DIRECTORS’ CARE AND DUTY IN CASE OF BREACH
By V. Karthyaeni,
Gujarat National Law
University
1. INTRODUCTION
Nature of
Responsibility for Liability of Corporations
Responsibility
is an elusive term. It has many equally plausible definitions and the values it
expresses differ from time to time, place to place. Indeed, it has been
described so integral a part of human relationships that it, in its various
meanings and shadings, serves as a synonym for every important political word.[1]
In
the context of corporate liability, an oft-cited opinion is the 18th
century expression of Baron Edward Thurlow L.C. that corporations have no soul to be damned and no body to be kicked.[2]
While
the corporation is legally separate and distinct from its members, it is
ultimately an artificial creation and it acts through its servants or agents.
The decisions of a majority of its members in general meetings are regarded as
the acts of the corporation. The Board of Directors, as a whole, is generally
delegated all powers of the management and it may sub-delegate any of these powers
to individuals directors or other servants and managers. There is a
relationship akin to agency between the corporation and its board as well as
the servants or agents that are delegated with specific responsibilities.
Traditional
Approach to Corporate Liability- Directing Mind Theory
Traditionally,
the approaches through which corporations may be said to incur liability for
the acts of its directors or other employees are vicarious liability, agency
and directing mind theory.
There
were decisions like that of Lennard’s[3]
and Tesco Supermarkets[4]
which held that personal liability may be established against corporations
where the reprehensible conduct or state of knowledge of an alleged
infringement or wrongdoing was found in an individual or individuals who were
identified as its ‘directing mind and will’ or alter ego. The essence of the traditional directing mind theory is
that it is necessary for those individuals, whose position or function in the
corporation are such that they are deemed to be its directing mind, to have
committed the acts or possessed the requisite knowledge in order for it to
incur personal liability.
Development of the
Directing Mind Theory and the Principles of Attribution
The
expression ‘principles of attribution’ has come to be associated with the
decision of the Privy Council in Meridian
Global Funds Management Asia Ltd v. Securities Commission[5].
The notion of attribution is not a completely new concept. It is essentially a
derivation of the traditional directing mind theory that was established in the
cases of Lennard’s and Tesco
Supermarkets. The idea is to identify the individual or individuals in a
corporation whose conduct or state of knowledge is attributable to it where
they are deemed to be the corporation whose conduct itself- its alter ego. It seeks to address the same
principles as that of the directing mind theory i.e to enable to finding of the
liability against the corporations, especially where the proof of which
requires corporations to have acted reprehensively or entertained a particular
state of mind.
The
question of attribution is fundamental to company law, as a corporation can
neither act nor think on its own. The damages and losses that result from the
infringements or wrongdoings associated with corporations also reinforce the
need to determine whether a corporation can undertake a prohibited action or
entertain a culpable state of mind. At the same it is necessary to avoid the
injustice of attributing to the corporation every act or omission of its servants
or agents. Under the traditional directing mind theory and principles of
attribution, it is through identifying the relevant individuals in the
corporation whose conduct or knowledge are attributed to it in order for
corporate liability to be established. Nevertheless, it is here that the
similarity ends.
The
difference with the principles of attribution, as expounded by Lord Hoffman in
the Meridian case, is that they seek
to provide a more systematic and coherent approach to determining liability of
corporations. The Meridian case
should be read with the cases of Lennard’s,
Tesco Supermarkets, El Ajou and Ready Mixed Concrete cases where the
principles of attribution were laid down.
Firstly,
they recognize corporations as legal abstractions involving references to rules
that determine its existence, powers and obligations.
Secondly,
it is governed by its organs (the board of directors and shareholders in
general meetings).
Thirdly,
the fact that the corporation acts through its servants or agents does not mean
that the conduct or state of knowledge of those individuals should be
attributed to it in every circumstance. The nature of criminal and regulatory
offences as well as civil infringements or wrongdoings also advances the need
for rules to ascertain the instances where the corporation may be charged with
personal responsibility. This is especially so since the claimant to satisfy
the court that the corporation had caused a certain event or responsibility
should be attributed to it for the existence of a certain state of affairs, and
it had a defined state of mind in relation to the causing of the event or the
existence of the state of affairs.
Therefore
the directing mind theory and the attributive principles focus directors and
officers running an enterprise making them liable for their acts. Hence the
concept of directors liability is of ongoing interest in corporate circles.
2.
Director of a Company
The
expression "director" includes any person occupying the position of
director, by whatever name called.[S.2(13)][6].
The Articles of a company may, therefore, designate its Directors as governors,
members of the governing council or, the board of management, or give them any
other title. However, so far as the law is concerned, they are simple
Directors.
Corporate executives today are possessed of “immense power which must be
regulated not only for public good but also for the protection of those whose
investments are involved.”[7]
Directorships will always be susceptible to abuse. The law therefore, imposes
upon them certain duties, which when, properly enforced, will, without driving
away from the field competent men, materially reduce the chances of abuse.
2.1 BONA FIDES DOCTRINE
The English and Australian Courts long considered
the bona fides doctrine and were geared more or less to arrest dishonesty or mala
fides , but well entrenched of a reluctance to interfere with the internal
management of companies acting within their powers[8].
That the courts should develop such a reluctance to interfere in the exercise
of director’s powers is not surprising for this was an area in which it was
felt that the shareholders were seized of control, and that such matters were
really for them. And so provided that directors of British and Australian
companies acted bona fide in the interests of the company as a whole, it
was felt that the shareholders had little cause for complaint.[9]
2.2
PROPER PURPOSES DOCTRINE
The proper purpose test or as it is also referred
as, the collateral purposes test[10]
allows directors acts to be reviewed by the courts upon a more objective basis
than that which has been traditionally applied in relation to bona fides. Notwithstanding that the
directors may have acted honestly in what they believe to be in the company’s
interests, they may nevertheless be liable to the company if they have
exercised their powers for purposes different from that for which the powers
were conferred upon them.[11]
Strict adherence of the bona fides doctrine
can permit too much of subjectivity in the directors’ decision-making process.[12]
The attractiveness of the proper purposes doctrine is that it introduces an
objective element into the equation absent statutory interference. It is
significant that the proper purposes doctrine has application where directors’
good faith is not challenged. [13]
It is however necessary to distinguish between an
excess of authority and an act which pima
facie is within the powers delegated to directors of British companies, but
which they have abused by exercising for an improper purpose.[14]
Ascertainment of that purpose is a question of fact and the relevant question
is whether the challenged power, ‘would have been exercised but for the presence of the impermissible
purpose.[15]
2.3
DEVELOPMENT OF THE PROPER PURPOSES DOCTRINE: AN ENGLISH PERSPECTIVE
The proper purposes doctrine, it must now be
recognized as having evolved into a separate test to be applied in
circumstances where prima facie the
power complained of is within the scope of the directors’ authority, but which
they have abused by exercising for an improper purpose; often, so as to
manipulate control.[16]
The following cases highlight how the proper
purposes doctrine has evolved under the general law. The first is Fraser v. Whalley[17].
The essential facts appear within the following extract from Page Wood VC’s
Judgment:
“The directors are informed that at the next
general meeting they are likely to be removed and therefore, on the very verge
of a general meeting, they, without giving notice to anyone, with this indecent
haste and scramble which is shown by the times at which the meetings were held,
resolve that shares are, on the faith of this obsolete power entrusted to them
for a different purpose, to be issued for the very purpose of controlling the
ensuing general meeting.”[18]
However, the case which probably more than any
other gave recognition to a separate test over and above the traditional bona fides test was, Hogg v Cramphorn Ltd [19].
In the case, the directors had issued shares with special voting rights to the
trustees of a scheme set up for the benefit of the company employees in an
attempt to forestall a takeover bid. While Buckley J, had accepted that the
directors had acted in good faith, and they honestly believed that what they
had done would benefit the company, his Lordship observed nonetheless that, ‘an
essential element of the scheme, and indeed its primary purpose was to ensure
control of the company by the directors and those whom they could confidently
regard as their supporters. Buckley J, formed the view that the power to issue
shares was fiduciary and if it was, ‘exercised for an improper motive, the
issue of these shares is liable to be set aside.’ The issue of shares was
accordingly declared invalid. However, since the directors’ breach of duty
rendered their action voidable rather than void, it was capable of ratification
by the shareholders in general meeting. The action was stood over and the
allotment was later ratified. This decision had excited a measure of
controversy in English and Australian Law.[20]
It is well established that the onus of showing
that a director has not acted honestly in the exercise of his or her powers and
the discharge of his or her office is upon the aggrieved party. The point is
well established in Hindle v. John Cotton
Ltd[21]
where the House of Lords were asked to declare a resolution of the board void.
Although the articles gave literal power to do what had been done, the House of
Lords nonetheless granted the order sought. In doing so, Viscount Finlay
outlined the nature of the task that the court must undertake as the following
passage from his celebrated speech to the House of Lords demonstrates:
“Where the question is one of abuse of powers, the
state of mind of those who acted, and the motive on which they acted , are all
important and you may go into the question of what their intention was,
collecting from the surrounding circumstances all the material which genuinely
throw light upon that question of the state of mind of directors so as to show
whether they were honestly acting in discharge of their powers in the interests
of the company or were acting from some bye-motive, possibly of personal
advantage, or for any other reason.”[22]
Although isolated cases can be found where the bona fides test has been applied, the
latter day English Courts have tended to promote, in preference, the proper
purposes doctrine which found very clear favor with the Privy Council in Howard Smith Ltd v. Ampol Petroleum Ltd[23].
In delivering its opinion in Howard Smith, the Privy Council reaffirmed the
judiciary’s reluctance to interfere with, or even supervise, the merits of
decisions within the powers of management honestly arrived at. But the Privy
Council nonetheless considered that a court ‘is entitled to look at the
situation objectively in order to estimate how critical or pressing or
substantial or per contra, insubstantial an alleged requirement may have been.
The application of the proper purposes test in this manner therefore enables the directors’ decision-making to be challenged without necessarily condemning their motives for so deciding. That in turn, permits judges, of a more robust interventionist disposition, to consider the decision itself rather than simply the decision-making process; thus giving rise to the review of business judgments of business men, long considered anathema to the English and the Australian judiciary.
3.1 Duties of Skill and Care
Unless the Articles of the
Company provide otherwise, the directors are responsible for the management of
the company. They should exercise skill and care in carrying out their
managerial functions. However, a mere error of judgment will not amount to a
breach of the duty of care which a director owes to a company. A professionally
qualified or expert person who is a director must however exercise his expert
skill and knowledge for the company.
3.1.1
A Brief History of Duty of Care
In an oft-cited article, Professor Bishop wrote
that “the search for cases in which directors of industrial corporations have
been held liable in derivative suits for negligence uncomplicated by
self-dealing is a search for a very small
number of needles in a very large haystack." Up to that point (May
1968), he had found only four such cases. A more recent count (December 1983)
brought the total to seven. By any reckoning, reported cases holding directors
liable for purely "honest mistakes" are rare indeed.
One reason for the duty of care doctrine's
twilight existence is that its greatest
strength is also its greatest weakness: the enormous coverage of its negligence
standard and then the application of “gross negligence” rule. Another
manifestation of this judicial avoidance is the liberal application of the
business judgment rule. It is well-noted that judges are very reluctant to
interfere with the business judgments of directors. The business judgment rule
has virtually en-gulfed the duty of care doctrine.
3.1.2
Liability for negligence
Fidelity
alone is not enough. A director has to perform his functions with reasonable
care. He has to attend with due diligence and caution the work assigned to him.[24]
An
early example is Overend Gurney & Co
v Gibb[25]
where a company was formed to take over a private bank. Without investigating
the value of the bank’s assets and the extent of its liabilities and with
knowledge that the bank was in a state of insolvency, the directors paid
₤50,000 for goodwill. Still holding them not liable, the House of Lords
laid down that there should be violation of either the Act or the memorandum or
the transaction was such that no man of ordinary prudence would have entered
into.
Directors
may not know the nature of the company’s trade, because all that the law
expects from them is that if they know they must use the knowledge for the
benefit of the company.[26]
Accordingly the directors were held guilty of negligence when they participated
in a transaction without trying to know whether the transaction was really for
the purposes of the company or they were authorized by the Board in that
respect, and it was no defence for any director to show that he believed that
he was bound to sign because the other directors wanted it or that he joined
under protest or that even without his joining, the other directors were
determined to carry out the transaction.[27]
Directors
were also held liable where they released the company’s funds for paying the
debt without trying to know whether anything
was really due and for purchasing the assets without knowing whether there was any real transfer of those
assets.[28]
Liability
for negligence also followed where without any board resolution being properly passed
a single member was allowed to manage a part of the company’s business and he
misconducted himself.[29]
3.1.3
Exclusion of liability now not allowed [S.201] –
ROMER
J’s formulation of directors’ duties in City
Equitable Fire Insurance Company, Re[30]
“His
duties will depend upon the nature of the company’s business and the manner in
which the work of the company is distributed between the directors and other
officials of the company. In discharging these duties a director must exercise
some degree of skill and diligence. But he does not owe to his company the duty
to take all possible care to act with best care. Indeed, he need not exhibit in
the performance of his duties a greater degree of skill than may reasonably be
expected from a person of his knowledge and experience, or in other words,
directors are not liable for mere errors of judgment.[31]
In
the above case one B was the director of City Equitable fire Insurance Co. the
company was ordered to be wound up. A searching investigation of the affairs of
the company was then made and this investigation showed a shortage of funds
which the company should have been possessed of over ₤12,00,000. The
collapse of the company was due to bad investments, bad debts and
misappropriation. All the losses were due to B’s instrumentality. He was
accordingly convicted for his funds.
But
the question of whether during the period covered by B’s nefarious activities
the other directors were properly discharging their duties to the company. But
there was exemption clause in the articles to which the directors were liable
only for gross negligence. The facts of the case did not disclose that the
degree of negligence and, therefore, the case of the official receiver against
B’s co-director failed.
S.201
renders void any provision in the company’s articles or in any agreement which
excludes liability for negligence, default, misfeasance, breach of duty or
breach of trust.
