Background
Hitherto, directors had negligible
guidance under company law as regards their duties and liabilities. The
preexisting Companies Act, 1956 (the 1956 Act) did not explicitly
stipulate directors’ duties, which made it necessary to fall back on common law
principles (to be articulated by courts while delivering specific decisions).
The statutory uncertainty was compounded by the absence of significant cases of
director duties and liabilities before Indian courts.
guidance under company law as regards their duties and liabilities. The
preexisting Companies Act, 1956 (the 1956 Act) did not explicitly
stipulate directors’ duties, which made it necessary to fall back on common law
principles (to be articulated by courts while delivering specific decisions).
The statutory uncertainty was compounded by the absence of significant cases of
director duties and liabilities before Indian courts.
This somewhat unsatisfactory
situation has been mended in the Companies Act, 2013 (the 2013 Act), which is
rather explicit about directors’ duties (somewhat similar to the codification
of directors’ duties under the UK Companies Act of 2006, section 172). The new
provisions not only provide greater certainty to directors regarding their
conduct, but also enable the beneficiaries as well as courts and regulators to
judge the discharge of directors’ duties more objectively.
situation has been mended in the Companies Act, 2013 (the 2013 Act), which is
rather explicit about directors’ duties (somewhat similar to the codification
of directors’ duties under the UK Companies Act of 2006, section 172). The new
provisions not only provide greater certainty to directors regarding their
conduct, but also enable the beneficiaries as well as courts and regulators to
judge the discharge of directors’ duties more objectively.
The duties of directors are set
forth in section 166 of the 2013 Act, and are principally as follows:
forth in section 166 of the 2013 Act, and are principally as follows:
– To act in accordance with the articles
of association of the company;
of association of the company;
– To act in good faith to promote the
objects of the company;
objects of the company;
– To act in the best interests of the
company, its employees, the shareholders, the community and for the protection
of the environment;
company, its employees, the shareholders, the community and for the protection
of the environment;
– To exercise duties with due and
reasonable care, skill and diligence and to exercise independent judgment;
reasonable care, skill and diligence and to exercise independent judgment;
– To not be involved in a situation of
direct or indirect conflict with the interests of the company; and
direct or indirect conflict with the interests of the company; and
– To not achieve any undue gain or
advantage.
advantage.
These duties can broadly be classified
into two:
into two:
(i) duty of care, skill and diligence; and
(ii) fiduciary duties.
The duty of care, skill and
diligence requires directors to devote the requisite time and attention to
affairs of the company, pursue issues that may arise through “red flags” and
take decisions that do not expose the company to unnecessary risks. Fiduciary
duties, on the other hand, require the directors to put the interests of the
company ahead of their own personal interests. Rules that prevent conflict of
interest and self-dealing on the part of directors are integral to this set of
duties.
diligence requires directors to devote the requisite time and attention to
affairs of the company, pursue issues that may arise through “red flags” and
take decisions that do not expose the company to unnecessary risks. Fiduciary
duties, on the other hand, require the directors to put the interests of the
company ahead of their own personal interests. Rules that prevent conflict of
interest and self-dealing on the part of directors are integral to this set of
duties.
Section 166 also provides for the
consequences of breach of these duties. Sub-section (5) provides for civil
liability that requires a breaching director to return any undue gain or advantage
received as a result of such breach. Sub-section (7) is a penal provision that
imposes a fine of Rs. 1 lac to Rs. 5 lac (i.e. rupees 0.1 million to 0.5
million) on directors who have contravened the section.
consequences of breach of these duties. Sub-section (5) provides for civil
liability that requires a breaching director to return any undue gain or advantage
received as a result of such breach. Sub-section (7) is a penal provision that
imposes a fine of Rs. 1 lac to Rs. 5 lac (i.e. rupees 0.1 million to 0.5
million) on directors who have contravened the section.
Comparative Position
The effort to codify directors’
duties is not altogether novel, as it has been undertaken in other common law
jurisdictions such as the UK and Singapore. However, in one significant
respect, the Indian codification exercise is different from the UK and
Singapore. Under the 2013 Act in India, there is no provision that reserves the
application of common law following codification. Contrastingly, both in the UK
and in Singapore, the applicability of common law has been preserved to the
extent that it can be utilized to interpret the statutory provisions relating
to directors’ duties.
duties is not altogether novel, as it has been undertaken in other common law
jurisdictions such as the UK and Singapore. However, in one significant
respect, the Indian codification exercise is different from the UK and
Singapore. Under the 2013 Act in India, there is no provision that reserves the
application of common law following codification. Contrastingly, both in the UK
and in Singapore, the applicability of common law has been preserved to the
extent that it can be utilized to interpret the statutory provisions relating
to directors’ duties.
