Understanding third party director

INTRODUCTION

• Here, third party director denotes "Nominee Director". Nomination of directors by institutions/ bodies, which can be termed as third parties, extending assistance financially or otherwise to their assisted companies has assumed significant importance for past many years. The basic idea of nomination has always been that the interests of such entities or third parties are protected by their directors. The Government had also issued policy guidelines in the year 1984.

• Over the years, numerous companies have had nominee directors on their Boards, appointed through the nomination of lenders and other third parties; such as financial /other institutions, banks, governments, joint venture partners, collaborators, etc.; by way of agreements, statutory provisions, obligations and the like. Such nominee directors have held the positions either as non-retiring or retiring directors. In virtually all the cases, the articles of association of the companies have provided for nomination generally inserted therein at the instances of the nominating entities.

Legality

• Whether such nomination was legally possible had been subject matter of debate in the initial years of the modern corporate existence. However, it emerged over the years that a company could enter into a valid contract by which a third party could be empowered to appoint director on the Board provided the memorandum and articles of association of that company permitted such contract. The third party could also ensure that on its nomination the company would appoint the nominee through the Board and general body meeting process. Interestingly in some of the earlier cases such as that of Plantation Trust Ltd v. Birla (Sumatra) Rubber Lands Ltd {1916} 85 LJ Ch 801 it was held that nomination contracts  cannot be specifically enforced.  

Status of Nominee

• An interesting legal position arises where there is conflict of interest between the nominating third party which has a nominee director on Board and the company itself. Many court judgments had held over the years that the nominee director should exercise his best judgment in the interest of the company and he could not be bound to act in accordance with the directions of his nominating third party. {Boulting v. ACTT, {1963}  2 QB 606, 626}. However, over the years, a more conciliatory approach has been taken by various courts laying down that the nominee director, in addition to his normal fiduciary duties and responsibility as director, has a special responsibility towards those who have nominated him. Hence, he may be absolved from breach of duty to his company, even if he acts in the interest of the nominator, provided that his conduct is in accordance with the bonafide belief that interest of the company is also being advanced.

Rights & Liabilities

• In the foregoing background the matter of liability of the nominee director has become an important aspect. It appears to be the same as other directors and he is in the same position as them. {Selangor United Rubber Estates Ltd v. Cradock { No.3} { 1968 } 1 WLR 1555}. Moreover, another critical issue would be his right to information from the company and transmitting the same to the nominator. It has been held that such right would exist where it is set out in the shareholders' or any other relevant contract including the letter of appointment of the director.  Further the Board may also take a view to minimize the potential conflicts or breach of confidentiality vis-a-vis the nominee director. It may be pertinent to note here about the immunity from liability of those directors who are nominees of certain financial institutions due to their governing legislation stipulating to that effect. But if the nominee director is personally involved in the default he would be liable.        

LAW IN COMPANIES ACT 2013

• While in the process of legislating, the new Companies Act 2013, {new Act} it was the general view that it would be better to have statutory provisions regulating nominee directors.

Nominee & Independent Directors

• It was also the view that with the introduction of the sections relating to independent directors in the new Act, the position of nominee directors in this respect should be laid down. In fact, the Report dated August 2010 of the Parliament Standing Committee on Finance had stated as follows: -

"11.29 The Committee agree with the view expressed by the Ministry that the nominee Directors cannot be treated as Independent Directors. Thus, there may not be any necessity for any modification in the Bill on this matter". 

• Keeping this Report in view, sub-section {6} of section 149 of the new Act stipulates, while defining the attributes of an independent director, that he in relation to a company, means a director other than a managing director or a whole-time director or a nominee director. (emphasis supplied)

Definition

• Although the definition of the nominee director is not given in the definition section 2 of the new Act, it has been provided in explanation to sub-section {7} of section 149 in the following lines:

"Explanation- For the purposes of this section 149, "nominee director" means a director nominated by any financial institution in pursuance of the provisions of any law for the time being in force, or of any agreement, or appointed by any Government, or any other person to represent its interests".

• If one examines the opening lines it becomes clear that the definition is meant only for section 149 of the new Act and that nomination is by a financial institution.

Scrutiny of operative provisions

•However, the provision of nominee director is also given in sub-section {3} of section 161 of the new Act which reads as follows: -

"(3) Subject to the articles of a company, the Board may appoint any person as a director nominated by any institution in pursuance of the provisions of any law for the time being in force or of any agreement or by the Central Government or the State Government by virtue of its shareholding in a Government company".

• This sub-section mandates the appointment of nominee director by the Board subject to the provisions in the articles of association {articles} of the company. Therefore, compliance of such articles, where it exists, is must. Pertinently it could be argued that where there is no provision in the articles in spite of such absence the appointment can be made. The provision does not say that the authority of the articles is required. Interestingly in Table F of Schedule I of the new Act, {the model articles of a company limited by shares}, there is no provision for nominee director.

• One may note that this sub-section provides for nomination by "any institution" of which the term "institution "has not been defined. However the term "financial institution" has been defined as follows in clause {39} of section 2 of the new Act: -

"(39) "financial institution" includes a scheduled bank, and any other financial institution defined or notified under the Reserve Bank of India Act, 1934."

• As discussed earlier, in section 149 {7} the term "financial institution" has been used for the limited purpose of that section only but this may assist in widening the interpretation of "any institution" in this sub-section to take into account "financial institution" also. 

• It also transpires from a literal interpretation of this sub-section that except "any institution", no other person can nominate, more particularly any individual or a company or any person which cannot be categorized as an institution. This may take an impractical view of the realities. For proper regulation of this important area it would be better if the Government comes out with suitable clarification or amendment to widen the scope.   

• The provision in section 161{3} further stipulates that the Board of a company may appoint the nominee director:-

1. in pursuance of the provisions of any law for the time being in force, or
2. in pursuance of any agreement. 

• It is therefore, a pre-requisite that there should be an applicable law or an agreement for valid nomination

Government Nominee

• This also provides that the Board of a Government company may appoint a director nominated by the Central Government or by the State Government. 

• It is worth noting here that nomination in a Government company can only happen when there is shareholding of the concerned Government in the said company. Thus, by virtue of that shareholding the Government acquire the right of nomination. 

• The term "Government company" has been defined in section 2 (45) of the new Act and includes a subsidiary. The holding of minimum 51% of paid up share capital of a company by the Central and /or State government is required to make it a Government company. If holding is less than that, that company is not a Government company.

• This may appear to be a limiting factor but it may be worthwhile to point out that where "any institution" is that of the Government such institution is permitted to nominate a director in a company, irrespective of whether the Government hold any shares or not in that company.  However there has to be a statute or an agreement.

WRAP-UP

Although it is welcome that statutory provisions have been made in Companies Act 2013 for nominee directors which is judicious in nature setting at rest deviating positions, some clarifications/amendments for widening the scope should definitely come from the Central Government for better regulation and compliance.


Amitav Ganguly 
on 11 January 2017
Published in Corporate Law
Views : 458
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