Intangible and Existing Only in Contemplation of Law

A corporation is an artificial being, invisible, intangible and existing only in contemplation of law. [1] It has neither a mind nor a body of its own. [2] A living person has a mind which can have knowledge or intention and he has hands to carry out his intention. A corporation has none of these, it must act through living persons. [3]

The noted author on Company Law Dr. Avatar Singh quotes these lines from different judges to argue why the company’s bussiness should be entrusted to some human agents.

Human beings have hands and possess the mental faculty. They are capable of taking right decisions and actions. A corporation does not take an action or make a decision or a judgement itself because it does not possess these essential qualities. Rather it requires a channel through, which it can take actions and decisions. The directors of the company serve as the required channel to make the decisions and take actions on behalf of the corportion. Lodging upon the inevitability of apponting agents for carrying out its task, the role of the directors of a company becomes vital.

POSITION OF DIRECTORS

The Companies Act, 1956 does not define the term “Director”. Rather it provides for the provision of the directors in terms that “director includes any person occupying the position of a director, by whatever name called”. [4]

It is not an easy task to explain the position of the directors in a company. They are the professional hired by the company to carry out its affairs. They are not the servants of the company, rather officers of the company. In case of Moriarty v. Regent’s Garage & Engg Co. [5] , LUSH J. opined that “a director is not a servant of any master. He cannot be described as a servant of the company or of anyone”. In the same case Mc CARDIE LJ delivered the opinion that “a director is in fact a director or controller of the company’s affairs. He is not a servant”. [6]

In words of BOWEN LJ [7] : “Directors are described sometimes as agents, sometimes as trustees and sometimes as managing partners. But each of these expressions is used not as exhaustive of their powers and responsibilities, but as indicating useful points of view from which they may for the moment and for the particular purpose be considered.”

RESPONSIBLITIES OF THE DIRECTORS WITHIN THE COMPANY

Under the Companies Act directors are accountable to for their acts done on behalf of the company. Besides the statutory duties, which the directors have to perform to ensure strict compliance with the various provisions of the Act they also have certain duties which arise out of their fiduciary relationship with the company.

General Responsibilities of the Directors within Company:

Fiduciary Obligation / Duty of good faith: The directors must act in the best interest of the company. Interest of the company implies the interest of the present and future members of the company on the footing that company would be continued as going concern. In Burland v. Earle, [8] the director was instructed to purchase some property for the company. But he first purchased the same for himself and then sold it to the company for the profit. The lower court held him liable for the profit so made, which in equity belonged to the company. But the Judicial Committee of the Privy Council set aside the decision of the lower court. A director cannot escape from his duty to account for his profit by resigning from his office of director in order to obtain a profit thereafter. [9]

Duty of care: the directors of a company must discharge their duties and obligations with skill and diligence as expected from a reasonable person of his knowledge and experience. A director must display care in performance of work assigned to him. He is, however, not expected to display an extraordinary care but that much which a man of ordinary prudence would take in his own case. Any provision in the company’s Articles or in any agreement that excludes the liability of the directors for negligence, default, misfeasance, breach of duty or breach of trust, is void. The company cannot even indemnify the directors against such liability. In Jorchester Finance Co. Ltd. v. Stebbing, [10] it has been held that the duty of care extends uniformly to all the directors of a company, whether they are executive or non-executive directors. In G.D. Bhargava v. Regitrar of Companies, [11] the High Court of Allahabad ruled that protection under Section 633 of the Companies Act shall not be available, where the negligence of the director amounts to an offence so as to attract the provisions of the IPC relating to fraud or forgery.

Duty not to delegate: Director being an agent is bound by the maxim delegates non potest delegare, which means a delegatee cannot further delegate. Thus, a director must perform his functions personally. However, he may delegate his in certain conditions.

Statutory Duties:

To file return of allotment: Section 75 of the Companies Act, 1956 requires a company to file with the Registrar, within a period of 30 days, a return of the allotments stating the specified particulars.

Not to issue irredeemable preference share or shares or share redeemable after 20 years: Section 80, as amended by Amendment Act, 1996, forbids a company to issue irredeemable preference shares or preference shares redeemable beyond 20 years. Directors making any such issue may be held liable as officer in default and may be subject to fine up to Rs. 10,000/-.

To disclose interest: In respect of contracts with director, Section 299 casts an obligation on a director to disclose the nature of his concern or interest (direct or indirect), if any, at a meeting of the Board of directors. [12] The said Section provides that in case of a proposed contract or arrangement, the required disclosure shall be made at the meeting of the Board at which the question of entering into the contract or agreement is first taken into consideration. In the case of any other contract or arrangement, the disclosure shall be made at the first meeting of the Board held after the director become interested in the contract or arrangement. The Delhi High Court in M/s. Raj Cylendrs & Containers v. Hindustan General Industries Ltd [13] , has observed that where the directors are personally interested in the deal, the contract is to the detriment of the company and hence not binding on it.

