IDirectors of a Company

NATIONAL LAW INSTITUTE UNIVERSITY

LAW OF BUSINESS ASSOCIATIONS- IVIII TRIMESTER

Directors of a Company

Submitted To- Submitted By-

Dr. KONDAIAH J. AMIT DUBEY

Assistant Professor (Corporate Law) BA LLB (Hons.)-2013-45

IIDirectors of a Company

TABLE OF CONTENTS

1. Introduction..............................................................................................................................................3

2. Role Of Directors.................................................................................................................................... 3

2.1. Directors As Agents.......................................................................................................................5

2.2 Directors As Trustees....................................................................................................................6

3.Powers And Obligations Of Company Directors........................................................................7

3.1. General............................................................................................................................................ 7

3.2. Good Faith...................................................................................................................................... 8

3.3. Conflict Of Interest.....................................................................................................................8

3.4. Limitation On Use Of Powers.................................................................................................8

3.5. Skill And Diligence......................................................................................................................9

3.6. Duty To Account............................................................................................................................ 9

3.7. Duty To Notify...............................................................................................................................10

3.8. Duty To Attend Board Meetings............................................................................................10

3.9. Duty Towards Employees........................................................................................................10

3.10. Duty To Creditors......................................................................................................................11

3.11. Directors Liabilities.................................................................................................................11

3.12. Fraudulent Or Reckless Trading.........................................................................................12

4. Qualifications Of A Director...........................................................................................................13

5.Conclusion............................................................................................................................................... 14

6.Bibliography........................................................................................................................................... 15

IIIDirectors of a Company

INTRODUCTION

The undoubted abuse of the corporate structure by unscrupulous business people over many years has brought about a change in the attitude of legislators and lawyers alike in relation to their dealings with and attitudes, in relation to limited liability companies. Perhaps the greatest illustration of the change in attitude towards companies is to be found in the Companies Acts, 1956, in this jurisdiction, which have created a web of intricate controls and regulations to prevent the outright abuse of the corporate personality as had previously been seen.

Directors now would be well advised to be familiar with their duties and obligations and furthermore the restrictions placed upon them by the Companies legislation, and set out below is a general overview of these duties, obligations and restrictions as they exist today. This project basically deals with the role and position of the Directors in a Company.

IVDirectors of a Company

ROLE OF DIRECTORS

“A Corporation is an artificial being, invisible, intangible and existing only in

contemplation of law”1.It has neither a mind nor a body of its own”2. This makes it

necessary that the company’s business should be entrusted to some human agents.

Section 149 of the Act, therefore requires that “every public company shall have at least

two directors”.

The primary Act governing the law relating to companies in India is the Companies Act,

1956, and Section 2(13) defines a director as including "any person occupying the

position of director by whatever name called". In the words of Bowen LJ,

“Directors are described sometimes as agents, sometimes as trustees and

sometimes as managing partners. But each of these expressions is not used as exhaustive

of their powers and responsibilities, but as indicating useful points of view from which

they may for the moment and for the particular purpose be considered.”

Directors, in company law, are the agents by whom a trading or public company acts, the

company itself being a legal abstraction and unable to do anything. As joint-stock

companies have multiplied and their enterprise has extended the position of directors has

become one of increasing influence and importance. It is they who control the colossal

funds now invested in trading companies, and who direct their policy (for shareholders

are seldom more than dividend-drawers). Upon their uprightness vigilance and sound

judgment depends the welfare of the greater part of the trade of the country concerned. It

is not to be wondered at that in view of this influence and independence of action the law

courts have held directors to a strict standard of duty.

When a company is formed, the first directors of the company will be named and any

subsequent directors are to be appointed pursuant to the provisions of the Articles of

Association, which is effectively the document governing the internal running of the

company. If the Articles of Association do not provide any specific mechanism for the 1MARSHALL J in Trustees of Dartmouth College v. Woodward, (1819) 17 US 518, 636 cited in Laski, The personality of Associations , 29 Hrav LR 404 2 HALDANE LC in Lennard’s Carrying Co. v. Asiatic Pertroleum Co, (1915) AC 705 at 713.

VDirectors of a Company

appointing of a director the members in general meeting may appoint one. Equally, any

director, other than a director for life, can be removed in general meeting and the Articles

of Association cannot interfere with this statutory power. A notice of 14 days must be

given of the intention to hold a general meeting for the purposes of removing a director.

It should be borne in mind that it is a useful practice to separate a person's role as

a director from his position as an employee of the company. Therefore, an individual's

removal as director of a company and the termination of his contract of employment must

be deemed to be separate acts. The company must keep a copy of all its service contracts

at its registered office for inspection by the members of the company. Any director who

is purported to be appointed must be approved in general meeting by the members.