3.1.4
Standard and degree of care and skill-
The
above ROMER J formulation is largely subjective, as a director has to use only
such “skill as may reasonably be expected from a person of his knowledge and
experience.” Traditionally, only gross negligence the directors used to be made
liable. But the current trend is towards objectivity.[32]
In
the words of Justice CARDOZO”
“The
diligent director is the one who exhibits in the performance of his trust the
same degree of care and prudence that men prompted by self interest generally
exercise on their own affairs.”[33]
This
standard demands reasonable business prudence form the managers.
Payment
of ₤4000 without legal advice, as compensation to a director for
retirement when, in fact, he was entitled to no compensation was, an act which
could not be regarded as reasonable.[34]
The
directors of a company manufacturing car components were held liable because
they failed to ensure that their company had established an efficient
production system before commencing production and caused loss by paying wages,
salaries and general overheads which were not matched by output.[35]
Directors
would decidedly be liable for omitting to do what they could have done in the
circumstances. Where the president of an investment company improvidently
invested in companies in which he was interested and caused loss, his fellow
directors were held liable because they had left the investment of the
company’s funds to the president’s unfettered discretion and exercised no
supervision over him.[36]
What
seems to be now the leading case on director’s duty of care is the New York
South Wales Court of Appeal decision in Daniels
v Anderson[37] wherein
it was observed that the old cases, with their notions of subjective tests and
gross negligence have become outdated. “The idea that the shareholders were
ultimately responsible for the unwise appointment of directors led to the duty
of care, skill and diligence, which a director owed to a company being
characterized as remarkably low.”[38]
One
must look to see whether there are reasons of policy for saying that a director
does not owe a duty of care to the company. The concept of negligence which
depends ultimately upon a general public sentiment of moral wrongdoing for
which the offender must pay can be adopted to measure appropriately in the
given case whether the acts or omission of an entrepreneur are negligent.
The
New Zealand Companies Act, imposes a new duty on the directors, not to engage
in reckless trading. This expression is defined in the act as agreeing to cause
or allowing conduct likely to create a substantial risk of serious loss to the
company’s creditors.[39]
The
director is not liable for the misapplication of a cheque properly drawn, but
before a director signs a cheque he should satisfy himself that a resolution of
the director or of a committee of the directors has authorized such a payment.
A director is not liable for omitting to claim a debt to the company, or to
enforce a liability incurred before he joined the Board.
3.1.5
Special Statutory Protection against Liability [S.633]-
S.633
extends special protection against a liability that may have been incurred in
good faith. Where it appears to the court that the director sued, “has acted
honestly and reasonably, and that having regard to all the circumstances of the
case….he ought to fairly to be excused, the court may relieve him either wholly
or partly from his liability on such terms as it may think fit. Three
circumstances must be shown to exist. The position must be such that the person
to be excused is shown to have acted honestly, secondly, reasonably, and
thirdly, having regard to all the circumstances he ought fairly to be excused.
In Claridge’s Patent Ashphalt Co, Re, [40]
a company was formed for the production of certain compositions of cement for
making roads. Owing to great increase in motor traffic there was a profitable
future in making roads and it was proposed that the company should embark upon
this new business. After consulting the company’s solicitors, who advised that
the scheme was not ultra vires, the
directors applied the company’s capital, but the new business proved a failure.
They
were sued for misapplication of funds but the court granted relief.
Similarly,
in a case before the Orissa High Court[41],
where the annual general meeting of a company could not be held in time on
account of the dissolution at the material time of the Company’s Board of
Directors by a court order, the court granted relief against liability for
default.
Where
a statement in the prospectus was that the company had 25 years of experience
in its line of business, whereas the experience was that of the partnership
which was taken over by the company and the business was commenced a bit late
than what was stated in the prospectus, the directors were held not guilty of
misrepresentation. Relief against prosecution was granted.[42]
Relief
was allowed where the directors could not hold AGMs and file annual returns,
the failure being due to the takeover of the company by the Government and the
matter being beyond their control.[43]
The
totality of the circumstances have to be examined for considering whether
relief is to be allowed or not.
3.1.6 Duty to attend Board Meetings
Negligence
by non-attendance-
If
some persons are guilty of gross non-attendance, and leave the management
entirely to others, they may be guilty by this means if breaches of trust are
committed by others.[44]
The defendants were directors of a trust company whose by-laws required monthly directors' meetings. A meeting was omitted because of the absence of several directors upon vacations. Losses resulted to the trust company which would have been prevented had the directors met and exercised proper supervision over certain loans. Held, that the directors are accountable to the trust company for such losses.[45]
3.2
Fiduciary Duties
The common law, the Quebec Civil Code and
corporate statutes impose duties on corporate directors. One of these is a
fiduciary duty for directors not to place themselves in a position where their
duty to act in the best interests of the corporation conflicts with their
personal interests. This principle has been adopted by the Indian Courts wherein the directors are required to
act in the best interests of the company. They should not act in a way which
could result in a conflict between their own interests and those of the
company. Should such a conflict arise the director should make full disclosure to
and, in certain circumstances, obtain the approval of the shareholders in
general meeting. If this is not done, any profits made by the director in
breach of his fiduciary duty will be held on trust for the company, and are
recoverable by it.[46]
By virtue of his position a company director will have control over the
company's assets, so a director could also be in breach of his fiduciary duty
if:
(a) he uses for his own benefit
information which he acquires in his capacity as director;
(b) if he disposes of corporate assets at an undervalue for purposes other than
for the benefit of the company;
(c) if he diverts contracts to himself which had been offered to the company.
Again there will usually be a liability to account to the company for any gain
or, as the case may be, to indemnify it against any loss.
3.2.1
Liability for Breach of Trust-
Traditionally,
the duties of directors fashioned out of common law as developed through the
cases.[47]
Good
faith requires that all their endeavors must be directed to the benefit of the
company. Thus where a director of a company, being also the member of another
company, earned business from the other company by providing some business
facility of his company, he was held
liable to account for such profits, although the company had itself not lost
anything and also could not have earned the bonus.[48]
Where a director was aware of the fact that the company’s property was being
sold for ₤350,000 when its real value stood at ₤650,000, this was a
breach of the fiduciary duty.
3.2.2
Business Opportunities-
A
Director should not exploit his own use the corporate opportunities. In Cook v. Deeks[49]
the directors of a company diverted a contract opportunity of the company to
themselves and by their votes as holders of three-fourth majority resolved that
the company had no interest in the contract. It was held that the benefits of
the contract belonged in equity to the company and the directors could not
validly use their voting power to vest it in themselves.
On
the same principle, where a director is instructed to purchase some property
for the company, and he purchases the same for himself and then sell it to the
company at a profit, he is clearly liable to account for the profit so made. As
he was under an obligation to acquire the property for the company, the
belonged in equity to the company from the moment he purchased it and could not
have made a profit on its resale.
Supposing
now he is not under any direction to purchase the property for the company, but
purchases the property on his own account which is subsequently sold to the
company at a profit. The Judicial Committee in Burland v. Earle[50]
answered that the company is entitled to claim for the profit.[51]
A
similar case in Thomas Marshall (Exports)
Ltd v. Guinle[52], a
company was importing foreign goods for resale in U.K. Its managing director
formed a new import company and solicited orders on its behalf from the U.K.
buyers. He imported goods from those very firms with whom he had established
contact while acting for the company. He was restrained from this course of
conduct. It was breach of service contract and also of the fiduciary duty.
In
Fine Industrial Commodities Ltd v.
Powling[53]
the demand for the company’s product had fallen. The director of the company
knew of an alternative product for which there was demand and he also knew of
the modification of the company’s plant and machinery which was necessary for
that purpose. But, instead of doing that, he created a new company and obtained
a patent of the new product in the name of his new company. He was held
accountable for the profits. His knowledge of the product in demand and of the
fact that the company’s plant and machinery could be modified for that purpose
was considered by the court to be company’s knowledge.
Another
parallel case is Cranleigh Precision
Engineering Ltd v. Bryant[54],
a director after resigning from directorship, formed a company with another
person and embarked upon manufacturing a product which embodied his own earlier
invention made by him while working for the company. He and his company were
restrained from doing so.
3.2.3
When Director may make personal use of company’s opportunity-
“Where
the corporation is insolvent and defunct, its officers are free to act for
themselves, since such condition is ascertainable and not easily feigned. Where
the opportunity is outside the scope of corporate business, or where the
corporation has shown no interest in the property, an officer may buy for
himself.”[55]
3.2.4
Position on cessation of Directorship-
Industrial Development Consultants
ltd v. Cooley[56], the Managing Director tried to get from the Gas
Board a Government contract for the company. But the Gas Board plainly told him
that the Government will not allow the contract to the company, but was willing
to deal with him personally. He therefore, reigned from the company under the
pretence of ill-health and then promptly obtained the contract for himself.
Having earned a handsome profit, he had to face an action from the company to
account for it.
The
court held that the managing director had acted in breach of his duty and
therefore, must account for it because the company grealt desired the contract
and employed Cooley only in a bid to obtain it.
In
contrast to this, in Peso Silver Mines
case[57],
a new venture was offered to the company and its directors bona fide come to the conclusion that it is not an investment that
the company ought to make, the individual directors who subsequently buy the
same do not violate any duty to the company even though they have consulted the
company’s geologist. The directors here in good faith had rejected the
opportunity to acquire the adjacent mines and then some directors used the
opportunity.
3.2.5
Competition by Directors-
There
is no breach of duty if a director competes with his company or olds some
interest in the rival company or is a director in a competing company.[58]
But accountability will chase a director if he uses the company’s assets for
the benefit of the rival concern and this includes its business connection,
goodwill, trade assets and the list of customers.[59]
If
a company had given special training to a director, he may be restrained by the
company from using those special skills for the benefit of the rival company.[60]
3.2.6
Trading in Corporate Control
–
“A
director who acquires property while in office will, however, be liable to
account for his profit upon resale if two elements are present. He must have
acquired property only by reason of the fact that he was a director and in the
course of the exercise of the office of director.”[61]
3.2.7
Misuse of Corporate Information-
Exploitation
of unpublished and confidential information belonging to the company is a
breach of duty and the company can ask the director in question to make good
its loss, if any. Any knowledge or information generated by the company is the
property of the company, commonly known as intellectual property. Turn over of
business, profit margins, list of customers, future plans, any personal use of
such knowledge is equivalent to misappropriation of property.[62]
Use of such information can be restrained by means of an injunction.[63]
Any gain made by the use of inside information has to be accounted for to the
company.
3.2.7.1
SEBI (Insider Trading) Regulations, 1992-
The
Securities and Exchange Board of India has formulated Regulations for preventing
and punishing the use of price sensitive unpublished inside information in dealings with the company’s
securities.
Directors dealing with their own
company’s shares is not illegal. It is considered desirable that the directors
of listed companies should hold the shares of their companies. As apart the
remuneration package, directors are often given share options which enable them
to acquire shares in their company, which they may afterwards sell. When
director decide to sell their shares however acquired or to buy more shares,
their trading comes to be governed by the legislation on insider trading.. “If
the director has access to unpublished price sensitive information, such as
information on future earnings, figures, security issues, assets disposal and
purchases, etc., which if it were made public would have a significant effect
on the share prices, it is illegal for them to trade on such information.”[64]
3.3. Tortious Liability of Directors: -
Directors as
such are not liable for the torts or civil wrongs of their company. To make a person
liable for a tort, e.g. for negligence, trespass, nuisance or defamation it
must be shown that he was himself the wrongdoer or that he was the employer or
principal of the wrongdoer in relation to the act complained of, or that the
tort was committed on his instructions.[65]
3.4. Statutory Liability: -
3.4.1 Misleading Prospectus-
A director is liable to compensate a person who has subscribed shares on the
faith of a prospectus, which contained untrue statement. The Director should
compensate every such subscriber for any loss or damage he may have sustained
by reason of such untrue statement in an action in tort and also under section
62 of the Act to pay compensate. If the Director discovers a mistake in the
prospectus, it is his duty to specifically point it out. The Director may also
have to face criminal prosecution for untrue statement in the prospectus. He
may be imprisoned for two years and fined Rs.5000.
3.4.2 Inducement to invest-
The Directors are liable to criminal prosecution for inducing or attempting to
induce a person by statement or even forecast which is false or misleading to
enter into or to offer to enter into any agreement to buy shares of the
company. They shall be punishable with imprisonment for a term which may extend
to five years, or with fine which may extend to Rs.10,000, or with both.
3.4.3 Maintenance of proper books of
accounts: -
Where directors manage a company then each director shall be responsible (if
there is no managing director) that the company should maintain and keep proper
books of account. Default or non-compliance will make the Director punishable
with imprisonment for a term not exceeding six months or fine of Rs.100 or
both. In the event of winding up, failing to keep proper accounts will make him
punishable with one-year imprisonment and for falsification of book
imprisonment for eight years.
3.4. Liability for Unauthorised
Contracts
Whatever the extent to which either
the company's Memorandum and Articles of Association or resolutions of the shareholders
may seek to impose limitations on a director's powers, the directors can bind
the company, or authorise others to do so, by entering into a contract with a
bona fide third party.
The contract will (almost always) be binding on the company. To balance this,
the directors may be held personally liable for any loss caused to the company
as a result of the unauthorised transaction. The directors' actions can be
ratified by a separate, special resolution of the shareholders, which will
relieve the directors from liability.
If a director is actually a party or associated with a party to a contract with
the company, and the directors have exceeded their powers, the company can
avoid the contract, and require the director to account for his gain or indemnify
the company for any loss it has suffered. Any director who authorised the
transaction (whether or not a party to the contract) will be so liable.
3.5 Liability of Directors for Corporate
Trustees for Breach of Trust
In First Trust Co. of Lincoln v. Carlsen[66],
the defendants were officers and
directors of the Lincoln Trust Company, which was acting as trustee for the
holders of certain bonds secured by a mortgage. Among other things, the trust instrument provided that the Trust
Company should foreclose whenever a breach of the conditions of the mortgage
should occur. The mortgagors defaulted on interest payments, but the Trust
Company nevertheless advanced the amount of the interest to the bondholders
without notifying them that the mortgagors had defaulted, the concealment being
apparently for the purpose of maintaining the market value of the bonds. In an
action brought by the successor trustee against the officers of the original
trustee (the original trustee itself being insolvent), heldy defendants
were liable for damages for breach of trust in not foreclosing the mortgage and
in not giving notice of the default.
