Directors are the Core of the Company

From the very beginning of the company establishment, board of directors comes into existence and they are the people who manages the company affair mainly. It exists till the end of the company means till the company is ordered to wind up. At the time of winding up the duties of directors and power are ceased to exist. [1] In the normal scenario directors acts through meetings. Sometimes some individual director is given more power by the board but generally directors should work together and exercise the power collectively as a board. The meeting is for discussing about the business and take any decision about the company. The directors can only act through the resolution passed in those meeting. If any liability is imposed on the directors that should be passed by the board in a meeting. [2]

The definition of “director” is given under section.2 of the Companies Act, 1956 which says that “any person occupying the position of a director by whatever name called”. So the determining factor of a director is the position, duties and function a person discharge, not the name. This view was excepted and confirmed in Re, Forest of Dean Coal Mining Co [3] which says that function is determining factor not name. The company is a judicial personality and board of Directors is human faces to it. The Board of Directors is the agent of the company who work on behalf of the company. The directors or board of directors act as the trustee of the company property or assets. Directors are suppose to work collectively as board of director and even though it is an agent of company in certain matter the company can not interfere into the working of the directors work like distribution of shares. The article of the company can give name to the directors as board of management, governors but legally they are simple directors.

The Board of Directors of a company can do all the activity, exercise power which the company has authorized it to do. [4] The act which should be done in the general meeting of the company according to the Companies Act or other Acts or memorandum or articles of the company should not be done by the directors. If these prohibited acts are done then they will be subjected to the provision of the companies act or memorandum or the articles of the company. The work done by the board of directors should be in compliance with the provisions of the Companies Act, or any other act or articles, memorandum or article passed in general meeting. [5]

There is power and chances of misusing of the power by the directors. This could results into mismanagement of the company. This paper is intended to discuss the mismanagement of company and directors liability in those situations. First part of the paper will discuss about the mismanagement and second part will discuss about the liability of the director in different situations and the steps can be taken by different body against it.

Part-1

Definition of Mismanagement:

According to Avtar Singh to prove mismanagement one has to prove that “ affair of the company being conducted in a manner prejudicial to the interest of the company or public interest, or that by reason of any change in the management or control of the company, it is likely that the affairs of the company will be conducted in that manner.” Tribunal can give appropriate order if it thinks fit observing the argument put forth to it. [6] Section 398 of the Companies Act talks about mismanagement in a company.

In the definition of mismanagement Calcutta high court in a case called Richardson & Cruddas Ltd. V. Haridas Mundra [7] said that where a group of person in the management is conspiring to defraud the other persons then that establish mismanagement. In another case in which the fact was like that there were two directors and one of them did not know any affair of the company and working of the company as the other director kept him in total dark about the functioning of the company. Court held that this is an example of mismanagement. In another instance the directors preffered the object of their liking and make the share allotment in return of consideration other than cash. It was held by the court that this is a case of mismanagement. [8]

Incidents considered as mismanagement:

Running company for the interest of the Board of directors: There are situation where company is not working according to the provision of Indian Company Act. When company is run according the board of directors for their own interest and which is negating the interest of the majority share holder is mismanagement. The court found that the company is taking care of certain group’s interest and not the interest of the company. If it can be proved that the company has been conducted in a manner that there is a likelihood of prejudicing the interest of the company then Sec. 398 (b) is proved. [9]

Holding office after the expiry of term: There was a situation where managing directors were continuing their office holding even thought his term of office has been expired and there was no meeting for their reappointment. This was considered as mismanagement by the court. [10]

Infighting among the Directors: A company was doing well but there was a problem in management because of lack of faith between the two groups of directors. This infighting caused a serious mismanagement which is result in serious prejudice to the company. In this case the court had appointed a special officer to maintain the company affair and said that it attracts section 398 of the company act. [11]

Not taking interest in the Company Affairs: Where directors are not taking any interest in the working of the company and keeping the proper records and as a result of that company is facing loss. The court was in view that this is a perfect situation fit under s. 398. [12]

Sale Company assets in improper way: One estate of a tea plantation company was sold by the directors at a low price without taking approval of the shareholders and giving proper notice. It was held that this is mismanagement and court set aside the sale. The directors were held liable and required to submit the accounts of that sale. [13]

