F IDUCIARY DUTIES OF A DIRECTOR: INVESTIGATION THROUGH CASE ANALYSIS

SUBMITTED TO

Dr. DIPAK DAS,

Associate Professor,

FACULTY: CORPORATE LAW

SUBMITTED BY

Abhinav K Shukla

SEMESTER-VI; SECTION-A

ROLL.NO.-03

SUBMITTED ON- 7 th April, 2015

1 | P a g e

TABLE OF CONTENTS

ACKNOWLEDGEMENTS 3

INTRODUCTION 4

OBJECTIVES 5

RESEARCH METHODOLOGY 5

FIDUCIARY DUTIES 6

DUTY OF GOOD FAITH AND BONA FIDE ACTS DUTY OF CARE DUTY NOT TO DELEGATE DUTY TO DO LEGAL ACTS AND PROPER USE OF POWERS UNFETTERED DISCRETION LACK OF CONFLICTING INTERESTS

DIRECTORS’ AND BREACH OF TRUST 11

DIRECTOR’S KNOWLEDGE AS KNOWLEDGE OF THE COMPANY12

CASE LAW ANALYSIS 14

Dale and Carrington Investment (P) Ltd v. P.K. Prathapan And Ors 13

Regal (Hastings) Ltd. v. Gulliver and Ors15

Alexander v. Automatic Telephone Co 16

Needle Industries (India) Ltd. v. Needle Industries Newey (India) Holding 16

Piercy v. S. Mills & Co. Ltd.17

The Tea Brokers (P) Ltd. and Ors. v. Hemendra Prosad Barooah 18

2 | P a g e

FIDUCIARY DUTY AND INDIAN TRUSTS ACT 18CONCLUSION 21BIBLIOGRAPHY 22

ACKNOWLEDGEMENTS

This project is a result of sheer hard work and dedication. I would like to pay my heartfelt

gratitude to my respected faculty Dr. Dipak Das Sir for providing such a challenging topic.

If he had not shown faith in me, I don’t think this project would have been reality. He guided

me at every footstep and providing me wholesome help, wherever I required.

I would also like to say thanks to entire HNLU administration for allowing me to use

whatever the facilities available throughout the campus.

Lastly, from the very outset, I was encouraged by my friends and classmates in the right

direction, so that I can focus on the task.

Some printing errors might have crept in, which are deeply regretted. I would be grateful to

receive comments and suggestions to further improve this project report.

Abhinav K Shukla,

Roll No. 03,

Section A, Sem VI

Batch XII.

3 | P a g e

INTRODUCTION

“A living person has a mind which can have knowledge or intention and he has hands to

carry out his intention. A corporation has none of these; it must act through living persons”.1

Human beings have their hands and also possess the mental faculty. They are thus, capable of

taking right decisions and actions. But a corporation, not being the natural person, is devoid

of these essential elements and hence, it cannot take an action or a judgment itself. Rather it

requires a channel through, which it can take actions and decisions. The directors of the

company thus serve as the required channel to accomplish the decision-making and action-

taking task of the corporation. “A corporation is an artificial being, invisible, intangible and

existing only in contemplation of law.”2 A corporation cannot have the intention. It is only

the intention of its agents, which make it liable for the wrongs in the nature of torts or

the criminal wrong.

A corporation has its separate identity than its shareholders and its agents. Dwelling upon the

necessity of the agents for carrying out its task, the role of the directors of a company

becomes of paramount essence.

A Director is an agent of the Company for the conduct of the business of the company. The

Directors of the subsidiary of a foreign company are not on any separate footing. As agents or

officers of the Company, directors have a fiduciary relation with the Company and its

shareholders. Directors are bound to use fair and reasonable diligence in discharging the

duties and to act honestly, and with such care as may be reasonably expected from, having

regard to their knowledge and experience. Express liability would usually arise only when a

director has personally guaranteed the performance of a contract. As far as fiduciary duties

are concerned, any breach by directors would make them liable. Directors would be liable for

1 HALDANE LC in Lennard’s Carrying Co. v.  Asiatic Petroleum Co., 1915 AC 705 at p. 713.2 MARSHALL J. in Trustees of Dartmouth College v. Woodward, (1819) 17 US 518, 636.

4 | P a g e

negligence, breach of trust, misfeasance, and ultra vires actions and for applying the funds of

the company for such acts.

