This article is written by Sakshi Singh, from Amity Law School, Lucknow. This article provides a detailed analysis of various duties of the directors and remedies available upon breach of such duties.
It has been published by Rachit Garg.
Table of Contents
Earlier, in the Companies Act, 1956, duties of directors were not specifically contemplated which created a void in the law. To fill this gap common law principles were applied while also placing reliance on Indian precedents. The Companies Act, 2013 (“the Act”) which replaced the earlier Act has explicit reference to some compliances for a company’s director.
The director of a company as the name suggests is the person responsible for directing and supervising the affairs of a company. The Companies Act, 2013 does not provide for a broad definition of the director but it specifies in Section 2(34) that director is the person appointed by the Board of the company. Further, in Section 2(10) ‘Board of Directors’ is defined as the collective body of directors in a company.
A director can be an agent to be bound by a principal-agent relationship under the Indian Contract Act, 1872 or trustee to be covered under the Indian Trust Act, 1882 or partners described in the Indian Partnership Act, 1932.
Directors being important dignitaries to a company are obligated to perform a wide range of duties stipulated under Section 166 of the Companies Act which inter alia include duty arising out of the fiduciary relationship with the company and duty to observe due diligence. In case of non-compliance with the duties associated with the position of director, a civil or criminal sanction, as the case may be, is to be imposed. The breach of duties can also be rectified by the shareholders.
Duties of a director
The duties of the directors are a form of responsibility to promote and represent the interests of the company wherever necessary.
Statutory duties of the directors
The statutory duties of a director consist of duties assigned to the directors under the Companies Act. Section 166 of the Companies Act specifically talks about the ‘duties of director’. There are seven distinct duties provided under Section 166 of the Companies Act, 2013 namely,-
- Duty to act in accordance with Articles of Association or to say not ultra vires;
- Duty to act in good faith toward the company and to promote its object to ultimately benefit its members as a whole;
The directors ought to act towards the best interest of the company in every company dealings. The duty to act in good faith is imposed upon directors so that they do not misuse their position of influence for personal gain or undue advantages over others. Companies’ interests should be above the self-interest of directors. This is also a general duty of the director arising as to the existence of a fiduciary relationship between the company and its directors.
- Duty to consider the best interest of the company, its shareholders, employees, communities and the working environment;
- Duty to exercise due diligence, care and caution along with reasonable and independent judgement;
A director must always display care and caution in the dealings of the company. As much care is required of the director as a man of ordinary prudence would exercise in a similar situation.
For example- When a shortage of funds is discovered during winding up of the company due to bad investment and misappropriation of funds. Directors will be made liable for the lack of care and diligence.
- Duty to avert any kind of conflict of interest within a company;
- Duty of not indulging in any nefarious activities of taking undue advantages or gain either for himself or any relative including associates or partners in the company; and
- Duty not to delegate his powers to anybody in the form of transferring the office.
What is breach of directors’ duties
As explained in the previous heading, the director owes certain duties towards the company and in case they contravene or goes beyond these duties, it will be considered as a breach of directors’ duties.
Breach of statutory duties
Sub-section 7 of Section 166 provides for directors’ liability in case of breach of the list of duties mentioned from sub-section 1 to sub-section 6. After any contravention to the said duties, the director shall be imposed with a fine of not less than Rs. 1 lakh which may extend to Rs. 5 lakhs.
Breach of administrative duties of the directors
Directors of the companies are associated with a number of administrative works relating to the management of the company on a day to day basis. However, not fulfilling these administrative duties bring them certain liability under the Companies Act. Following are some of the administrative duties of the director of the company and punishment provision for the breach of duties:
- Duty to attend board meetings
The powers of the company are exercised by its directors in their meetings held from time to time. Directors are obligated to attend these meetings.
Punishment for breach
If a director fails to attend all the meetings of the Board of Directors held during a period of 12 months with or without seeking leave for being absent from the meetings, he shall be discarded automatically as per Section 167(1)(b) of the Companies Act.
- Duties of directors to assist in the inspection
In case of a call for documents or papers by the registrar, directors under Section 207 of the Companies Act are duty bound to produce such documents along with the statement to assist the inspector or registrar with their inspection.
Punishment for breach-
In case the director does not obey the call of the inspector or registrar he shall be punishable with imprisonment of not more than 1 year and fine of not more than one lakh rupees.
