My goal in this post, though, is to address one knotty legal issue that arose before the Court and to critically analyse its ruling on the point. The controlling shareholders of Tata Sons Pvt. Ltd. are essentially two charitable trusts created by the Tatas, while the minority shareholders are the Mistry group. The Tata Sons’ articles of association enable the Tata Trusts to nominate a third of the directors on the board of Tata Sons, so long as the Trusts hold in the aggregate at least 40% of the paid up share capital. Such nominee directors also enjoy affirmative voting rights (“AVRs”), i.e., veto rights, on certain matters specified in the articles, including “any matter affecting the shareholding of the Tata Trusts in the Company” [at paras. 19.7 and 19.8 of the judgment].
In this background, the issue before the Supreme Court was whether the very existence of the AVRs to the nominee directors of Tata Trusts perpetrated oppression or prejudice against the minority shareholders of Tata Sons. The Mistry group called into question these rights on the ground that they breached the duties of directors under company law. In addressing this question, the Court tested the validity of the AVRs in the light of directors’ duties under the Companies Act, 2013, which it upheld. Here, I seek to discuss the Court’s reasoning from a critical perspective.
Affirmative Voting Rights: Existence or Exercise?
At the outset, it is generally the case that the existence of AVRs by itself is not problematic as a matter of company law. What is important is the exercise of the AVRs on the facts and circumstances of each case and whether, in the exercise thereof, the directors have discharged their duties or breached them. In the present case, this distinction did not appear starkly, and the nub of the issue appears to be the existence rather than exercise of AVRs.
Nature of the Company
In arriving at its decision that the AVRs did not affect directors’ duties, the Supreme Court placed emphasis on the nature of Tata Sons, first that it is a private limited company, and second that it is an investment holding company rather than a company engaged in manufacturing or trading activity. The Court found that, as a private company, the entire range of provisions in the Companies Act (several of which apply only to listed companies or unlisted public companies) cannot be invoked in the case of Tata Sons. While this is true for provisions such as the requirement of having a minimum number of independent directors, section 166, which is the bulwark of directors’ duties, makes no distinction whatsoever to the nature of the company. It is corporate form-agnostic, and universally applies to all types of companies. The rationale behind the Court’s second distinction concerning the nature of the company, namely that Tata Sons is only an investment holding company, is hard to comprehend because the duties of directors under company law bears no correlation to the business or activity in which the company is involved, at least as far as the core of directors’ duties is concerned.
Nature of Directors: Nominees and the “Dual Agency” Problem
As is well known, nominee directors are in an unenviable position. Since they are nominated by a shareholder (or other stakeholder such as a creditor or regulator), they are contractually bound to advance the interests of their nominators when they participate in decision-making in the company on whose board they are a director. At the same time, they bear duties under company law to act in the best interests of the company. A rudimentary examination of company law suggests that it is necessary to judge the discharge of directors’ duties on a case-by-case basis. If, in a given circumstance, the nominee director acts in the interest of her nominator, which is aligned with the interests of the company, there is no risk of such a director breaching her duties to the company. However, if the situation creates a conflict between the two sets of duties, the law generally stipulates that the corporate law duties of the director owed to the company trump her duty owed contractually to the nominator. The director may proceed acting in the interests of the nominator at risk of liability for breaching duties owed to the company. The Supreme Court’s ruling in the Tata-Mistry case has the effect of muddying the waters in this regard in a number of different ways.
The Supreme Court observed that the directors nominated by the Tata Trusts are not like any other directors appointed at a general meeting of the company. It further went on to state [at para. 19.23]:
In fact it is a paradox to claim that by virtue of Subsections (2) and (3) of Section 166, every Director of a Company is duty bound to act in good faith in order to promote the objects of the company for the benefits of its members and in the best interests of all the stakeholders as well as environment and a duty to exercise independent judgment, and yet mandate the appointment of independent Directors under Section 149(4). If all Directors are required under Section 166(3) to exercise independent Judgment, we do not know why there is a separate provision in Section 149(4) for every listed Public Company to have at least 1/3rd of the total number of Directors as independent Directors. We do not also know whether the prescription in Section 149(4) is a tacit acknowledgment that all the Directors appointed in a General meeting under Section 152(2) may not be independent in practice, though they may be required to be so in theory.
The ruling proceeds on an analysis of two sections of provisions in the Companies Act. The first, in section 149(4), requires the appointment of independent directors in certain types of companies. The second is the broader directors’ duties under sections 166(2) and 166(3), the latter of which requires the “the director of a company” to “exercise independent judgment”. This does not depend upon the type of director involved and applies to all, including executive, non-executive, insider, outsider or independent directors. The Court appears to draw strength from the existence of special provisions for independent directors to lay down a lower standard for non-independent directors, almost obliterating the need for a directors’ independent judgment in section 166(3).
Such a stance represents a diminution in the role of directors’ duties as a primary tool of corporate governance when it comes to non-independent directors, and undermines with one fell swoop the legislative and regulatory efforts over the last couple of decades to enhance the roles, responsibilities and liabilities of directors on the boards of Indian companies. I would argue that the logic adopted by the Supreme Court ought to turn on its head. If the law casts more onerous duties on independent directors, it would be anachronistic for the other directors (whether executive or non-executive, insider or outsider, nominee or otherwise) to be subject to a lower standard of liability. The tone and tenor of the Companies Act has only been to enhance the standard of the directors’ duties of care, skill and diligence compared to the erstwhile position under common law rather than to diminish it.