The basic function of the directors is to manage the affairs and activities of the company

and in order to do so, they must have certain powers. It is common in legal parlance to

say that wherever powers go, obligations must surely follow. It is now time to consider

some of these.

2.1. Directors as Agents

It was clearly recognized as early as 1866 in Ferguson vs. Wilson3 that directors

are in the eyes of law, agents of company. The court said:

The company has no person, it can act only thorough directors and the case is as

regards, those directors, merely the ordinary case of principle and agent.

The general principles of agency, therefore govern the relations of directors with the

company and of persons dealing with the company through its directors. Where the

directors contract in the name, and on behalf of the company, it is the company which is

liable on it and not the directors. Thus where the plaintiff supplied certain goods to a

company through its chairman, who promised to issue him a debenture for a price but

never did so and the company went into liquidation, he was held not liable to the

plaintiff4. Similarly, where the directors allotted certain shares to the plaintiff, they were

not liable when the company having exhausted its shares failed to give effect to the

3 (1866) LR 2 Ch 774 Elkington & Co v Hurter, (1892) 2 Ch 452

VIDirectors of a Company

allotment5. But notice to a director will amount to a notice to the company only if the

director is, like an agent, bound in the course of his duty to receive the notice and to

communicate it to the company. It was held in Hampshire Land Co, Re6 that where one

person is an officer of two companies, his personal knowledge is not necessarily the

knowledge of both the companies unless he is under a duty to receive a notice and to

communicate it to the other. Like agents, they have to disclose their personal interests, if

any in any transactions of the company. It should however be remembered that they are

the agents of an institutions and not of its individual members, except when their

relationship arises due to the special facts of a case7.

2.2 Directors as Trustees

Although directors are not properly speeking trustees, yet they have always been

considered and treated as trustees of money which comes to their hands or which is

actually under their control and ever since joint stock companies were invented directors

have been held liable to make good moneys which they have missapplied upon the same

footing as if they were trustees. In Ramaswamy Iyer v. Bramhayya & Co8.,the Madras

High Court observed that:

The directors of a company are trustees for the company and with reference to

their power of applying funds of the company and for misuse of the power they

could be rendered liable as trustees and on their death, the cause of action

survives against their legal representatives.

Another reason why directors have been described as trustees is the peculiar nature of

their office. The directors are persons selected to manage the affairs of the company for

the benefit of the shareholders. It is an office of trust which if they undertake, it is their

duty to perform fully and entirely. Some of their duties of the company are of the same

nature as those of the trustees. For example they, like trustees, occupy a fiduciary

5 Supra note 36 (1896) 2 Ch 7437 Allen v. Hyatt, (1914) 30 TLR 444: It is a matter of evidence in each case whether a director can be regarded as a principle officer or agent for income tax purposes.8 (1966) 1 Comp LJ 107 Mad.

VIIDirectors of a Company

position. Moreover, almost all the powers of the directors are powers in trust9. The

power to make calls10, to forfeit shares11, to issue further capital12, the general powers of

management13, and the power to accept or refuse a transfer of shares are powers in trust

which have to be exercised in good faith for the benefit of the company as a whole.

Yet, directors are not trustees in the real sense of the word. There is nothing in common

between a director and a trustee of a will or a marriage settlement. Moreover, a trustee is

a legal owner of the trust property and contacts in his own name. A director, on the other

hand is a paid agent or officer of the company and contracts for the company. The real

truth of the matter is that directors are commercial men managing a trading concern for

the benefit of themselves and of all the shareholders in it.

POWERS AND OBLIGATIONS OF COMPANY DIRECTORS

3.1. General

The powers of the directors are normally those delegated to them by the company. In

practical terms the directors of a company can do anything that the company can do. It

should be borne in mind that neither the directors nor the company can do anything

which is ultra vires; by this is meant beyond the powers of the company. The powers of

the company are defined in the Memorandum of Association and contained in what is

known as the Objects Clause. In addition, a company obviously cannot do anything

which is illegal and the same limitation is placed upon company directors. Once the

directors are acting in good faith and doing their best for the company, the company in

general meeting does not have power to set aside the day-to-day actions of the directors,

provided it can be established that the actions of the directors were within the powers of

the directors.

9 See, Berle, Corporate Powers as Powers in trust, 44 Harv LR, 1949 where the learned writer enlists the powers which have been held as powers in trust.10 Alexander v. Automatic Telephone Co. (1900) 2 Ch 56.11 Esparto Trading Co., Re, (1879) 12 Ch D 19112 Nanalal Zavr v. Bom Life Assurance Co, AIR 1949 Bom 5613 Marshall Valve Gear Co. v. Manning, Wardley & Co, (1909) 1 Ch 267.