It is stated that in applying the general equitable principles to directors of a company, four

separate rules have emerged. These are: (1) that directors must act in good faith in what they

believe to be the best interests of the company; (2) that they must not exercise the powers

conferred upon them for purposes different from those which they were conferred; (3) that

they must not fetter their discretion as to how they shall act; and (4) that, without the

informed consent of the company, they must not place themselves in a position in which their

personal interests or duties to other persons are liable to conflict with their duties to the

company.3

RESEARCH METHODOLOGY

Research Methodology adopted in completion of this project is mainly Doctrinal in nature.

Secondary sources such as Books and journals have been used widely in completion of this project

OBJECTIVES

To study the position of directors with respect to the fiduciary duties they are required to perform

To analyze certain case-laws, Indian as well as British, to study the fiduciary position of the directors with respect to the company

3 Gower’s principles of Modern Company Law (6th Edition, 1997, page 601

5 | P a g e

FIDUCIARY DUTIES

A Director owes fiduciary duties towards the company, and not to individual shareholders,

creditors (other than during winding up when their interest has to be taken care of) or fellow

Directors. These generally consist of the following:

Duty of Good faith and bona fide acts

Directors must act honestly, without negligence and in good faith in the bona fide best

interests of the company. Interest of the company implies the interest of the present and

future members of the company on the footing that the company would be continued as a

going concern.

While applying this rule, Directors are not expected to act purely for the economic

advantages of the company, disregarding the interests of the members, employees or

creditors. The presumption is that a Director, acting within his or her authority, has acted in

good faith, though the act may have been foolish or wrong, unless proved otherwise. The

Courts usually refuse to substitute their judgment for the commercial judgment of the

Director. The directors should not make any secret profits. He should also not exploit to his

own use the corporate opportunity.

In Coke v. Veeks4, it was observed that “men who assume complete control of a

company’s business must remember that they are not at liberty to sacrifice the interest which

they are bound to protect and while ostensibly acting for the company, direct in their own

favour business which should properly belong to the company they represent.” In this case

there was an offer of a contract to the company. Directors who were the holders of the share

3/4th of the votes resolved that the company had no interest in the contract and later entered

into the contract by themselves. Held, the benefit of the contract belonged in equity to the

company. As regards the director selling his property to the company there would be breach

of faith and he would have to account for the profit to the company if the property was

acquired by him under circumstances which made it in equity the property of the company.

But if the property in equity as well as in law belonged to him, there is no breach of faith.5

In Regel (Hastings) Ltd. V. Gulliver case, the plaintiff was a director in one company

and a shareholder and creditor in another company. The second company was being wound

up and the plaintiff purchased the assets of the second company at a public auction in four 4 [1916] AC 5545 Burland v. Earle [1902] AC 83.

6 | P a g e

lots. One such lot he sold to the former company (in which he was a director) at almost the

tree times the price he had paid for it. The lower Court decided that should account for the

profit in resale to the company. But, the Privy Council overruled the decision. Again if the

property is acquired by a director by reason of the fact he is a director and in the course of the

exercise of the office of director, then the profit on resale of such property would belong to

the company.6

Duty of Care

A director must display care in performance of work assigned to him. He is, however,

not expected to display an extraordinary care but that much care only which a man of

ordinary prudence would take in his own case. Justice Romer In Re City Equitable Fire

Insurance Company’s case observed:7

“Director’s duty will depend upon the nature of the company’s business, the manner

in which the work of the company is distributed between the directors and other officials of

the company. In discharging these duties a director must exercise some degree of skill and

diligence. But he does not owe to his company the duty to take all possible care or to act with

the best care. Indeed, he need not exhibit in the performance of his duties a greater degree of

skills than may reasonably be expected from a person of his knowledge and experience. It is

therefore, perhaps another way of stating the same proposition that directors are not liable for

mere error of judgment.”

Similar view was expressed in Lagunas Nitrate Co. Ltd v. Lagunas Nitrate Syndicate8, in

the following words:

“If directors act within their powers, if they act with such care as is to be reasonably

expected of them having regard to their knowledge and experience and if they act honestly

for the benefit of the company they discharge both their equitable as well as legal duty of the

company.”

6 Regel (Hastings) Ltd. V. Gulliver, [1942] All ER 378 (HC)7 Infra, 98 [1899] 2 Ch. 392

7 | P a g e

Three propositions laid down by Justice Romer in City Equitable Fire Insurance Co.9

(which was relied upon in India in the case of National Bank of Upper India, Lucknow vs.