To disclose receipt from transfer of property: [14] Any money received by the directors from the transferee in connection with the transfer of the company’s property or undertaking must be disclosed to the members of the company and approved by the company in general meeting. Otherwise, the amount shall be held by the directors in trust for the company. This money may be in the nature of compensation for loss of office but in essence may be on account of transfer of control of the company. But if it is bona fide payment of damages for the breach of contract, then it is protected by sec. 321(3). Even no director other than the managing director or whole time director can receive any such payment from the company itself.

To disclose receipt of compensation from transferee of shares [15] : If the loss of office results from the transfer (under certain conditions) of all or any of the shares of the company, its directors would not receive any compensation from the transferee unless the same has been approved by the company in general meeting before the transfer takes place. If the approval is not sought or the proposal is not approved, any money received by the directors shall be held in trust for the shareholders, who have sold their shares.

Duty to attend Board meetings: A number of powers of the company are exercised by the Board of directors in their meetings held from time to time. Although a director may not be able to attend all the meetings but if he fails to attend three consecutive meetings or all meetings for a period of three months whichever is longer, without permission of the Board, his office shall automatically fall vacant. [16]

Other Duties:

To convene statutory, Annual General meeting (AGM) and also extraordinary general meetings. [17]

To prepare and place at the AGM along with the balance sheet and profit & loss account a report on the company’s affairs including the report of the Board of Directors. [18]

To authenticate and approve annual financial statement. [19]

To appoint first auditor of the company. [20]

To appoint cost auditor of the company. [21]

To make a declaration of solvency in the case of Members voluntary winding up. [22]

LIABILITES

Liability to the company:

Breach of fiduciary duty: where a director acts dishonestly to the interest of the company, he will be held liable for breach of fiduciary duty. Most of the powers of directors are powers in trust, and therefore, should be exercised in the interest of the company and not in the interest of the directors or any section of members.

Ultra vires acts: Directors are supposed to act within the parameters of the provisions of the Companies Act, Memorandum and Articles of Association, since these lay down the limits to the activities of the company and consequently to the powers of the Board of directors. Further, the powers of the directors may be limited in terms of specific restrictions contained in the Articles of Association. The directors shall be held personally liable for acts beyond the aforesaid limits, being ultra vires the company or the directors.

Negligence: As long as the directors’ act within their powers with reasonable skill and care as expected of them as prudent businessman, they discharge their duties to the company. But where they fail to exercise reasonable care, skill and diligence, they shall be deemed to have acted negligently in discharge of their duties and consequently shall be liable for any loss or damage resulting there from.

Mala fide acts: Directors are the trustee for the moneys and property of the company handled by them, as well as exercises of the powers vested in them. If they dishonestly or in a mala fide manner, exercise their powers and perform their duties, they will be liable for breach of trust and may be required to make good the loss or damage suffered by the company by reason of such mala fide acts. They are also accountable to the company for any secret profits they might have made in course of performance of duties on behalf of the company. Directors can also be held liable for their acts of .misfeasance. i.e., misconduct or willful misuse of powers.

Liability to third parties:

Liability under the Companies Act:

Prospectus: Failure to state any particulars as per the requirement of the section 56 and Schedule II of the act or mis-statement of facts in prospectus renders a director personally liable for damages to the third party. Section 62 provides that a director shall be liable to pay compensation to every person who subscribes for any shares or debentures on the faith of the prospectus for any loss or damage he may have sustained by reason of any untrue or misleading statement included therein.

With regard to allotment: Directors may also incur personal liability for:

Irregular allotment, i.e., allotment before minimum subscription is received (Section 69), or without filing a copy of the statement in lieu of prospectus (Section 70): Under section 71(3), if any director of a company knowing contravenes or willfully authorizes or permits the contravention of any of the provisions of section 69 or 70 with respect to all allotment, he shall be liable to compensate the company and the allottee respectively for any loss, damages or costs which the company or the allottee may have sustained or incurred thereby.

For failure to repay application monies in case of minimum subscription having not been received within 120 days of the opening of the issue: Under section 69(5) read with SEBI guidelines, in case moneys are not repaid within 130 days from the date of the issue of the prospectus, the directors of the company shall be jointly and severally liable to repay that money with interest at the rate of 6 % per annum on the expiry of 130th day. However, a director shall not be liable if he proves that the default in repayment of money was not due to any misconduct or negligence on his part.

