Duties of Directors
Chapter Sixty
Syllabus topic 3.1, "Duties of Directors"
Pages 409 to 415 of 830
In one line
The Act now writes down what a director owes his company: obey the articles, act in good faith for everybody's benefit, use care and independent judgment, avoid conflicts, take no secret gain, and never hand the job to somebody else.
In exam wording: section 166 codifies the duties of a director. He shall act in accordance with the articles; act in good faith to promote the objects of the company for the benefit of its members as a whole, and in the best interests of the company, its employees, the shareholders, the community and for the protection of the environment; exercise his duties with due and reasonable care, skill and diligence and independent judgment; avoid conflicts of interest; make no undue gain; and not assign his office.
Why the law has this at all
Before 2013 a director's duties in India came from decided cases. They were real, but they were scattered, they had to be extracted from judgments about particular facts, and a director who wanted to know what was expected of him had nowhere to look.
Section 166 puts them in one place, and that is its main achievement. It also does three things the old law did not.
It widens who the director must consider. Sub-section (2) names the employees, the community and the environment alongside the members. That is a deliberate move away from the pure shareholder model, and it is the most discussed sentence in the section.
It requires independent judgment. Sub-section (3) means a director cannot simply follow the managing director or the person who nominated him. A nominee director owes his duties to the company, not to his nominator, and that is where sub-section (3) bites hardest.
And it attaches a money remedy to secret profit. Sub-section (5) does not merely prohibit an undue gain: it makes the director liable to pay an amount equal to that gain to the company, which is a restitutionary remedy written into the statute.
Some words this chapter uses
Good faith means honestly and for the proper purpose. Independent judgment means forming one's own view rather than adopting another's. A conflict of interest is a situation where a person's own interest may pull against his duty. Undue gain is a benefit obtained without justification. To assign an office is to transfer it to somebody else. Relatives are defined in section 2(77).
The seven duties: section 166
(1) Act in accordance with the articles
Subject to the provisions of this Act, a director of a company shall act in accordance with the articles of the company.
Two limits in one sentence. The articles are the director's instructions, and he must follow them. But the duty is subject to the provisions of this Act, so an article that conflicts with the Act gives him no authority, which is what section 6 already provides.
Duties of Directors
(2) Act in good faith, and for whom
A director of a company shall act in good faith in order to promote the objects of the company for the benefit of its members as a whole, and in the best interests of the company, its employees, the shareholders, the community and for the protection of environment.
This is the sentence to quote. Take the beneficiaries in order, because an examiner is looking for all of them:
- the objects of the company, which ties the duty back to the memorandum;
- the members as a whole, which excludes acting for one faction of them;
- the company itself;
- its employees;
- the shareholders;
- the community; and
- the protection of the environment.
The words "as a whole" are doing real work. A director appointed by a majority block must act for the general body of members, not for the block that put him there.
And the last three are the innovation. English company law reaches the same result through a duty to promote the success of the company while having regard to a list of factors; the Indian Act states them as part of the duty itself.
(3) Care, skill, diligence and independent judgment
A director of a company shall exercise his duties with due and reasonable care, skill and diligence and shall exercise independent judgment.
Four requirements: due and reasonable care, skill, diligence, and independent judgment.
The standard is not perfection. It is due and reasonable, judged by what may fairly be expected of a person in that position with that knowledge. A director is not liable for an honest commercial misjudgment made with proper care.
Independent judgment is separate from the other three, and it is the limb that catches the passive director. A director who signs whatever is put in front of him has not exercised independent judgment even if he has been diligent about attending.
(4) Avoid conflicts
A director of a company shall not involve in a situation in which he may have a direct or indirect interest that conflicts, or possibly may conflict, with the interest of the company.
Read the width of it. It covers a direct or indirect interest, and a conflict that possibly may arise, not only one that has arisen. It is a duty to stay out of the situation, not merely to behave properly once in it.
How it works in practice is through the disclosure machinery: section 184, under which a director discloses his concern or interest and does not participate, and section 188, which regulates related party transactions. Section 166(4) is the principle; those two are the procedure.
Duties of Directors
(5) No undue gain, and the remedy
A director of a company shall not achieve or attempt to achieve any undue gain or advantage either to himself or to his relatives, partners, or associates and if such director is found guilty of making any undue gain, he shall be liable to pay an amount equal to that gain to the company.