Dina Nath Sapru and others):10

(i) A director need not exhibit in the performance of his duties a greater degree of skill than

may reasonably be expected from a person of his knowledge or experience.

(ii) A director is bound to give continuous attention to the affairs of his company, his duties

being of an intermittent nature to be performed at periodical Board meetings or committee

meetings. He is not bound to attend all Board and committee meetings, though he ought to

attend all such meetings as he is reasonably able to.

(iii) In respect of all such duties as may be properly left to some other official having regard

to the exigencies of business or articles of association of the company, a director is, in the

absence of grounds for suspicion, justified in trusting that official to perform such duties

honestly.

In discharging their duties, directors must act honestly and must exercise such reasonable

degree of skill and diligence as would amount to reasonable care which an ordinary man

might be expected to take.11 While negotiating a contract for his / her company, a director

should make it clear to the other party that the contract will be entered into by the company

and not the director personally. If he does not do this and the other party believes that he is

contracting with the director or agent and not the company, the contract they conclude will be

a personal one made with the director and he will be personally liable for fulfilment of the

promises made.12

Section 201 states a provision in the company’s Article or in any agreement that excludes the

liability of the directors for negligence, default and misfeasance, breach of duty or breach of

trust, is void. The company cannot even indemnify the directors against such liability. But, if

a director has been acquitted against such charges, the company may indemnify him against

costs incurred in defence.

9 (1925) Ch 407 10 AIR 1926 Oudh 24311 Govind Narayan Karkade vs. Rangnath Gopal Rajopadhye, AIR 1930 Bom 572.12 Raja Ram Jaiswal vs. Ganesh Prasad AIR 1959 All 29.

8 | P a g e

Section 633 further states that where a director may be liable in respect of the negligence,

default, breach of duty, misfeasance or breach of trust but if he has acted honestly and

reasonably and having regard to all circumstances of the case, he ought fairly to be excused,

the court may relive him either wholly or partly from his liability on such terms as it may

think fit. However, the plea of a director that he was merely a non-executive independent

director at the time of issuance of the prospectus by itself is not enough to grant him relief

under Section 633.13

Duty not to Delegate

Director being an agent is bound by the maxim ‘delegatus non potest delegare’ which

means a delegate cannot further delegate.14 Thus, a director must perform his functions

personally. A director may, however, delegate in the following cases:

Where permitted by the Companies Act or Articles of the company.

Having regard to the exigencies of business certain functions may be delegated to the

other officials of the company.

Directors have, both collectively and individually, a continuing duty to acquire and maintain

a sufficient knowledge and understanding of the company’s business to enable them properly

to discharge their duties as directors. Whilst directors are entitled (subject to the articles of

association of the company) to delegate particular functions to those below them in

management chain, and to trust their competence and integrity to a reasonable extent, the

exercise of the power of delegation does not absolve a director from the duty to supervise the

discharge of the delegated functions. It has been held that no universal application can be

formulated as to this duty of supervision, and the question of whether it has been discharged,

must depend on the facts of each particular case, including the director’s role in the

management of the company.15

Though the directors as a body are responsible for the conduct of the company’s business, it

is undoubted law that they can delegate their powers to one or more of themselves for the

purpose of carrying it on more conveniently.16

13 TEC Venkatesh v. ROC [2007] 78 SCL 1 (AP)14 MESSY I.P., ADMINISTRATIVE LAW(8th Edn. Eastern Book Company) 2012.15 Barings plc (No. 5) Re (1999) 1 BCLC 433 at page 489: (1999) 1 All ER 1017 (Ch D) by Jonathan Parker, J.16 Public Prosecutor vs. T.P. Khaitan (1957) 27 Com Cases 77, 83: AIR 1957 Madras 4

9 | P a g e

Duty to do Legal Acts and Proper use of powers

Directors must not exercise the powers conferred upon them for purposes different

from those for which they were conferred. Notwithstanding that Directors have acted in

honest belief for what they believe to be for the benefit of the company, they may

nevertheless be liable for improper use of their powers, especially for purposes collateral to

what they have been conferred for, for instance, furthering the Director’s own interests or

diluting the majority shareholding. A breach occurs when the dominant purpose of the act is

improper.17

It is a settled principle of law that ignorance of the law is not a defence in legal proceedings

for violation of any statutory obligation. Specifically in the context of companies and its

directors, it has been observed that where directors use their powers to part with the moneys

of their company in a manner or for a purpose which the law forbids, it is not a defence to

proceedings to make them liable for their act to plead merely that they acted in ignorance of

the law.18

A similar prohibition would also apply in cases where a director obtains any secret

commission or any illegal gratification for the award of a contract with the company.19 A

company can recover from its director any money received by him by way of a bribe in fraud

of the company and the company can also sue him and the person giving the bribe for any

loss sustained through entering into a disadvantageous contract or the company may rescind

the contract.