The instant case presents a problem worthy of
consideration in view of the growing use of corporations as trustees. A natural
person acting as trustee is normally expected to perform the duties of the
trust himself, and the law has placed rather stringent limitations upon any
delegation of his duties.1 But in the case of the corporate
trustee, it is obvious that all duties must be performed by the agents of the
corporation. Thus, although there are problems as to liability of
the agent where a natural person is permitted to delegate some of his duties as
trustee, these problems become more acute in the case of a corporate trustee.
It might be well to begin the discussion of the
liability of officers of a corporate trustee with a consideration of some
fundamental principles of agency. It is well recognized that in a tort action
an agent cannot set up his agency as a defense, as his principal cannot authorize
him to do a tortious act. The agent will, therefore, be held liable whether or
not his principal did in fact direct him to do the act. In case he did the act
at the command of the principal, or in the ordinary course of his employment,
the principal will be held liable along with the agent. But where
the agent is acting outside the scope of his authority, and the principal used
due care in the selection of his agent, the principal will not be held liable.
The question then arises as to how these principles fit in with the corporate
trustee picture. In the first place, it is important to note that an officer of
a corporation is something more than an agent.
It has been said that when a corporation is acting
through an officer, such officer "acts directly and in chief, and not by
delegation." A federal judge has
described the officers as "the moving force itself of the
corporation." However that may be,
the officers of a corporation occupy the position of agents so far as third
parties are concerned, and may in general be treated as agents for the purpose
of this discussion. It would seem, then, that the ordinary liabilities of an
agent will attach to the officers of a corporation.
But added to the ordinary liabilities of an agent
there are certain other claims of liability that arise by virtue of the fact
that the agents here are not only corporate officers and therefore a very
special kind of agent, but also are agents of a trustee. Since a trust
relationship is involved here, there are certain duties of the corporation to
the beneficiaries of the trust, for breach of which the corporation will be
held liable.9 But are the officers as individuals liable for the
corporate act?
We may start with the maxim of trust law that all
who participate in a breach of trust are liable therefore. Since a corporation
is an intangible being, it is inconceivable that it can act otherwise than
through some human being. The acts of a corporate trustee, then, are those which
its officers and directors say shall be the acts of the corporation. Thus, when
the corporation converts to its own use funds held in trust by it or commits
some other act in breach of trust, it must have done so because its officers
and directors have so determined. Since the breach could not have occurred
except through their connivance, it follows that the officers and directors
have participated in a breach of trust, and are therefore liable under the
aforesaid rule of trust law imposing liability upon those who so participate. Such
is the rationale of the rule of liability of officers and directors of a
corporate trustee, as shown by the decided cases.
The action of the officers in advancing the
corporation's money to the bondholders with the purpose of deceiving them was
affirmative and willful and in utter disregard of the interests of the
bondholders.
The court has found in the instant case that the
defendants acted fraudulently, that the purpose of their act was to promote the
selfish interests of the corporation by maintaining a market for its bonds.
But from the authorities it would appear that the
defendants would have been liable even if they had acted without fraudulent
intent. Such is the direct holding of the Kansas court in Sweet v.
Montfelier Savings Bank &Trust Co. In that case the trust
company collected a note and
mortgage
for the plaintiff and retained the amount so collected as a part of its own
funds, using the money for its own purposes. The defendants, officers of the
trust company, offered as a defense that they did not intend to keep the funds
permanently for the use of the corporation, but intended to return them on
demand, and they excepted to an instruction which failed to present to the jury
the question of intent to defraud. [67]
Thus
far the discussion has been confined to cases where the breach of trust by the
corporation was committed through the connivance of the officers. What, then,
is the liability of the officers if they do not actually participate in the
breach of trust?
Suppose the officers know of a breach of trust by
the corporation, but do not actually take part in it. Or suppose they know
nothing about the breach, but could have discovered it had they exercised
ordinary diligence. Or suppose they did not know about the breach and could not
have discovered it even in the exercise of ordinary diligence. The Kansas
court, in the first hearing of Sweet v. Montpelier Savings Bank & Trust
Co.[68],
went into some detail in discussion of these problems. In that case
the instruction was given that if subordinate employees committed acts of
conversion of trust funds, the officers would be held personally liable, even
in the absence of actual knowledge of the misappropriation, on the theory that
they could have ascertained the fact of this misappropriation by the exercise
of ordinary diligence. This instruction was held to be error. The court
admitted that the officers would be liable for the conversion if the
subordinate employees misappropriated with the knowledge of the officers, but
refused to extend the rule to make the officers liable for mere negligence.
As to misappropriation with the knowledge of the
officers, it is clear that the court was correct in holding that the officers
should be liable. In principle, this situation is indistinguishable from actual
participation by the officers. If the basis of the rule of liability is
participation in breach of trust, it might be argued that the officers, not
having participated, are therefore not liable. Such argument, however, loses
sight of the basic consideration that the officers are in direct control of the
corporation. The corporation, in this situation, is sitting idly by and watching
funds held by it in trust be converted by its agents.
The
officers had not actually, affirmatively, participated in the breach of trust,
but having knowledge of the conversion and being in a position to prevent it,
by virtue of their dominating position in the corporation, they may be deemed,
by their failure to prevent the conversion, to have consented to it. They have
given their consent to an unlawful act, to which they have no authority to
consent. It is but one more step, then, to say that they are deemed to have
participated in the breach.[69]
From an examination of the cases, then, these
conclusions may be drawn as to the liability of officers of a corporate trustee
for breach of trust: (i) for a willful breach to the use of the corporation the
officers are clearly liable, on a basis of participation in breach of trust,
and because of their dominant position of control over the trustee corporation;
(2) their liability is not restricted merely to cases of misappropriation of
trust funds, but extends to all acts ordinarily treated as breaches of trust;
(3) that the officers did not intend to defraud the
cestui que trust is not a defence; (4) that a breach by other officers or employees
with the knowledge of the defendant officers imposes the same liability upon
the defendants as a breach in which they willfully participate; (5) that a
breach by other officers or employees which is unknown to defendant officers
but could have been discovered and prevented by due diligence may in some states
impose liability upon the officers, but in the majority of states does not; (6)
that a breach by other officers or employees unknown to defendant officers and
which they could not have prevented by due diligence will not impose liability
upon the officers.
3.6. Other Forms of
Liability
A director may incur personal liability towards the company if:
(a) he acquires non-cash assets of the company
or the company acquires such assets from him (exceeding in value either
£100,000 or the equivalent of 10% of the company's assets), without also
obtaining the approval of the shareholders. The contract may be set aside, and
the company may recover any of its loss, or his gain, from the director;
(b) the company of which he is a director makes a loan to him (which is
generally prohibited, although there are some exceptions). The transaction will
be voidable and, again, the company may recover any of its loss or his gain (if
any, arising out of any transaction for which the loan was used) from the
director;
(c) the company makes a payment by way of compensation to a director for loss
of office without details of it being disclosed to and approved by the
shareholders. The payment is unlawful, and as such can be recovered from the
director;
(d) a payment is made to him (by the company or some third party) on the
transfer of the whole or any part of its undertaking by way of compensation for
loss of office or in consideration of his retirement, again without shareholder
approval. The payment is held on trust for the company and as such can be
recovered from him.
3.6.1
Personal Liability of Directors for Corporate Mismanagement
The theory
behind the imposition of directors’ personal liability is that the risk of
being found liable will make directors more attentive to their legal
obligations in managing the corporation. It is felt directors will be prompted
to become more active in monitoring corporate compliance with the statutory
requirements. Moreover, where a corporation has violated a statutory
requirement, the liability of directors provides a means of punishing that
violation.
The directors of a company incur a personal
liability in the following circumstances:
Express
liability will usually arise only when a director has personally guaranteed the
performance of a contract. Implied liability will arise when a director signs a
contract for the Company or mentioning the name but failing to add the vital
word "limited" or its
abbreviation. This rule rests on the ordinary principle of agency that where an
agent enters into a contract without disclosing that he is acting as agent he
accepts personal liability. In the case of Penrose v. Martyr a bill was addressed to a company and omitted the
word "Limited" in describing it. The defendant (Secretary to the Co.)
signed the acceptance and was held to be personally liable by the Court of
Exchequer Chamber.
The
extent to which a personal responsibility will be imposed upon directors is a
matter of vital importance to the prospective director, the courts, and the
investing public.
Directors are liable for fraud or gross
dereliction of duty is an obvious consequence of the quasi trusteeship assumed.
It is, however, in those "twilight zone" cases, where directors,
being guilty of no fraud or gross negligence, have wrecked the corporation
through their honest but reckless and, from a business standpoint, absurd
mistakes of judgment that courts have divided.
The leading case in America on the liability of
directors for mismanagement is Spering's Appeal, in which the opinion is
by Justice Sharswood. In that case the financial depression after the Civil
War, caused the failure of the National Safety Insurance Trust Company, a
Philadelphia bank. The directors, in their effort to save the institution
consumed the funds of the company in reckless and improvident investments;
loans were made at usurious rates of interest in anticipation of large profits;
collateral was sacrificed in a vain attempt to sustain credit; and, in the
failure of the directors to assign at a time when a great part of the assets
could have been saved, there was a lack of that reasonable business judgment on
the part of the directors on which stockholders rely. An action was brought
against the directors to recover damages resulting from the improvident
investments sanctioned by the board. The court denied relief holding that
directors are merely gratuitous mandatories and are to be held
responsible to the corporation only where their breach of trust is of such a
character as to warrant the
imputation of fraud
or gross negligence
amounting to fraud.[71]
In Spering's Appeal, so long as the
directors act in good faith, and within the scope of their authority, they
cannot be held responsible to the corporation "for honest mistakes of
judgment no matter how reckless and absurd, when measured by the standard of
reasonable prudence and ordinary business judgment.
The case of Hun v. Cary[72]
stands in dramatic contradiction to the rule laid down by Justice Sharswood in Spering's
Appeal.
In
Hun v. Cary,the trustees of an insolvent savings bank voted the
purchase of an expensive lot in New York City as a site for a new bank
building, hoping thereby to induce confidence in the financial standing of the
institution and increase its deposits. The insolvent condition of the bank was
known to the trustees at the time of the purchase, but there was no suggestion
of bad faith on the part of the trustees, their purpose in making the purchase
being the mistaken belief as to what constituted the best interests of the
corporation. The charter empowered the corporation to purchase a lot requisite
for the transaction of the banking business. The purchase was intra vires.
The
court held that the facts justified a finding that the case was not one of mere
error or mistake of judgment on the part of the trustees, but of improvident
and reckless extravagance and that the trustees should be held liable for the
loss occasioned by such action on their part. [73]
In both cases the improvident investment was made
in the interest of the corporation; in both cases there was no suggestion of
fraud; in both cases the act of the directors was within the powers conferred
by the charter; but in Hun v. Cary
the court held that honest but reckless improvidence in an intra vires transaction
is the foundation of liability
In both cases the improvident investment was made
in the interest of the corporation; in both cases there was no suggestion of
fraud; in both cases the act of the directors was within the powers conferred
by the charter; but in Hun v. Cary
the court held that honest but
reckless
improvidence in an intra vires transaction is the foundation of
liability
Watt's
Appeal,[74]
Justice Potter speaking for the court, holding:
"Directors
are trustees or quasi trustees of the capital of the company, and liable as trustees for any breach of
duty with respect to the application of it. . . .
growing
conception that directors occupy a fiduciary position with reference to the
corporation,and that their liability is to be judged by standards applicable to
express trusteeship.
Hopkins & Johnson's Appeal [75]
where it was held that
directors could not use their knowledge as to the solvency of the corporation
to obtain a preference over other creditors, even though their debts were
valid.[76]
The rule precluding a director from
obtaining any advantage or secret
profit
as a result of his position is fundamental.
The
rule of due care, referred to in Hun v. Gary, supra, should be
applied to all directorate action and should be the measure of
directorate liability whether the act complained of is intra vires or ultra
vires, whether affirmative action, or the reckless and absurd exercise of
judgment.
While a
director owes fiduciary duties to the company, he owes no such duty to the
shareholders. He does, however, owe to the shareholders - collectively, not
individually. They could be liable for improper use of corporate assets that exist
for the benefit of all shareholders or for favoring one group of shareholders
over another in a takeover battle.
4.1 Liability for Infringement of Personal Rights
If the directors override the rights which the company's Articles confer upon
the shareholders, by causing the company to act in a manner inconsistent with
those rights, they will incur a liability, in damages, to the shareholders for
procuring a breach of contract.
4.2 Statutory Liabilities
A director may incur liability for losses suffered by shareholders resulting
from non-compliance with legislation. Examples include
(a) where shares are issued in breach of
the statutory pre-emption rights of the existing shareholders. Any director
responsible will be liable to pay compensation to any person suffering a loss;
(b) where there has been a misrepresentation in a prospectus inviting
subscriptions for the company's shares. Any director responsible will, again,
be liable to pay compensation;
(c) if, on a takeover, a payment is made to a director (by the company or a
third party) for loss of office of in consideration of his retirement, without
shareholder approval, any sum received by that director will be held on trust
for the former shareholders, and as such recoverable by them.
(d) for any
dishonest disclosure to the shareholders before they vote on a resolution.[77]
4.3 Shareholder Derivative Suits
Securities class action suits—filed
by shareholders when alleged
negligence or fraud by a company's directors or officers leads to a loss of
shareholder value. Suits against companies such as Enron and WorldCom have
dominated the headlines, but virtually any public company can find itself
targeted by disgruntled shareholders and their attorneys. a similar type of
suit known as a shareholder derivative suit or derivative action. Derivative
suits are filed by shareholders on behalf of a company. They allege that the
company's directors or
officers violated one or more
fiduciary duties owed to the company and its shareholders. Typically,
plaintiffs don’t seek to extract monetary damages, but rather they seek to
protect their long-term interest in the company by imposing corporate governance
and management
changes. If there is a monetary
recovery, it runs to the firm, not to the individual plaintiffs.
4.3.1 The Basis of Liability in Shareholder Derivative Actions
There are two broad categories of
breach of fiduciary duty that underlie derivative actions: duty of loyalty and
duty of care. Breach of duty of loyalty is typically easier to prove.
Basically, duty of loyalty means that a director or officer may not profit at
the expense of the company, but instead must put the company's interests first.
