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This article is written by Mohd. Hashim Miyan, an LL.M student from School of Law, Galgotias University.

Introduction

Directors, through the board process and on their own as authorized, are responsible for carrying out the business and managing the affairs of the company. One important aspect of a limited liability of companies is that liabilities of a company are its own and the directors normally are not liable for the same.

However, apart from this general rule, numerous exceptions have been created by Companies Act and various other laws to hold the directors or other “officers-in-charge” responsible for various defaults of the company as directors are the one who are responsible for the company’s actions, omissions and decisions. In Indian law, this is a very important aspect of corporate governance.

From point of view of directors, including directors of startup companies (usually founders become directors in the company, funded companies may have investor directors as well) it is very important to know about various duties that they are required to perform under a large number of statutes as well as the consequences of failure to perform those duties. Besides, third parties having a dispute against the company may involve the directors in various proceedings. This chapter will assist in understanding these risk factors associated with directorship of a company in India.

Liabilities of Directors of a Company 

Liabilities of directors of an Indian Company may arise under the Companies Act, 2013 or under other legislations that apply to the company due to the nature of its business. Responsibility for violations under the Companies Act is placed on the ‘Officer in default’, as defined under the Act. Liability of directors under other legislations applicable to the company is discussed later in this chapter.

Liability for violations of the Companies Act

The Companies Act imposes liability for violation of its provisions on all persons who qualify as ‘officers-in-default’. An officer of a company includes any director, manager or secretary or any person in accordance with whose directions or instructions the Board or any one or more directors is or are accustomed to act. The following persons are deemed to be liable for any non-compliance (in the same order as mentioned below) as ‘officers in default’ unless any of them can prove that he was not in-charge of the affairs of the company at the time when the offence occurred:

  • The managing director,
  • The whole-time directors,
  • The manager,
  • The secretary,
  • Any person in accordance with whose directions or instructions the board of directors (“Board”) is accustomed to act, any person charged by the Board with the responsibility of complying with that provision of the Companies Act. However, this excludes persons who give advice in professional capacity – for example, a lawyer or an accountant, or another business consultant who is engaged by a company to provide advisory services.
  • Where there is no manager/managing director or where no person has been specifically charged with the responsibility for any compliance, all the directors on the Board are deemed to be officers in default.

The Companies Act 2013 adds additional categories of persons who can qualify as officers in default:

  • Key managerial personnel.
  • Any person who has been authorized by the Board of Directors for specific functions such as filing or distribution of accounts or records – such a person must authorize, participate or fail to take active steps to prevent the default, in order to be liable.
  • Every director who is aware of the violation, or with whose consent or connivance the violation has taken place is also liable as an officer in default. How can awareness or connivance in an action which leads to violation of a statutory provision be established? The Companies Act 2013 clarifies that directors who have received information about any proceedings of the Board of Directors from which a violation can be inferred, or have attended or participated in such proceedings without objecting to such a violation can be inferred.
  • With respect to issue or transfer of shares of a company – share transfer agents, registrars and merchant bankers to the issue or transfer can also qualify as officers in default, even though they are not strictly speaking officers of the company, and are merely appointed by the company for performing very specific functions. This provision is largely relevant to public companies which are either listed on a stock exchange or immediately prior to their listing on the exchange.

Which persons qualify as key managerial personnel?

A Chief Executive Officer, managing director, manager, company secretary, whole-time director, chief financial officer qualify as key managerial personnel of the company. Apart from these persons, the government may prescribe other categories of officers who will qualify as key managerial personnel.

At present the Ministry of Corporate Affairs have directed to the Registrars of Companies that there should be proper application of mind on the part of an in deciding whether a person to be implicated is an ‘officer in default’ by examining the Annual Return (i.e. FC.4), Form DIR-8 and DIR-12 database available in the Registry.

While most liabilities have monetary consequences, certain offences such as authorizing the issue of a misleading prospectus to an investor, are punishable with imprisonment and fine. Few other examples of offences that can lead to imprisonment are-

  • Inducing or attempting to induce a person by a false or misleading statement to enter into any agreement to buy shares of the company;
  • Default in maintaining proper books of accounts for 2 (two) years prior to commencement of winding up;
  • Default in notifying that the company is in liquidation, on every invoice, order for goods or business letters issued by the company (any officer, manager);
  • For wrongfully obtaining possession of the property of the company or wrongfully withholding any property in their possession (any officer or employee of a company);
  • Destruction, alteration, or falsification of books with intent to defraud or deceive any person;
  • Making false representations to induce anyone to give credit to the company, and with intent to defraud creditors, conceal property of the company.