Failure to repay application monies when application for listing of securities are not made or is refused: Under section 73(2) .Where the permission for listing of the shares of the company has not been applied or such permission having been applied for, has not been granted, the company shall forthwith repay without interest all monies received from the applicants in pursuance of the prospectus, and, if any such money is not repaid within eight days after the company becomes liable to repay, the company and every director of the company who is an officer in default shall, on and from the expiry of the eighth day, be jointly and severely liable to repay that money with interest at such rate, not less than four per cent and not more than fifteen per cent, as may be prescribed, having regard to the length of the period of delay in making the repayment of such money.

Unlimited liability: Directors will also be held personally liable to the third parties where their liability is made unlimited in pursuance of section 322(i.e., vide Memorandum) or section 323(i.e., vide alterations of Memorandum by passing special resolution). By virtue of section 322, the Memorandum of a company may make the liability of any or all directors, or manager unlimited. In that case, the directors, manager and the member who proposes a person for appointment as director or manager must add to the proposal for appointment as a statement that the liability of the person holding the office will be unlimited. Notice in writing to the effect that the liability of the person will be unlimited must be given to him by the following or one of the following persons, namely: the promoters, the directors, manager and officers of the company before he accepts the appointment. Further, in case of limited liability Company, the company may, if authorized by the articles, by passing resolution alter its Memorandum so as to render the liability of its directors or of any director or manager unlimited. But the alteration making the liability of director or directors or manager unlimited will be effective only if the concerned officer consents to his liability being made unlimited. This alteration also, unless specifically consented to by any or all directors will not have any effect until expiry of the current term of office.

Fraudulent trading: Directors may also be made personally liable for the debts or liabilities of a company by an order of the court under section 542. Such an order shall be made by the court where the directors have been found guilty of fraudulent trading. Section 542(1), in this regard, provides that if in the course of the winding up of a company, it appears that any business of the company has been carried on, with intent to defraud creditors of the company or any other person, or for any fraudulent purpose, the court, on the application of the Official Liquidator, or the liquidator or any creditor or contributory of the company may if it thinks it proper so to do, declare that any persons who were knowingly parties to the carrying on business in the manner aforesaid shall be personally responsible without any limitation of liability, for all or any of the debts or other liabilities of the company as the court may direct.

Further, section 542(3) provides that every person who was knowingly a party to the carrying on of the business in the manner aforesaid, shall be punishable with imprisonment for a term which may extend to two years, or with fine which may extend to fifty thousand rupees, or with both.

Liability for breach of warranty:

Directors are supposed to function within the scope of their authority. Thus, where they transact any business in repsects of matters, ultra vires the company or ultra vires the articles; they may be proceeded against personally for any loss sustained by any third party.

Liability for breach of statutory duties:

The Companies Act, 1956 imposes numerous statutory duties on the directors under various sections of the Act. Default in compliance of these duties attracts penal consequences. The various statutory penalties which directors may incur by reason of non-compliance with the requirements of Companies Act are referred to in their appropriate places.

Liability for acts of co-directors:

A director is the agent of the company except for matters to be dealt with by the company in general meeting and not of the other members of the Board. Accordingly, nothing done by the Board can impose liability on a director who did not participate in the Board’s action or did not know about it. To incur liability he must either be a party to the wrongful act or later consent to it.

Thus, the absence of a director from meeting of the Board does not make him liable for the fraudulent act of a co-director on the ground that he ought to have discovered the fraud.

Contractual Liability:

Directors are bound to use fair and reasonable diligence in discharging the duties and to act honestly, and act with such care as is reasonably expected from him, having regard to his knowledge and experience. In R.K. Dalmia and others v. The Delhi Administration, [23] it was held that “A director will be personally liable on a company contract when he has accepted personal liability either expressly or impliedly. Directors are the agents or the trustees of a Company”.

Civil Liability to the Company:

Director’s liability to the Company may arise where

the directors are guilty of negligence,

the directors committed breach of trust,

there has been misfeasance and

the director has acted ultra vires and the funds of the company have been applied for such an act.

A director is required to act honestly and diligently applying his mind and discharging his duties as a man of prudence of his ability and knowledge would do. It has been explained in the duties of directors as to what is standard or due care and diligence expected from him as explained by Justice Romer in Re City Aquintable Fire Insurance Company. [24]

Any willful misconduct or culpable negligence falls within the category of misfeasance. It was held in Re Duomatic Ltd, [25] “A director has to act in the way in which a man of affairs dealing with his own affairs with reasonable care, and circumspection could reasonably be expected to act…..”

Criminal liability:

A director may be held criminally liable for any offence committed by the company, where he has aided, abetted, counseled, or procured the commission of the offence. Just as individuals owe a duty not to harm or injure others in society without justification, so do companies owe a duty not to poison our water and food, not to pollute our rivers, beaches and air, not to allow their workplaces to endanger the lives and safety of their employees and the public, and not to sell commodities, or provide transport, that will kill or injure people.