Suits seeking relief under the duty of care theory allege that a company's
directors or officers failed to manage corporate affairs honestly and in good
faith. In either case, the burden is on the plaintiff to demonstrate a
violation has occurred.
4.4.Directors
Liability to Minority Shareholders
Directors
who are
investment bankers, venture capitalists, CEOs or CFOs should be aware that they
may be called to a higher standard of “good faith” in reviewing a transaction’s
economic fairness to minority holders where their financial
expertise gives them a unique ability to evaluate,
and advocate against, unfair elements of the transaction.
The Delaware Court of Chancery, in its decision in
the case In Re Emerging Communications, Inc.,[78]
effectively raised the bar for a showing of good faith director conduct that
will be sufficient to avoid director liability. The case also makes clear that
a director with the financial expertise to know that a transaction is unfair
may not rely on a fairness opinion alone to carry the burden of showing that
the director acted in good faith.
Jeffrey Prosser indirectly held majority control of
Emerging Communications, Inc. (ECM). He proposed a two-step going private
transaction, resulting in a cash-out of ECM’s minority holders for $10.25 per
share. Stockholders challenged the fair value of the merger in an appraisal
proceeding and sought recovery based on a breach of fiduciary duty by the ECM
directors. A special committee of ECM’s board had approved the transaction
following limited negotiations and receipt of a fairness opinion from Houlihan
Lokey Howard & Zukin (Houlihan), the committee’s financial advisor. The
court reviewed the transaction for “entire fairness,” looking to the fairness
of the price and whether Prosser and his affiliates had engaged in fair dealing
with the committee and minority stockholders. The court determined that neither
the price nor the course of dealings was fair. The court found that directors
breached their duty of care and that Prosser and his affiliates, including his
personal attorney (and ECM board member) John Raynor, had breached their duty
of loyalty through self-dealing and failures to disclose. The court also found
that ECM director Salvatore Muoio, an investment banker with “specialized
expertise or knowledge” that was on par with that of Houlihan, had breached his
duty of good faith because he “knew or had strong reasons to believe” that the
proposed deal value was unfair, yet he failed to vote against the deal, make
his concerns known to other directors on the record, or advocate that the Board
reject the deal. Accordingly, the court ruled in favor of the plaintiffs in the
appraisal proceeding (awarding them $38.05 per share plus interest) and found
that Prosser, Raynor and Muoio were jointly and severally obligated to pay the
minority stockholders approximately $77 million, representing the difference
between the fair value of ECM determined by the court of $38.05 per share and
the $10.25 cash-out merger price.
In the recent McMullin v. Beran,[79]
the recognized that the Board has special obligations to minority shareholders.
The court stated that, in the absence of a majority shareholder, directors
considering the sale of the corporation must diligently pursue the transaction
offering the best value reasonably available for all shareholders. When a sale
proposal instead comes at the behest of a majority shareholder, the duty of the
directors is essentially the same — i.e., value maximization for all
shareholders — but with a special obligation to protect the interests of the
minority shareholders. The court held that, even though ARCO’s voting power
made the outcome a forgone conclusion, the Chemical directors were required to
perform a full analysis of the sale to determine whether the proposal would
result in maximum value for the minority shareholders.[80]
5.1 Liability on Contracts
Where the directors enter into a contract on behalf of the company, in the
unlikely event of the company itself not being bound by that contract, the
director may incur liability to the other party.
A director may likewise be liable under a contract made by him on behalf of the
company: (a) where the contract was entered into pre-incorporation, or
(b) in respect of a transaction where the company's name has not been properly
disclosed on the stationery relevant to that transaction e.g a cheque.
5.2 Potential Liability of Directors
for the Breach of Fiduciary Duty to Creditors
The primary
duties of the directors of a solvent company are the duties of care and loyalty
to the company and its shareholders. When the directors fulfill these duties,
they are usually protected from personal liability. However, officers and
directors of an insolvent company also owe fiduciary duties to creditors, and
are under a heightened duty to maximize value in connection with the inevitable
break up of the company. Although there are several different tests to
determine insolvency, it is often hard to pinpoint when fiduciary duties to creditors
arise. The conservative approach to complying with fiduciary duties to
creditors is to assume that a company is in the zone of insolvency if there is
any substantial doubt.
Once it is determined that a company is in the zone of
insolvency, officers and directors are charged with a fiduciary responsibility
of protecting the interests of creditors based on an "informed business
judgment" standard of care. This usually involves taking appropriate
actions designed to maximize payment of the company's outstanding creditors.
Directors who fail to carry out this responsibility may be subject to liability
for breach of fiduciary duty. For example, a claim of breach of fiduciary duty
may arise when directors favor the interests of shareholders over creditors, engage
in insider transactions, prefer one creditor over another creditor with an
equally valid claim (make a "preferential payment"), or continue the
business longer than is justified, thereby "wasting" the remaining
corporate assets.
The
directors of the A corporation, without giving notice to creditors, transferred
all the corporate assets to the B corporation, which contracted to pay the
debts of the A corporation. Later, the plaintiff recovered a judgment against
the A corporation and, execution being returned unsatisfied, brought suit
against the directors. Held, that the directors are liable.[81]
Directors, who have directly caused such a fraudulent conveyance without making
proper provision for creditors, should be held responsible to the parties prejudiced
thereby.
5.3 The Liability of Directors arising
on Corporate Insolvency
When a company goes into
insolvent liquidation a director of the company may be exposed to a risk of
personal liability.
Generally, in the event of liquidation, the liquidator has a duty to realise
the assets of the company, but to do this he will have to investigate the
affairs of the company, including the actions of the directors. If there has
been any breach of statutory duty or there have been unlawful payments such as
loans or compensation, the liquidator will claim against the director.
Specifically, there are a number of provisions in the Insolvency Act 1986 which
provide for the potential liability of directors, both in the period leading up
to liquidation and during the liquidation itself. These include the following
matters.
(a) Fraud, etc in anticipation of
winding-up.
It is a criminal offence to conceal or destroy the company's property, books,
records and the like within 12 months before insolvent liquidation (or up to 5
years if done with intent to defraud the creditors). The court may also order
repayment, restitution or the payment of compensation by the directors;
(b) Concealment from, and failure to co-operate with, the liquidator.
It is a criminal offence not to hand over property, books, etc to the
liquidator, or deliberately to make a false Statement of Affairs;
(c) Fraudulent trading.
If a liquidator proves that a company carried on its business with the intent
to defraud creditors, the court may order the directors responsible to
contribute to the assets of the company. This is also a criminal offence.
6.1 Generally
A director may be held criminally liable for any offence committed by the
company, where he has aided, abetted, counselled, or procured the commission of
the offence.
Just as individuals owe
a duty not to harm or injure others in society without justification, so do
companies owe a duty not to poison our water and food, not to pollute our
rivers, beaches and air, not to allow their workplaces to endanger the lives
and safety of their employees and the public, and not to sell commodities, or
provide transport, that will kill or injure people.
On 19th July, 2005 the
Supreme Court of India ordered the government to pay a remaining $325.5 million
(15.03 billion rupees) due to Bhopal gas tragedy victims. The U.S. based Union
Carbide Company, now owned by Dow Chemical Co., paid $470 million in
compensation to victims in 1989. But distribution of most of that money was
held up by bureaucratic disputes over the categorization of victims. At last on
19th July the victims or their representatives got justice 20 years after the
tragedy took place.
In 2003
Supreme Court in Assistant Commissioner,
Assessment-ll, Banglore & Ors. v. Velliappa Textiles Ltd
& Anr. took the view that since an artificial person like a
company could not be physically punished to a term of imprisonment, such a
section, which makes it mandatory to impose minimum term of imprisonment,
cannot apply to the case of artificial person. However, Supreme Court in 2005
in Standard
Charted Bank v. Directorate Of Enforcement [82]in
majority decision of 3:2 expressly overruled the Velliapa Textiles case on this
issue.[83]
In Standard
Charted Bank v. Directorate Of Enforcementt, appellant filed a writ petition before High Court Of
Bombay challenging various notices issued under section 50 read with section 51
of Foreign Exchange Regulation Act, 1973 & contended that the appellant
company was not liable to be prosecuted for an offence under section 56 of FERA
Act, 1973
against the decision of High Court appellant filed a special leave before
Supreme Court, contended that no criminal proceeding can be initiated against
appellant company under section 56(1) of FERA Act, 1973 as the minimum
punishment prescribed under section 6(1) (i) is imprisonment for a term which
shall not be less than six months and with fine. Section 56 of FERA Act, 1973
read as follow:
56. Offences and
prosecutions (1) Without prejudice to any award of
penalty by the adjudicating officer under this Act, if any person contravenes
any of the provisions of this Act (other than section 13, clause (a) of
subsection (1) of section 18, section 18A, clause (a) of subsection (1) of
section 19, sub-section (2) of section 44 and sections 57 and 58, or of any
rule, direction or order made thereunder, he shall, upon conviction by a court,
be punishable, -
(i) In the case of an offence the amount or value involved in which exceeds
one lac of rupees, with imprisonment for a tern not less than six months, but
which may extend to seven years and with fine:
Provided
that the court may, for any adequate and special reasons to be mentioned in the
Judgment, impose a sentence of imprisonment for a term of less than six months.
The question for consideration before court was:
Whether a company or a corporation being a juristic person, can be prosecuted
for an offence for which mandatory punishment prescribed is imprisonment &
fine
Prosecution is pre-requisite for inflicting any punishment. But it is natural
when no punishment can be inflicted, no prosecution
can be launched. So it is clear from Standard Charted case that prosecution can
be initiated and fine can be imposed even when imprisonment is given as
mandatory punishment with fine.
6.2 Law Commission Report
Law commission in its 41st report suggested amendment to section 62 of the
Indian penal code by adding the following lines:
In every case in which
the offence is only punishable with imprisonment or imprisonment and fine and
the offender is the company or other body corporate or an association of
individuals, it shall be competent to the court to sentence such offender to
fine only.
This recommendation got no response from the parliament and again in the 47th
report, the law commission in paragraph 8(3) made again the above
recommendation.
U.S. Supreme Court in
New York Central and Hudson River Rail Road Co. v. U.N [17] clearly held that a
corporation is liable for crimes of intent.[84]
A director is not the agent of his
co-directors and the other officers of the company are not the agents of the
directors. Therefore, the fact that a particular director is liable to the
company for breach of duty does not itself render liable any other director of
the company. In the absence of negligence, a director is not liable for the
breach of duty by other directors of which he was ignorant.
However, where a director is under a duty of care, imposed by his contract or
by the general law, to supervise the activities of another director and he
fails to do so, or where he knowingly participates to some degree in or
sanctions conduct which constitutes a breach of duty, he will be just as liable
for those wrongful acts as the other director. A relatively slight degree of
participation will suffice. [85]
The Act or
Articles of Association of the Company may make a delegation of functions to
the extent to which it is authorized. Also, there are certain duties, which
may, having regard to the exigencies of business, properly be left to some
other officials. A proper degree of delegation and division of responsibility
is permissible but not a total abrogation of responsibility. A director might
be in breach of duty if he left to others the matters to which the Board as a
whole had to take responsibility. Directors are responsible for the management
of the company and cannot divest themselves of their responsibility by
delegating the whole management to agent and abstaining from all enquiries. If
the latter proves unfaithful, the liability is that of the directors as if they
themselves had been unfaithful.
To
incur liability, he must either be a party to the wrongful act or later
acquiesce (consent) to it. Thus, the absence of a director from meeting of the
Board does not make him liable for the fraudulent act of a co-director on the
ground that he ought to have discovered the fraud, except where he had the
knowledge or he was a party to confirm that action. The exception is set out in
Section 58AA(10)[inserted by the Companies (Amendment) Act,2000] which provides
if there is contravention of Section 58AA, all the directors and the company
shall be deemed to be guilty of the offence and liable to be prosecuted and
punished accordingly.
Where a
director is made liable for the acts of a co-director, he is entitled to
contribution from the other directors or co-directors who were a party to the
wrongful act. However, where the director seeking contribution alone benefited
from the wrongful act, he is not entitled to contribution.
Generally,
a director has to perform his functions personally. He is bound by the maxim delegates non-potest delegare.
Shareholders have appointed him because of their faith in his skill, competence
and integrity and they may not have the same faith in another person. However,
delegation is proper and valid in two cases;
Firstly,
a delegation of functions may be made to the extent to which it is authorized
by the Act or Articles of Association of the company.
Secondly,
there are certain duties which may, having regard to the exigencies of
business, properly be left to some other officials.
Directors
must be able to entrust details of the management to the sub-ordinates or else
the business cannot be carried on.however a total abrogation of responsibility
is not permissible since this would the collective responsibility of the Board
of Directors.
Now
if a co-director or other official to whom a function is so delegated commits a
fraud and the company suffers a loss, the extent to which the other directors
are liable came up before the House of Lords in the leading case of Dovey v.Corey [86]
There are a number of ways in which a
director may be relieved from liability which would otherwise be incurred for
breach of duty.
8.1 Ratification by the Shareholders
Some breaches may be remedied through the director's conduct being disclosed to
a general meeting and being ratified by the shareholders passing an Ordinary
Resolution.
However, the following breaches of duty cannot thus be ratified:
(a) Any breach involving a failure of honesty
on the director's part;
(b) Any breach of duty which results in the company performing an act which it
cannot lawfully do e.g by reason of some prohibition imposed by statute or the
general law;
(c) Any breach of duty which results in the company performing an act not in
adherence with the company's articles;
(d) A breach of duty bearing directly upon the personal rights of the
individual shareholders;
(e) A breach of duty involving "fraud on the minority".
8.2 Ratification by Consent of all
Shareholders
The common law principle of unanimous approval by all the shareholders is
effective in relieving a director from liability for any breach of duty,
provided only that the breach does not involve fraud on its creditors and
(probably) is not ultra vires the company, so far as that doctrine still
exists.
8.3 Contractual Relief
Any contract between the directors and the company, or any similar provision in
the Articles which attempts to exempt the directors from liability for
negligence, default or breach of trust towards the company is void.
However, directors may exclude their liability to third parties by means of an
express contractual provision or a disclaimer.
8.4 Judicial Relief
The court has power to relieve a director from some civil or criminal
liabilities for negligence, default or breach of trust if it is satisfied that
the director has acted honestly and reasonably and in all the circumstances he
ought fairly to be excused.