While imprisonment has been prescribed, it is relatively rare that a director is imprisoned for violation of Companies Act. Most offences under the Companies Act are non-cognisable (i.e. an arrest would require a warrant), except for certain offences by companies relating to acceptance of deposits from the public. A shareholder is generally not held responsible or liable for the acts of its nominee director.

Liabilities arising from duties to minority shareholders

We have covered the obligation to disclose conflicts of interest earlier. Let’s examine the duties of directors towards shareholders in more detail – if the majority shareholders are dissatisfied with the actions of directors, they can at any time galvanize support (only ten percent of shareholders are required to call an extraordinary general meeting) and remove them from office by passing an ordinary resolution.

What can the minority shareholders do if the actions taken by the directors are prejudicial to their interest? Do the directors have duties towards depositors? Under the Companies Act (both 1956 and 2013), any group of shareholders who own at least 10 percent of the shares can approach the tribunal claiming that the affairs of the company are being carried out in a manner that is prejudicial to public interest or the interest of the members or is oppressive to its members (Oppression and Mismanagement Claims).

The tribunal has wide powers to issue corrective measures, which includes stipulating measures for appointment of directors, removal of directors, recovery of any fraudulent amounts by a manager or director, setting aside of agreements or other necessary measures as it may think fit in such applications. Apart from the reliefs permitted with respect to Oppression and Mismanagement Claims, Section 245 of the Companies Act, 2013 has also specifically permitted class action suits, which will now enable shareholders or depositors to file applications claiming monetary compensation or damages against directors, auditors, experts, consultants and advisors or other persons for incorrect or misleading statements made to the company or fraudulent or unlawful actions.

Liabilities under other legislations

  • Labor Laws:

Depending on their operations, companies involved in construction or manufacturing or employing labourers (usually in excess of 20) are expected to comply with various labor legislations for social welfare, which typically require employers to obtain various permissions or licenses, maintain registers, submit forms to labor departments, or make financial contributions for the benefit of labourers. Failure to comply with applicable provisions of such laws can attract penalties.

  • The Building & Other Construction Workers (Regulation of Employment and Conditions of Service) Act, 1996 states that if any of the provisions of this Act are not adhered to (provisions include fixing appropriate work hours, taking adequate safety and on-site protection measures, etc.), and such offence is committed by a company, with the consent or connivance of, or is attributable to any of the directors of the company, then such person shall be deemed to be guilty of that offence. Violations of this Act can attract penalties which include both civil fines and imprisonment.

For instance, directors guilty of contravention of the provisions regarding safety measures under this Act are punishable with imprisonment for up to three months, or with fine up to INR 2,000/- or with both. Where an employer fails to give notice of the commencement of his building or other construction work, he is punishable with imprisonment up to three months, or with fine up to 2,000/- or with both. 

  • The Contract Labor (Regulation and Abolition) Act, 1970 has similar provisions. The duties of the company would include a requirement to register with statutory authorities (and make regular reportings) if a construction site/establishment employs a certain number of contract labourers, making adequate arrangements to provide certain required amenities such as canteens, rest rooms, clean drinking water and first aid, and the regular payment of wages to the contract labourers. It should be noted herein that in the investee company there would typically be a number of contract labourers used for construction work. Contravention of any of the provisions of this Act or any rules made thereunder may attract imprisonment up to 3 months and a fine of up to INR 1,000/-.
  • The Industrial Disputes Act, 1947 (“ID Act”) provides the machinery for the settlement and investigation of disputes of the workers of an industrial establishment/undertaking (subject to specific facts and circumstances, a construction site may qualify as an ‘industrial establishment or undertaking’). The ID Act also prescribes a punishment for certain actions, which are considered offences under the act. If such offence is committed by a company, any person including a manager or a director who was in charge of the affairs of the company at the time when the offence was committed may be held liable. Penalties for any offence under the ID Act can range from fines up to INR 5,000/-, or in some cases, imprisonment up to the extent of one year, or a combination of both, depending on the nature of the non-compliance.
  • Other welfare legislations can also apply to the establishment such as the Payment of Bonus Act, 1965, the Equal Remuneration Act, 1976, the Employees’ Provident Fund and Miscellaneous Provisions Act, 1952 (“EPF Act”), the Employees State Insurance Act, 1948, etc. Under these legislations, every person who at the time of commission of a violation was responsible for and in charge of the conduct of the business of the company is liable and may be punished with imprisonment and/or fine accordingly.