Breach of duties of director during winding up of the company
Section 305 of the Companies Act 2013 provides for the duties of directors in voluntary winding up. When a voluntary wind-up is proposed the majority of directors in the meeting of the board owe a duty to declare it. This declaration should be accompanied by an affidavit stating that they have inquired about every affair of the company.
After such inquiry, they opined that the company is either free from debts or it will be able to pay up every debt by soldering its assets. However, if they fail to declare the voluntary winding up or provide any false information pertaining to debts incurred and payable by the company, they will be prone to liability for breach of duties.
Punishment for breach
If the directors make the declaration without any reasonable ground that the company will be able to pay its debt then they shall be punishable with imprisonment for a term between 3 years and 5 years. A fine may also be imposed of 50,000 rupees which may extend to 3 lakhs rupees as specified in sub-section 4 of section 305.
Unlimited liability of directors
Section 286 of the Companies Act provides for unlimited liability of directors in a limited company during winding up. The director shall have to take liability upon themselves as if they were the members of the unlimited company at the commencement of winding up.
Breach of duty arising out of an agency
A company incorporated under the Companies Act is considered a separate legal entity, having its own artificial legal personality. However, it does not have a mind or body of its own. Therefore, when the question is about liability or exercising rights, it has to act through other professional people who are obliged to see through the matters and dealings of the company. These professionals are the directors of the company.
In the landmark English case of Ferguson v. Wilson (1866) LR 2 Ch App 77, while describing a director of the company, it was held by the Court of Appeal in Chancery that “directors are agents of the Company. As the Company cannot act as its own person because it is not a natural person. It has to only act through Directors and thus form a relationship of principal-agent.” This principle is validated by the Indian judiciary from time to time. As recently held by the Delhi High Court in Tristar Consultants vs. Vcustomer Services India Pvt. Ltd., 2007 that “directors of the company are agents to the extent they have been authorised to perform certain acts on the behalf of the company.”
Under the law of agency, an agent has to act within the scope of the agency, if not they will be held accountable for it. Accountability of directors will arise in case of breach of duty assigned under the principle of agency. Generally, a company is solely responsible for the deeds done on its behalf by the director. A new concept of ‘lifting the corporate veil’ has emerged which specifies the liability of the director also on the work done on behalf of the company.
Section 226 of the Indian Contract Act, 1872 states that an act done through an agent will have the same legal consequences and it will be enforced in the same manner as it would have been enforced if it was done by the principal himself. Thus, it can be said that for any particular deed completed by the director (agent) on behalf of the company (principal), liability will be cast upon the company and not upon the director. But, this does not mean that directors are absolved f-+9rom all forms of liability.
Breach of duty arising out of trusteeship
A trustee is a person who is vested with the legal right to ownership of assets which he administers for the benefit of another person. According to Section 3 of the Indian Trust Act, 1882, a trustee is one who accepts the confidence of the ‘author of trust’ for the interest of the ‘beneficiary’.
Directors of the company are often regarded as ‘trustees’ because of the power vested in them to administer the assets and to perform duties in the interest of the company rather than doing it for personal gain. A landmark case of York and North Midland Ry. v. Hudson relating to the designation of the directors as ‘trustees” was decided way back in 1853 by the High Court of Chancery where judges opined that, “the directors are persons selected to manage the affairs of the company for the benefit of the shareholders; it is an office of trust, which, if they undertake, it is their duty to perform fully and entirely.”
The principle that directors could be considered as the office of trust is continued across Indian precedents as well. As decided by Supreme Court in the case of Narayandas Shreeram Somani vs. Sangli Bank Ltd, 1966, directors of the company stand in the trust-based relation, often considered as trusteeship. It is an established rule of equity that he must not place himself in a position which could result in a conflict of interest between their duties and personal interest.
Where the directors work as a trustee to the company, various duties arise in the name of trusteeship. Any breach of said duties will render them liable for breach of trust. In the case of V. S. Ramaswamy Iyer vs. Brahmayya and Co. 1965, it was held by Madras High Court that directors are the trustee and in the issue of directors’ power of applying funds of the company and misusing that power, they could be held liable as trustees. Also, upon their death, the course of action lies against their legal representatives.
Punishment for breach of trust
Directors can be punished for the breach of trust under the Indian Trust Act, 1882 as well as the Companies Act, 2013;
- Section 88 of the Indian Trust Act provides for, among others, the director’s accountability for undue advantages derived while being in entrusted position.
- Section 340 of the Companies Act inter alia states the liability of delinquent directors during winding up. When a director is found guilty of breach of trust in relation to the company, then upon application of the official liquidator, the Tribunal will direct them to contribute a fair amount to the company’s assets by way of compensation.
