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Duties of Director
Introduction
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.
CONCLUSION
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.
Article by Syed Burhanur
Rahman. |