The director of a company that fails to make contributions on behalf of employees to the provident fund established under the EPF Act can be punished with a minimum penalty of imprisonment for 6 months and fine of INR 5,000/- which may extend to 3 years and INR 10,000/- respectively.

Depending on their operations, companies, especially those involved in construction or manufacturing in India are expected to comply with various Indian environmental legislations that aim to prevent and contain environmental pollution. The primary laws that may apply are the Air (Prevention & Control of Pollution) Act, 1981 and the Water (Prevention & Control of Pollution) Act, 1974 and several rules and regulations framed there under.

Punishment for various offences under Environmental Laws can be imprisonment up to 6 years and/or fine, depending on the nature of the offence and degree of non-compliance. For instance, failure to renew an existing license is considered a relatively minor non-compliance that may be punishable with a late fine if not renewed within the specified extended time limit provided in the respective legislations. However, discharge or emission of any environmental pollutants in excess of the prescribed standards is considered a serious offence that may attract criminal prosecution, especially if the non-compliance leads to loss of life or property.

Liability under Tax Laws:

Contravention of tax laws in India can lead to imprisonment and/or fines, the magnitude of which can vary according to the nature of the offence. Few examples are mentioned below-

  • Failure to deduct tax at source is punishable with imposition of fine to the extent of the amount of tax failed to be deducted. 
  • A willful attempt to evade tax may be punishable with imprisonment that may extend up to 7 years with fine under the Income Tax Act.
  • Making a false statement in any verification required under the Income Tax Act will be punishable with imprisonment which may extend to 7 years or with fine.

In case of offences committed by companies, in addition to the company, every person including a director, manager, secretary or other person who was in charge of the company for the conduct of its business can be held liable, unless such person can show that the offence was committed without his knowledge or that he had exercised all due diligence to prevent the commission of such offence.

Under some of the statutes such as the Income Tax Act, 1961, and the Central Sales Taxes Act, 1956 if the tax cannot be recovered from a private company under liquidation, then the persons who were directors for the period of non-payment of taxes can be held jointly and severally liable for the payment of such tax. If such directors can prove that the non-recovery cannot be attributed to any gross neglect, misfeasance or breach of duty on their part in relation to the affairs of the company then they cannot be held liable.

Liability under exchange control laws

The Foreign Exchange Management Act, 1999 (“FEMA”) and the rules and regulations made pursuant to the FEMA regulate cross-border transactions between Indian companies on the one hand and non-resident entities on the other. Where a company contravenes the provisions of FEMA, every person who was in charge of, or was responsible for the conduct of the company at such time, can be held personally liable for the contravention. However, if such proves that he had exercised due diligence in undertaking the activities of the company, he shall not be held responsible for such contraventions. Note that there cannot be any imprisonment for violation of FEMA.

Liability under Negotiable Instrument Act

This is a rather common source of trouble for directors of a company. The Negotiable Instrument Act, 1881 (“NI Act”) makes the director of a company liable to be punished by imprisonment and fine if the company’s cheques are dishonored by the bank on account of insufficiency of funds etc, and it can be proved that the offence was committed with the consent or connivance of, or is attributable to, any neglect on the part of the said director. The NI Act provides for criminal liability of responsible directors and the penalty may consist of imprisonment up to 2 years or a fine that is twice the amount of the cheque dishonoured or both. Liability under the NI Act attaches to a director in the following circumstances:

  • Such director was ‘in charge of’ and responsible for the company for the conduct of the business of the company at the time of the commission of the offence; or
  • Where such director was not in charge of the business of the company, but the offence was committed with his consent or connivance, or due to any neglect on his part.

Non-executive directors, who are not involved in the management of the funds and issuance of the cheques of the company, are typically not held liable under the NI Act.

