Saturday, December 17, 2011

Companies Bill, 2011: Duties of Directors

The Companies Act, 1956 does not contain any specific provision that generally governs the duties of directors. The duties are instead governed by common law, which judges are required to apply to a given set of facts and circumstances. Under common law, there are two broad sets of director duties: (i) duty to act with skill, care and diligence, and (ii) fiduciary duties (to act in the interests of the company, to avoid conflicts of interest and to act for proper purposes). However, past track record in India indicates that cases where common law director duties have been applied are few and far between. For this reason, duties of directors are incapable of being defined as clearly as one can in other jurisdictions, particularly in the developed markets.
In order to induce a greater level of clarity in directors’ duties, the Companies Bill, 2011 has a specific provision that deals with the subject matter. Clause 166 of the Bill is substantially similar to the provision contained in the Companies Bill, 2009, with some iteration. The UK too adopted the strategy of codifying directors’ duties in the Companies Act, 2006 (sections 171-177).
The following are some of the primary duties specified by the Companies Bill, 2011:
- to act in accordance with the articles;
- to act in good faith and in the best interests of the company, its employees, the shareholders, the community and for the protection of the environment;
- to exercise due and reasonable care, skill and diligence, and exercise independent judgment;
- not to involve in a situation that presents a conflict of interest;
- not to achieve any undue gain or advantage (and to return any equivalent amount to the company if such gain or advantage is indeed made); and
- not to assign office.
In case of any breach of duties, it would also amount to a criminal offence with punishment of Rs. 1 lakh to Rs. 5 lakhs. This is different from the common law position where there is an only civil liability for breach.
At the outset, it is necessary to note that this is only a partial codification of directors’ duties. It is not possible to prescribe rules for every situation in which directors’ actions can be judged. That necessarily has to be left for a principles-based determination, usually by judges in specific cases, and hence the role of courts in implementing these duties cannot be taken away. While the statutory provisions do give some guidance, much would depend on the manner in which courts interpret these duties, on which previous jurisprudence is scant. Moreover, with issues surrounding delays and costs in the court system, it is not clear if a body of judge-made law (in terms of principles) is likely to emerge to guide the actions of directors. Hence, it is not clear if the codification of the duties will necessarily result in a tangible enhancement when it comes to enforcing the duties.
One crucial change from the duties contained in the Companies Bill, 2009 is noteworthy. The previous Bill required directors to act in the best interest of the company. This epitomizes the shareholder model of corporate governance wherein the primary role of the directors is to protect the interests of the shareholders, and at most the interests of creditors in the event of insolvency. However, the new Bill also requires directors to act in the interests of “employees, the shareholders, the community and for the protection of the environment”. This encapsulates the stakeholder model of corporate governance wherein the directors are required to take into account the non-shareholder constituencies as well. This is consistent with the renewed emphasis on CSR, which has been discussed earlier. While it seems unlikely that any duties owed by directors in connection with non-shareholder constituencies can be justifiable or enforceable in a court of law, this at least prevents shareholders from initiating actions against directors for not solely (or even primarily) considering shareholder interests.
A similar debate was played out when the Companies Act, 2006 was enacted in the UK (and specifically section 172 thereof) where the end-result was the concept of an “enlightened shareholder value” model.

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