In 2003 Supreme Court in Assistant Commissioner, Assessment-ll, Banglore & Ors. v. Velliappa Textiles Ltd & Anr., [26] took the view that since an artificial person like a company could not be physically punished to a term of imprisonment, such a section, which makes it mandatory to impose minimum term of imprisonment, cannot apply to the case of artificial person. However, Supreme Court in 2005 in Standard Charted Bank v. Directorate Of Enforcement [27] in majority decision of 3:2 expressly overruled the Velliapa Textiles case on this issue.

In Standard Charted Bank v. Directorate Of Enforcement, appellant filed a writ petition before High Court Of Bombay challenging various notices issued under section 50 read with section 51 of Foreign Exchange Regulation Act, 1973 and contended that the appellant company was not liable to be prosecuted for an offence under section 56 of FERA Act, 1973. Against the decision of High Court appellant filed a special leave before Supreme Court, contended that no criminal proceeding can be initiated against appellant company under section 56(1) of FERA Act, 1973 as the minimum punishment prescribed under section 6(1) (i) is imprisonment for a term which shall not be less than six months and with fine.

The question for consideration before court was: Whether a company or a corporation being a juristic person, can be prosecuted for an offence for which mandatory punishment prescribed is imprisonment and fine Prosecution is pre-requisite for inflicting any punishment. It is clear from Standard Charted case that prosecution can be initiated and fine can be imposed even when imprisonment is given as mandatory punishment with fine.

Liability on winding up:

A Director of a company in liquidation must co-operate with the liquidator in realizing the assets of the company and distributing them among the creditors and contributors of the company. If they fail to do so they are liable to imprisonment, which may extend to five years and fine. Therefore, Directors are liable for theft of the company’s property or for false accounting. Directors are liable to prosecution on several issues.

SPECIAL STATUTORY PROTECTION AGAINST LIABILITY

The Act extends special protection against a liability that may have been incurred in good faith. A good illustration here will be to cite an early case of Re Claridge’s Patent Ashphalt Co, [28] where the Court said that the Directors were acting for the benefit of the company and took the best advice from the company’s solicitor and thus were not held liable. The Bombay High Court in the case of Gautam Kanoria v. Asstt ROC [29] also granted relief to the Directors where the AGMs could not be held and annual returns could not be filed due o the takeover of the company by the Government and the matters being beyond their control. The totality of the circumstances has to be examined for considering whether relief is to be allowed or not. It was also observed in Om Prakash Khaitan v. Shree Keshariya Investment Ltd [30] that it would be proper to relieve directors of consequences of defaults and the breaches unless they are directly involved in the acts or omission complained of or have otherwise not acted honestly or reasonably or have financial involvement in the company.

RELIEF FROM LIABILITY

There are a number of ways in which a director may be relieved from liability which would otherwise be incurred for breach of duty.

Ratification by the Shareholders. Some breaches may be remedied through the director’s conduct being disclosed to a general meeting and being ratified by the shareholders passing an Ordinary Resolution. However, the following breaches of duty cannot thus be ratified: Any breach involving a failure of honesty on the director’s part;

Any breach of duty which results in the company performing an act which it cannot lawfully do e.g by reason of some prohibition imposed by statute or the general law;

Any breach of duty which results in the company performing an act not in adherence with the company’s articles;

A breach of duty bearing directly upon the personal rights of the individual shareholders; A breach of duty involving “fraud on the minority”.

Ratification by Consent of all Shareholders. The common law principle of unanimous approval by all the shareholders is effective in relieving a director from liability for any breach of duty, provided only that the breach does not involve fraud on its creditors and (probably) is not ultra vires the company, so far as that doctrine still exists.

Contractual Relief. Any contract between the directors and the company, or any similar provision in the Articles which attempts to exempt the directors from liability for negligence, default or breach of trust towards the company is void. However, directors may exclude their liability to third parties by means of an express contractual provision or a disclaimer.

Judicial Relief. The court has power to relieve a director from some civil or criminal liabilities for negligence, default or breach of trust if it is satisfied that the director has acted honestly and reasonably and in all the circumstances he ought fairly to be excused. This is not however available in respect of all defaults and in particular it is not available in a case of wrongful trading.

CONCLUSION

Accountability is an important element of Board effectiveness. There should be some mechanism for evaluating the performance of the directors. The extent of liability of a director would depend on the nature of his directorship. In applying the general equitable principles to company directors, four separate rules have emerged.

They are (1) that directors must act in good faith in what they believe to be the in the best interest of the company (2) they must not exercise powers conferred upon them for purposes different from those for which they are conferred (3) that they must not fetter their discretion as to how they shall act and (4) that without the informed consent of the company, they must not place themselves in a position in which their personal interests or duty to other persons are liable to conflict with the duties to the company.