THE Companies Act, 1956, did not clearly differentiate between independent and non independent directors, keeping the rules for liability same for both categories of directors. The Act also shielded independent directors in case a managing director existed in the company, as in such scenarios, it was assumed that an independent director was not responsible in running the day-to-day affairs of the company.
Moreover, the courts were also generally protective towards independent directors while fastening liabilities. To successfully prosecute an independent director, one needed to establish that the accused independent director was in control of the day-to-day business of a said company. Though this provided safeguard against the actions of other directors or key managerial personnel, it did not completely absolve independent directors of their liabilities.
They could still be held responsible for the default/wrongdoing under their knowledge or direction or in cases where they were responsible for the act, which lead to a default/wrong. Now, in order to encourage a healthy environment where learned and well respected individuals become independent directors in a company, the Companies Act 2013 Act has, to a certain extent, protected independent directors from liability. An analysis of Section 149 (12) of the Companies Act, 2013, which is the primary provision governing the liability of independent directors, also indicates that independent directors can no longer afford to be onlookers and avoid liabilities. Diligence is the least that is expected of them. In the revised scenario, the following risks must be mitigated by independent directors:
It was widely believed that only executive or directors in charge of the management are liable for any offence. However, at leastin the ruling of Union Carbide of India, its chairman Keshub Mahindra, a nonexecutive director, was booked by the Central Bureau of Investigation (CBI) under the same sections as the managing director, executive director, works manager and others directly involved in the day-to-day running of the company. The position is clearer in the Companies Act 2013. Now, independent directors can fall within the definition of an ‘officer in default’ at least in respect of the functions for which they have been put in charge of or of any default within their knowledge. Whether a NED/ID is actually liable or not will be a question of evidence and proof which will be resolved at the stage of trial. Going through the entire process of prosecution is in itself a harrowing experience and could act as a serious disincentive to join the board by NED/IDs where they are not even involved in the day-to-day management of the company. Thus, this risk needs to be mitigated by the independent directors.
In many cases, especially those of dishonour of cheques, independent directors have faced vexatious proceedings. As pointed out earlier, it is very difficult to avoid these proceedings at least at the early stages. As such, independent directors need to take appropriate steps to guard themselves against such events and to be adequately protected, if and when such proceedings are issued against them.
Sections 166, 134(5), 149 and Schedule IV of the Act as well as Clause 49 of the Listing Agreement, along with various other sections, set out a code of conduct for the role, responsibilities and functions of an independent director. The essence of these provisions is that professional conduct is expected from independent directors and they should use their skill and independence in implementing the best corporate governance in the interests of shareholders. Violating some of the provisions of the code can lead to criminal law consequences, while in case of others there could be civil consequences in terms of disqualifications or other action decided by the relevant stakeholder. Therefore, it is important for independent directors to make themselves aware of the code of conduct and the consequence of breach for a trouble-free career.
One of the most important duties of independent directors under the 2013 Act is to ascertain that the company has an adequate and functional vigil mechanism and to ensure that the interests of a person who uses such mechanism are not prejudicially affected on account of such use. A director may be in breach of his fiduciary and statutory duties for failing to ensure the same.
Directors of a private company can be held liable for the payment of arrears of tax of a company in liquidation, if the non-recovery is attributable to any gross neglect, misfeasance, or breach of duty on their part. Directors can also be held liable for contractual obligations of a company, if fraud on their part can be established. The same is true for any misrepresentation made in the prospectus during fund raising or for fraudulent conduct of business.
In order to avoid the risks outlined above and many other, independent directors need to have access to good quality and independent legal advice. It is in their interest to negotiate a favourable and clear Directors Responsibility Statement, seeking within their letter of appointment the commitment of the company to fund the costs of good quality independent legal advisor not associated with the company. Since risks of liability are higher in less well-governed companies, independent directors need to be careful in their choice of companies. In case of inkling that their prospective company is not governed well, they can ask the company to commit resources for enhancing governance at least within the functional areas in which s/he is likely to work. Of course, all this assumes that the independent directors act with integrity, in good faith, exercise independent judgment, are cognizant of their confidentiality obligations and avoid conflict of interest.
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