Three points.
"Achieve or attempt to achieve", so an unsuccessful attempt is a breach.
The gain may be to himself or to his relatives, partners or associates. Routing a benefit through a family member is squarely within it.
And the remedy is restitution: he pays an amount equal to that gain to the company. Note that it is the gain he must pay over, not the company's loss, which may be smaller or nil.
(6) No assignment of office
A director of a company shall not assign his office and any assignment so made shall be void.
Void, not voidable. A director is chosen for himself, so he cannot transfer the office to another. This is not the same as appointing an alternate under section 161(2): an alternate acts during the original's absence and vacates when he returns, and the original keeps his office throughout.
(7) The penalty
If a director of the company contravenes the provisions of this section such director shall be punishable with fine which shall not be less than one lakh rupees but which may extend to five lakh rupees.
Note that it is the director alone, not the company, and that it is a fine, which survived the general conversion of the Act's penalties.
How section 166 sits with the rest of the Act
The duties are not the only source of liability. A breach of section 166 may also be:
- a failure to disclose interest under section 184, which vacates the office under section 167(1)(c) and (d);
- a related party transaction without approval under section 188, conviction for which is a disqualification under section 164(1)(g);
- fraud under section 447, if there was an intent to deceive; and
- ground for oppression or mismanagement proceedings under sections 241 and 242, or a class action under section 245.
And for independent directors there is more. Section 149(8) requires the company and its independent directors to abide by the provisions of Schedule IV, which sets out a code containing their professional conduct, roles, functions and duties, and their manner of appointment, evaluation and resignation. Section 149(12) then limits an independent director's liability to acts of omission or commission by the company which had occurred with his knowledge, attributable through Board processes, and with his consent or connivance or where he had not acted diligently.
Duties of Directors
A worked example
Mr Ghatge is a director of Ichalkaranji Textiles Limited. The company is deciding whether to buy a dyeing plant.
Duty (1). The articles require any purchase above two crore rupees to be approved by the Board with a specified quorum. He must act in accordance with the articles, subject to the Act.
Duty (2). In deciding, he must act in good faith to promote the objects of the company for the benefit of the members as a whole, and in the best interests of the company, its employees, the shareholders, the community and the protection of the environment. The plant discharges effluent, so the environmental limb is not decoration: it is part of the duty he is exercising.
Duty (3). He must apply due and reasonable care, skill and diligence, which means reading the papers and asking about the effluent treatment, and independent judgment, which means forming his own view rather than deferring to the managing director's enthusiasm.
Duty (4). His brother-in-law owns the company selling the plant. That is an indirect interest that conflicts, or possibly may conflict, with the company's interest. He is in breach of section 166(4) simply by being in the situation, and the machinery for dealing with it is section 184, disclosure and non-participation, and section 188 if the seller is a related party.
Duty (5). Suppose he negotiates a private commission of eight lakh rupees from the seller. He has achieved an undue gain, and he is liable to pay eight lakh rupees to the company under section 166(5). It makes no difference that the company paid a fair price and lost nothing: the section takes the gain, not the loss. It would equally have applied had the commission gone to his brother-in-law.
Even an attempt. Had the seller refused to pay the commission, he would still have attempted to achieve an undue gain, which section 166(5) prohibits in terms.
Duty (6). He is unwell and proposes that his son take his seat on the Board "in his place". He cannot assign his office, and any assignment is void. What he may do, if the articles or a general meeting resolution allow and he will be absent from India for not less than three months, is have an alternate director appointed under section 161(2).
The consequences. For the contravention he faces a fine of one lakh to five lakh rupees under section 166(7). Separately, his failure to disclose under section 184 vacates his office under section 167(1)(d); if the transaction was a related party transaction without approval, conviction under section 188 disqualifies him for five years under section 164(1)(g); and if there was an intent to deceive, section 447 applies.
Duties of Directors
Change one fact. Suppose Mr Ghatge were an independent director who knew nothing of the commission, had attended and questioned properly, and had no consent or connivance. Section 149(12) limits his liability to acts which occurred with his knowledge, attributable through Board processes, and with his consent or connivance, or where he had not acted diligently.