Company fated to trade unprofitably: “There can be no doubt that if the directors of a company continue to trade when the company is making losses and when it should have been apparent that there is no real prospect that the company would return to profitability, the court may draw interference that the directors decision was improperly influenced by their desire to continue in office and in control of the company and to draw remuneration and other benefits for themselves and other connected with them.” The court can come into conclusion that there is mismanagement of the company affair. [14]

Violation of Articles and statutory provisions and Memorandum: When the conditions mentioned in the memorandum is not followed by the people in the management then that will results into mismanagement. [15] If shares are not offered to the existing members according to the rights mentioned in the articles or holding meeting without giving any notice to the members and issuing shares for a consideration other than money can be constructed as mismanagement and can be referred to the CLB under s.398 according to the case Akbarali A. Kalvert v. Konkan Chemicals P. Ltd. [16]

Infringement of fiduciary duties: In a small private company one of the managing directors did not inform the other member, share holders about the financial position and accounts. He also did not call meeting properly. The company incurred loses and the company was closed because of non renewal of the license. The CLB held that it is a clear case of mismanagement and a different set of directors were given the duty to take case of the company. [ V.G.Balasundaram v. New Theatres Carnatic Talkies P.Ltd] [17]

Misuse of the Funds of the Company: In the case of Narain Das v. Bristol Grill Ltd [18] there were a company of four bothers and three of them started using the money breaking the agreement of using the money. The court held that the forth brother has legitimate ground to say that there is mismanagement under section 398.

In another situation directors of the company has allotted the shares in a selective basis and allotted illegally and they also failed to file return and other documents and fail to show proper accounts of financial assets. The court held that the board of directors should be changed with a new set of administrator. [19]

Relief against Mismanagement:

“Relief against mismanagement runs in favour of the company and not to any particular member or members.” [20]

Section 398 gives relief in the cases of mismanagement. Conditions to invoke s. 398 for relief in case of mismanagement is to prove that company is running or will be running in a manner which is prejudicial to public interest or company’s interest. [21]

In Suresh Kumar Sanghi v. Supreme Motors Ltd [22] Delhi High Court has given a clear picture to held that in which situation relief can be asked under section. 398. They are: “ (i) the affair of the company are being conducted in a manner prejudicial to public interest (ii) if the affairs are being conducted in a manner prejudicial to the interest of the company or (iii) if there is material change which has taken place in the management or control of the company in the manner set out in the said section and that by reason of such change it is likely that the affairs of the company will be conducted in a manner prejudicial to public interest or in a manner prejudicial to the interest of the company.” This section will be applicable in the actual mismanagement or simple apprehension of it.

Part-2

Liability of the Directors:

There are different kinds of liability of the directors. They are criminal liability, liability to the company, liability to the third parties, liability for the acts of co- directors, liability for breach of statutory duties. There are four kinds of liability towards the company. They are liability in case of breach of duty, Ultra vires acts, negligent acts, mala fide acts. [23]

To make a director liable for the wrongful act done by the board of director, he should have been participated in that act and have knowledge about it. Therefore if the director is absent from a meeting of board of director he can not be held liable for fraudulent activity or wrongful activity of his co directors if he does not know about those acts. [24]

Liability for breaches of fiduciary duty or breach of trust:

In a case where the directors work for the company without honesty then it can be say that he has breaches fiduciary duty toward the company. The power in the hand of the director is mainly comes from trust so he must work for the interest of the company not his personal interest or for any other members. [25] The breaches of fiduciary duty by the directors is also a mismanagement and director would be held liable [26] .

All the property of the company is given in the hand of the directors. So there is a relation of trust. If directors act in a mala fida manner and dishonestly then they are liable and they have to make good of the loss. [27] In a case situation a director was also member of another company and earning bonus by giving some business facility of his own company. That person was held liable to explain those profit even though the company did not suffer any lose. [28]

In the next instance the Managing Director and other three directors planed to set up another rival company. The managing Director resigned and established it while others were working in that company. It was held that they should have informed the company about this matter and held liable to make good of the company’s loss. [29]

Liability for Misuse of the Funds of the Company:

In a case where the directors misused the money of the company that is again mismanagement [30] . Court held that “where a director misapplies or misappropriates money or properties of the company or has been guilty of breach of trust or misfeasance, the court may order him to repay the money or restore the property or to pay compensation” [31]

Liability of Directors for Sale Company assets in improper way:

If the directors’ sales company property in a price lower than the actual price then that is mismanagement [32] and directors are liable. In this particular case a property was sold in a less price were the actual price is much higher and directors knew about that but did not take any step and held accountable to the company. [33]