- Section 407 of the Companies Act provides for punishment for criminal breach of trust. It specifies punishment for the offence as imprisonment of not less than 3 years or a fine or both.
- Section 447 states the punishment for fraud is imprisonment of 6 months and may be extended to 10 years. A fine may also be imposed proportional to the amount of fraud.
Essentials of the breach
Breaking fiduciary relation
One of the essentials of a breach of company directors’ duty is not to act with due care and diligence. Directors owe to act as trusted allies in the interest of the company. Any deviance from the said principle would lead to breach of duty.
Illustration- If a director transfers the unused share of the company to a trustee for the sake of obstructing a take-over bid and also an-interest free loan from the company is given to the trustees to enable them to pay for the shares, it will be considered to be the wrongful exercise of fiduciary powers of the director.
A director must exercise his duty in favour of the company and not its employees or anybody else. Thus, directors must remain loyal and faithful to the cause of the company.
Ultra vires act
Directors are to act within the limited scope of companies at, the Memorandum of Association (MoA) & Article of Association (AoA). The directors will be held accountable for all the acts that go beyond the aforesaid limit. This is also known as Ultra Vires acts.
When a director fails to exercise due diligence, care and caution they shall be deemed to have acted in negligence and thereafter accountability arises for any resultant injuries. Since the contents of an Article of Association (AoA) cannot go beyond law, therefore, any contract making the directors absolved from their liability for negligence will be considered to be null and void.
Mala fide acts
The directors are considered trustees for the company and its property and they are vested with the legal right to exercise the powers to operate the company. If they exercise these powers with the dishonest intentions they will be held for breach of trust and also be made to pay off the damages accrued via such dishonest conduct. As held in P. K. Nedungadi vs. Malayalee Bank Ltd, 1971.
Liability of the directors for breach of duties
The directors are bound by duties towards the company, so upon any breach, the right to bring about any action will be on the company. However, in certain conditions directors have liability to third parties as well for their breach of duties.
Personal liability of the director
The directors owe the duty to see that shareholders’ funds are used in good faith for promoting the company’s interest only. In case of any contravention to the Article of Association or Memorandum of Association, directors will be held to be personally liable.
In the case of Dr. A Lakshmanaswami Mudaliar vs. L.I.C. 1963, LIC acquired the business of United India Life Insurance Co. Ltd. which was incorporated as a company to carry on the life insurance business. Before the acquisition, donations of 2 Lakhs were made by the directors of the company to a trust formed with the object of promoting insurance education and business knowledge. It was held by the Supreme Court that the donation of 2 lakhs was beyond the object and outside the scope of the Article of Association (AOA) i.e. ultra vires and thus, directors will personally be held liable for that.
Liability to the company
If the directors indulge themselves in any negligent or mala fide acts or they break the trust-based relationship they will be held liable to the company.
In PK. Nedungadi vs. Malayalee Bank Ltd. 1971 the Supreme Court held that where the directors have misappropriated money or property from the company or have committed a breach of trust, they will be required by the court to return or restore such fund or property and also to pay compensation to the company.
Liability to third person
The company is accountable for the contract entered into by third parties. However, if the directors enter into a contract with a third person in their own name hiding the fact that they are doing so in the capacity of director for the company, in that case, they shall be personally liable for any damage caused to the party as a result of such contract. For any omission, they shall be liable the same. Also, compensation may also be granted to the damaged party payable by the director.
In UP Pollution control board vs. Modi distillery & Ors, 1988 where directors along with others were prosecuted for deliberate default in furnishing details about anti-pollution measures deployed by the company. In this case, the Apex Court held that where an offence has been committed by a company, persons in charge of the company’s conduct at the time of commission shall be held responsible. Thus, holding the director’s liability.
Liability for misstatement in prospectus
Section 34 and Section 35 of the Companies Act, 2013 state the criminal and civil liability of directors for misstatement in prospectus respectively. These sections render directors personally liable to the damages of third parties for their breach of duty to remain honest about the company’s affairs.
Section 35 of the Act further states that the person who is a director at the time of issuing a prospectus and also who is named as director of the company in the prospectus shall be responsible for anything in the prospectus which can be misleading in nature and have caused party damage from it.
