Column: Raising the bar for directors conduct

Written by Allwyn Noronha | Updated: Sep 6 2013, 10:41am hrs
In the current turbulent times, corporates take many difficult decisions some of which come back to haunt them and directors are the one category of persons who while holding the greatest responsibility in guiding the affairs of companies also have to bear the cross of being held accountable for misdeeds of companies. This article seeks to discuss a few aspects relating to directors conduct and liability as it would unfold in the coming months.

Directors are, in a limited sense, in the role of trustees who owe a fiduciary duty to the company where they serve. Directors, therefore, are liable for breach of trust if, for example, they are held to have misapplied funds of the company or have knowingly breached or caused a breach of a law applicable to the company. Currently, the concept of officer who is in default seeks to fasten liability for breaches of company law provisions which could lead to imposition of fine, imprisonment, or both depending on the nature of the breach involved. This concept applies to managing directors/executive directors and other persons who by being responsible for the affairs of the company are also held accountable for breaches by it. In companies where there is no managing/executive director, all other directors could come under the purview of this provision. Even under other legislations, e.g. under the Income Tax Act, the liability for non-compliance by a company could fasten on the managing director or other director(s) involved in the affairs of the company. The Factories Act also seeks to make the occupier, being a director responsible for the affairs of a factory, and by consequence also the key official, responsible to authorities for defaults or non-compliances. In listed companies, the onus of ensuring compliance with various listing requirements is the responsibility of the board of directors, the audit committee and the MD/CEO. Even under criminal law where charges are filed for alleged criminal acts against the company and its directors, besides the requirement of mens rea, the fact, whether or not a director was directly in charge of the affairs of the relevant division /matter, would be the critical ingredient in establishing the liability of a director so charged.

There have been several instances in the recent past where directors have been the subject matter of prosecution due to various breaches by companies. Even though only a managing/executive director would be actually involved in day-to-day operations, it is not uncommon for other directors (e.g. independent or nominee directors or all directors in board-managed companies) being sucked into proceedings. While D&O insurance policies are usually the norm to provide directors some degree of comfort, vexatious proceedings through such actions do result in nuisance and harassment for such non-working directors.

Directors conduct while discharging their duties is therefore the key to establishing whether or not they are culpable. While an across the board behaviour analysis is probably not feasible, there have been instances where directors in large Indian companies and foreign nominee directors (i.e. nominees of foreign investors) having adopted a hands-off approach, e.g. not taking an interest in the functioning of the investee companies, not being present at board meetings, or not being involved in approving annual business plan/budgets, not reviewing statutory compliance certifications, etc. This conduct of directors not exercising due care and not being diligent while discharging their duties, from a governance perspective may seem to suggest a degree of neglect rather than mere disinterest and in many cases has exposed such directors to litigation (which sometimes is vexatious), doing rounds of various courts/regulators and even in some cases having to become familiar with the local police station.

The Companies Act, 2013 (hereafter Act), notified on August 30, 2013though its provisions are yet to come into forcenow seeks to raise the bar further in respect of the responsibilities of directors and their consequent liabilities should they not measure up.

While directors being in a fiduciary role vis--vis their companies and being required to act with due care and diligence is well recognised in India, the Act breaks new ground as Section 166 now provides for specific duties for every director. These include requirements for every director to act in good faith, with due care and diligence and with independent judgement in discharge of his duties.

Section 134 (5) of the Act now requires the boards of all companies to approve respective Directors Responsibility Statements, which requires the directors to take sufficient care in not only approving suitable accounting policies, applying them while drawing up the financial statements, maintaining adequate accounting records, but also to take due care in ensuring that proper systems are put in place and complied with in accordance with applicable laws and further, in the case, of listed companies, to ensure that internal financial controls are adequate and operate effectively. While some of these requirements exist currently for listed companies, these new requirements are now proposed to be part of the law as would be applicable to all companies. Similarly, the Act now seeks to enhance the role of independent directors where companies would henceforth be required to appoint independent directors (e.g. listed companies or for other class of companies where such requirement is prescribed); such companies would need to now comply with the requirements of Section 149(6) read with Schedule IV of the Act, which inter alia prescribes a very detailed set of requirements from both, the company and the concerned independent directors, on an ongoing basis, including criteria relating to appointment, guidelines for conduct, role, duties and performance evaluation of such independent directors.

Section 149 (12) of the Act, also makes a clear carve-out in respect of liability for directors who are not actually 'hands-on', i.e. independent directors or other non-executive directors who are not linked to the management, and thereby seeks to strengthen the role of independent and non-executive directors. In such cases, the Act provides that the independent director/non-executive director would be liable only in respect of acts of the company which have been done with his knowledge (either through board interaction or otherwise), or where such directors acted without diligence. Understandably, there can be no such saving for other directors who are directly involved on a day-to-day basis with the affairs of the company. This provision would enable boards to get the benefit of truly independent thoughts on important matters.

As we witness declining governance standards across various strata of the society, these new provisions of the Act are an extremely welcome development for enhancing corporate governance. It leads one to conclude that going forward directors need to reorient themselves to the vastly enhanced governance standards being introduced through the Act, be well informed and conduct themselves with care and diligence, as they could well be required to demonstrate that they acted in a bonafide manner and in the interest of the company. Where a directors conduct does not measure up to the new order, the Act has several penal provisions (including enhanced fines) to address such deviant conduct. Hopefully these should provide more bite through effective implementation of the new Act.

The author is partner, AZB & Partners