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Introduction: -
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.
Conclusion: -
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. |
The
author can be reached at: somadhawal@legalserviceindia.com /
