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Analysis of directors' statutory obligations - Sec 166 of CA 2013

Amitav Ganguly 
on 30 November 2015

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BACKGROUND

The Companies Act 2013 {new Act 2013} for the first time has laid down the duties of directors in unequivocal terms in the section 166 in contrast to erstwhile Companies Act 1956. It is a well established judicial precedent that the Directors have fiduciary obligations and also duties to act reasonably and in the best interests of the companies where they hold such positions. Their duties emanate due to holding positions which may be synonymous to trustees as well as agents of their companies.     

SECTION 166

The law laid down by section 166 under the new Act 2013 is analysed hereinafter.

Articles of Association

The law in sub section {1} mandates that a director shall act according to the articles of association of the company {articles}. This shall be subject to the provisions of the new Act 2013. The articles, to be valid, shall evidently have to be in pursuance to the new Act 3013 and anything contrary thereto is void in terms of section 6 thereto. Hence compliances with the valid provisions the articles are required to enable the director to fulfil his duty. This sub section does not seem to stipulate that duties of the director should be specifically laid down and provided in the articles of a company, but if that is so, it will be a desirable provision. The companies may, therefore, endeavour to specify the duties of their directors and make them part of their articles.   

Good Faith

The next sub section {2}, at the outset, provides that a director shall act in good faith. This, apparently, is a subjective matter. What is termed as good faith would be difficult to define but it should be judged from the view and actions of a reasonable, prudent and ordinary man in the best interests of the company with no ulterior or mala fide motive to harm the company or take undue benefits from it. Notably it was held in case of  Turner Morrison & Co v. Shalimar Tar Products {1980} 50 Comp case 296 Cal,  that good faith requires that all endeavours of directors must be directed to the benefit of the company.

This provision also lays down the purposes and objectives of the action to be taken in good faith by the director. Such actions will, therefore, have to be taken to promote the objects of the company for the benefit of its members as a whole, and in the best interests of the company, its employees, the shareholders, the community and for the protection of environment.

Pertinently, both the terms “members” as well as “shareholders” have been used here. The  “members”  as per Section 2 {55} of the new Act 2013 are those persons who agree in writing to become  members and whose names are entered in the register of members or whose names are entered as  beneficial owners. A shareholder is not defined but will be a person who acquires shares but whose particulars have not yet been entered in the register of members. Thus by using both the terms, a wide coverage has been made in the provisions.  

It is worth understanding that the duties enumerated are very onerous and extensive which on many occasions could be hard to be definitive and may not be practically achievable. Particularly duties could take different hues and colours in various circumstances and be subject to varying interpretations.  It has to be seen how, in the coming years, directors will be judged in carrying out their duties in good faith in the touch stones of the areas laid down herein.

Care

The sub section {3} goes on to lay down that the director shall exercise his duties with due and reasonable care. Moreover, skill and diligence are also required from him.  Exercise of independent judgment is also mandated. Pertinently, one might appreciate that exercise of duties of care, skill and diligence can be   subjective and judgemental and may vary from case to case or circumstances. The touch stone of such performance in terms of common law could be that of a reasonable, prudent and ordinary person acting bonafide for the benefit of the company.  Further, exercise of independent judgment would indicate that while carrying out his duties, the director should make assessments without being influenced by extraneous factors and by persons hampering his sovereign views. It is of course to be understood that the director can seek information, clarification and advises to enable him to take free decisions on his own.

Clash of Interest

The following sub section {4} stipulates that a director shall avoid conflict of interest. This means that he should not be involved in a situation in which he may have a direct or indirect interest which conflicts, or possibly may conflict, with the interest of the company. As a corollary this means that where there is conflict of interest, there are probabilities that the interest of the director may prevail over that of the company which may be detrimental to the company. This law accentuates the position that the directors are in the position of agents of the company with consequent duties. It has been held in the case of Allen v. Hyatt {1914} 30 TLR 444 that directors like agents have to disclose their personal interest, if any, in any transaction of the company to avoid conflict of interest. 

Unwarranted Gain or Advantage

The provision of the sub section {5} takes forward, logically, the duties encapsulated in the earlier sub sections. In addition to the fiduciary duty of a director not to have any conflict of interest with that of the company, he shall also not achieve or attempt to achieve any undue gain or advantage either to himself or to his relatives, partners, or associates.

The terms “Undue gain” or “advantage” have not been defined but would indicate an unwanted or improper benefit.

The term “relative” has been defined in section 2 {77} of the Companies Act 2013 but the new Act does not define the term “partner” which would however, have the meaning as per the Partnership Act 1932. The term “associates” too has not been defined but wider interpretation could be made to cover any significant connectivity with the director.

It is also laid down here that if a director is found guilty of making any undue gain he shall be liable to pay an amount equal to that gain to the company.

Significantly, in the provisions of the liability to pay an equal amount, the term “advantage” has not been used along with “undue gain” as has been done earlier portion of this sub section.  This therefore indicates that an element of monetary benefit is present in the term “gain” which would not be so in case of the term “advantage”, hence that has been omitted.

It was held in the case of Guinness plc v. Saunders {1990} 1 All ER 652 HL that director in question is bound to hand over the benefits , if any, that he might have secured under the transaction and he cannot ask for set off for any claim that he may have against the company.

The initial interpretation here would be that where the company has been put to loss by the director’s actions, such loss would be neutralised by his returning the entire gain back to the company.

Additionally it may also be interpreted here that since this sub section does not specifically stipulate any loss to the company, it therefore merely acts as a deterrent for the errant director by disgorging his gain and making him pay an equal amount to the company.

Assignment of office

The penultimate sub section {6} prohibits a director, as a duty, not to assign his office and any assignment if so made by him shall be void. Assignment would mean transfer of rights of his office by a director to another person which is prohibited.

This is not a new concept. As per section 312 of the Erstwhile Companies Act 1956, any assignment of his office by any director of a company was prohibited and was void. This section does not appear in the new Act 2013 but the provision has been made a part of the Duties of Directors as laid down herein. It was held in the case of Oriental Metal Pressing Works {P} Ltd., v  Bhaskar Kashinath Thakoor {1961} 31 Com Cas 143 {SC}  that the word “assignment” appearing in section 312 of the Companies Act 1956 does not include appointment and a director can therefore appoint his successor.

Contravention

The last sub section {7} lays down the penal provisions where a director contravenes the section. Such director shall be punishable with fine which shall not be less than one lakh rupees but which may extend to five lakh rupees. It is interesting to note that contravention of this section although attracts penalty {not imprisonment}, it does not render vacation of his office in terms of Section 167 of the Companies Act 2013 unless he becomes disqualified by an order of a court or the Tribunal. 

CONCLUSION

Although specific law of duties of directors has been laid down giving a direction to the plethora of precedent laws set down over decades, the matter is quite subjective. Obviously objectivity may not be possible in such provisions. The interpretations of courts of this law, hereinafter, will play a significant role in giving body and substance to these important provisions. Pertinently the precedent laws, already existing, will always remain relevant.           

AMITAV GANGULY


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