The following provisions in the UK
Companies Act of 2006 are relevant:
Companies Act of 2006 are relevant:
Section 170 Scope and nature of general duties
[….]
(3) The general duties are
based on certain common law rules and equitable principles as they apply in
relation to directors and have effect in place of those rules and principles
as regards the duties owed to a company by a director.
based on certain common law rules and equitable principles as they apply in
relation to directors and have effect in place of those rules and principles
as regards the duties owed to a company by a director.
(4) The general
duties shall be interpreted and applied in the same way as common law rules or
equitable principles, and regard shall be had to the corresponding
common law rules and equitable principles in interpreting and applying the
general duties.
duties shall be interpreted and applied in the same way as common law rules or
equitable principles, and regard shall be had to the corresponding
common law rules and equitable principles in interpreting and applying the
general duties.
(emphasis added)
The relevant provision in the
Singapore Companies Act (Cap. 50, Rev. Ed. 2006) is as follows:
Singapore Companies Act (Cap. 50, Rev. Ed. 2006) is as follows:
S. 157 As to the duty and liability of
officers
officers
[….]
(4) This
section is in addition to and not in derogation of any other written law or
rule of law relating to the duty or liability of directors or officers of a
company.
section is in addition to and not in derogation of any other written law or
rule of law relating to the duty or liability of directors or officers of a
company.
In stark contrast, the 2013 Act in India does not
carry a similar provision explaining whether the principles of common law are
applicable (or excluded) in the interpretation of the directors’ duties as
codified in common law. This would give rise to an interpretational issue as
discussed below. While this issue is somewhat technical in nature from a
jurisprudential standpoint, it could turn out to be a reality once cases
relating to directors’ duties under section 166 of the 2013 Act come up for
litigation before the courts.
carry a similar provision explaining whether the principles of common law are
applicable (or excluded) in the interpretation of the directors’ duties as
codified in common law. This would give rise to an interpretational issue as
discussed below. While this issue is somewhat technical in nature from a
jurisprudential standpoint, it could turn out to be a reality once cases
relating to directors’ duties under section 166 of the 2013 Act come up for
litigation before the courts.
The legislative history appears to be silent
regarding the rationale for the manner in which section 166 has been drafted.
Furthermore, this specific issue has also not received the attention of the
Parliamentary Standing Committee on Finance that extensively reviewed the
Companies Bill prior to its enactment.
regarding the rationale for the manner in which section 166 has been drafted.
Furthermore, this specific issue has also not received the attention of the
Parliamentary Standing Committee on Finance that extensively reviewed the
Companies Bill prior to its enactment.
Issue
Whether section 166 of the Companies Act, 2013 is exhaustive regarding
duties or company directors, or whether directors are also bound by common law
duties (that are either in addition to the statutory duties or that can be used
to interpret or explicate the statutory duties)?
duties or company directors, or whether directors are also bound by common law
duties (that are either in addition to the statutory duties or that can be used
to interpret or explicate the statutory duties)?
Options
Similar to a format
previously followed on this Blog, I propose to refrain from expressing any
preferences or stating arguments on this issue. Instead, I set out two possible
views along with some rationale for each, and invite readers to post their
comments on these or other possible views or arguments on the issue.
previously followed on this Blog, I propose to refrain from expressing any
preferences or stating arguments on this issue. Instead, I set out two possible
views along with some rationale for each, and invite readers to post their
comments on these or other possible views or arguments on the issue.
Option 1:
Section 166 is exhaustive of directors’
duties and is a complete code.
Section 166 is exhaustive of directors’
duties and is a complete code.
According to this view, the codification exercise is
exhaustive, and directors’ duties must be determined solely by the language of
the statutory provision. It leaves no room for the application of common law.
exhaustive, and directors’ duties must be determined solely by the language of
the statutory provision. It leaves no room for the application of common law.