Unfettered Discretion

Directors must not fetter their discretion for any reason whatsoever. They cannot

validly contract or act pursuant to any arrangement either with one another or with third

parties as to how they shall vote at board meetings or otherwise conduct themselves in the

future. However, this does not include contracting to take further action to give effect to a

contract entered into in a bona fide exercise of such discretion. Nominee Directors must be

particularly careful not to act only in the interests of their nominators, but must act in the best

interests of the company and of its shareholders as a whole.

17 A, Ramaiya, GUIDE TO THE COMPANIES ACT, PART 1 (16th ed. 2008)18 Louis Steen vs. Charles Allen Law (1963) 3 All ER 77019 Boston Deep Sea Fishing & Ice Co. Ltd. vs. Ansell (1886-1890) All ER Rep 65 (CA)

10 | P a g e

Lack of Conflicting Interests

Directors must not, without the informed consent of the company, place themselves in

a position in which their personal interests or duties to other persons are liable to conflict with

their duties to the company or where there is a real and distinct possibility of conflict. This

requirement covers the following aspects:20

i. Directors have to make continuous disclosures of their interests in the various

transactions of, and with, the company. A Director cannot enter into a contract

with the company without its informed consent, even if there is no unfair

advantage to be gained, or abuse of position, by such Director.

ii. Directors cannot use, without the consent of the company, the company’s

properties, opportunities or information for their own profit. In order to establish a

breach of this duty, it must be shown: (1) that what the Directors did was so

related to the affairs of the company that it can be said to have been done in the

course of their management and in utilization of their opportunities and special

knowledge as Directors, and (2) that what they did resulted in a profit to

themselves. The English Courts, adopting a strict approach, have held directors to

be in breach of this fiduciary duty, even if the opportunity was not one which

would have been of use to the company. Indian courts generally follow this strict

English law approach.

iii. Directors have a duty not to compete with the company, which is in many respects

a corollary of the immediately preceding rule.

DIRECTORS’ AND BREACH OF TRUST –

Traditionally the duties of directors were non-statutory. They were fashioned out

essentially from the common law as developed through cases. The Nigerian Act contains the

following provision on the point:21

“A director of a company stands in a fiduciary relationship towards the company

and shall observe the utmost good faith towards the company in any transaction with it or

on its behalf.”

20 Supra, 1721 The Companies Act and Allied Matters Act, 1990. S. 279.

11 | P a g e

The first and the most obvious obligation of persons in fiduciary positions are to act with

honesty. “Greatest good faith is expected in the discharge of their duties.”22 Good faith

requires that all their endeavours must be directed to the benefit of the company. Where a

Director acts dishonestly to the interest of the company, he will be held liable for breach of

fiduciary duty. Most of the powers of Directors are powers in trust and, therefore, should be

exercised in the interest of the company and, not in the interest of the Directors or, any

section of members. Thus, in a case where the Directors, in order to forestall a take-over bid,

transferred the unissued shares of the company to trustees, to be held for the benefit of the

employees, and an interest-free loan from the company was advanced to the trustees to enable

them to pay for the shares, it was held to be a wrongful exercise of the fiduciary powers of

the Directors.

