Section 166: What Must Do Directors

Although duties of Directors have been laid down, objectivity may not be possible in many of the provisions and to this effect, interpretation of courts hereinafter will play a significant role in giving body and substance to these provisions

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

Court Judgements

The following are some of the court cases, pronounced over the decades, indicating and generally laying down duties of Directors as precedent law:

Honesty

In York and North Midland Railway Co. v Hudson (1853)61 Beav 485: 22 LJ Ch 529, it was held that Directors have been selected to manage the affairs of the company for the benefit of shareholders. It is an office of trust which if they undertake; it is their duty to perform fully and entirely. Since Directors hold a fiduciary position of trust, the first and most obvious obligation is to act with honesty.

Good Faith

Good faith would require that all endeavours of Directors must be directed to the benefit of the company. {Ref case: Bank of Poona Ltd v. Narayandas, AIR 1961 Bom 252 at 253}. It was held that a Director should not exploit for his own use corporate opportunities.{Ref. case: Cook v. Deeks {1916} 1 AC 554}.

Care

Directors also have a duty of care which should be reasonable care. They have to attend with due diligence and caution the work assigned to them. The duty of care is uniform for all Directors. {Ref case: Jorchester Finance Co Ltd v. Stebbing 1989 BCLC 498 Ch D.}. However, courts had extended relief where Directors had acted in good faith although liability had been incurred. Thus they cannot be held liable for mere errors of judgement.

Diligence

The Supreme Court in the case of Official Liquidator v. P.A. Tendolkar {1973} 43 Com cases 382, held that a Director could be held liable for dereliction of duties if his negligence was of such character as to enable frauds to be committed and losses thereby incurred by the company.

Disclosure of Interest

The Director’s other duties would include duty to disclose interest to the company and ensure that his personal interest as an agent of the company and the interest of the company which is the principal, do not conflict. {Ref case: Walchandnagar Industries v Ratanchand, AIR 1953 Bom 285}

Attending Board meetings

Various other duties of a Director would include duty to attend board meetings although he is not bound to attend all board meetings. In case of genuine reasons, he can seek leave of absence from the Board. However, if there is regular absence from attending the board meetings, it could be held to be an act of negligence on the part of the Director. {Ref case: Charitable Corpn. v Sutton{1742} 26 ER 642}.

Delegation

Another duty is that the Director is not to delegate his functions and he is bound by the maxim "delegatus non potest delegare" (a delegate cannot delegate). Shareholders have appointed the Director because of their faith in his skills, competence and integrity and may not have the same faith in another person. But there are many exceptions to this as delegation is permitted in terms of company law and articles of association. Moreover, certain duties may, having regard to the exigencies of business, be properly left to some other responsible officers. Subsequent to delegation, ordinary Directors are, in absence of features arousing suspicions, entitled to presume that the affairs of the company are being properly conducted. {Ref case: Ganesan v. Brahamaya & Co {1946} Comp LJ 262 Mad}.

Section 166

The law laid down by section 166 under the new Act 2013 is in line with the jurisprudence in this regard.

How Director Shall Act

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 2013 and anything contrary thereto is void in terms of section 6 thereto.

Hence, compliances of the valid provisions of 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.

Acting in Good Faith and in Best Interest

• 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 purpose 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, shareholders, community and for protection of the 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.

Acting with Care, Skill & Independent Judgement

• 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 judgement is also mandated. Pertinently, one might appreciate that exercise of duties of care, skill and diligence can be subjective as well as 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 bona fide for the benefit of the company. Further, exercise of independent judgement 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 advice to enable him to take free decisions on his own.

No Conflict 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 Directors are 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.

No Undue 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 in the 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 the 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 also acts as a deterrent for the errant Director by disgorging his gain and making him pay an equal amount to the company

No Assignment

• 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 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 vacating 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 for duties of Directors have been laid down giving a direction to the plethora of precedent laws set out over decades, the matter is quite subjective. It is but obvious that objectivity may not be possible in such provisions. However, 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.

Disclaimer - The views expressed in this article are the personal views of the author and are purely informative in nature.