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Director's Liability

Written by: Soma Dhawal from ILS Law College, Pune - IV B.S.L. LL.B
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Directors are agents of the Company in transactions they enter into on behalf of the Company, though they are not agents for individual shareholders or members. A director may be an employee, a servant or even a "worker" of the Company. He occupies the position of a trustee, though he is not a trustee in the strict sense in respect of the Company’s properties and funds.

Director’s liability arises because of their position as agents or officers of the Company as also for being in the position of trustees or having fiduciary relation with the Company or its shareholders.

Some of these liabilities are in contract, some are in tort, some are under the criminal law and others are statutory, i.e., under the Companies Act, 1956 and other laws. The courts have, in deciding the liability of Directors, taken into consideration a director’s position as a whole.

Contractual Liability:
Directors are bound to use fair and reasonable diligence in discharging the duties and to act honestly, and act with such care as is reasonably expected from him, having regard to his knowledge and experience.

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."

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.

As far as fiduciary duties/obligations are concerned, any breach by any director would visit them with liability. Our Supreme Court has considered this issue of fiduciary liability. It has been observed in Official Liquidator vs. PA Tendulkar.

Pre- Incorporation Liability- A Company cannot make a contract before it is incorporated because, before incorporation, it has no legal existence. Therefore, a Company after incorporation cannot ratify a contract previously made. It must make a fresh contract. But, those who act on behalf of the unincorporated company may find themselves personally liable. In Kelner v. Baxter the Court of Common Pleas held that where a person purports to sign a contract as agent, but has no principle in existence at the time, he is personally responsible.

Liability of Directors for Torts of the company:

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.

Civil Liability to the Company- director’s liability to the Company may arise where
(1) the directors are guilty of negligence,
(2) the directors committed breach of trust,
(3) there has been misfeasance and
(4) the director has acted ultra vires and the funds of the company have been applied for such an act.

A director is required to act honestly and diligently applying his mind and discharging his duties as a man of prudence of his ability and knowledge would do. It has been explained in the duties of directors as to what is standard or due care and diligence expected from him as explained by Justice Romer in Re City Aquintable Fire Insurance Company.

Any willful misconduct or culpable negligence falls within the category of misfeasance. It was held in Duomatic Ltd, Re-
"A director has to act in the way in which a man of affairs dealing with his own affairs with reasonable care, and circumspection could reasonably be expected to act....."
Therefore, Directors would decidedly be liable for omitting to do what they could have done in the circumstances.

A Director is liable to make good with interest all amount paid from time to time out of the funds of the company for the purchase of shares of the company. He is not entitled to spend money for a purpose not covered by the Memorandum of Association although such payment is sanctioned by the Board of Directors and by the majority of shareholders. A shareholder can maintain an action against the director to compel them to restore to the company its funds employed in transactions that the directors have no authority to enter into. The funds of the company cannot be used by the Directors to pay their litigation costs, although these would not have been incurred if they had not been directors. A Director will, however, not be liable for any such unlawful act if he had no knowledge of such payments.

Liability of co-director’s defaults:

A director is bound by the maxim delegatus non-potest delegare. Shareholders appoint him because of their faith in his skill, competence and integrity and they may not have the same faith in another person. 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. 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.

Tax Liability:

Under Section 179 of the Income Tax Act 1961, when any private company is wound up and the tax assessed cannot be recovered, then every person who was a director of the private company shall be jointly and severely be liable for the payment of such tax. Where the bank account of a Director was frozen for recovering income tax dues of the Company, it was held in Gurudas Hazra v. P.K.Chowdhury that it was for the Director to show that the default on the part of the company was not attributable to any breach of duty on his part. The case of Peter J R Prabhu v. Asstt Commissioner of Commercial Taxes stated that apart from any provisions of the taxing statute, arrears of the tax amount are not to be recovered from the directors personally.

Directors with unlimited liability:

The liability of the directors like the shareholders is limited to the extent of the shares held by them remaining unpaid. A limited liability can make the liability of any or all of its directors unlimited. A provision to this effect has to be contained in the Memorandum. that a person who becomes director after incorporation of such a clause will have unlimited liability.

Statutory Liability:
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.

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.

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.

Annual General Meeting:

Directors must hold the meeting even though the accounts are not ready or the company is not functioning or the management of the business is vested in the Central Government. The holding of the meeting must be within the period of 15 months after the preceding annual general meeting (AGM). The Board of Directors shall at the meeting lay a balance sheet and a profit and loss account for the financial year. For default, the Directors are liable to be punished with imprisonment for a term of six months and fine of Rs.1,000.

Liability on winding up:

A Director of a company in liquidation must co-operate with the liquidator in realizing the assets of the company and distributing them among the creditors and contributors of the company. If they fail to do so they are liable to imprisonment, which may extend to five years and fine.

Therefore, Directors are liable for theft of the company’s property or for false accounting. Directors are liable to prosecution on several issues. There are more than 150 sections dealing with criminal or penal liability of the Directors and other officers of the company. Some of these provisions have been listed and explained above.

Special statutory protection against liability:
The Act extends special protection against a liability that may have been incurred in good faith. A good illustration here will be to cite an early case of Claridge’s Patent Ashphalt Co, Re where the Court said that the Directors were acting for the benefit of the company and took the best advice from the company’s solicitor and thus were not held liable. The Bombay High Court in the case of Gautam Kanoria v. Asstt ROC also granted relief to the Directors where the AGMs could not be held and annual returns could not be filed due o the takeover of the company by the Government and the matters being beyond their control. The totality of the circumstances has to be examined for considering whether relief is to be allowed or not. It was also observed in Om Prakash Khaitan v. Shree Keshariya Investment Ltd that it would be proper to relieve directors of consequences of defaults and the breaches unless they are directly involved in the acts or omission complained of or have otherwise not acted honestly or reasonably or have financial involvement in the company.

Accountability is an important element of Board effectiveness. There should be some mechanism for evaluating the performance of the directors. The extent of liability of a director would depend on the nature of his directorship. In applying the general equitable principles to company directors, four separate rules have emerged. They are (1) that directors must act in good faith in what they believe to be the in the best interest of the company (2) they must not exercise powers conferred upon them for purposes different from those for which they are conferred. (3) that they must not fetter their discretion as to how they shall act and (4) that without the informed consent of the company, they must not place themselves in a position in which their personal interests or duty to other persons are liable to conflict with the duties to the company.

Three propositions in regard to the duties and responsibilities of directors:
(1) a director 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.

(2) a director is not bound to give continuous attention to the affairs of his company, his duties being of an intermittent nature to be performed at periodical board meetings or committee meetings.

(3) in respect of such duties as may be properly left to some other official having regard to the exigencies of business or the articles of association of the company, a director is, in the absence of grounds for suspicion, justified in trusting that official to perform such duties honestly.

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