VIIIDirectors of a Company

This does not however make the company powerless in the face of directors. They have a

number of options available to them, one option is by special resolution, i.e. a vote of

75% or more of the members in general meeting, where they can amend the Articles of

Association and thereby alter the powers of the directors.

In addition, it should be noted that directors can be removed from their office as directors

by an ordinary resolution, i.e. a vote of 51% or more of the members in general meeting.

3.2. Good Faith

Every director has a duty to act in good faith in the interests of the company. Even though

the company itself is an artificial legal personality, the duty is still owed to the company,

not to the shareholders or creditors of the company, though some duties to creditors and

shareholders are in fact imposed by statute.

3.3. Conflict of Interest

At all times directors have a duty to avoid conflicts of interest and by this is meant

effectively that a director must not do anything for and on behalf of the company where

his motivation and loyalites would be divided in that his own self interest, of someone

connected to him, may be given equal stature to that of the company. As we will see later,

in the event of such actions taking place, the director has a duty to account to the

company for any profits or gains he may have made as a result of this, and in

consequence thereof, the companies have certain rights against the director for acting in

circumstances of such conflict of interest.

3.4. Limitation on Use of Powers

The powers conferred by the Articles of Association on the directors for the purposes of

managing the affairs of the company may only be used for the purposes for which they

were intended. Therefore, any hidden motivation or purpose which is not in the interest of

IXDirectors of a Company

the company may lead to the allegation of abuse of powers and could lead to considerable

difficulties for the director in question.

3.5. Skill and Diligence

It is a generally accepted principle that the position or status of director is not a

professional position. However, a director in exercising his duties is expected to exercise

skill and diligence14. What is often problematic is to determine the level of skill or

diligence which is to be required. It is generally accepted and has been stated in a number

of cases in English and Irish Courts, that a director is expected to exercise reasonable

skill and diligence to a level which could reasonably be expected from a person of the

director's individual knowledge and experience. This is not to say however that errors of

judgment would not occur, but provided that the errors of judgment are reasonable, the

director will not necessarily be answerable therefore. It is also acknowledged that the

directors are not generally 24 hours servants of the company and that they may devote

some of their energy and time to other pursuits and interests, and this is not per se to be

taken as a failure to exercise reasonable skill and diligence.

3.6. Duty to Account

A director of a company is under a duty to account for all benefits that he receives by

virtue of his position as a director. Any contract that a director enters into where the

company of which he is director is the other party to that contract, is voidable, i.e. can be

set aside at the election of the company in general meeting. In addition of course, the

contract can be ratified. Any contract which is proposed between the director and the

company must, pursuant to statute, be preceded by a disclosure of the director's interests

to the board of directors.

A register must be kept of said director's interests. It should be noted in addition that the

duty to account for all benefits received by virtue of position as director is not limited

exclusively to contracts but also includes loans and quasi loans given by the company,

14 RE Forest of Dean Coal Mining Co, (1878) 10 Ch D 450.

XDirectors of a Company

any credit transactions, and any guarantees or security given by a company for loans

given by third parties to directors.

3.7. Duty to Notify

Directors are also under a duty to notify the company in writing of their interests in

company shares or debentures, and dealings in the company shares or debentures. This

also includes interests of spouses and minor children in the same shares and debentures.

3.8. Duty to attend Board meetings

Duties of directors are of intermittent nature to be performed at periodical board

meetings. In other words, they are not bound to pay continuous attention to the affairs of

the company. As Romer J in City Equitable Fire Insurance Co, Re15 remarked “ they do

not undertake to manage the company. A director is not even bound to attend all the

meeting of the board, although he is under an obligation to attend whenever in the

circumstances he is reasonably able to do so”.

According to section 283 (g) the office of a director will be vacated if he absence

himself from 3 consecutive meeting of the board, or from all meetings of the board for a

consecutive period of 3 months, which ever is longer, without obtaining leave of absence

from the board. Moreover, a director habitual absence from the board meetings may,

taken in light of other circumstances, become evidence of negligence on his part. In an

early case, in which liability was imposed for failure in this respect, the court said, “ if

some persons are guilty of gross non attendance, and leave the management entirely to

others, they may be guilty by this means if breaches of trust are committed by others”.16

3.9. Duty towards Employees

Directors owe no duty to company’s employees. In cases where directors have exercised

their discretion for the benefit of employees and for example, made ex gratia payments to

15 (1925) 1 Ch 40716 Charitable Corpn. v. Sutton, (1742) 26 ER 642

XIDirectors of a Company

them, the courts have considered those payments not in relation to the directors ‘ duties

but, actually, whether they are ultra vires the company.