Liability for Running company for the interest of the Board of directors:

The director should always work for the profit of the company and if he does for his own profit and profit of some other members then that is mismanagement. [34] In the case of Rjamundry Electic Supply Corpn v. A Nagashara Rao [35] , shareholders of the company filed a suit against the company on the ground that the directors are mismanaging the company. Court in this matter found out that the vice chairman of the company has grossly mismanaged the company affair and used company funds for his personal use. The company had large amount due for electricity supply to the government, the machinery was in the damaged condition, the directorate had very little power and “a powerful local junta was ruling the roost” and the share holder outside the chairman had no power to set the matter right. The court held that this is an evidence of mismanagement. The court appointed two administrators who will manage the company who will have the power of the director.

In Albion Steel and Wire Co. v. Martin [36] a director sold the property of his company at the market price which he bought before in lower price and thus made profit. The court held that the director is accountable for his profits.

Liability for Violation of Articles and statutory provisions and Memorandum:

In the case of Central Government v. Pentamedia Graphics Ltd [37] statutory provision was infringed and it was considered as mismanagement by the CLB. In the case of violation of statutory provision directors can be liable to the company. Violation of articles, memorandum and statutory provision is mismanagement [38] and directors are liable to the company.

Personal Liability:

Doctrine of ultra vires and Personal liability of Directors: The director is working as the agent of the company and he has the duty to represent the company in proper way according to memorandum. He has the duty to look into the appropriate use of the company capital for legitimate use. If the director is exceeding his authority and doing something whose power he has not been given then third party can held liable the director personality that means in case of substantive ultra vires directors are personally liable. In the case of Jehangir R. Modi v. Shamji [39] the Bombay High Court said that a shareholder has the right to take against the director along with the company to make him refund the fund to the company which has been used for a transaction which they have no authority to enter into. In another case also this view has been supported. In Kathiawar Trading Co. V. Virchand [40] the company’s fund was used for the purpose which is not the main objective of the company but ancillary. In this situation director is personally liable.

Directors can be personally liable for the liability of the company or debt of company if court give order accordingly. Same kind of order can be made by the court if the directors are guilty of fraudulent activity. [41]

Some Consequence of Such Malfunction of the Directors:

(a)Interference by the Share Holders:

There are certain situation where share holders can interfere. When the directors are mal functioning mainly in those situation this can happen. Director Acting mala fide: when the director of the company work for his own interest and in that process he does not act for the company then the shareholders can interfere in that situation. [42] Impasse in management: in this case the directors can not exercise their power and in this situation share holders can implement their power in the general meeting. [43]

(b)Removal of Directors:

Removal of a director can be in three different ways – removal by shareholders, by central government and by company law board. According to section 284 share holders has a right to remove the directors it appointed and does not need to prove any mismanagement, breach of trust or other misconduct on the part of the directors. This kind of removal is necessary in the case when share holders do not like the decision taken by the board of director as they do not have any right to interfere into the decision making of the board of directors. [44]

(1)Removal by the Central Government:

In recent time Satyam case [45] is good example of this kind. Under section 388B central government can refer a matter to the CLB [46] (now replaced by tribunal) against any managerial person. In this case a huge corporate mismanagement in terms of money came into right and also fraudulent activity by the management. The CLB took into notice the factual situation and the reference made by the central government. Then ordered to remove the existing Board of directors and permitted the central government to appoint a new board of directors. The conclusion is that the center can refer to CLB in a case of mismanagement and remove the board of directors. [47]

(2)Removal By the Company Law Board (now tribunal) :

If an application has been made to the CLB under section 398 and 397 for mismanagement and oppression of the company then the CLB can terminate or set aside any of the agreement made between the company and the director. [48] Such director will not be able to act as manager, managing director or director of the company within five years of such order without taking leave from the CLB. This terminated director is not entitling to any compensation of office loss. [49]

Conclusion:

The directors are the core of the company and they are the main secret behind a successful company. The company management should in the hand of responsible people who can use their power in the proper direction as the greater power comes with greatest responsibility.

The company has a board of director who runs the company and takes every decision collectively through organizing meeting. Even though it has been seen that there is large number of incident of mismanagement of the company. The directors are the first person to held liable in this regard. In the case of mismanagement director mainly are liable to the company to indemnify. But there are situation when public at large suffers problem because of their mismanagement in the company. So there should be provisions and measurement to prevent this thing from happening.