Upon any breach of duty by the director, certain remedies are available in the hands of the company. The company may bring about legal action against such a director. The breach may also be ratified sometimes. There are certain remedies commonly exercised which include:-
- Setting aside the contract made out by that director
- Obtaining an injunction order for any action taken by the director ultra vires to the limit under which duties are assigned to him
- Imposition of penalty
If the directors make any default in compliance with the duty assigned to them, a sum of fine, as may be prescribed, can be imposed on them. Sub-section 7 of Section 166 states that upon any contravention to the provision of this section, the director shall be imposed with a fine of Rs. 1,00,000 which may extend to Rs. 5,00,000.
If the director of the company is found guilty of misappropriating money or property then under Section 340 of the Companies Act, 2013 they will be held liable to pay damages as ordered by the tribunal in the course of winding up. A compensation amount will also be imposed on them.
- Legal action of the company against such directors
A company has locus standi to bring about legal action upon breach of the company’s directors’ duties. In Rajeev Saumitra vs. Neetu Singh, 2016 Delhi High Court held that directors are liable to pay accordingly for all undue advantages going beyond duties provided under Section 166 of the Companies Act, 2013.
- Ratification of breach by Shareholders
Ratification is the process in which any irregularities in conduct or acts or any omission of the director is brought to conformity with the law. A bench of Security Appellate Tribunal Mumbai, in the case of Terrascope Ventures Ltd. V. SEBI, 2022 held that ‘acts or deeds done by a director in breach of his duties become valid once it is ratified by the company’.
However, not all the breaches of duty of directors can be ratified by the shareholders. Committing fraud with malice intention can not be ratified as these are offences of criminal nature and thus no margin is left for correcting it.
- Remedies under Indian Trust Act
Section 88 of the Indian Trust Act, 1882 states the remedy in the situation of unwarranted pecuniary advantage by the director of the company. When the director of a company or any other person who is bound by fiduciary relationship to act in good faith and in the interest of another person, acts in contravention of the same to derive pecuniary advantage, he shall be held accountable for the advantages so derived.
Section 88 of the trust act specifically makes the director of the company liable for unwarranted advantages. Also, directors of the company stand on the footing of fiduciary relations with the company itself. They are obliged to act towards the paramount interest of the company.
In Sangramsinh P. Gaekwad and others vs. Shantadevi P. Gaekwad (Dead), through LRS. and Others (2005) 11 SCC 314, the Supreme Court, in this case, has observed that “under Section 88 of the Trusts Act, a person bound in fiduciary character is required to protect the interests of other persons and one is bound to protect the interests of the other as between two persons, if the former was availing of such a relationship and makes a pecuniary gain for himself, section 88 would be attracted. When a person makes a pecuniary gain by way of a transaction, the cestui que trust created thereunder must be restored.”
Directors of the company are bound to the company and the rules of the Article of Association. All the actions of the directors should be to protect and promote the interest of the company in good faith. They can act within the purview of objects specified in the Memorandum of Association and regulations of the Article of Association (AoA). Any deviance with these would lead to a breach of duty for which directors shall be personally liable. Directors are often regarded as agents and trustees of the company owing to their resemblance with them, thus, making them vulnerable to a breach of duties arising out of agency and trusteeship.
Considering these a director must remain honest with the company and follow the interest of the company above anything.
Frequently Asked Questions (FAQs)
Can a director sue another director?
The duty of the director is towards the company therefore a company is the only entity to sue him for any breach. However, other directors or shareholders can initiate proceedings only when they are in a representative character.
Can a shareholder take action against the director for breach of its duties?
By means of amending the Article of Association (AoA), shareholders can restrict the powers of directors but it does have a retrospective effect. If the shareholders are dissatisfied with what directors do they have to either remove them as per the regulation or rectify their breach.
What are the possible sanctions which might be imposed for a breach of the director’s duties?
(iii) Reversing the contract
(iv) Restoration of property
Are directors trustees for the individual shareholder along with the company?
No. In the landmark English case of Percival vs. Wright, 1902 it was held by the High Court of Justice that directors are not trustees for individual shareholders. They do owe some duty towards the company as a part of the fiduciary relationship but not to the shareholders.
Is a director of the company considered an agent?
Technically, directors are not agents of the company under any statute. But, seeing their resemblance as both director and agent act for others and they are bound by fiduciary relation to act with due diligence and care, directors are being held as agents in many cases.
- Company law by Dr. N.V. Paranjape
- Taxmann’s Company Law, 22nd edition, Aug 2019
- Ferguson v. Wilson (1866) LR 2 Ch App 77
- Percival vs. Wright, 1902 2 ch 421
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