Investors typically try to ensure that their nominee directors are appointed as non-executive nominee directors of the investee company. They may require such position to be explicitly recorded in the corporate records of the company, such as:

  • The minutes of the meeting as well as the text of the resolutions passed at the Board and/or the general meeting of the company for appointing the investor director;
  • The register of directors maintained by the company; and 
  • The relevant forms (Form No DIR – 8) and documents filed by the company with the relevant registrar of companies in connection with the appointment of the director.

Delegation: Delegation of administrative functions of the Board, to identified directors (typically managing or executive directors) and/or officers of the company is an important tool for mitigating the personal liability of non-executive nominee directors. Most administrative functions of the company can be delegated by the Board. However, unless the articles specifically authorize the Board, it is not permitted to delegate their powers that involve the exercise of judgment and discretion. The Board is also not permitted to delegate powers that have been specially conferred on it by the shareholders or under law. However, the duty of the Board or where the responsibility is vested with a specific director or committee of directors, such director or such committee, is to exercise reasonable and adequate supervisory powers over such delegated duties.

The extent of delegation permissible is contingent on the requirements of the business in which the company is engaged and the provisions of the articles of association. The larger the business carried on by the company, the more numerous and more important the matters that would be left by the directors to the officers of the company.

  • Action points to protect innocent directors from potential liability 

Even though the statutes discussed above impose personal liability on, inter alia, the directors of the company, such liability can be mitigated if it can be demonstrated that a director has no executive/administrative role in the company, is not responsible for the day to day management and/or was not responsible for compliance with the statutory provisions which were not complied with. In some instances, a director may avoid personal liability if it can be demonstrated that the director has exercised due diligence in ensuring compliance with the requirements of applicable laws and the contravention/offence was committed without his knowledge, consent or connivance.

However, such a director will also need to make judicious use of information available to him through the board process and act diligently to be able to claim benefit of this exception. If a non-executive director has knowledge of a particular violation of law and ignores to take reasonable steps to mitigate the same and if his actions convey acquiescence to the violations he can be held liable.

  1. Record-keeping measures: The records of the company and the minutes of meetings of the Board/shareholders of the company should clearly record the nature and extent of delegation of responsibilities and duties by the Board, to specific directors and/or officers, executives of the company and the names of such directors, executives and officers should also be recorded.
  2. Measures for identification and allocation of responsibility: It should be ensured that administrative functions (such as maintaining statutory books and registers, filing all documents and returns with relevant governmental agencies, including the registrar of companies, etc.) and the day to day management of the company are properly delegated to identifiable directors/officers of the company.

Further, all compliances with environmental, labor and all other laws having penal consequences should also be delegated to identified directors/officers of the company. It should also be ensured that the extent of powers delegated to directors/officers is in accordance with the provisions of its articles of association.

It should be ensured that all governmental and regulatory filings, to the extent practical, identify the directors, officers and/or executives who are responsible for the day to day administration of the company and complying with the requirements of applicable laws.

Conclusion

By carefully considering adherence to due diligence and the specific types of actions required in areas such as employment, environment, taxation, and corporate governance, the liability risks of Company’ directors and officers can be mitigated. As always, taking and following the advice of a qualified attorney who is well informed about the details of a company’s specific situation will be an important step in ensuring compliance.

References

  1. Dhaval Gusani, Duties and Officers Liability in India, November 26, 2020, available at: Directors and Officers liability in India (taxguru.in)
  2. Surabhibairathi, Directors & Their Liabilities, available at: Directors & Their Liabilities (legalservicesindia.com)
    3. Shipra Sayal, Duties & liabilities of director, April 23, 2021, available at: Duties & liabilities of director – Law Times Journal
  3. Anubhav Pandey, Liabilities of directors after dissolution of a company, November 2, 2017, available at: Liabilities of directors after dissolution of a company – iPleaders
  4. Sunil Bharti Mittal v. Central Bureau of Investigation
  5. Iridium India Telecom Ltd. v Motorola Inc.
  6. Companies Act, 2013
  7. Jorchester Finance Co Ltd v. Stebbing 1989 BCLC 498 Ch D
  8. In P. K. Nedungandi v. Malayalee Bank Ltd A I R (1971) SC 829.

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