Distinctions that carry marks
| Duty | Sub-section | The point |
|---|---|---|
| Act per the articles | 166(1) | Subject to the Act, so the Act prevails |
| Good faith for the objects, members as a whole, company, employees, shareholders, community, environment | 166(2) | The widest statement of whom a director serves |
| Due and reasonable care, skill and diligence, and independent judgment | 166(3) | Catches the passive and the deferential director |
| Avoid conflicts, direct or indirect, actual or possible | 166(4) | A duty to stay out of the situation |
| No undue gain to himself, relatives, partners or associates; attempt included | 166(5) | Remedy is to pay the gain to the company |
| No assignment of office | 166(6) | Any assignment is void |
| Fine | 166(7) | One lakh to five lakh rupees, on the director |
| Assignment of office, section 166(6) | Alternate director, section 161(2) | |
|---|---|---|
| What happens to the original's office | He tries to transfer it | He keeps it |
| Trigger | None; simply prohibited | Absence from India three months or more |
| Validity | Void | Valid, if the articles or a general meeting resolution allow |
| Ends | Not applicable | When the original returns to India |
| Breach of section 166 may also be | Provision |
|---|---|
| Non-disclosure of interest, vacating office | Sections 184 and 167(1)(c) and (d) |
| An unapproved related party transaction | Section 188; conviction disqualifies under 164(1)(g) |
| Fraud | Section 447 |
| Oppression or mismanagement, or a class action | Sections 241, 242 and 245 |
What this does NOT mean
It does not mean a director guarantees success. The standard is due and reasonable care, skill and diligence, not perfection, and an honest commercial misjudgment made with proper care is not a breach.
It does not mean a nominee director serves his nominator. Section 166(3) requires independent judgment, and section 166(2) fixes the beneficiaries, which do not include the nominating institution.
It does not mean the company must have lost money. Under section 166(5) the director pays an amount equal to the gain, whether or not the company suffered.
It does not mean a director may never step back. He may resign under section 168, or have an alternate appointed under section 161(2) if he is absent from India for three months or more. What he may not do is assign the office.
Duties of Directors
Quick revision
- 166(1): act in accordance with the articles, subject to the Act.
- 166(2): act in good faith to promote the objects of the company for the benefit of its members as a whole, and in the best interests of the company, its employees, the shareholders, the community and for the protection of environment.
- 166(3): due and reasonable care, skill and diligence, and independent judgment.
- 166(4): do not involve yourself in a situation of direct or indirect interest that conflicts, or possibly may conflict, with the company's interest.
- 166(5): no undue gain or advantage, or attempt, to himself or his relatives, partners or associates; if guilty, liable to pay an amount equal to that gain to the company.
- 166(6): shall not assign his office; any assignment is void.
- 166(7): contravention, fine not less than one lakh and up to five lakh rupees, on the director.
- Related: section 184 disclosure, section 188 related party transactions, section 167(1)(c) and (d) vacation, section 447 fraud, section 149(8) and Schedule IV for independent directors, and section 149(12) limiting their liability.
Test yourself
1. State the duty in section 166(2) in full. A director shall act in good faith in order to promote the objects of the company for the benefit of its members as a whole, and in the best interests of the company, its employees, the shareholders, the community and for the protection of environment.
2. What standard of care does the Act require? Due and reasonable care, skill and diligence, together with the exercise of independent judgment: section 166(3). It is not a standard of perfection, and an honest commercial misjudgment made with proper care is not a breach.
3. How wide is the duty to avoid conflicts? A director shall not involve himself in a situation in which he may have a direct or indirect interest that conflicts, or possibly may conflict, with the interest of the company: section 166(4). It covers indirect interests and merely possible conflicts.
4. What is the remedy where a director makes an undue gain? He is liable to pay an amount equal to that gain to the company: section 166(5). The prohibition covers an attempt, and a gain to his relatives, partners or associates as well as to himself.
5. May a director appoint somebody to take his place? He may not assign his office, and any assignment is void: section 166(6). He may, if the articles or a general meeting resolution permit and he is absent from India for not less than three months, have an alternate director appointed under section 161(2), in which case he keeps his own office.
Duties of Directors
6. What is the penalty for contravening section 166? The director shall be punishable with a fine of not less than one lakh rupees and up to five lakh rupees: section 166(7).
The rest of this subject
These notes are cut from the University's printed syllabus. Open the syllabus itself, or the past papers, for the same subject.