The Need to Reform the Duties of Directors Under the Indian Law

Introduction

Prior to the enactment of the Companies Act, 2013 (“Act”), the erstwhile Companies Act, 1956 offered very little clarity on the duties of directors, leading to reliance on common law doctrines of ‘no conflict’ and ‘no profit’. The ‘no-conflict rule’ prevents directors from placing themselves in situations where their duties to the company clash with their own personal interests. The ‘no-profit rule’ prohibits directors from retaining any profit earned through a fiduciary relationship. This unclear position was addressed by the addition of section 166 of the Act (“Section 166”), which codified the aforesaid common law doctrines.

Consent Based Exceptions

While Section 166 clearly outlines the duties of directors, neither Section 166 nor any other provision of the Act provides for any consent based exceptions to the performance of such duties. This conflicts directly with the very basis of the common law doctrines of ‘no-profit’ and ‘no-conflict’. Under common law, the doctrines of no-profit and no-conflict only apply when consent of the company and its shareholders has not been accorded for a particular act[1].

The Act only requires directors to ‘disclose’ interests that they may have in other companies and does not deal with ‘consent’[2]. It also does not address situations where directors may enter into agreements with third parties that could create a conflict with their duties to the company. For instance, upside sharing arrangements, which may be tied to short-term company performance and could lead to the director sacrificing long-term growth of the company, thereby creating a conflict of interest.

In such instances, Section 166 should not be triggered if the company itself consents to such agreements entered into by directors through a board or a shareholder resolution. While the Securities and Exchange Board of India has regulated these agreements for listed companies[3], the Act is silent on such conflict of interest in case of private or public unlisted companies.

In contrast, the United Kingdom law allows for consent through board and shareholder resolutions as an exception to breach of certain duties by directors[4]. In the case of Sharma v. Sharma and others[5], the appellants and the respondent (a director) set up a company solely to acquire dental clinics. However, the director, on one occasion, acquired a dental clinic in her own name rather than doing so in the name of the company. The appellants alleged that the director was in breach of her duties. The UK Court of Appeal noted that although there arose a conflict of interest due to the actions of the director, this would not amount to breach of her duties, as the shareholders of the company consented to such acquisition by the director.

Recommendation

Since duties of directors are an important aspect of corporate governance in India, it is essential for the Act to have express consent based exceptions similar to those found in the legal regime of the United Kingdom. It would strike a balance between safeguarding companies and their shareholders while also allowing directors to engage in commercial activities that could conflict with the company’s interests.

At present, it is difficult to argue that with the consent of the company, through board or shareholder resolutions, directors can breach their duties under Section 166. While the Act allows for authorization of conflicts by the board, for related party transactions, its purview is restricted to contracts entered into by the company[6]. The ideal approach would be to amend the Act and require a shareholder resolution to be passed to consent to exceptions under Section 166. This would prevent directors, who may also be majority shareholders, from entering into and ratifying arrangements that would benefit them but would be detrimental to the interests of the company or the minority shareholders.

References:

1. Mothew (T/A Stapley & Co) v. Bristol and West Building Society, [(1996) EWCA Civ 533].
2. Section 184 of the Companies Act, 2013.
3. Regulation 26 of the Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015.
4. Section 175 of the Companies Act, 2006 (United Kingdom).
5. Sharma v. Sharma and others, [(2013) EWCA Civ 1287].
6. Section 188 of the Companies Act, 2013.