A corporation has neither a mind nor a body of its own .This makes it necessary that the company’s business should be entrusted to some human agents.
Therefore Sec 252 of the Company Act 1956, requires that every public company shall have at least three directors and every private company shall have at least two directors. Due to the possession of immense power, directorships are always susceptible to abuse. The law, therefore, impose upon them certain duties which, when properly enforced will, without driving away from the field competent men, materially reduce the chance of abuse.
Broadly speaking, the duties of directors fall into two categories,
- Fiduciary Duties
- Duties of Care and Skill.
In the context of fiduciary duties, the directors must exercise their powers honestly and in the interest of the company and the share holder. As fiduciaries, they must not place themselves in a position in which there is a conflict between their duties to the company and their own personal interests.
Turning now to the main elements of the directors’ fiduciary duties we may divide them below into the following sub groups:
- A director must remain within the scope of the power, which has been conferred upon him.
- A director must act in good faith in what he believes to be the best interest of the company.
- A director must not fetter their discretion, as to how they shall act,
- Out of a transaction with a company.
- Out of director’s personal exploitation of the company’s property, information or opportunity
- Out of the receipt from a third party of a benefit for exercising their directorial functions in a particular.
Duties of care and skill include the Director’s liability for negligence. In such a case, good faith alone is not sufficient. A director has to exercise his duty with reasonable care. If he fails to do so he is liable for the losses occurring to the company.
In view of the changing role of a Company, especially in the global context it is important to ensure that the functionaries of the company, its officers, function with a great sense of responsibility and are aware of the vital role they play in the development of the economy of the country .This article critically analyses at the various duties and of the care and Skill that a Director must exercise and makes certain recommendations in that regard.
Before turning to the substance of directors’ duties, we need to ask who are their beneficiaries? At one level the answer is very clear: they are owned to the company. However the personal assets and liabilities of the legal personality of the company is a highly abstract concept. Its main function is to separate the assets and liabilities generated by the business carried on by the company from those who invest in it, manage it, work for it or deal with it. Directors would have to strike a balance between the interests of the creditors and those of the shareholders However, the law is silent in this regard. The issue of when and how far directors owe duties to the creditors collectively, presumably, will be left for development in the hands of judges. At common law, the duties of directors are owned to the shareholders alone, so long as the company is a going concern. However they are owned to the shareholders collectively, not individually.
POSITION OF DIRECTORS.
The Companies Act, 1956 provides that a Director is any person, occupying the position of Director, by whatever name called. They are professional men, hired by the company to direct its affairs. But, they are not the servants of the company. Legal position of Directors in a Company is a convoluted issue. They are rather the officers of the company. In Moriarty V Regents Garage & Engineering Co. it was held that, “A director is not a servant of any master. He cannot be described as servant of a company or of anyone.” A director however may work as an employee in a different capacity. Directors are sometimes described as agents, sometimes as trustees and sometimes as managing partners. But each of these expressions is used not as exhaustively of their powers and responsibilities.
By an amendment of the section by the Amendment Act, 2000, it has been provided that a public company having a paid up share capital of rupees five crores or more and one thousand or more share holders should have a director elected by the small shareholders. The directors of a company collectively are referred to as the "Board of directors" or “Board". Only individuals can be appointed as directors. No body corporate, association or firm can be appointed as the director of a Company.
DUTY OF CARE AND SKILL
Directors being a vital part of company have profound duties of care and skill towards the company. However, the traditional view is to be found in a stream of largely 19th century cases which culminated in the decision in 1925 in Re City Equitable Fire Insurance Co. Fact of this case will be discussed later. Suffice is to say at this point that those cases seem to have framed the Directors’ duties of skill and care with non executive rather than executive directors in mind. Moreover, the view that a non executive director had no serious role to play within the company but was simply a piece of window dressing aimed at promoting the company’s image, made the directors’ duty highly subjective. The proposition was famously formulated in the City equitable case that “a director need not exhibit in the performance of his duty a greater degree of skill than may reasonably be expected from a person of his knowledge and experience.”