Directors are bound to use fair and reasonable diligence in discharging the duties and to act

honestly, and act with such care as is reasonably expected from him, having regard to his

knowledge and experience. Sensibility

In R.K. Dalmia and others v. The Delhi Administration23 it was held that "A director will be

personally liable on a company contract when he has accepted personal liability either

expressly or impliedly. Directors are the agents or the trustees of a Company." As far as

fiduciary duties/obligations are concerned, any breach by any director would visit them with

liability. Our Supreme Court has considered this issue of fiduciary liability. It has been

observed in Official Liquidator vs. PA Tendulkar.24

Director’s Knowledge as knowledge of the company

Where an individual can be identified with a company then that individual’s knowledge may

be regarded as the knowledge of the company, if he is under a duty to communicate that

knowledge to the company. In most cases, a Managing Director is identified with his

company and therefore the Managing Director’s knowledge is imputed to the company.25 The

officer of a company is under a duty, if he is aware that a transaction into which his company

or a wholly owned subsidiary is about to enter is illegal or tainted with illegality, to inform

the board of the company of this fact.26

22 Bank of Poona v. Narayandas, AIR 1961 Bom 252.23 1962 AIR 182124 AIR 1973 SC 110425 Union India Sugar Mills Co. Ltd., Re, AIR 1933 All 60726(Belmont Finance Corporation vs. Williams Furniture Ltd. (No. 2), (1980) 1 All ER 393

12 | P a g e

It has been held that the default of the managing director who is the ‘directing mind and will’

of his company, could be attributed to the company.27 In the same case (i.e. Lennard’s

Carrying Company Case) Viscount Haldane articulated the alter ego doctrine peculiar to

company law and as something distinct from the ordinary principle of agency and vicarious

liability. In a celebrated passage (At page 713), he observed that “… a corporation is an

abstraction. It has no mind of its own any more than a body of its own; its active and

directing will must consequently be sought in the person of somebody who for some purposes

may be called an agent, but who is really the directing mind and will of the corporation.”

This principle has also been followed in India inasmuch as the Supreme Court of India has,

in J. K. Industries Ltd. & Ors. v. Chief Inspector of Factories and Boilers & Ors .28, held

that, “…since a company is a legal abstraction, without a real mind of its own, it is those who

in fact control and determine the management of the company, who are held vicariously

liable for commission of statutory offences. The directors of the company are, therefore,

rightly called upon to answer the charge, being the directing mind of the company”. The

Supreme Court relied upon the Lennard’s Carrying Company’s case as well as Tesco

Supermarkets vs. Nattras,29 where the House of Lords held that “… the question: what natural

persons are to be treated in law as being the company for the purpose of acts done in the

course of its business, including the taking of precautions and the exercise or due diligence to

avoid the commission of a criminal offence, is to be found by identifying those natural

persons who by the Memorandum and Articles of Association or as a result of action taken by

the directors, or by the company in general meeting pursuant to the Articles, are entrusted

with the exercise of the powers of the company.

CASE LAW ANALYSIS

1. Dale and Carrington Investment (P) Ltd v. P.K. Prathapan And Ors,30

27 Lennard’s Carrying Company vs. Asiatic Petroleum Ltd. 1915 AC 705 (HL)28 [1997] 88 Comp Cas 285 (SC) 29 (1972) AC 153 (HL30 (2004 )122 Comp Case 161 SC, (2004) 4 Comp LJ 1 SC

13 | P a g e

At this stage it may be appropriate to consider the legal position of Directors of

companies registered under the Companies Act. A company is a juristic person and it acts

through its Directors who are collectively referred to as the Board of Directors. An individual

Director has no power to act on behalf of a company of which he is a Director unless by some

resolution of the Board of Directors of the Company specific power is given to him/her.

Whatever decisions are taken regarding running the affairs of the company, they are taken by

the Board of Directors.

The Directors of companies have been variously described as agents, trustees or

representatives, but one thing is certain that the Directors action behalf of a company in a

fiduciary capacity and their acts and deeds have to be exercised for the benefit of the

company. They are agents of the company to the extent they have been authorized to perform

certain acts on behalf of the company. In a limited sense they are also trustees for the

shareholders of the company. To the extent the powers of the Directors are delineated in the

Memorandum and Articles of Association of the company, the Directors are bound to act

accordingly. As agents of the company they must act within the scope of their authority and

must disclose that they are acting on behalf of the company.

The fiduciary capacity within which the Directors have to act enjoins upon them a

duty to act on behalf of a company with utmost good faith, utmost care and skill and due

diligence and in the interest of the company they represent. They have a duty to make full and

honest disclosure to the shareholders regarding all important matters relating to the company.

