may be unable to carry out one of their primary functions – to promote the success of the subsidiary company. If this in any way conflicts with their duties to their own parent company then they would have to consider their position.

FIDUCIARY DUTIES OF A NON-EXECUTIVE DIRECTOR

A fiduciary duty is defined as a duty of utmost good faith, trust, confidence and condor owed by a fiduciary to a beneficiary. Although a company is an independent juristic person, with a separate legal entity from its members, companies act through their directors and other officers. As a result of this the directors of the company become the agents and trustees of the company by default and are in a position to exercise significant influence over the company giving rise to a fiduciary duty towards the company.

Directors have been classified into two broad categories,

1. a) Executive Directors
2. b) Non-executive Directors

Executive Directors are those directors, which take part in the day to day functioning of the company, and are usually in-charge of such daily activities of the company. While, Non-executive Directors are those directors of the company who do not take part in the day-to-day functioning of the company, and are usually in the form of independent non-executive directors or nominee directors.

The question of the duties of Non-executive directors then arises. A corporate body can only act by agents, and it is of course the duty of those agents so to act as best to promote the interests of the corporation who affairs they are conducting. Such agents have duties to discharge of a fiduciary nature towards their principal. And it is a rule of universal application, that no one, having such duty discharge, shall be allowed to enter into engagements in which he has, or can have a personal interest conflicting or which possibly may conflict, with the interests of those whom he is bound to protect.[7]

In the case of Commonwealth Oil & Gas Company Limited v. Nicholas Wilson Baxter and Eurasia Energy Limited[8], at all material times Mr. Baxter was a director of COGCL. The issue was with regard to the Eurasia block opportunity, and whether there was a conflict between Mr. Baxter’s personal interest in that opportunity and his duty to COGCL such that has acted in signing the Memorandum of Understanding on Eurasia’s behalf constituted his breach of fiduciary duties to COGCL. It was held that he owed to it certain fiduciary duties. The Fact that he has no executive functions and that he received no emoluments from his directorship do not serve to negative the existence of fiduciary duties. It also held that even though he had these fiduciary duties, the question to be resolved was the scope or extent of these duties.

Fiduciary duties of a director are said to be “uniform and universal”, but there may be no breach of obligation where the director is excluded from taking any part in the affairs of the company. The duty to avoid conflicts may not extend to circumstances where a direct so excluded.[9]

In the case of Aberdeen Railway Co. v. Blaikie Bros[10]., Mr. Blaikie, a director, had a duty to protect the interest of the railway company and that, by being a party to a transaction in which it and the partnership had conflicting interests (in relation to the purchase price of the chairs), he was in breach of his fiduciary duty to the company.

It has been held that a fiduciary who acts for two principals with potentially conflicting interest without the informed consent of both is in breach of the obligation of undivided loyalty; he puts himself in a position where his duty to one principal may conflict with his duty to the other.[11] Therefore in a situation where an Independent director is allowed to be a director in more than one company (upto 15 companies), he has to make the necessary disclosures to the companies on whose board he sits, and he must take the consent of the members of such companies, failing which he in breach of his fiduciary duties of the companies.

In Aberdeen Railway Co. v. Blaikie Bros[12], Lord Cranworth said that the directors are a body to whom is delegated a duty of managing the general affairs of the company. Even though some members of a board may be executive and others non-executive directors, and the executive directors have some specific executive functions, but the fact that he has an executive function does not alter a director’s status. He is a director of the company and is not confined to the responsibilities arising from his executive function. A director’s fiduciary duty of loyalty is owed to the company as a whole; and the duty to avoid conflict of interest must be related to the interests of the company as a whole.

LIABILITY OF THE NON-EXECUTIVE DIRECTORS[13]

1. Directors’s Personal Liability[14]

As a general rule, since the company and its Director are separate entities, the Director has no personal liability on behalf of the company. However, under certain circumstances, a Director may be held liable on behalf of the company. These circumstances are:

Liability for Tax: Under the Income Tax Act, 1961, where any tax due from a private company in respect of any income of any previous year cannot be recovered from such private company, then, every person who was a Director of such private company at any time during the relevant previous year is liable, jointly and severally, for the payment of such tax. A Director (including any past Director but only for the duration when he was in office) can, however, escape such liability if he or she proves that the non-recovery of such tax cannot be attributed to any gross neglect, misfeasance or breach of duty on his or her part in relation to the affairs of such private company. Under the Central Sales Tax Act and certain state Sales Tax laws, liability may be fastened on Directors of a company, which is wound up, for recovery of sales taxes due from such liquidated company.

