Personal Liabilities of a Director as per the Indian Companies Act of 2013
A company is a legal person that appoints directors as its agents to carry its business. Due to its separate legal entity characteristic, the company itself is responsible for liabilities arising from day to day activities being conducted. Personal liability of a director comes into picture when he/she breaches his/her duties while performing fiduciary activities.
What do we man by the Fiduciary Duties of a Director
Defining fiduciary: The term fiduciary revolves around trust. A person acting as a fiduciary puts the opposite party’s interests above his own and acts in good faith with a bona fide intention.
Upon suggestions given by the J.J. Irani Committee, section 166 was added to the Companies Act, 2013. This section discusses the various duties of a director. Although this section does not explicitly mention the word ‘fiduciary’ it is given, because the director performs all of his duties while remaining in a fiduciary position.
Duties as per Section 166:
Since the Articles of Association mentions about rules and regulations that the company has to follow, the director is also expected to work in accordance with it. The director has to put the interests of the stakeholders before his own. He has to exercise due care while performing all the duties. A director shall not work to achieve an undue advantage or gain. If the director breaches any of these mentioned under this section, he will be liable to pay an amount not less than one lakh rupees which may extend to five lakh rupees.
Various Acts that attract Personal Liability:
A director is bound to act in accordance with the company’s Articles of Association:
Any act done by the director which exceeds what is mentioned in the Articles of Association is considered to be ultra vires in nature. If the acts are ultra vires to the articles but are well within the powers mentioned under the Memorandum of Association, such acts can be ratified to that extent. But the personal liability of a director comes into picture when the funds of the company are used for purposes that are beyond the scope of the Memorandum of Association.
A director is supposed to act in good faith:
Good faith implies that both parties act honestly and fairly. The opposite of this is to commit fraud, misrepresentation and inducement.
Section 447 of the Companies Act, 2013 defines fraud as an act, omission, concealment of fact or abuse of any position. Under the Companies Act, 2013 various instances of fraud have been mentioned where a director can be held liable. For example, Section 75 of the Companies Act, 2013 penalises for accepting deposits with any fraudulent intention.
It is nowhere explicitly defined under the company law. However, under section 18 of the Indian Contract Act, 1872 misrepresentation is intentionally stating a material fact knowing it to be untrue in order to deceive the opposite party. Section 34 of the Companies Act, 2013 mentions about misleading statements made in a prospectus. It attracts liability under section 447 of the same act. In the case of I.B. Rao v Registrar of Companies 2007 (1) ALD (Cri) 104, where a director could not sufficiently prove that he was not the officer in default, it was held that all of the directors were responsible (as was stated by the complainant) for inducing the public to subscribe through misstatements made in the prospectus. A director cannot avoid liability when he is a signatory to a prospectus that is misrepresented.
It is the act of persuading the opposite party to enter into a contract with the intention to defraud them. Section 36 of the Companies Act, 2013 describes the misleading statements made to induce the opposite party to invest money and the offender is made liable under section 447.
A director shall conduct all the activities with due care and skill:
A director is in charge of major decision making in the company. If he does not exercise due care and caution, then the he is deemed to have acted negligently. Due to which he will be personally liable for the acts arising out of that negligence.
Although a director cannot be held vicariously liable for the actions of the company especially when the statute (company law) does not mention about it, a director (acting on behalf of the company) can be made liable if sufficient evidence can be provided to prove his active role in the negligent act. In the case of Shiv Kumar Jatia v State of NCT of Delhi AIR 2019 SC 4463, criminal negligence charges against the directors were quashed because there was no clear link established between the managing director and the negligent act. The day-to-day affairs of the hotel (where the negligent act took place) was managed by its staff. On an occasion where a direct nexus is established, the director can be made liable.
A director shall be bound by the contractual obligation:
In general, it is not the duty of the director to pay debts to the third party on behalf of his company. But through a contract, if a director accepts personal liability either expressly or impliedly he is bound to fulfill that obligation. In the case of Mukesh Hans & Anr v Smt. Uma Bhasin & Ors RFA 14 of 2010, since the directors neither have extended any contract of guarantee nor have undertaken to pay the third party on behalf of the company it was held by the High Court of Delhi that it was the sole liability of the company to pay the debts to the third party.
Liabilities during insolvent proceedings:
A director can be liable for wrongful trading under section 66(2) of the Insolvency Bankruptcy Code, 2016. The director will have to contribute personally to the assets of the company if it is proved that he/she knew or ought to have known that the company had no other choice but to initiate Corporate Insolvency Resolution Process and also if he did not exercise sufficient due diligence to reduce the loss expected to be faced by the creditors.
Liabilities of various types of directors:
The Whole Time Directors (executive directors) can be made liable under the above-mentioned sections of the Companies Act, 2013. Independent directors and nominee directors (non-executive directors) can be made liable only when a default has occurred with his knowledge, consent or connivance as is mentioned under section 149 (12) of the Companies Act, 2013.
How can the directors seek exemption from liabilities?
If a director takes a conscious decision to breach the fiduciary duties, he is voluntarily attracting various criminal and civil liabilities. But, sometimes a director acting with a bona fide intention still may end up attracting personal liabilities because of not exercising sufficient caution. These latter types of liabilities can be avoided if the director:
• Discloses from time to time, various conflict of interests and related party transactions to avoid any sort of allegations later on. If the director gets into a conflict of interest after signing the contract, he is obliged to disclose the same.
• Is extremely cautious while dissenting to something in a meeting. He has to make sure that their disagreements are properly recorded in the minutes of the meeting.
• Make sure that none of the agreements signed by him makes him personally liable (on behalf of the company) towards the third parties.
• Carefully examines the statements mentioned in the prospectus before giving consent for the same. This can rule out any sorts of misrepresentation on the part of him.
• Takes up the Directors & Officers (Insurance Policy) that insures him against certain kind of liabilities.
• Ensures that his indemnification is mentioned in the Articles of Association. This indemnity can be provided if it is proved that the director acted in good faith.
Section 166 of the Companies Act, 2013 is the most important provision for a director of a company. Abiding by all the duties under this provision and exercising caution while performing all the day-to-day affairs can minimise the liabilities that a director will face.
Authored By: Adv. Anant Sharma & Sriya Sindhoor