It follows that in the matter of issue of additional shares, the directors owe a fiduciary duty to

issue shares for a proper purpose. This duty is owed by them to the shareholders of the

company. Therefore, even though Section 81 of the Companies Act which contains certain

requirements in the matter of issue of further share capital by a company does not apply to

private limited companies, the directors in a private limited company are expected to make a

disclosure to the shareholders of such a company when further shares are being issued. This

requirement flows from their duty to act in good faith and make full disclosure to the

shareholders regarding affairs of a company. The acts of directors in a private limited

company are required to be tested on a much finer scale in order to rule out any misuse of

power for personal gains or ulterior motives. Non-applicability of Section 81 of the

Companies Act in case of private limited companies casts a heavier burden on its directors.

Private limited companies are normally closely held i.e. the share capital is held within

members of a family or within a close knit group of friends. This brings in considerations

akin to those applied in cases of partnership where the partners owe a duty to act with utmost

14 | P a g e

good faith towards each other. Non-applicability of Section 81 of the Act to private

companies does not mean that the directors have absolute freedom in the matter of

management of affairs of the company.

This Court held that the directors act on behalf of a company in a fiduciary capacity and their

acts and duties are to be exercised for the benefit of the company. It, however, while

analyzing the acts of a director as an agent of the company observed that in a limited sense

they are also trustees for the shareholders of the company. However, without discussing the

limitations of such fiduciary relationship, it was observed: "15_ The fiduciary capacity within

which the Directors have to act enjoins upon them a duty to act on behalf of a company with

utmost good faith, utmost care and skill and due diligence and in the interest of the company

they represent. They have a duty to make full and honest disclosure to the shareholders

regarding all important matters relating to the company. It follows that in the matter of issue

of additional shares, the directors owe a fiduciary duty to issue shares for a proper purpose.

This duty is owed by them to the shareholders of the company. Therefore, even though

Section 81 of the Companies Act which contains certain requirements in the matter of issue

of further share capital by a company does not apply to private limited companies, the

directors in a private limited company are expected to make a disclosure to the shareholders

of such a company when further shares are being issued. This requirement flows from their

duty to act in good faith and make full disclosure to the shareholders regarding affairs of a

company. The acts of directors in a private limited company are required to be tested on a

much finer scale in order to rule out any misuse of power for personal gains or ulterior

motives."

2. Regal (Hastings) Ltd. v. Gulliver and Ors,31 Lord Russell of Killowen observed as

under:

"Directors of a limited company are the creatures of a statute and occupy a position peculiar

to them. In some respects they resemble trustees, in others they do not. In some respects they

resemble agents, in others they do not. In some respects they resemble managing partners in

others they do not. The said judgment quotes from Principles of Equity by Lord Kames. In

one sentence the entire concept is conveyed. The sentence runs "Equity prohibits a trustee

from making any profit by his management, directly or indirectly. Ultimately the issue in

each case will depend upon facts of that case".

31 [1942(1) All ER 379]

15 | P a g e

3. Lindley MR observed in Alexander v. Automatic Telephone Co.32:

"The Court of Chancery has always exacted from directors the observance of good faith

towards their shareholders and towards those who take shares from the company and become

co-adventurers with themselves and others who may join them. The maxim "Caveat emptor"

has no application to such cases, and directors who so use their powers as to obtain benefits

for themselves at the expense of the shareholders, without informing them of the fact, cannot

retain those benefits and must account for them to the company, so that all the shareholders

may participate in them."

4. Needle Industries (India) Ltd. and Ors v. Needle Industries Newey (India) Holding

Ltd. and Ors33 is a judgment of this Court in which amongst various other aspects the

power of directors regarding issue of additional share capital was also considered.

This Court observed:

"The power to issue shares is given primarily to enable capital to be raised when it is required

for the purposes of the company but it can be used for other purposes also as, for example, to

create a sufficient number of shareholders to enable the company to exercise statutory

powers, or to enable it to comply with legal requirements as in the instant case. Hence if the

shares are issued in the larger interest of the company, the decision cannot be struck down on

the ground that it has incidentally benefited the Directors in their capacity as shareholders. So

if the Directors succeed, also or incidentally, in maintaining their control over the company or

in newly acquiring it, it does not amount to an abuse of their fiduciary power. What is

objectionable is the use of such power simply or solely for the benefit of Directors or merely

for an extraneous purpose like maintenance or acquisition decontrol over the affairs of the

company. Where the Directors seek, by entering into an agreement to issue new shares, to

prevent a majority shareholder from exercising control of the company, they will not be held

to have failed in their fiduciary duty to the company if they act in good faith in what they

believe, on reasonable grounds, to be the interests of the company. But if the power to issue

shares is exercised from an improper motive, the issue is liable to be set aside and it is

immaterial that the issue is made in a bona fide belief that it is in the interest of the

company."