Debts of the Company: Generally, a Director is not personally liable for any debt of the company unless fraud on the part of such Director can be established.

Liability for company’s Contracts: A Director is, generally, not liable for any contract entered into by the company, unless expressly provided for, or fraud on the part of such Director can be established.

Refund of Share application money: A Director is personally liable along with the company to repay the share application or excess share application money, as the case may be, if the same is not repaid within the stipulated time limit.

Liability to pay for qualification shares: If the Director has not acquired his or her qualification shares within the prescribed time period and the company goes into liquidation the day after this period expires, the Director will be called upon by the Official liquidator to pay for the shares he or she was supposed to have purchased.

Mis-statement in the Prospectus: Civil liability can be imposed on a Director for any untrue statement in the prospectus of a public company if he or she is a Director at the time of the issue of the prospectus, unless he or she proves that he or she withdrew consent before the issue of the prospectus or that it was issued without his or her authority or consent or without his or her knowledge or that, once he or she came to know of the untrue statement, he or she withdrew consent and gave reasonable public notice of the same, or proves that he or she believed the impugned statements to be true.

Fraudulent Conduct of Business: A Director may be held personally responsible, without any limitation of liability, for all or any of the debts or other liabilities of the company if he or she was knowingly party to the fraudulent carrying on of business.

Unlimited Liability: The liability of any or all of the Directors of a limited company can be unlimited if so provided by the Memorandum, or can be so done if approved by a special resolution as authorized by the Articles.

Criminal Liability[15]

Dishonored Checks: The Director signing a check which is dishonored so as to constitute an offense under the Negotiable Instruments Act, 1881, can be prosecuted along with the company.

Mis-statement in the Prospectus: The Companies Act imposes criminal liability on any person who was responsible for a mis-statement in the prospectus of a public company. Offenses under the Income Tax Act: An offense committed by a company under the Income Tax Act, 1961 is attributed to the persons who were responsible for and in charge of the business of such company.

CONCLUSION

At present, only 40 percent of medium sized companies employ non-executive directors. As companies get larger, they are more likely to have at least one non-executive director. The point at which a company decides to engage a non-executive director relates more directly to the number of employees than to the turnover or the age of the company. Yet, there are essential qualities that a non-executive can bring to the growing, whatever its position in the business cycle. Non-executive directors add an enormous value in the business or company. But having an enormous value also brings the liabilities as well as duties to the non-executive directors. While the stands taken by various courts in India with respect to the liability of a non-executive director (whether or not a Chairman of the board) of a company in India, it was found out that each case turns on its own facts. Hence, whenever something goes beyond what the statues have provided and the courts in its judgments have laid down for the non-executive directors, the decisions / conviction is based upon the degree of involvement of said director on the Board of the company and also on the criticality of the matter in question.

[1] Official Liquidator, Supreme Bank Ltd. v. P. A. Tendolkar, AIR 1973 SC 1104

[2] Section 149, Companies Act, 2013

[3] AES OPGC Holding (Mauritius) and Anr v. Orissa Power Generation Corporation Ltd and Ors, (2005) 125 Comp. Cas. 299 (CLB), (2005) 3 Comp.LJ 139 (CLB)

[4] Clause 49, Listing Agreement, 2014

[5] Cadbury A, Report of the Committee on the Financial Aspects of Corporate Governance, 1992 (London)

[6] id.

[7] Aberdeen Railway Co. v. Blaikie Bros (1854) 1 Macq. 461

[8] [2009] CSIH 75 CA5/07

[9]  In Plus Group Limited v. Pyke

[10] Aberdeen Railway Co. v. Blaikie Bros (1854) 1 Macq. 461

[11] Bristol and West Building Society v. Mothew [1998] Ch. 1

[12] Aberdeen Railway Co. v. Blaikie Bros (1854) 1 Macq. 461

[13] Jayati Sarkar, Board Independence & Corporate Government in Indai: Recent Trends & Chanllenges Ahead, Vol. 44, No. 4, INDIA JOURNAL OF INDUSTRIAL RELATIONS, Pp. 576-592

[14] Vyapak Desai & Ashish Kabra, Director and Officers Liability in India, Vol. 41, No. 4, LITIGATION, Pp. 1-3

[15] Nigam Nuggehalli, Vicarious Criminal Liability for Corporate Officers in India: Problems and Prospects, Azim Premji University, http://azimpremjiuniversity.edu.in/SitePages/pdf/Vicarious-Corporate-Criminal-Liability%20.pdf