This is not however available in respect of all defaults, in particular it is
not available in a case of wrongful trading.
9.1 Limited Indemnity
The company can, in the following circumstances, indemnify a director in
respect of his legal costs. This indemnity may be ex gratia, or it may be
contained in the director's service contract or in the Articles.[87]
The power to indemnify is limited to the following: (a) costs incurred by the
director in successfully applying for judicial relief generally;
(b) costs incurred by the director in successfully applying for judicial relief
re non-payment for shares by a nominee of the company.
However, the indemnification statutes cannot help outside directors in
two respects. First, smaller corporations could not afford to indemnify their
directors. Second, indemnification statutes did not relieve a director from
personal liability for a breach of duty of care, even if the director otherwise
had acted in good faith.
9.2 Be a Whistle Blower
For an independent director, the best way out
before landing in a legal mess, of course, is to be a whistle-blower. To point
out the minutest of irregularities and make sure they are recorded in the
minutes of the meetings.
9.3 Liability Insurance for Directors
A director can obtain insurance to cover certain of his personal liabilities,
including the costs of litigation in which he becomes involved in or arising
out of his office. A company is permitted to pay the director's premiums on
this type of policy.[88]
Policies such as "Directors & Officers Policies", however, often
exclude a number of important potential claims including claims arising from
the director's breach of duty; claims arising out of intentional breach of
contract on the part of a director; claims caused by the director's dishonesty;
claims for bodily injury or property damage; claims arising from libel or
slander; and any claims made by one director against another (although possibly
not claims by the company against the director, depending on the policy).[89]
It may in some cases be more effective for a director to obtain cover limited
to legal expenses (not limited to successful defences).
9.4 Business Judgment Rule
Directors
have historically been protected from personal liability against them by a
legal principal known as the Business Judgment Rule. This legal principal
shields corporate directors & officers by applying the rule for mistakes in
judgment (i.e. second-guessing). As long as the director or officers has acted
according to the duties of loyalty, obedience and diligence, then the director
or officer may be protected by the Business Judgment Rule.
Judiciary had always been reluctant in intervening
with “business judgment decisions” of directors. An example of this judicial
distaste for "hindsight" adjudication of good faith business
decisions is Kamin v. American Express Company. In Kamin, the
defendant company had made a disastrous investment in another company, which
could have resulted in a capital loss of $25 million had the shares in the target
company been sold on the open market. Such a sale, however, would have resulted
in an $8 million tax savings. Instead, the
board of directors declared a "special dividend" pursuant to which
the shares in the target company would be distributed in kind. The plaintiff shareholders challenged this distribution.
The court, however, declared that "[t]he directors' room rather than the
courtroom is the appropriate forum for thrashing out purely business questions.
. . ,”[90]
According to Delaware
law, the business judgment rule provides a presumption that in making a
decision directors were informed, acted in good faith and honestly believed
that the decision was in the best interests of the corporation. Under this
rule, the court will defer to the directors' decision and will not make a
second-guessing about the decision.
In McMullin
v. Beran, [91]a minority
shareholder of ARCO Chemical Company (Chemical) claimed that Chemical’s
directors improperly delegated to the majority shareholder, Atlantic Richfield
Company (ARCO), the responsibility for negotiating Chemical’s sale. The suit
alleged that by failing to put in place certain procedural safeguards — such as
asking the ARCO-related directors to rescue themselves — the Chemical directors
did not adequately protect the interests of the minority shareholders. The
Delaware Supreme Court found that the lower court improperly dismissed the
complaint because the plaintiff had alleged facts that, if true, would rebut
the "business judgment rule" presumption that generally protects
corporate directors from liability.
The standard
applied by the court was the business judgment rule, a legal presumption that
corporate directors have acted on an informed basis, in good faith, and with
the honest belief that they are acting in the best interests of the
corporation. A plaintiff shareholder in a case against corporate directors must
initially meet the burden of rebutting the presumption by providing evidence
that the directors breached any of their fiduciary duties of due care, loyalty,
and good faith. If the plaintiff fails to do so, the business judgment
rule attaches and protects the directors from individual liability for the
board’s actions. However, if the plaintiff shareholder succeeds in getting past
this initial hurdle, the case against the directors may proceed with the burden
shifting to the directors to prove the "entire fairness" of the
transaction.
McMullin
asserted that the Chemical board failed to exercise due care by allowing ARCO
to negotiate without procedural safeguards in place to protect the interests of
the minority shareholders, and by permitting ARCO to place its own restrictions
through a cash-only offer requirement. Furthermore, the Chemical board met only
once to consider the proposed transaction, and approved it based on
representations made chiefly by ARCO’s financial advisor. As a result, McMullin
alleges that the Chemical directors "rubber stamped" a transaction
that sacrificed value that the minority might otherwise have realized. The
court held that McMullin’s claims "suggest that the directors of Chemical
breached their duty of care by approving the merger … without adequately
informing themselves about the transaction and without determining whether the
merger consideration equaled or exceeded Chemical’s appraisal value as a going
concern."
Regarding the
directors’ duty of loyalty to the corporation, the business judgment rule
presumption is rebutted upon a showing of improper influence on the directors
that compromised their ability to independently evaluate the proposed sale. The
court held that the Chemical directors owed an uncompromising duty of loyalty
to the minority shareholders and that "[t]here is no dilution of that
obligation in a parent subsidiary context for the individuals who acted in a dual
capacity as officers or designees of ARCO and as directors of Chemical."
The plaintiff shareholder claimed that six of the twelve directors were
employed by ARCO and two others had former affiliations with ARCO, and none of
these conflicted directors abstained from the vote regarding the sale. The
court held that the directors should be required to answer the well-pled
loyalty allegations regarding the effects of the ARCO-related conflicts.
The court
further found that due care, loyalty and good faith obligated the Chemical
directors to disclose to the shareholders all information material to the
proposed Lyondell transaction. Because McMullin’s allegations of significant
omissions in the shareholder communications justify a detailed factual inquiry
to determine their merit, the court held, the case was improperly dismissed.
9.4.1 Do
we need a Business Judgment Rule?
There was a call from the business community of
several countries for the enactment of the Business Judgment Rule.[92]
There was a considerable confusion on the exact nature of such a rule but the
work of the American Law Institute[93]
on its Principles of Corporate Governance provided some clarification of the
concept. This formulated the basic Business Judgment Rule[94]
Such a rule
exists under the case law of the various United States jurisdictions and has
been codified in some of the States. In the ALI formulation the rule gives an
immunity to the directors satisfy the three prerequisites.
There however
had been growing pressures on the Courts to expect more of company directors. A
few courts like Australia have begun to recognize the legitimacy of some degree
of risk taking in business judgment.[95]
Consistent
with their view of the duty as a common law duty, their Honours thought that
the law of negligence could accommodate differing degrees of duty subject to
the ultimate test resting ‘upon a general public sentiment of moral wrong doing
for which the offender must pay.’
The recent
trend in the Antipodean case law in the insolvent trading cases has been
increasingly rigorous and many of the cases have contained general statements
which have been used by the courts in tightening the law on the duty of care.
Such a rigour is in fact inconsistent with an increased recognition of the
legitimacy of risk taking and United States style of Business Judgment Rule. On
the other hand, judging by the United States experience, the introduction of
the Business Judgment Rule without the tightening up of disclosure requirements
and the effective policing of self-interested transactions could be disastrous
for investors.[96]
10. SEBI’s Clause 49 of Listed Companies
On
January 1 2006, when India embraces SEBI's Clause 49 for listed compaanies,
independent directors will come under the purview of a host of liabilities and
governance parameters. What must they guard against?
•
About 8.3 lakh Worldcom investors will get back $6.1 billion from investment
banks, auditing firms and former WorldCom directors in settlements.
• Cendant
Corp, the US travel and real estate service provider, paid $2.83 billion in
investor settlement for unspecified accounting irregularities. Ernst &
Young, the former auditor of CUC International, Inc., also agreed to settle
allegations for $335 million.
•
Time Warner will pay $2.4 billion and reserve another $600 million to settle
investor claims in the failed merger with Internet firm America Online.
• Morgan
Stanley will pay $188.9 million to Parmalat Finanziaria SpA. It spent $140
million on legal matters in Q2 2005, mostly on settlement negotiations
• Bank of
America Corp. and FleetBoston Financial Corp. reached a record $675 million
settlement with the Securities and Exchange Commission and New York Attorney
General Eliot Spitzer over illegal mutual fund trading.
These are
instances of only some of the corporate settlements in cases filed against
company directors and companies worldwide. As India embraces its most stringent
corporate governance norms till date for listed companies under Clause 49 on
January 1, 2006, those planning to occupy the “independent director” position
on company boards will face greater scrutiny and accountability.
While
ringing in stricter corporate governance norms for Indian industry, Clause 49
also has major ramifications for senior management. Greater personal accountability,
deemed knowledge of violations, distinct role of each director as against collective functionality of the
Board, stricter monitoring and supervision required on the part of
non-executive / independent directors are just some of them. The clause also
widens the scope of claimants of corporate governance from shareholders and
Investors to all stakeholders, including employees and regulators.
Independent
directors are to play an active role in various committees to be set up by a
company to ensure good governance. For instance, listed companies are required
to set up audit committees of a minimum three directors, on which, two thirds
should be independent directors. The audit committee, chaired by an independent
director, shall inspect the company's financial statements and can also
recommend replacement of the statutory auditor.
Directors
& officers will be held liable for a host of reasons including misuse of
corporate funds, false statements to government agencies, irregularities in
securities issues, breach of duty to minority shareholders, imprudent expansion
leading to erosion of shareholder wealth, employment irregularities/harassment,
mergers &
acquisition,
among others.
Says JJ Irani,
chairman JJ Irani committee on corporate governance: “Under Clause 49, at
present an independent director can even be held liable to the bouncing of a
cheque. We are working on changing an independent director's liability to be
restricted to that which is stated in the minutes of the meeting.”
But close association
with a company's day to day functioning is not always possible for an
independent director. He may be a member of more than one board and may also be
running his own business or have other professional liabilities. Says Richard
Elias, chairman, Hyperion insurance group, “outside directors are most
vulnerable since they are not involved with the day to day running of the
company. Unfortunately, if a suit is filed against them, they can be in
trouble. For instance, the defense costs alone in the Equitable Life case ran
to $ 40 million.” What more, with the Indian companies inviting foreign
capital, listing on foreign exchanges and investing in foreign companies
abroad, the independent directors may also be liable under laws of different
countries. Says Praveen Vashishta, CEO and MD Howden India: “According to a US
law, as soon as the total number of employees for a foreign company in the US
crosses 300, the employees are treated as investors and they can avail of all
investor rights. They can then sue the Indian board of directors for a breach,
if any. This is just one of the instances of a director's liability in a
rapidly globalising world order.”
11.
Directors and Officers Liability vis-à-vis Adequacy of Protection under the
Provisions of The Companies Act,
The introduction of clause 49 in the Stock Exchange Listing
Agreement based on Corporate Governance Philosophy, the legislative changes in
various enactments like SEBI Act, SEBI (Disclosure and Investor Protection)
Guidelines and some recent landmark judgments by the High Courts and the
Supreme Court based on the above have cast onerous responsibilities on the
corporate functionaries, especially the Directors and key officers of the
company. If one looks at the number of
enactments under which a director of a company, executive and non-Executive
alike, can be held directly liable for any act of negligence or default, he
will find that the number is not less than 50. Apart from these statutory
liabilities, a company director/officer can also be held liable for contractual
obligations undertaken by the Company having his active involvement and for any
tortuous liability.
So simply swap the role of the investor or dealer and step into
the shoes of a Corporate Executive/Director and you will realize that in
today’s era there is much more pressure on a Director or a key executive than
what it used to be may be a decade earlier. Interestingly, the independent
directors who otherwise used to enjoy substantial immunity under the pretext of
being non-wholetime Director and being only a general advisor to the management
on certain policy decisions, can no longer enjoy the same immunity under the
modern corporate regime because of the exposure they face today. They can be
sued even for certain defaults committed by the Company. In such eventualities
their personal assets can be threatened. Add to this the continued media
attention which any corporate litigation gets nowadays and one can really sense
the complexity and gravity of the situation.
To understand this in a better perspective, let us refer to
Section 292(1) (c) of the Companies Act, 1956 (hereinafter the “Act”) which confers
borrowing powers on the Board of Directors of a Company. Subject to the
provisions of the Memorandum and Articles of Association of the Company, the
said powers can be delegated to individual Directors and also to agents other
than Directors. Thus, generally speaking, whether the Director of a Company who
incurs debts on behalf of the Company (even when the Company is in financial
difficulty) can be held personally liable for such debts, would hinge mainly on
the following :
(a) whether the Director in question has acted in good faith and
in a bona fide manner in the interests of the company ;
(b) whether the Director has acted in accordance with his powers
i.e. whether he was empowered to incur debts on behalf of the Company; and
finally
(c) whether he has acted negligently in the exercise of his
powers.
Hence, if a Director has acted with due care, in a bona fide manner
and within the bounds of his authority, he cannot be held personally liable for
his acts. Where however, the debt has been incurred by a Director acting
negligently, or in a mala fide manner, or even outside the scope of his
authority, the Director may be held personally liable for such debt. Thus in the
case of Weeks v. Propert[97] it was held that a Director is liable if he
negotiates a loan on behalf of his Company which results in the company
exceeding the limits of his borrowing powers as fixed by the Memorandum of
Association. Similarly, it was held in the case of Kundan Singh v. Moga
Transport Co. Pvt. Ltd.[98]
that though there is no specific provision in the Companies Act making a
Managing Director of a Company liable for company’s debts, such liability may be
attributed to a Director by the application of agency principles to the
transaction in question. There are several such sections under the Companies
Act or in other Acts, where such liabilities can be fixed on the head of the
company and/or the director in question. The question thus
arises is that whether there is any protection available to the Directors under
the Act or elsewhere to guard the individual Director?
A careful reading of S.2(30)[99]
and S.5[100] suggests
that in the absence of a specification of some Director or Directors as
Officers responsible for the affairs of the Company, all the ordinary Directors
are deemed to be “Officers in Default” in the event of failure to comply with
statutorily prescribed obligations e.g. if no Director is specifically
appointed as an “Occupier” under the provisions of the Factories Act, then any/all
Directors, who are directly responsible for any particular offense under that
act, can be dragged into litigation, if default is committed by the Company under
the said act.