Nature and Identity of Nominator
Perhaps the most intriguing part of the ruling emerges from the Court’s discourse on balancing the interests of shareholders and other stakeholders (including public interest) with specific reference to nominee directors. The Court observed [at para. 19.30]:
19.30 Coming to the argument revolving around the duty of a Director, it is necessary that we balance the duty of a Director, under Section 166(2) to act in the best interests of the company, its employees, the shareholders, the community and the protection of environment, with the duties of a Director nominated by an Institution including a public charitable trust. They have fiduciary duty towards 2 companies, one of which is the shareholder which nominated them and the other, is the company to whose Board they are nominated. If this is understood, there will be no confusion about the validity of the affirmative voting rights. What is ordained under Section 166(2) is a combination of private interest and public interest. But what is required of a Director nominated by a charitable Trust is pure, unadulterated public interest. Therefore, there is nothing abhorring about the validity of the affirmative voting rights.
19.34 … the best interest of the majority shareholders need not necessarily be in conflict with the interest of the minority or best interest of the members of the company as a whole, unless there is siphoning of or diversion. Such a question does not arise when the majority shareholders happen to be charitable Trusts engaged in philanthropic activities.
The Supreme Court’s analysis in allowing AVRs in favour of nominee directors of the Tata Trusts hinges upon the pluralistic approach adopted in section 166(2). However, this arguably goes against the grain of the stakeholder model envisaged in the statutory provision, and is likely to cause considerable confusion in its interpretation and implementation. This is so for a number of reasons.
First, the Court’s assumption that nominee directors can use section 166(2) as a platform to discharge their duties owed towards their nominators is not beyond question. As seen earlier, the general principle is that in case of a conflict between the duties owed to the nominator and the company, the nominee director’s duties owed to the company must take precedence. Although the Companies Act, 2013 does not express stipulate the beneficiaries to whom directors owe their duties, namely whether to the company or to the shareholders, the principle under common law is clear that directors owe their duties only to the company and not directly to the shareholders, except when there are specific circumstances [see Sangramsinh P. Gaekwad v Shantadevi P. Gaekwad, (2005) 11 SCC 314, at para. 42]. Hence, even under section 166(2), though the interests of several stakeholders are to be taken into account, the duty is nevertheless owed to the company.
Second, and arising from the above, is the fact that the company is a separate legal personality. If so, the duties that directors owe to the company cannot be conflated with that they owe to their nominating shareholder, as the Supreme Court has sought to do in the present case. This undermines the basic principle of corporate law that the company’s interests are not necessarily the same as the interests of the shareholders. Although its earlier ruling in Vodafone International Holdings BV v Union of India, (2012) 6 SCC 613, was raised in support of this point, the Supreme Court merely dismissed that approach on the ground that the case involved a dispute relating to taxation.
Third, a confounding element of the judicial analysis in the ruling is its dominant reliance on the nature and identity of the shareholder. The validity of the AVRs have been justified on the fact that they are exercised by directors of nominators who are public charitable trusts rather than individuals or private entities. In that sense, the Court extends the requirements of section 166(2) not only concerning the company but also in relation to the shareholder. Such an undue extension of the scope of the duties is likely to give rise to unintended consequences.
On the one hand, this may permit directors to take cover under the fact that their nominators are public entities and thereby prefer their nominators’ interests over that of the company’s. For instance, would this not allow nominee directors of the Government in public sector undertakings to further the interests of the Government (on the ground that this represents public interest) and ride roughshod over the interests of the company and its other stakeholders, including the shareholders? On the other hand, the Court’s interpretation would endanger nominee directors who may act in the interests of the company with potential liability for not acting in the interests of their nominators even though conventional jurisprudence offers precedence to the interests of the company (whether that may be private or public).
The final conundrum posed by the Court’s ruling is that the duties of nominee directors are likely to vary depending upon the identity and nature of the nominator. Here, the Court upheld the AVRs because of the nature of the Tata Trusts as public charitable trusts. What if they were private investment vehicles? Would the outcome have been different? A logical application of the Court’s jurisprudence would suggest so, which would lead to a problematic situation where the duties of directors would differ depending upon who the nominator is. This would not only make the functioning of nominee directors even more cumbersome, but it would cause significant uncertainty into the jurisprudence surrounding directors’ duties. In all, it is necessary to refocus the discussion on to the company’s interest rather than the nominator’s interest.
In deciding on the question of whether the AVRs amounted to oppression or prejudice, the Court engaged in an analysis of the intersection between AVRs and directors’ duties under the Companies Act. In doing so, it made several observations which appear contrary to conventional understanding within the remit of directors’ duties generally. This is important given that directors’ duties were codified in India only under the Companies Act, 2013, and the present ruling is perhaps the first that offers attention to the codified version of directors’ duties. However, as discussed, there remain some areas open for discussion. One way of viewing this is that the question before the Supreme Court was essentially whether the AVRs amount to oppression or prejudice and not necessarily the validity of the AVRs themselves. Hence, it remains to be see whether the Court’s arguments regarding directors’ duties fall within the realm of obiter dicta or whether they carry precedential value.