This article is written by Diganth Raj Sehgal, Student, School of Law, Christ University, Bangalore. The author in this article has discussed the vicarious liability of the company when tortious acts are done by the directors. The author also discussed the concepts of separate legal entity and corporate veil.
Before understanding the vicarious liability of a company, it is very important to understand the dynamics of the relationship between the directors and the company. We can understand the structure of the company by relating it to the structure of the Parliament. The shareholders are the owners of the company but they can only vote during the meetings of the company but do not take part in the day to day affairs of the company, just like a citizen of a democratic country does in the elections.
Directors are much like the Ministers of Parliament, they make the rules and run the company and are in charge of the daily affairs. The directors are one of the parts of the management of the company.
When an act is done by the director in the name of the company and a third party files a suit due to loss caused by such act, it is important to determine whose liability it is, the company or the directors. The relationship between the company and the directors bring the following questions to light;
- Can businesses be held vicariously liable for the actions of their employees?
- What conditions must apply for an employer to be held vicariously liable for the torts committed by his employees?
- Can a company recover anything from its employee if the company is being sued?
- How can the company recover the loss due to the act of the director?
The Concept of Vicarious Liability
The answer to all the above questions lies in the concept of Vicarious Liability. To understand this concept, let us take an example;
Example- If a Pizza Delivery boy from a restaurant meets with an accident while going to deliver a pizza to a customer and he injured an old lady walking on the road, the owner of the restaurant would be held liable for the acts committed by the delivery boy. This is because he has acted in the course of employment of his employer and for all the acts committed by the delivery boy in the course of employment would render the employer liable.
The concept of Vicarious liability is based on the Latin Maxim of ‘Qui facet per alium facit per se’ that means ‘He who acts through another, acts through himself’. Under the concept of vicarious liability, the liability arises when the employer authorizes the employee to do certain acts which are to be done during the course of employment and the employee causes loss to a third party by his actions. This legal theory arises when an injured party claims that another party had the right, ability or duty to control another individual.
Employers may be found liable for their employees’ tortious acts if they are part of their employment. For example, an employer of a bouncer may be found liable for assault and battery if the bouncer used force on a person due to instructions to do so or because he or she believed this was desired.
Relations where Vicarious Liability arises
Vicarious liability can be seen in several business relationships which can be between
Employer and Employee
This is a relationship in which an employer (master) has control over his employee (servant) and the employer is held liable for any act done by the employee in his course of employment. This relationship is driven by a Latin maxim Respondeat superior which translates to ‘let the master answer’. The above-mentioned example explains this relationship.
Partnership and Partner
The partnership firm is held vicariously liable for the actions of all the partners of the firm. This is because the partners act on behalf of the firm. A person who has suffered any loss because of the act of any partner, he has the right to sue the partnership firm to which the partners belong. These partners are the agents of the firm and are jointly and severally liable for their actions. They can be sued individually or jointly. In a partnership, the concept of Mutual Agency is brought forth.
Example- If Popo and Moto are partners and Moto defaults in payment in a contract with Lala, then Lala can sue Popo or Moto or both.
Corporation and Director
The Company or the corporations are responsible for the actions of the company’s executives and directors because they act on behalf of the company and all the major decisions about the company are taken by them. The corporation which they are representing is held vicariously liable for the acts committed by them in the course of employment and that affects the position of the business or creates a new relationship with a third party. Directors are the trustees of the company’s assets, transact business and take on duties as its representatives. Also, the directors of the corporations are liable for the offences committed by the corporations.
Example- If a director takes a decision and it causes the company to not gain profits for a certain year and therefore they are not able to pay Natwarlal(a debenture holder). Here if Natwarlal files a suit, it would be against the company and not the director even though the act was done by the director.
The vehicle owner and Permissive owner
A person (called a permissive owner) who is appointed by the actual owner of a vehicle to take care of his vehicle or use it for a particular purpose, for a temporary period of time, commits any act which resulted in a loss to any third party, would render the actual owner vicariously liable for the actions of the permissive owner.
Example- Ninni borrowed her father’s car to go to her friend’s house. She was driving negligently while going there and injured a pedestrian. When the case was brought to court, Ninni’s father had to pay compensation to the victim as he was the owner of the car.
Company and the role of its Directors
The position of the company is very unique. It is a separate legal entity which means that it has a legal personality, has its own seal and can acquire and sell property on its own name, and is capable of holding rights and duties. But despite the personhood, the company cannot actually act on its own. So the directors, who manage the company, act and take decisions on behalf of the company.
Directors act in three capacities in their relation to the company
- As Agents acting on behalf of the company,
- As trustees of the assets and profits, and
- As employees of the company.
A director is required to act honestly and diligently applying his mind and discharging his duties as a man of the prudence of his ability and knowledge would do. It has been explained in the duties of directors as to what is the standard or due care and diligence expected from him as explained by Justice Romer in Re City Equitable Fire Insurance Company.
Any willful misconduct or culpable negligence falls within the category of misfeasance. It was held in Re Duomatic Ltd, –
“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…..”
Therefore, Directors would decidedly be liable for omitting to do what they could have done in the circumstances.