“Mens Rea” requires the prosecution to prove that the accused had guilty
mind in committing an offence. However after the Companies (Amendment) Act,
1988, various provisions of the Companies Act, 1956 were amended and ‘mens
rea’ no longer forms the part of the definition of the “Officer in
Default”. Therefore ‘mens rea’ is no more an essential ingredient for
establishing the offence in question and when there is a failure to comply with
the statutory obligations, the failure is punishable summarily. That means
prosecution need not prove that there was:
a) guilty mind
b) mala fide intention on part of the accused and c) the
default was committed by the accused knowingly or willfully.
There are still a number of sections under the Act, which do not
have the words “Officer in Default”, where guilty mind needs to be established.
Besides the provision of “Officer who is in Default” several other Acts contain
identical provisions for offences committed by the Companies. Interestingly,
while deciding the cases for determining the liability, modern day courts award
not the actual damages incurred by the aggrieved party but they take into
consideration the ability of the Company to pay for such damages. Similarly all
reasonable steps are taken to avoid the occurrence/claim is no longer a valid
ground for escaping the liability. This is a paradigm shift from the earlier
position.
PROTECTION UNDER
THE COMPANIES ACT, 1956
There are certain sections under the
Companies Act which provides some kind of protection/immunity to the Directors and
Officers.
The relevant sections are S.201[101],
S.633[102] and S.635A[103]
ADEQUACY OF SUCH PROTECTION
Although it appears from a general
reading of these sections that protection and cover is provided to the
Directors under the Act, how much adequate it will be under a peculiar
situation when a particular Director passes through rough waters is to be seen.
The main reason is that in all such circumstances the ‘onus’ or the ‘burden of
proof’ for proving ‘innocence’ is always on that particular Director. If a
Director/Officer is not provided adequate financial cover by the Company his
personal assets will be at stake and this may tend to his becoming
non-committal, non-functional as he will avoid taking any risk associated with
his decision making, his advise and where his actions for which he will be made
accountable or directly responsible are exposed to such risk. Now is the
financial cover provided by the provisions of section 201, adequate? Facts
suggest that the answer is “No”, primarily for the following reasons.
1. The Proviso to this section is
relating to “indemnification” i.e. to enable the Company to indemnify against
liability incurred in defense of any of its Directors/Officers only in the
event of his having been found innocent or acted bona fide by
the competent court and not in any other cases;
2. It would also appear that the
Company cannot spend its own funds or give financial help to any Officer for
defending him in any civil or criminal proceedings. It can only indemnify him is
cases where he is successful in defending
action against him;
3. Although the definition of
‘Officer’ is an inclusive definition and includes in its purview, Directors, key
executives (i.e. employees who have been charged with a particular
responsibility), from the Company and auditors or authorized agents of the
Company, it excludes such class as shareholders, creditors, third parties etc.
EXTERNAL
PROVISIONS FOR PROTECTION
How does the Director/Officer protect
himself or how does the Company assure him of his financial protection to
achieve desired contribution from him? The answer to this lies in two things.
First and foremost is adherence to the highest level of corporate governance
and secondly the Directors and Officers Liability Insurance (D&O cover).
Interestingly enough, Section 201 of the Act nowhere prevents the company from
insuring its Directors/ Officers against potential liabilities undertaken by
them and any loss likely to be incurred on that account. This fact itself is
suggestive that the indemnity factor provided in the section is limited only to
the successful defense of the action and as such it is not all pervasive.
CORPORATE
GOVERNANCE
How does the
company or the Director ensure good corporate
governance?
Apart from simply monitoring the
Corporate Governance standards through disclosures made by the company,
pursuant to Clause 49 of the listing agreement or otherwise, following 10 point
programme would help a better governance and reduction of risk:
Continuously visit the corporate governance
practices and to treat this as a continuous improvement area;
Make the maximum use of the
Independent Directors in decision making process;
Hold meetings of Independent
Directors without management’s presence;
Review and evaluate the performance of
every individual Director on the Board, at least annually;
Set up a nomination committee for
nomination of Director on the Board;
Increase the frequency of the
meetings of audit committee, remuneration committee, nomination committee;
Investigate any warning sign;
Create/preserve a record supporting
the investigation and generally helpful for the cause e.g. minutes of meetings,
important documents etc. ;
Provide for indemnification for every
individual Director/Officer who is actively involved in the decision making process;
Provide for D&O cover.
How does this
help the Company and its Directors?
The insurance companies which
provides the D&O cover, rate companies having the highest Corporate
Governance standards, higher for providing the cover as it views such companies
as less risky and accordingly the premium is on a lower side. This way the
company is financially benefited. Courts in India also have taken liberal views
while viewing allegations against Directors of such Companies, where they
observe highest corporate governance standards.
DIRECTORS AND
OFFICERS LIABILITY INSURANCE COVER
A standard D&O policy, apart from
the regular features has following insuring clauses :
(a) The D&O section indemnifies
the Directors and Officers for their wrong doings like wrongful acts, errors of
judgment, negligence and ;
(b) The Company reimbursement section
pays the Company for any money it has settled on behalf of the Directors and
Officers. The coverage includes the damages awarded against the Directors and
Officers and expenses incurred by the Company on litigation. A cover can be
taken on ‘Occurrence’ basis or ‘Claims made’ basis.
An all inclusive D&O cover,
covers subsidiary/associate/group Companies also.
The premium for this policy is
dependant on the size, turnover, business activity, risk involved (e.g. as
narrated above a Company following good corporate governance practice will
attract lesser premium), ongoing litigations, nature of cover, add-on cover,
riders so on and so forth.
To give an indicative example,
ideally, a manufacturing Company, having operations mainly in India, following
good Corporate Governance Practices and having a turnover in the range of Rs.
100 cr. to 250 cr. per annum, can take out a policy for its Directors and
Officers carrying a cover of Rs. 5 cr., by paying an annual premium in the
range of Rs. 2-3 lacs.
While summing up, it can thus be seen
that while the modern day era burdens the Director/Officer of the Company with
rigorous responsibilities, the Company of which he is a Director/Officer, with
judicious planning and policy making, can relieve him of his financial and
mental obligations to a greater extent by adhering to good corporate Governance
Practices and protection of insurance cover.
12. CONCLUSION
A MORE INTERVENTIONIST APPROACH BY THE COURTS?
Indian
companies are following the increased responsibilities and accountability on
the part of the directors as that of the British companies. In the light of
this the following concerns recently identified by the learned editor of The Company Lawyer are increasingly
likely to be met:
“That
high standards of directors should be enforced by the law we accept as
fundamental. If an individual accepts that office and if there is then a
failure in those standards, the office of director should not be available to
that individual. Accordingly, it is important to ensure that those who become
directors understand that they contribute to major decisions, are obliged to
take an overview and are obliged to receive and have regard to information in
enable them to take decisions[104]”.
In
such circumstances, and for such reasons, challenges are now being made to the
English Judiciary’s traditional approach of non-intervention with the internal
management of the companies.[105]
It is considered that today’s judges should be more alert for ulterior purposes
of private advantage than were their predecessors. They should be prepared to
intervene and interdict by reference to the real purposes which primarily
motivate directors’ actions. Statements by directors of British companies about
their subjective intention, whilst relevant, are no longer conclusive of their bona fides or of the purposes for which
they acted as they did.[106]
It is suggested that the day when then the directors could shield themselves
from scrutiny by asserting that they acted honestly and with good intention are
gone.
Kirty
P in Darvall v North Sydney Brick &
Title Co Ltd (No.2)[107]put
the proposition in this way:
“Directors
of corporations cannot immune themselves from a scrutiny of their purposes by
asserting that they acted honestly and with good intention for this or that
legitimate purpose. The purpose may be scrutinized by a court to see if this
assertion should be accepted. The directors, cannot by dooming blinkers, ignore
the plain facts disclosed to them and then assert that they acted bona fide in
the best interests of the company. A more rigorous standard of conduct is
required by law.
While
the pre-eminence of the proper purpose doctrine, and its current resurgence
with popularity with the English Courts, it is considered likely that the
judiciary will become more vigilant and more involved in reviewing directors’
decision-making in order to determine whether in fact decisions which directors
assert on oath, as having been made bona
fide in the interests of the company as a whole, accord with a strict
application of the proper purposes doctrine.[108]
Mere assertion of subjective honesty will no longer be considered enough to
hold the day.
Although
the cases are replete with caveats reminding judges not to second guess
business decisions, when faced with allegations that those business decisions
are improper, more and more are today’s judges obliged to test those decisions
against objective criteria. It is inevitable that that will require the
directors directors’ of British companies whose decisions are under attack to
give evidence of their subjective intention in this regard. That in turn
obliges the judges to step upon dangerous ground for proper purposes focuses
upon the decision itself and ‘calls for a more interventionist line, reviewing
the business judgments of business men.’
But
as Ipp J in Permanent Building Society v
Wheeler[109] reminded
us, the issue is, ‘not whether a management decision was good or bad: it is
whether the directors acted in breach of their fiduciary duties. That involves
an inquiry into, and a determination of, whether but for the improper purpose
the directors would have performed the act impugned, it is suggested that
tomorrow’s English courts will be increasingly prepared to conduct such an
inquiry.
REFERENCES
PRIMARY SOURCES
A. STATUTES
1. Companies Act, 1956
2. SEBI Clause 49 of Listed Companies
SECONCONDARY SOURCES
A.
BOOKS
1. Rider,A.K,Barry., ‘The Realm of Company Law,’ A Collection of Papers in Honour of Professor Leonard Sealy, Kluwer Law International, The Hague, Netherlands.
2. Cheong-Ann Png., ‘Corporate Liability-A Study in the Principles of Attribution,’ Vol 13, Kluwer Law International, The Hague, Netherlands, 2001.
3. Arthur A.Pinto, Gustavo Visentini, ‘The Legal Basis of Corporate Governance in Publicly Held Corporations- A Comparative Approach,’ Vol 1, Kluwer Law International, The Hague, Netherlands, 1998
4. Demetra Arsalidou, ‘The Impact of Modern Influences on the Traditional Duties of Care, Skill and Diligence of Company Directors’ Vol 14, Kluwer Law International, The Hague, Netherlands, 2001
5. Bruce S.Butcher, ‘Directors’ Duties-A New Milennium, A New Approach?’,
Vol 7, Kluwer Law International, The Hague, Netherlands, 2000.
6. Halsbury’s Laws of England, 3rd Edn, Vol 6.
7. A.Ramaiya, ‘Guide to the Companies Act,’ Part 1, 16th Edn, Wadhwa &Company, Nagpur, 2006.
8. Pennington’s Company Law, 8th Edn, Oxford University Press, New Delhi, 2006.
9. Paul.L.Davies, Gower & Davies, ‘Principles of Modern Company Law’, 7th Edn, Sweet & Maxwell, London, 2003.
10. L V V Iyer, ‘Guide to Company Directors’ Powers, Rights, Duties & Liabilities’, 2nd Edn, Wadhwa & Company, Nagpur, 2003.
11. Avtar Singh, ‘Company Law,’ 14th Edn, Eastern Book Company, Lucknow, 2005.
12. A.K.Majumdar, Dr.G.K.Kapoor, ‘Company Law’, 9th Edn, Taxmann Publications (Pvt) Ltd, New Delhi, 2005.
1. “Corporations. Duties of Directors. Neglect Resulting from Absence upon Vacations” Harvard Law Review, Vol. 23, No. 4. (Feb., 1910), p. 309.
2. Corporations: Liability of Officers of Corporate Trustee for Breach of Trust, Michigan Law Review, Vol. 34, No. 6. (Apr., 1936), pp. 867-875.
3. Carter G. Bishop, ‘A Good Faith Revival of Duty of Care Liability in Business Organization Law’, Legal Studies Research Paper Series Research Paper 07-02 January 24, 2007
4. Aubrey L. Diamond, ‘Lifting the Veil?,’ The Modern Law Review, Vol. 38, No. 2. (Mar., 1975), pp. 198-200.
5. Thomas C. Lee, ‘Limiting Corporate Directors' Liability: Delaware's Section 102(b)(7) and the Erosion of the Directors' Duty of Care,’ University of Pennsylvania Law Review, Vol. 136, No. 1. (Nov., 1987), pp. 239-280.
6. Ross Grantham; Charles Rickett, ‘Directors' 'Tortious' Liability: Contract, Tort or Company Law?,’ The Modern Law Review, Vol. 62, No. 1. (Jan., 1999), pp. 133-139.
7. C. Brewster Rhoads, ‘Personal Liability of Directors for Corporate Mismanagement,’ University of Pennsylvania Law Review and American Law Register, Vol. 65, No. 2. (Dec., 1916), pp. 128-144.
8. Margaret Smith, ‘Directors Liability,’ Canadian Law and Government Division, 29 February 2000
9. Simon Johnson; Rafael La Porta; Florencio Lopez-de-Silanes; Andrei Shleifer, ‘Tunneling,’ The American Economic Review, Vol. 90, No. 2, Papers and Proceedings of the One Hundred Twelfth Annual Meeting of the American Economic Association. (May, 2000), pp. 22-27.
10. Marilyn R. Kaplan; J. Richard Harrison, ‘Defusing the Director Liability Crisis: The Strategic Management of Legal Threats,’ Organization Science, Vol. 4, No. 3, Focused Issue: The Legalistic Organization. (Aug., 1993), pp. 412-432.
C. TABLE OF CASES
1.
Lennard’s Carrying Co.Ltd
v.Asiatic Petroleum Co.Ltd: (1915) A.C.705, p.713
2.
Tesco Supermarkets Ltd v.
Nattrass. (1972)
A.C. 153
3.
Meridian Global Funds Management
Asia Ltd v. Securities Commission (1995) 2 A.C. 705
4.
Brlande v.Earle [1902] AC 83
5.
Clemens
v.Clemens Bros Ltd [1976] 2 All ER 268
6.
Darvell vs. North Sydney Brick
& Title Co Ltd (No.2) (1989) 7 ACLC 659 at 676
7.
Permanent Building Society v. Wheeler
(1993-1994) 11 WAR 187 at 193.