32 (1900) 2 Ch. 5633 AIR 1981 SC 1298

16 | P a g e

5. Piercy v. S. Mills & Co. Ltd.,34 where directors, who controlled merely a minority of

the voting power in the company allotted shares to themselves and their friends not

for the general benefit of the company, but merely with the intention of thereby

acquiring a majority of the voting power and of thus being able to defeat the wishes of

the existing minority of shareholder. It was held that, “Directors are not entitled to use

their powers of issuing shares merely for the purpose of maintaining their control or

the control of themselves and their friends over the affairs of the company, or merely

for the purpose of defeating the wishes of the existing majority of shareholders." even

assuming that the directors were right in considering that the majority's wishes were

not in the best interests of the company, the allotments were invalid and ought to be

declared void and was held that It follows from this case that the exercise by directors

of fiduciary powers for purposes other than those for which they were conferred is

invalid. It may be said that although the power of issuing shares is given to directors

primarily for the purpose of enabling them to raise capital when required for the

purpose of the company, this was not the object of the directors in this case..."

6. The Tea Brokers (P) Ltd. and Ors. v. Hemendra Prosad Barooah35 was also a case

of a minority shareholder who on becoming managing director of the company, issued

further share capital in his favour in order to gain control of management of the

company. Barooah and his friends and relations were majority shareholders of the

respondent company having 67% of the total issued capital of the company. Barooah

personally held 300 equity shares out of 1155 shares issued by the company. He was

at all material times a director of the company. His case was that he was wrongfully

and illegally ousted from the management of the company. One Khaund, who initially

started as an employee of the company had 110 shares in the company and belonged

to the minority group. Khaund was appointed as the managing director of the

company. Barooah's grievance was that Khaund took advantage of his position as

managing director and acted in a manner detrimental and prejudicial to the interests of

the company and in a manner conducive to his own interest. Khaund had hatched a

plan with other directors, to convert petitioner Barooah into a minority and to obtain

full and exclusive control and management of the affairs of the company. In a petition

filed under Sections 397 and 398 of the Companies Act, 1956, acts of Khaund were

34 1920 1 Ch 77 (Ch D)35 [(1998) 5 Company Law Journal 463]

17 | P a g e

found to be by way of 'oppression and mismanagement' within the meaning of

Sections 397 and 398 of the Companies Act. Allotment of 100 equity shares by the

company to Khaund at a meeting of the Board of Directors said to have been held on

14 January, 1971 was held to be illegal. The Board of Directors of the company was

superseded and a special officer was appointed to carry on management of the

company with the advice of Barooah, Khaund and a representative of labour union.

There were several other directions issued by the court which are not necessary to be

mentioned here. The Division Bench considered in detail the relevant legal position.

Without using the phrase 'proper purpose doctrine' the principle enunciated therein,

was applied. The following observations of Justice A.N. Sen are reproduced: "It is

well settled that the directors may exercise their powers bona fide and in the interest

of the company. If the directors exercise their powers of allotment of shares bona fide

and in the interest of the company, the said exercise of powers must be held to be

proper and valid and the said exercise of powers may not be questioned and will not

be invalidated merely because they have any subsidiary additional motive, even

though this be to promote their advantage. Exercise of power by the directors in the

matter of allotment of shares, if made mala fide and in their own interest and not in

the interest of the company, will be invalid even though the allotment may result

incidentally in some benefit to the company."

FIDUCIARY DUTY AND INDIAN TRUSTS ACT Chapter IX of the Indian Trusts Act provides for certain obligations in the nature of trusts.

The Trust Act recognizes various kinds of trusts including resulting trust. An express trust,

however, may be created by reason of an agreement between the parties.36 By reason of

Section 88 of the Indian Trusts Act, a person bound in fiduciary character is required to

protect the interests of other persons but the heart and soul thereof is that as between two

persons one is bound to protect the interests of the other and if the former availing of that

relationship makes a pecuniary gain for himself; Section 88 would be attracted. What is

sought to be prevented by a person holding such fiduciary benefit is unjust enrichment or

unjust benefit derived from another which is against conscience that he should keep. When a

person makes a pecuniary gain by reason of a transaction, the cestui qui trust created there

under must be restored back.