However this proposition is highly inappropriate for executive directors who are paid handsomely with huge financial inducement for the expertise which they assert they can bring to the business. The modern approach can be found in Dorchester Finance Co V Stebbing, where it was held that the proposition made in Re City Equitable case applied only to the exercise by a director of his skill. This duty was to be distinguished from his duty of diligence, where what was required was “such care as an ordinary man might be expected to take on his own behalf”. This is an objective test unlike the traditional view which presumed it to be subjective.
But the line between an objective duty of diligence and a subjective duty to exercise skill is not always easy to draw, nor in principle should such a line be drawn. Consequently, it is highly significant that in two recent cases of Norman v Theodore Re D’Jan Of London Ltd, Hoffman .J has expressed the view that both elements of the duty of care are to be assessed objectively. This is that an assessment of what the director should have done or known is to be based on what a “a reasonably diligent person having both
(a)the general knowledge, skill and experience that may reasonably be expected of a person, carrying out the same person as are carried out by that director in relation to the company and
(b)the general knowledge skill and experience that director has.”
A company director’s duties are usually regulated by the Articles of Association. Directors have statutory duties as well. Mere fidelity towards the company is not enough; another general duty imposed upon directors is the duty of care and skill.
The courts usually have been very liberal in the matter of expected standards of skill and care in Overend Gurney & Co v Gibb. 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. This was not the matter in the instant case according to the court.
Now let us discuss the famous case of City Equitable Fire Insurance Company, Re ,One B was a director of the City Equitable Fire Insurance Co. The company was ordered to be wound up. A search investigation of the affairs of the company was then made and this investigation showed a shortage in the 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 frauds. But the question naturally arose as to whether during the period covered by B's nefarious activities the other directors were properly discharging their duties to the company? It was alleged that they were guilty of negligence in not detecting the frauds. But there was an exemption clause in the articles according to which the directors were liable only for gross negligence. The facts of the case did not disclose that degree of negligence and, therefore, the case of the official receiver against B 's co-directors failed. Romer J stated that, a directors 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 or 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. It is, therefore, perhaps, another way of stating the same proposition that directors are not liable for mere errors of judgment.
Following the decision in this case S-201 of the Companies Act, was amended. Accordingly, the Act now does not allow liability for negligence to be excluded. Section 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. The company is also not allowed to indemnify its officers against such liability. The only exception is that where an officer has been sued or prosecuted on any of the above charges and the judgment is in his favour or he has been acquitted, or relief has been granted to him under Section 633, the company may indemnify him against costs incurred in defence.
There is thus a practical difference between the old and the new developments in this regard. The major differences are first that the focus is on the level of responsibility taken on by directors rather than the director's actual level of expertise of experience, and secondly that it is likely that the courts will continue the line of applying a higher standard of care and attention to business by all directors. The standard required is that to be reasonably expected of someone occupying the office in question. Thereby it is apparent that, unless the action of the directors amounts to gross negligence, in most cases they are usually discharged from any liability. The tests in relation to this aspect of the roles of a director being vague or too subjective, gives the directors liberty to function at will and take risks they are not entitled to take. Such situation is hardly healthy and needs to be altered.
Thus we may conclude with regard to the duties and skill of a company director, which it is still largely towards holding the directors liable for gross negligence alone and not for any ordinary lack of judgments. The directors are required to show a certain degree or standards of skill while executing their duties for the company. The directors have been provided with a remarkable amount of freedom to run their companies incompetently. Thereby, the duty of care and skill that the directors have is usually low on their list of priorities. There is a need to impose upon directors more rigorous duties, however there is no consensus in this regard and a broad view on this matter has yet to develop.
Considering the fact that a huge amount of responsibility rests on their shoulders it is important that there be a certain amount of control and also regulation of their activities. Such regulations and control, though not available in the common law system can be statutory in nature, thereby suitable amendments can be made in the Indian Companies Act, 1956.
Syed Burhanur Rahman, Attorney, New Delhi
Syed Burhanur Rahman is an alumnus of St. Stephen’s College and Campus Law Center, Delhi University. A Quiz aficionado, he has featured in premier T.V Quiz shows including Mastermind India(BBC),University Challenge Quiz(BBC) and Nat Geo Genius Quiz (National Geographic Channel).An Attorney working with INDUS G & D Law(Delhi),his practice areas include Corporate Law, IPR and Taxation Law .