8.
Fraser
v. Whalley (1864) 2 H&M 10
9.
Hogg
v. Cramphorn Ltd [1967] Ch 254
10.
Punt
v. Symons & Company Ltd [1903] 2 Ch
506
11.
Piercy
v. S.Mills & Company Ltd[1920] 2 Ch 77 at 84.
12.
Hindle v. John Cotton Ltd (1919) 56 Sc LR 625
13.
Howard
Smith Ltd v. Ampol Petroleum Ltd [1974] AC 821
14.
Brazilian
Rubber Plantations and Estates Ltd, Re [1911] 1 Ch 425” 103 LT 697.
15.
Selangor United Rubber Estates v.
Cradock (No.3),[1968]
2 All ER 1073
16.
Land
Credit Co of Ireland v. Lord Fermay (1869) LR 3 Eq 7: (1850) 5 Ch App 763.
17.
City
Equitable Ins Co, Re, 1925 Ch 407
18.
People
v. Mancuso, 255 GY 463, 469.
19.
Duomatic
Ltd, Re [1969] 2 WLR 114 233 NY 103 USA.
20.
Barnes v. Andrews, (1924) 298 F 614, USA.
21.
Kavanangh v. Common Wealth Trust
Co, (1918
22.
Daniels v Anderson (1995) 16 ACSR 607
23.
Claridge’s Patent Ashphalt Co,
Re, [1921] 1 Ch
543: 125 LT 255.
24.
S.L.Kapoor v. ROC, [1964] 1 Comp LJ 211 Ori
25.
Progressive Aluminium Ltd v ROC, (1999) 95 Comp Cas 138 AP.
26.
Gautam
Kanoria v. Asst ROC, (2002) 108 Comp Cas 260 Bom
27.
Charitable
Corpn v Sutton, (1742) 26 ER 642
28.
Official Liquidator vs. PA
Tendulkar.
29.
Bostan Drep Sea Fishing & Ice
Co. v.Ansell,
(1888) 39 Ch D 339
30.
Cook v. Deeks [1916] 1 AC 554: [1916-17] ALL
ER Rep 285
31.
Burland
v. Earle 1902 AC 83 : [1900-3] ALL ER Rep Ext 1452.
32.
Thomas
Marshall (Exports) Ltd v. Guinle 1979 Ch 227.
33.
Fine Industrial Commodities Ltd
v. Powling (1954)
71 RPC 253
34.
Cranleigh Precision Engineering
Ltd v. Bryant [1964]
3 ALL ER 289.
35.
Peso Silver Mines Ltd v. Cropper, (1966) 58 DLR (2d) I.
36.
London and Mashonaland ExplorationCo.
V. New Mashonaland Exploration Co, 1891 WN 185.
37.
Bell v. Lever Bros Ltd, 1932 AC 161
38.
Industrial Development
Consultants ltd v. Cooley[1] [1972] I WLR 443: [1972] 2 ALL
ER 162.
39.
Hivac
Ltd v. Park Scientific Investments Ltd, 1946 Ch 169.
40.
Regal
Hastings Ltd v. Gulliver [1942] 1 All ER 378.
41.
Boardman
v. Phipps, [1967] 2 AC 46.
42.
Salman
Engg Co. Ltd v. Campbell Engg Co.Ltd, 1948 PRC 203
43.
Trevor
Ivory Ltd v Anderson [ 1992] 2 NZLR 517
44.
First
Trust Co. of Lincoln v. Carlsen (Neb. 1935) 261 N. W. 333.
45.
Sweet
v. Montfelier Savings Bank &Trust Co 73 Kan. 47, 84 P. 542 (1906)
46.
R.K. Dalmia and others v. The
Delhi Administration
47.
Spering's
Appeal ubi supra, at p. 24. '38 L J., Ch. 639 (1869). 82 N.Y. 65 (1880).
48.
Turquard
v. Marshall7
49.
Hun
v. Cary 78 Pa. 370 (1875).
50.
Watt's
Appeal,
51.
Hopkins & Johnson's Appeal 90 Pa. 69 (1879).
52.
John Crowther Group plc v Carpets
International plc [1990] BCLC 460).
53.
In Re Emerging Communications, Inc.,
54.
McMullin v. Beran 2000 WL 1741717 (Del. Supr. Nov. 20, 2000),
55.
Darcy
v. Brooklyn New York Ferry Co., 89 N.
E. 461 (N. Y.).
56.
Assistant
Commissioner, Assessment-ll, Banglore & Ors. v. Velliappa
Textiles Ltd & Anr. AIR 2004 SC 86
57.
Standard Charted Bank v.
Directorate Of Enforcement (2005) 4 SCC 50
58.
H.L BOLTON (engg.) co. ltd v. T.J
Graham and sons[18].
59.
J.K. Industries v. Chief
Inspector of Factories
60.
Kamin
v. American Express Company 2000 WL 1741717 (Del. Supr. Nov. 20, 2000),
61.
Weeks
v. Property (1873) LR 8 CP 427
62.
Kundan
Singh v. Moga Transport Co. Pvt. Ltd (1987) 62 Com Cases 600
(P&H)
D. ELECTRONIC
DATA
[1] A.Widavsky, Responsibilities are Allocated by Cultures (1986), p.1
[2] The expression has become commonly associated with the intricacies of corporate accountability following the discussion in J.C.Coffee, ‘No Soul to Damn, No Body to Kick- An Unscandalised Inquiry into the Problem of Corporate Punishment’ (1981)
[3]
The traditional directing mind theory is generally traced to the judgment of
Viscount Haldane L.C’s in Lennard’s
Carrying Co.Ltd v.Asiatic Petroleum Co.Ltd:
“A corporation has no mind of its own than it has a body of its own; its active and directing mind musy consequently be sought in the person of somebody who for some purposes may be called an agent, but who is really the directing mind and will of the corporation, the very ego and the centre of the personality of the corporation. That person may be under the direction of the shareholders under the general meetings; that person may be the Board of Directors given to him under the articles of association, and is appointed by the general meeting of the company, and can only be removed by the general meeting of the company.” (1915) A.C.705, p.713
[4] The traditional directing mind theory was subsequently considered and approved by the House of Lords in Tesco Supermarkets Ltd v. Nattrass. (1972) A.C. 153
[5] (1995) 2 A.C. 705
[6] In Re, Forest of Dean Coal Mining Co, it was stated
that ''function is everything; the name matters nothing.'' So long as a person
is duly appointed by the company to control the company's business and is
authorized by the Articles to contract in the company's name and, on its
behalf, he functions as a Director
[7] William C.Douglas, Directors who do not Direct, (1934) 47 Harv LR 1305, 1307
[8] Brlande
v.Earle [1902] AC 83
[9] Justice Foster in Clemens v.Clemens Bros Ltd considered that a director must not only
act within the powers but must also exercise them bona fide in what he believes
to be the interests of the company. [1976] 2 All ER 268 at 280; Prentice D.D, ‘Restraints on the Exercise of Majority
Shareholder Power’(1976) 92 LQR 502.
[10] Darvell vs.
North Sydney Brick & Title Co Ltd (No.2) (1989) 7 ACLC 659 at 676; Permanent Building Society v. Wheeler (1993-1994)
11 WAR 187 at 193.
[11] Fraser v.
Whalley (1864) 2 H&M 10
[12] The Law Commission in the recent report entitled Company Directors: Regulating Conflicts of
Interests and Formulating a Statement of Duties,HMSO, London, Cm 4436, 1999
at para 5.19 is in favor of a dual
objective/subjective test based on that enacted in Insolvency Act 1986 (UK) s214(4). In expressing its preference for
the codification of such an objective/subjective standard, the Law Commission
considers it important that regard should be had to the functions of the
particular directors and the circumstances of their particular company. In this
respect the Law Commission recommended that:
(1) a director’s duty of
care and skill and diligence to his company should be set out in statute; (2) the standard should be set by a twofold
objective/subjective test; and (3) regard should be had to the functions of the
particular director and the circumstances (including size and type) of the
company.
[13] Hogg v.
Cramphorn Ltd [1967] Ch 254
[14] Improper in the sense of, ‘beyond the scope of or
not justified by the instrument creating the power.’ Vatcher v. Paull (1915) AC 372 at 378 per Lord Parker
[15] Darvell vs.
North Sydney Brick & Title Co Ltd (No.2) (1989) 6 ACLC 154 at 174 per
Hodgson J
[16] Wedderburn K.W., ‘Shareholders’ Control of
Directors’ Powers: A Judicial Innovation?’ (1967) 30 MLR 77 at 83
[17] (1864) 2 H&M 10; Birds J R., ‘Proper Purposes as a Head of Directors Duties’ (1974) 37 MLR 580 at 586
[18] In Punt v.
Symons & Company Ltd where the
directors had issued shares with the object of creating a sufficient majority to enable to pass a
special resolution depriving other shareholders of special rights conferred on
them by the articles. In determining that the directors had acted improperly,
Bryne J., had reaffirmed that directors must exercise their powers for
company’s benefit. Although the power in question was primarily for the purpose
of raising capital, his Lordships have recognized that there might be occasions
where the directors could fairly and properly issue shares for other reasons.
However, a limited issue of shares to secure the necessary statutory majority
in a particular interest is not a ‘fair or bona fide exercise of the power.
[1903] 2 Ch 506; Sealy L S, ‘Company Directors Powers- Proper Motive but
Improper Purpose’
Similarly in Piercy v. S.Mills & Company Ltd,
Peterson J, held that directors are not entitled to use their powers of issuing
shares merely for the purpose of maintaining control or defeating the wishes of
the existing majority of shareholders. [1920] 2 Ch 77 at 84.
[19] [1967] Ch 254
[20] Buckley J’s recognition in Hogg that subjective
honesty of purpose was not always sufficient, launched proper purposes as a
separate test. The Court of Appeal in Bramford
v Bramford relied upon Hogg as an
accurate statement of the law; [1970] Ch 212; (1974) 48 ALJ 319 at 321.
[21] (1919) 56 Sc LR 625
[22] (1919) 56 Sc LR 625 at 630-631.
[23] [1974] AC 821. There the Privy Council was asked
to consider whether or not the allotment and issue of shares to Howard Smith
Ltd was to satisfy the need for capital or whether the directors’ primary
purpose was to destroy the majority shareholding of Ampol Petroleum Ltd and another.
[24] The Nigerian Act set provisions on this aspect of
directors duties:
“A Director shall act at
all times in what he believes to be the
best interests of the company as a whole so as to preserve the assets, further
its business and promote the purposes for which it is formed and in such manner
as a faithful, diligent, careful and ordinarily skilful director would act in
the circumstances.” Section 279 (1) of the Companies and Allied Matters Act,
1990.
[25] (1872) LR 5 HL 480
[26] Brazilian
Rubber Plantations and Estates Ltd, Re [1911] 1 Ch 425” 103 LT 697.
[27] Land Credit
Co of Ireland v. Lord Fermay (1869) LR 3 Eq 7: (1850) 5 Ch App 763.
[28] Selangor
United Rubber Estates v. Cradock (No.3),[1968] 2 All ER 1073
[29] City
Equitable Ins Co, Re, 1925 Ch 407.
[30] [1925] Ch 407
[31] Supra note 21; directors are not liable for
ignorance of trade practices.
[32] M.J.Trebilock, Liability of Directors for Negligence, (1969) 32 Mod LR 409.
[33] People v.
Mancuso, 255 GY 463, 469.
[34] Duomatic
Ltd, Re [1969] 2 WLR 114.
[35] Barnes v.
Andrews, (1924) 298 F 614, USA.
[36] Kavanangh
v. Common Wealth Trust Co, (1918) 233 NY 103 USA.
[37] (1995) 16 ACSR 607.
[38] S.M.Watson, Directors
Duties in New Zealand, 1998 JBL 495 at 502.
[39] “The taking of business risks and allowing
directors a wide discretion in matters in business judgment requires a sober
assessment by directors as to the company’s likely future income stream. Given
current economic conditions, did the directors make reasonable assumption in
their forecasts of future revenue? Creditors are likely to suffer serious
losses if future outflows of cash exceed the cash inflows for the same period.
If there is no profit margin on the goods being sold or services provided the
company will reach a stage where the shareholders’ risk capital has been
exhausted and directors are instead using resources otherwise available to meet
all creditors’ claims. In those circumstances, the company should have stopped
trading. To continue trading is to risk creditors’ money.” Ross.M, Directors Liability and Company Insolvencies-the
New Companies Act, [1994] Commerce Clearing House, 98.
[40] [1921] 1 Ch 543: 125 LT 255.
[41] S.L.Kapoor
v. ROC, [1964] 1 Comp LJ 211 Ori
[42] Progressive
Aluminium Ltd v ROC, (1999) 95 Comp Cas 138 AP.
[43] Gautam
Kanoria v. Asst ROC, (2002) 108 Comp Cas 260 Bom
[44] Charitable
Corpn v Sutton, (1742) 26 ER 642
[45] Kavanaugh v. Commonwealth
Trust Co., 118 N. Y. Supp. 758 (Sup. Ct.).
[46] Our Supreme Court has considered
this issue of fiduciary liability. It has been observed in Official Liquidator vs. PA Tendulkar.
[47] The Nigerian Act contains the following
provisions on the point:
“A Director of a company
stands in a fiduciary relationship with the company and shall observe the
utmost good faith towards the company in any transaction with it or on in
itself.”
[48] Bostan Drep
Sea Fishing & Ice Co. v.Ansell, (1888) 39 Ch D 339
[49] [1916] 1 AC 554: [1916-17] ALL ER Rep 285.
[50] 1902 AC 83 : [1900-3] ALL ER Rep Ext 1452.
[51] Ibid;
“It is one thing if a director sells a property to the company which in equity
as well as at law is his own. It would be quite another thing if the director
had originally acquired the property which he sold to the company under the
circumstances which made it in equity the property of the company.”
[52] 1979 Ch 227.
[53] (1954) 71 RPC 253
[54] [1964] 3 ALL ER 289.
[55] Peso Silver
Mines Ltd v. Cropper, (1966) 58 DLR (2d) I.
[56] [1972] I WLR 443: [1972] 2 ALL ER 162.
[57] Supra, note 10
[58] London and
Mashonaland ExplorationCo. V. New Mashonaland Exploration Co, 1891 WN 185.
