Monday, February 1, 2016

Board of Directors’ Reliance on Legal Advisers

The question of whether, and to what extent, the board of directors of a company can rely upon the advise of the legal advisers of the company came up for consideration before a division bench of the Rajasthan High Court in Rajasthan Urban Co-operative Bank Ltd. v. Ajay Kumar Katewa (hat-tip: LiveLaw, once again). In this case, certain employees of a co-operative bank were compulsorily retired, which action was challenged by those employees before the High Court.

The employees were retired in terms of rules 14 and 15 of the Urban Cooperative Bank Employees Service Rules, 2006 (the “Rules”), which provided that the board of directors of the bank had to be satisfied as to the existence of specific grounds for such retirement and also to give reasons to show that the retirement was in the bank’s interest. The High Court negatived the bank’s plea that the board had relied on legal advice while deciding that the grounds under the Rules were satisfied. It noted:

10. In pursuance to the directions of the Single Bench, record pertaining to the retirement/compulsory retirement was produced by the counsel for the appellant bank wherein it was evident that the impugned orders had been passed by the Board of Directors on the advise of the Legal Advisers and the Banking Experts. In terms of Rule 15, it was incumbent upon the Board of Directors to have independently applied their mind and taken decision based on specific grounds. The specific grounds which have been spelt out in Rule 15 include doubtful integrity or incompetence to discharge official duties or inefficiency in due performance of official duties which would have the effect of the employees losing their utility.

11. It was, therefore, necessary for the Board of Directors to have independently considered the entire service record of the employees so as to form opinion with regard to their utility to the Bank. The requirement of recording specific grounds to arrive at the decision in the rules is intended to ensure that the Board of Directors does not act arbitrarily while compulsorily retiring the employees. There does not seem to be any independent and due application of mind on the part of the Board of Directors while arriving at the decision which has the effect of bringing the services of the employees to a premature end. The function which had been entrusted upon the Board of Directors by the rule could not have been outsourced to the legal advisers.

For these reasons, the decisions made by the board of director’s of the bank were set aside.

At the outset, it is to be noted that this is not a case under company law, but under employment law and service conditions. To that extent, it is not a typical directors’ fiduciary duty claim that would be brought by the company or a shareholder (by way of a derivative action). However, the ruling may have some broader implications in the discussion of directors’ duties.

The most significant implication is that the directors will have to apply their minds to decision-making powers that have been granted under statute or subsidiary legislation. They cannot simply rely on experts such as legal advisers, but can only be guided by their advice. This becomes relevant in the context of the enhanced duties imposed under company law as well by the Companies Act, 2013. However, this could also create some practical difficulties, as boards of directors – especially in large companies – may not be in a position to make operational decisions such as retaining or terminating employees. Of course, some of these functions can be delegated to management committees who may in turn report to the entire board.

Alternatively, it would be possible to consider controlled delegation similar to that provided under the Companies Act in Singapore where section 157C allows directors to rely on expert advice so long as the directors act in good faith, they make proper inquiry as circumstances require, and where they have no knowledge that such reliance in unwarranted. This provides a balance whereby directors may place reliance on external sources, but they cannot abdicate their duties entirely as they have to satisfy the conditions stipulated above. While in India the Companies Act, 2013 does not carry express stipulation on matters relating to delegation and reliance, these aspects may be considered by the courts and tribunals while interpreting the duties of directors set forth in section 166 of the Act.

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