Director’s Liability: Directors to Tread Carefully

In-House Counsel

Director’s Liability: Directors to Tread Carefully

Naresh Arora | February 2018

Part 1 of An In Depth Authorship Series

The recent advent of commercial reforms and economic growth witnessed in India tough impressive but have come with their own drawbacks. Amidst, the numerous corporate scams and frauds in India, the ubiquitous problem of corruption coupled with the increasing risk of internal fraud had raised many concerns leading to the seminal shift in the Indian corporate regime with the enactment of the Companies Act of 2013. However, a Director’s liability is not just limited to his/her duties under the Companies Act of 2013. In this article we examine and provide an overview of the current legal landscape related to Director’s Liability under the various laws in India and understand how the risks to Director’s may be reduced.

INTRODUCTION

Who is a Director and What is He Liable for?

Directors are agents of the Company in transactions they enter into on behalf of the Company, although they are not agents for individual shareholders or members. Director’s liability arises because he/she occupies a position of immense as an agent or officer and exercises duties of fiduciary nature towards the Company and its shareholders. Consequently, a Director is saddled with the liability for any offence made by the Company and for these purposes, he/she can be summoned/ issued notice to defend himself/herself. The courts have (in deciding the liability of Directors) generally taken into consideration a Director’s role in the day to day operations or the business of the Company and have held that in order to be liable for the wrongdoing committed by a Company, a Director must (at the time of commission of such act/offense/omission) be in charge / in control of responsible to the company for conduct of its business.

Under Indian laws, a Director, may be held responsible for renege, disobedience, failure, refusal, or contravention of any statutory obligation of the Company in case he/she comes within the purview of an ‘officer who is in default’.

Director’s Liability under the Companies Act, 2013 (“The Act”)

The Director pays a crucial role in corporate governance. The Act seeks to bring more accountability and defines the Duties and Responsibilities of the Directors of the Company making them responsible for various contraventions through several provisions. The Board may consist of several categories of Directors including

whole-time directors, managing directors, independent directors, nominee directors and women directors. The Independent Directors’ liability has been limited only to the extent of any commission / omission by company which has occurred with his/her knowledge/ attributable through Board processes, and with his/her consent or connivance or where he/she had not acted diligently. In no other case shall an Independent Directors shall be liable for the acts / omission of the Company. A separate code has been prescribed for Independent Directors in Schedule IV (under Section 149). Every listed public company need to appoint Independent Directors.

Contravening Director’s Duties

Under the Companies Act, a Director’s duties are defined in the Section 166. His/Her duties are earmarked below:

To act as per the Articles of the Company
To act in good faith to promote the objects of the company for the benefit of its members/ employees/ shareholders.
To carry out duties with due and reasonable care, skill and diligence; exercise independent judgment
Should not have a direct/ indirect interest that conflicts/ may conflict with company’s interest.
Neither achieve nor attempt to achieve any undue gain/ advantage for himself/ his/her relatives/ partners/ associates (if found guilty – amount equal to such gain to be paid to company).
To not assign his/her office to others

In case a Director contravenes any of the above, a fine of minimum of Rs. One lakh to maximum of Rs. Five Lakhs is payable. The Act has enhanced the liabilities and obligations of the Directors. The new company law regime prescribes

Management and inspection of documents in electronic form, electronic voting, electronic notices, etc. that require a techno legal compliance on the part of Indian companies. The Directors are under an obligation to comply with techno legal requirements of not only The Act but also the Information Technology Act, 2000 and other applicable laws.

The Companies (Appointment and Qualification of Directors) Rules, 2014 have imposed many obligations upon the Directors of a Company. Rule 14 (1) of the same prescribes that every Director shall inform to the Company concerned about his/her disqualification u/s 164 (2) before he is appointed or re-appointed. When a Company fails to file the financial statements or annual returns, or fails to repay any deposit, interest, dividend, or fails to redeem its debentures, as per section 164, the Company shall immediately file Form, to the Registrar furnishing therein the names and addresses of all the directors of the company during the relevant financial years. Non-filing of the Form entails the disqualification of the Director.

The Companies (Management and Administration) Rules, 2014 also prescribe many techno legal and cyber security obligations upon the Directors of a Company. The Directors must be well versed with the techno legal regulatory provisions under The Act and other technology laws of India.

Further, the Act contains various provisions where a Director (on behalf of the company & as Director) may be liable for the acts or omission of the Company. Few of such acts or omissions are listed below:

In S.M.S. Pharmaceuticals Ltd. v. Neeta Bhalla and Anr (decided on 20.02.2007) the Supreme Court decided that Companies Act, 1956 does not provide that a Director of a Company shall automatically be vicariously liable for commission of an offence on behalf of the Company. Necessity is that specific averments should be made to show that the person must be in charge and shall also be responsible to the Company for the conduct of its business.

The Supreme Court also laid down the following principles in this regard

The primary responsibility is on the complainant to make specific averments as are required under the law in the complaint so as to make the accused vicariously liable. For fastening the criminal liability, there is no presumption that every Director knows about the transaction.
The criminal liability can be fastened only on those who, at the time of the commission of the offence, were in charge of and were responsible for the conduct of the business of the company.
Vicarious liability can be inferred against a company registered or incorporated under the Companies Act, 1956 only if the requisite statements, which are required to be averred in the complaint/petition, are made so as to make accused therein vicariously liable for offence committed by company along with averments in the petition containing that accused were in-charge of and responsible for the business of the company and by virtue of their position they are liable to be proceeded with.
Vicarious liability on the part of a person must be pleaded and proved and not inferred.
If accused is Managing Director or Joint Managing Director then it is not necessary to make specific averment in the complaint and by virtue of their position they are liable to be proceeded with.
If accused is a Director or an Officer of a Company who signed the cheques on behalf of the Company then also it is not necessary to make specific averment in complaint.

The Companies Act defines ‘document’ under section 2 (36) to include a summon or notice and as per section 20, the document can be served on the Company of any officer thereof, thereby meaning that a Director can also be served a summon/ notice. It shall be duty of the Company and its officers (including Directors) to respond to the notices with adequate information or issue statements (section 207).

The Registrar of the Company has powers akin to civil courts and Directors can be called upon to obey directions in regard to relevant information etc. and any violation provides for punishment upto 1 year and or fine.

Director’s Liability under Labour Laws

There is plethora of labour laws in India and few are listed below. There is common thread of definitions in all labour laws for employer, principal employer, offence in case committed by company.

Contract Labour (Regulation and Abolition) Act, 1970
Employees’ Provident Funds and Miscellaneous Provisions Act, 1952 (EPF Act)
Employees’ State Insurance Act, 1948 (ESI Act)
Payment of Bonus Act, 1965
Payment of Gratuity Act, 1972
Payment of Wages Act, 1936
State Shops & Establishment Act
Industrial Dispute Act 1947
Minimum Wages Act 1948
Employee compensation Act 1923
Maternity Benefit Act, 1961

In almost all the laws, there are similar provisions, defining the “employer”, “offence committed by company”. “Employer” in relation to commercial establishment is the person who, or the authority which, has the ultimate control over the affairs of the establishment, and where the said affairs are entrusted to a manager, managing director or managing agent, such manager, managing director or managing agent.

About Author

Naresh Arora

Naresh is a perfect combination of In – House Counsel as well as an Attorney with over 25 years of extensive experience in legal industry. Naresh is the VP-Legal for Viom Networks Limited and has responsibility to manage all legal matters in India & abroad.