[59] Bell v.
Lever Bros Ltd, 1932 AC 161
[60] Hivac Ltd
v. Park Scientific Investments Ltd, 1946 Ch 169.
In Charlesworth and Cain, COMPANY LAW, 406 (13th Edn
19987):
“Under the general law,
apart from the case where a director has a service contract with the company
which requires him to serve only the company, there is authority to the effect
that he may become the director of a rival company, i.e., in this way he may
compete with the first company, provided that he does not disclose to the
second company any confidential information obtained by him as a director of
the first company and that what he may do for the second company, he may do it
for himself or for the rival firm….He must not subordinate the interests of the
first company to those of the second…”
[61] Regal
Hastings Ltd v. Gulliver [1942] 1 All ER 378. It was held that the
directors were in a fiduciary relation to the company and liable, therefore, to
repay to it the profit they had made on the shares.
[62] Boardman v.
Phipps, [1967] 2 AC 46.
[63] Salman Engg
Co. Ltd v. Campbell Engg Co.Ltd, 1948 PRC 203.
[64] David Heller and Andrew Marshall, The Timings of Directors’ Trade in the
United Kingdom and the Model Code, 1998 JBL 454.
[65] In Trevor Ivory Ltd v Anderson. In his
Honour's view, a director is not personally liable for torts committed on behalf of the company because of the combined
effect of the company's separate existence and the doctrinal process by
which the company acts. While directors may
act as the agents of the company, in appropriate circumstances the directors' actions,
knowledge and intention will be directly attributed to the company and treated as if they were the acts, knowledge and
intention of the company itself. The special
treatment of directors thus arises because the tortious act is not that of the director,
but of the company itself. [ 1992] 2 NZLR 517, 526-527.J. Farrar, The Personal
Liability of Directors for Corporate Torts' (1997) 9 Bond LR 102, 108;
R. Grantham, 'Company Directors and
Tortious Liability' (1997) CLJ 259, 262.
[66] (Neb. 1935) 261 N. W. 333.
[67] The court, through Graves, J.,
said:
"When the managing agents of a trust company mingle money
collected for another with the current funds of the company, for use in its
business, in violation of the express directions of the owner to remit, or
knowingly permit their subordinates so to do, and the fund is thereby lost,
such agents will be personally liable to the owner therefor, although at the
time of such misappropriation it was the intent of such managing agents to
account for and return the money to the owner upon demand.
". . . The rapidly increasing volume of important
business transacted between persons widely separated from each other, wherein
trust companies and similar agencies are necessarily employed, demands that
the officers of such agencies be held to a strict performance of the duties
confided to them...."
[68] 73 Kan. 47, 84 P. 542 (1906) ; this case is a
rehearing of 69 Kan. 641, 77 P.
538 (1904).
[69] The court, discussing the rule
as to liability for negligence, said:
"It is a well-known fact that much of the business of this day
and age is transacted by corporations, many of them employing numerous persons
in the various departments of the work in which they are engaged. Large amounts
of money and property are daily handled by the employees of such corporations.
The instruction complained of casts upon the executive officers and managing
agents of such corporations an unreasonable degree of liability. It would be a
great hardship to hold them liable for acts of misappropriation of money or
property by subordinates of which they had no actual knowledge. ..."
[70] In R.K. Dalmia and others v. The Delhi Administration it was held that
"A director will be personally liable on a company contract when he has
accepted personal liability either expressly or impliedly. Directors are the
agents or the trustees of a Company."
[71] Spering's Appeal ubi supra, at
p. 24. '38 L J., Ch. 639 (1869). •82 N.Y. 65 (1880).
The court, speaking through Mr. Justice Sharswood,
concluded that
"While
directors are personally responsible to the stockholders for any losses resulting from
fraud, embezzlement or wilful misconduct
or breach of trust for their own benefit and not for the benefit of the stockholders, for gross inattention and
negligence by which such fraud and misconduct has been perpetrated by agents,
officers or co-directors, yet they are not liable for mistakes of
judgment, even though they may be so gross
as to appear to us absurd and ridiculous, provided they are honest and
provided they are fairly within the scope of
the powers and discretion confided to the managing body."
In the course of the opinion the famous English case of Turquard
v. Marshall7 is cited with approval. In that case Lord
Hatherly, speaking of a loan by the directors of a corporation without
security, says:
"It was within the power of the deed to
lend to a brother director, and,
however foolish the loan might have been, so long as it was within the power of the directors, the court could not interfere and
make them liable. They were entrusted with full powers of lending the money. It
was part of the business of the concern to trust people with money, and their
trusting to an undue extent is not a matter
with which they could be fixed, unless there was something more than that alleged, namely, that it was done fraudulently
and improperly and not merely by a default of judgment. Whatever may have been
the amount lent to anybody, however ridiculous
and absurd it would seem, it is a misfortune for the company that they chose
such unwise directors; but as long as they kept within the powers of the deed, I could not interfere with the discretion
exercised by them."
[72] 82 N.Y 65 (1880)
[73] Hun v. Cary, but
its soundness squarely denied. In referring to that case he says:
"In Spering's Appeal, Justice Sharswood said that directors 'are
not liable for mistakes of judgment, even though they may be so gross as to
appear to us absurd and ridiculous, provided they were honest, and provided
they are fairly within the scope of the powers
and discretion confided to the managing body.' As I understand this language I cannot assent to it as
properly defining to any extent the nature of a director's
responsibility. Like a mandatory, to whom he
has been likened, he is bound not only to exercise proper care and
diligence, but ordinary skill and judgment. As he is bound to exercise ordinary
skill and judgment he cannot set up that he does not possess them."
[74] 78 Pa. 370 (1875).
[75] 90 Pa. 69 (1879).
[76] This principle does not prevent a director from
enforcing his security or issuing execution
where his preference was not the result of an advantage due to his position
and the transaction was fair.
[79] 2000 WL 1741717 (Del. Supr. Nov. 20, 2000),
[80] "Under the circumstances presented in this case, although the Chemical board could not effectively seek an alternative to the proposed Lyondell sale by auction or agreement, and had no fiduciary responsibility to engage in either futile exercise, its ultimate statutory duties … and attendant fiduciary obligations remained inviolable,"
[81] Darcy v. Brooklyn b° New York Ferry Co., 89 N. E. 461 (N. Y.).
[82] ] JT 2005 (5) SC 267; (2005)
4 SCC 50
[83] K.J
Balkrishanan J. in majority opinion held:We hold that there is no
immunity to the companies from prosecution merely because the prosecution is in
respect
of offences for which punishment prescribed is mandatory imprisonment. We
overrule the views expressed by the majority in Velliappa Textiles on this
point. At p. 293 JT 2005 (5) SC 267; (2005) 4 SCC 50
[84]
In H.L BOLTON (engg.) co. ltd v. T.J
Graham and sons[18]. Lord Dening Observed:
A company may in many ways be likened to a human body. They have a brain and a nerve centre, which controls what
they do. They also have hands, which hold the tools and act in accordance with
directions from the centre. Some of the people in the company are mere servants
and agents who are nothing more than hands to do the work and cannot be said to
represent the mind or will. Others are directors and managers who represent the
directing mind and will of the company and control what
they do. The state of mind of these managers is state of mind of company and it
treated by law as such. So you will find that in case where the law requires
personal fault as a condition of liability in tort, the fault of the manager
will be the personal fault of company.
[85] It was held in the case of J.K. Industries v. Chief Inspector of Factories that the directors
being in control of the company’s affairs cannot get rid of their managerial
responsibility by nominating a person as the occupier of the factory. The rule
is, however, not inflexible
[86] 1901 AC 477
[87] The doctrine of indemnification
is well reflected in Section 145 of the DGCL, which authorizes Delaware
corporations to indemnify directors, and persons serving in such capacity for
other entities at the request of the corporation. The law distinguishes between
indemnification in third party actions and stockholder derivative actions.
Based on that, the law also distinguishes between mandatory indemnification and
permissive indemnification. In either type of suit, if the director is
"successful on the merits or otherwise in defense of any action, suit or
proceeding," section 145(c) requires that the corporation indemnify him.
[88]
According to industry
figures, India has only about 300 D&O (directors & officers) policies
at present. Says Tata-AIG's Verma, only 5 to 7 % of all listed companies have
D&O liability at present. Compare this to US where D&O claims form 70 %
of the total claims posted in the US. In Israel this figure lies in the 50 to
70 % region while UK has 50 % of all claims as D&O claims. The respective
figure for India is just 3%. Says Vinayak Chatterjee, independent director on
SRF Limited board: “I have bought the policy as all other directors were buying
it. There were no other reasons or risk perception when I was purchasing the
cover.”
[89] The Delaware model of
D&O insurance is followed by most jurisdictions. The model declares:
"A corporation shall have the power to purchase and maintain insurance on
behalf of any person who is or was a director…whether or not the corporation
would have the power to indemnify him against such liability under this
section."
Under
the US law, it is against public policy to insure a director against liability
for his own intentional wrongdoing. D&O insurance policies are not
obtainable for anything more serious than negligent misconduct. In this
respect, it is not different from other insurance such as doctors' and lawyers'
malpractice insurance.
[90] 2000 WL 1741717 (Del. Supr. Nov. 20, 2000),
[92] Farrar,J.H, ‘Corporate Governance, Business
Judgment and the Professionalism of Directors’ , 1993, 6, p.1
[93] Principles
of Corporate Governance: Analysis and Recommendations, Final Report, Part
IV
[94] ‘A Director or officer who makes a business
judgment in good faith fulfils the duty under this section if the director or officer (1) is not interested in the
subject of the business judgment; (2) is informed with respect of the subject
of the business judgment to the extent to the director or officer reasonably
believes to be appropriate under the circumstances; and (3) rationally believes
that the business judgment is in the best interest of the corporation’.
[95] In the words of the majority in Daniels v. AWA Ltd, ‘the courts have
recognized that the directors must be allowed to make business judgments and
the business decisions in the spirit of enterprise untrammeled by the concerns
of a conservative investment trustee. Any entrepreneur will rely upon variety
of talents in deciding whether to invest in a business venture. These may
include legitimate but ephemeral, political insights, a feel for future
economic trends, trust in the capacity of other human beings. Great risks must
be taken in the hope of commensurate rewards. If such ventures fail, how is the
undertaking of it to be judged against an allegation of negligence by the
entrepreneur…?’
[96] Debroh A.De Mott, ‘Directors’ Duty of Care and
the Business Judgment Rule, Bond LR, 1992.
[97] (1873) LR 8 CP 427
[98]
(1987) 62 Com Cases 600 (P&H)
[99] Section
2(30) provides that the term “Officer” shall include any “Director, Manager or
Secretary or any other person in accordance with whose directions, the Board of
Directors or any one or more of the directors is or are accustomed to act”.
[100] Section 5
prescribes who is an “Officer who is in default” for the purpose of other
provisions under the Act. The said section stipulates that an “Officer who is
in Default” means all of the following Officers :
1. Managing
Director/s
2. Whole time
Director/s ;
3. Manager
4. Company
Secretary ;
5. Any person
according to whose direction/instruction the Board is accustomed to act ;
6. Any person
charged by the Board with the responsibility with that provision and that
person have given his consent.
7. Where there
are no Managing Director and Whole time Director or Manager, any Director
specified by the Board, or if not so named
then all the Directors
[101]
S.201Avoidance of provisions relieving liability of Officers and
Auditors of the Company : Section 201 (1)
“Save as provided in this section, any provision, whether contained in the
articles of a Company or in an agreement with a Company or in any other instrument,
for exempting any Officer of the Company or any person employed by the Company
as auditor from, or indemnifying him against, any liability which, by virtue of
any rule of law, would otherwise attach to him in respect of any negligence,
default, misfeasance, breach of duty or breach of trust of which he may be
guilty in relation to the Company, shall be void ;
(2) ***(Deleted)
Provided that a
Company may, in pursuance of any such provision as aforesaid, indemnify any
such Officer or auditor against any liability incurred by him in defending any
proceedings, whether civil or criminal, in which judgment is given in his
favour or in
which he is acquitted or discharged or in connection with
any application under section 633 in which relief is granted to him by the
Court”.
[102] Section 633
(1) “If in any
proceeding for negligence, default, breach of duty, misfeasance or breach of
trust against an Officer of a Company, it appears to the Court hearing the case
that he is or may be liable in respect of the negligence, default, breach of
duty, misfeasance or breach of trust, but that he has acted honestly and
reasonably, and that having regard to all the circumstances of the case,
including those connected with his appointment, he ought fairly to be excused,
the Court may relieve him, either
wholly or
partly, from his liability on such terms as it may think fit:
Provided that in
a criminal proceeding under this sub-section, the Court shall have no power to
grant relief from any civil liability which may attach to an Officer in respect
of such negligence, default, breach of duty, misfeasance or breach of trust.
(2) Where any
such Officer has reason to apprehend that any proceeding will or might be
brought against him in respect of any negligence, default, breach of duty,
misfeasance or breach of trust, he may apply to the High Court for relief and
the High Court on such application shall have the same power to relieve him as
it would have had if it had been a Court before which a proceeding against that
Officer for negligence, default, breach of duty, misfeasance or breach of trust
had been brought under sub-section(1).
(3) No Court shall grant any relief to any Officer under
sub-section (1) or sub-section (2) unless it has, by notice served in the
manner specified by it, required the Registrar and such other person, if any,
as it thinks necessary, to show cause why such relief should not be granted”.
[103] Section 635A “No suit, prosecution or
other legal proceeding shall lie against the Government or any Officer of
Government or any other person in respect of anything which is in good faith
done or intended to be done in pursuance of this Act or any rules or orders
made thereunder, or in respect of the publication by or under the authority of
the Government or such Officer of any report, paper or proceedings”.
[104] Editorial Comment, ‘Directors-true or false?’
(1997) 18 Co Law 129 at 129.
[105] Carlen
v.Drury (1812) 1 V & B 154 at 158
[106] Permanent
Building Society v. Wheeler (1993-1994) 11 WAR 187 at 218.
[107] (1989)
7 ACLC 659 at 679.
[108] Kokotivich
Constructions Pty Ltd v Wallington (1995) 13 ACLC 1113 at 1125.
[109] (1993-1994) 11 WAR 187 at 218