Tortious Liability of a Director towards the Company
Tortious liability is a liability which arises due to a breach of duty which is fixed by law. A director is imposed with tortious liability if he actively participates in the act of commission of a tort or authorizes or instructs anyone to commit such a tort. Generally, a company is liable for all the acts done by the directors or other officers of the company as long as such acts are done in a manner befitting the position of the director.
A director must fulfil the duties that are placed on him by law and as long as the director complies with his duties, he is not liable. Any act done by the director in violation of his statutory duties could lead to the imposition of liability on him separately and not on the company.
Why is the Company Vicariously liable for acts of Directors?
This is due to the concepts of Separate Legal Personality and the Corporate Veil.
- Separate legal entity: When we say that a company has a separate legal entity, it means that the personality of the company is detached from the personality of the people working in it.
- Corporate veil: Corporate veil is almost an extension to separate legal entity. It is a legal concept which protects the directors and other officers from being personally liable for the company’s debts and other obligations by separating the personality of a corporation from the personalities of the people working in it. There is a veil or some sort of cover on the corporation that hides the individual members and makes the company accountable as a whole. So when a suit is filed, the company is the party to the suit and liable even if the act was done by certain individual members. Illustration: Looney and Toons are directors in a company named CN Ltd. The company does not pay taxes for two consecutive years and the tax department wants to file a suit of recovery. Here, the suit will be filed against the company and not against the directors as the directors are behind the corporate veil.
- General rule: The general rule in the determination of the liability of the company versus the liability of the directors is that the company is also liable for the acts of the directors (due to the presence of the corporate veil). The liability of the director arises only when the director’s acts fall in the exceptions given in the next section.
When is the company not Vicariously Liable?
Concept of Piercing of the Corporate Veil
Generally, there is a presumption that acts done in the name of the company are done Intra vires the company (within the legal power or authority), and the judiciary does not interfere in the internal matters of the company. Therefore, all acts done by the directors are also assumed to be acts done by the company and so the liability is on the company. But there are times when such a corporate veil is pierced or lifted by the courts. This is done in the following cases:
- Company’s actions are wrongful or fraudulent: The court may order the directors to be liable if they are indulged in wrongful and illegal activities under the name of the company.
- Company’s creditors suffered an unjust cost: If any third party with whom the company was carrying out business and if they are left unpaid, due to which they suffer losses and unnecessary costs, then the court may order to pierce the veil.
- No Actual separation between the directors and the company: If the directors do not establish any separation between the company and themselves as generally there is a separation (Separate Legal Entity). The directors are carrying on their personal business under the name of a falsely created company, then also the court may direct to lift the corporate veil and hold the directors liable.
When are Directors Directly Responsible for their acts?
Act of director ultra vires his power
- This means that the director acted in a manner outside his scope i.e. not in his scope during the course of his employment or in a manner he was not authorized to act in.
- In such case where the director acted outside the powers and authorities conferred upon him and caused harm to any third party, the company would not be held liable for such action of the director.
- Such an act should be ultra vires the director in the eyes of the people. If the people believe that it was in the capacity of the director to do so under his directorship of the company, then the company would not be liable.
- The director has acted ultra vires and the funds of the company have been applied for such an act
Functions not duly performed
When the director’s act in a manner not fulfilling their duties and functions, then the directors are liable for such acts and not the company. If the director acts in a manner that is in accordance with his duties, then he remains protected by the corporate veil and the company is vicariously liable for the acts done by him. In case the duties are not performed by the director, he is imposed with a penalty and is punishable with fine which shall not be less than One Lakh Rupees but which may extend to Five Lakh Rupees. Duties of a Director (As given under Section 166 of the Companies Act, 2013)
- Duty of the director to act in accordance with the Articles of Association of the company.
- Duty of the director to pursue the best interests of the stakeholders of the company, in a bona fide manner.
- Duty of the director to promote the objects of the company.
- Duty of the director to be aware of the conflict of interest situations and to avoid such conflicts for the interest of the company.
- Duty of the director to use independent judgement to exercise his duties with due and reasonable care, skill and diligence.
- Duty to ensure that adequate deliberations are held before approving related party transactions (Section 188).
- Duty to ensure confidentiality of sensitive proprietary information, commercial secrets, technologies, unpublished price.
- Duty of the director of the company to not assign his office and to not delegate his work.
Fraud and Misrepresentation
If the director acted fraudulently and misrepresented the company which led to the piercing of the corporate veil. The director would be held liable for his acts personally and the company would not be held liable. This also includes when the director commits a breach of trust or an act of misfeasance
The Director is guilty of Negligence
If a director acts in a manner that is either negligent or reckless or his actions are not in the best interest of the company or if the aim of the director’s actions is his personal gain, then the company is not vicariously liable.
Vicarious liability is a form of no-fault liability where one person is made liable for the acts of the other. When an act is done by a director in a bona fide manner, the company is the one liable in case any liability arises from such bona fide transactions.
Further, the concept of the existence of a corporate veil keeps the affairs of the company in a bubble, whereby only the company is held accountable for all acts. Such a veil is pierced only when the courts believe that act done was not in the interest of the company and in a fraudulent manner.
So, generally, a company is vicariously held liable for the tortious acts of the directors.