But nevertheless, they have a duty to act in the interest of the employees. Directors whilst

acting in the interests of the company have a duty to have regard to the interests of the

company's employees as well as the members/shareholders of the company. Since the

duty imposed on the directors is over to the company and not to the employees

themselves, the duty can be enforced only in the form of a fiduciary duty to the company.

3.10. Duty to Creditors

Up until a few years ago, the general attitude of the courts was inconsidering that

directors are not trustees for creditors of the company. The creditors have certain rights

against the company and its members but they have no greater rights against the directors

than against any other members of the company. They had only those statutory rights

against the members, which are given to them in winding up.

Now, instead of owing a duty directly to a creditor, the position is that directors have, in

fulfilling their duties to the company in certain circumstances, most notably when the

company is insolvent, a duty to consider the interests of creditors. Conformation that a

director does not owe duties to creditors as such was made in Kuwait Asia Bank EC v.

National Mutual Life Nominees Ltd17, where in the judgment of the Privy Council, it was

stated that a director does not by reason only of his position as director owe any duty to

creditors of the company.

3.11. Directors Liabilities

A director can always be sued at common law under the tort of negligence, i.e. the failure

to take reasonable care or a breach of a duty of care to the company in circumstances

where he has acted negligently. In general terms, the director as an agent of the company

17 (1991) 1 AC 187

XIIDirectors of a Company

is entitled to an indemnity against claims being made against the company, which said

acts may in fact have been carried out by the company director.

3.12. Fraudulent or Reckless Trading

Directors should be aware of the fact that if in the course of a winding-up or liquidation

of a company, it appears that a director was knowingly a party "to the carrying on of any

business of the company in a reckless manner", or was knowingly a party to the carrying

on of any business of the company "with intent to defraud creditors of the company or

creditors of any other person or for any fraudulent purposes, the Court is at liberty to

make such a director personally liable without any limitation of liability for all or any

part of the debts or liabilities of the company".

That is, if a director has misapplied or retained or become liable or accountable for any

money or property of the company, or has been guilty of any misfeasance or other breach

of duty or trust in relation to the company, the Court may order the director to repay or

restore the money or property, or any part, with interest at such rate as the Court thinks

fit, or to contribute monies to the assets of the company by way of compensation in

respect of the misapplication, retainer, misfeasance or other breach of duty or trust, as the

Court thinks just.

XIIIDirectors of a Company

QUALIFICATIONS OF A DIRECTOR

Most parties would be qualified to act as a director of a company as no specific

qualifications are required, except that the articles of the company may provide that a

certain number of shares will have to be held by each director. Such shares are called

qualification shares. However, there are certain categories of person who are specifically

excluded and prohibited from being directors of companies18.

For instance,

1. Where he is of unsound mind, provided that the fact has been certified by a court of

competent jurisdiction and the finding is enforced;

2. Where he is an undischarged insolvent;

3. Where he has applied to be adjudicated as an insolvent;

4. Where he has been sentenced to at least six months of imprisonment for an offence

involving moral turpitude and five years have not elapsed from the date of expiry of

the sentence.

5. Where he has not paid for six months any call on shares;

6. Where he has been disqualified under section 203 of the Act for the purpose of

preventing fraudulent persons from managing companies.

18 Section 274

XIVDirectors of a Company

CONCLUSION

The director is the kingpin of the functioning of a company. His role is not only indispensable to its working but is also vital to its economic well being, since it is with them that all the powers of management are vested. Day to day corporate decision making can be carried out only under the able leadership of a director. Hence, it is pertinent to understand the role, office, duties and liabilities of a director while interacting with any company.

XVDirectors of a Company

BIBLIOGRAPHY

Books

1. Singh, Avtar, Company Law, 11th edn., Eastern Book Company (1998)

2. Datey, Company Law, 2nd Edition, Taxmanns Publishing House(2000)

Articles

3. “Directors’ ‘Wider’ Responsibilities- Problems, Conceptual, Practical &

Procedure”, Leonard Sealy, Monash University Law Review, Vol.13, No.3,

September 1987

4. “ New Developments in Director’s Duties; The Victorian Stance on Financial

Competence, Julie Dodds, Monash University Law Review, Vol.17, No.1, 1991

Websites

5. http://www.howtolaw.co.nz

6. http://58.1911encyclopedia.org/D/DI/DIRECTORS.htm

7. http://www.tallaght.com/lawyer/commercial/director