This option emerges from a plain and simple textual
interpretation. It is also consistent with the objective of codification, which
is to introduce certainty and clarity. If directors are nevertheless subjected
to common law principles, the codification exercise might be rendered redundant
(at least partially). Moreover, unlike the company law statutes in countries
such as the UK and Singapore, there is no express provision that preserves the
use of common law either in addition to the statutory duties or by way of an
aid to interpret the statutory provisions.
interpretation. It is also consistent with the objective of codification, which
is to introduce certainty and clarity. If directors are nevertheless subjected
to common law principles, the codification exercise might be rendered redundant
(at least partially). Moreover, unlike the company law statutes in countries
such as the UK and Singapore, there is no express provision that preserves the
use of common law either in addition to the statutory duties or by way of an
aid to interpret the statutory provisions.
Option 2:
Section 166 is only a partial
codification of directors’ duties, and the principles of common law are
preserved through implication and operate in addition to the statutory
provisions or to at least aid in their interpretation.
Section 166 is only a partial
codification of directors’ duties, and the principles of common law are
preserved through implication and operate in addition to the statutory
provisions or to at least aid in their interpretation.
In this dispensation, the codification in the 2013
Act is incomplete as the statutory provisions lay down only the broad and basic
principles, and do not provide the details as to how the duties must be
discharged by the directors. Moreover, it is not possible for the statute to
envisage all possible situations in which directors must discharge their duties
and also the manner in which they are to do so. Those details are to be
determined by the courts based on the facts and circumstances of each case,
which is where common law comes into the picture.
Act is incomplete as the statutory provisions lay down only the broad and basic
principles, and do not provide the details as to how the duties must be
discharged by the directors. Moreover, it is not possible for the statute to
envisage all possible situations in which directors must discharge their duties
and also the manner in which they are to do so. Those details are to be
determined by the courts based on the facts and circumstances of each case,
which is where common law comes into the picture.
Furthermore, if common law were not resorted to, the
remedies would be inadequate as well apart from the substantive duties themselves.
For example, Mihir has elaborately discussed in an earlier
post, the statutory remedy for breach of directors’ duties is only a return
of profits or undue gains. This is only a personal remedy, and there is no
provision for proprietary remedies such as constructive trust. Moreover,
staying with personal remedies, there could be scenarios where a director has
not received a gain but the company has suffered a loss. In that case, without
resorting to common law, it is not possible for the company to recover such
losses from the director by way of damages or compensation. Therefore, any
inability to import principles of common law will substantially diminish the
scope of remedies for breaches of directors’ duties.
remedies would be inadequate as well apart from the substantive duties themselves.
For example, Mihir has elaborately discussed in an earlier
post, the statutory remedy for breach of directors’ duties is only a return
of profits or undue gains. This is only a personal remedy, and there is no
provision for proprietary remedies such as constructive trust. Moreover,
staying with personal remedies, there could be scenarios where a director has
not received a gain but the company has suffered a loss. In that case, without
resorting to common law, it is not possible for the company to recover such
losses from the director by way of damages or compensation. Therefore, any
inability to import principles of common law will substantially diminish the
scope of remedies for breaches of directors’ duties.
Finally, and more specifically, the 2013 Act does not
have a section corresponding to section 170 (3) of the UK Companies Act of 2006
(extracted above) which specifically states that that the duties in section166
(are based on common law rules and equitable principles and) shall have effect
in place of such rules and principles. In other words, there is no express
provision to state that the statutory duties replace the common law duties.
have a section corresponding to section 170 (3) of the UK Companies Act of 2006
(extracted above) which specifically states that that the duties in section166
(are based on common law rules and equitable principles and) shall have effect
in place of such rules and principles. In other words, there is no express
provision to state that the statutory duties replace the common law duties.
Readers’ comments are welcome.
(The
motivation for this post arose from immensely helpful discussions with (i) Shinoj
Koshy, Ashwin Bishnoi and Arjya Majumdar on the sidelines of the International
Conference on Trade, Investment and Corporate Governance: Law and Policy in
India and China, and (ii) the students in the intensive course on
“Corporate Governance” held in April 2014 at the National Law School of India
University, Bangalore. As might be evident, those discussions remain
inconclusive, and a search for the yet elusive answer continues!)
motivation for this post arose from immensely helpful discussions with (i) Shinoj
Koshy, Ashwin Bishnoi and Arjya Majumdar on the sidelines of the International
Conference on Trade, Investment and Corporate Governance: Law and Policy in
India and China, and (ii) the students in the intensive course on
“Corporate Governance” held in April 2014 at the National Law School of India
University, Bangalore. As might be evident, those discussions remain
inconclusive, and a search for the yet elusive answer continues!)
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