36 Barclays Bank v. Quistclose Investments [1970] AC 567

18 | P a g e

A Director of a Company indisputably stands in a fiduciary capacity vis-a-vis the Company.

He must act for the paramount interest of the company. He does not have any statutory duty

to perform so far as individual shareholders are concerned subject of course to any special

arrangement which may be entered into or a special circumstance that may arise in a

particular case. Each case, thus, is required to be considered having regard to the fact

situation obtaining therein and having regard to the existence of any special arrangement or

special circumstance.37

"Directors owe no fiduciary or other duties to individual members of their company in

directing and managing the company's affairs, acquiring or disposing of assets on the

company's behalf, entering into transactions on its behalf, or in recommending the adoption

by members of proposals made to them collectively. If directors mis-manage the company's

affairs, they incur liability to pay damages or compensation to the company or to make

restitution to it, but individual members cannot recover compensation for the loss they have

respectively suffered by the consequential fall in value of their shares, and they cannot

achieve this indirectly by suing the directors for conspiracy to breach the duties which they

owed the company. However, there may be certain situations where directors do owe a

fiduciary duty and a duty to exercise reasonable skill and care in advising members in

connection with a transaction or situation which involves the company or its business

undertaking and also the individual holdings of its members."38

In Dawson International plc vs. Coats Patons plc39 was relied upon holding that the

Directors are, in general, under no fiduciary duty to shareholders and in particular current

shareholders with respect to the disposal of their shares in the most advantageous way as

directors are not their agents and as such are not normally entrusted with the management of

their shares. It was, however, observed that if the directors take it upon themselves to give

advice to current shareholders they have a duty to act in good faith and not fraudulently nor

can mislead the shareholders whether deliberately or carelessly, in which event, they may

have a remedy. A distinction, thus, has been carved out as regards the fiduciary duty of the

directors with regard to the property and funds of the company as contra-distinguished from

37 Supra, 1738 In Pennington's Company Law 6th Edn. at page 608-09.39 1988 SLT 854

19 | P a g e

the duty of directors to current shareholders as sellers of their shares. In case of conflict

between two interests, the company's interest must be protected. The directors, however, will

have a fiduciary relation if they have taken unto themselves the burden of giving advice to

current shareholders.

The aforementioned principles of law found favour with the Court in Needle Industries

(India) Ltd. And Others Vs. Needle Industries Newey (India) Holding Ltd.40 wherein it was

held: "Where directors of a company seek, by entering into an agreement to issue new shares,

to prevent a majority shareholder from exercising control of the company, they will not be

held to have failed in fiduciary duty to the company if they act in good faith in what they

believe, on reasonable grounds, to be the interests of the company. If the directors' primary

purpose is to act in the interests of the company, they are acting in good faith even though

they also benefit as a result."

In Bajaj Auto Ltd. v. N.K. Firodia and Another41, the Court was concerned with the

discretionary exercise of power by the Directors in terms of Section 111(3) of the Companies

Act. In the light of refusal by director to register a transfer, the Court held that it is necessary

for the directors to act bonafide and not arbitrarily in the following terms: " Article 52 of the

appellant company provided that the Directors might at their absolute and uncontrolled

discretion decline to register any transfer of shares. Discretion does not mean a bare

affirmation or negation of a proposal. Discretion implies just and proper consideration of the

proposal in the facts and circumstances of the case. In the exercise of that discretion the

Directors will Act for the paramount interest of the company and for the general interest of

the shareholders because the Directors are in a fiduciary position both towards the company

and towards every shareholder. The Directors are therefore required to act bona fide and not

arbitrarily and not for any collateral motive." This Court therein also applied the bona fide

test of the Director and for the benefit of the company as a whole. In that case, the directors

assigned reasons which were tested from three angles view, viz., (i) whether the directors

acted in the interest of the company; (ii), whether they acted on a wrong principle; and, (iii)

whether they acted with an oblique motive or for a collateral purpose. It was observed in M/s.

Harinagar Sugar Mills Ltd. v. Shyam Sunder Jhunjhunwala & Others42 that the action of

the directors must be set aside if the same was done oppressively, capriciously, corruptly or

40 (1981) 3 SCC 33341 [(1970) 2 SCC 550]42 [(1962) 2 SCR 339]

20 | P a g e

in some other way mala-fide. In this case, this Court is not faced with such a situation. The

Board has observed that it is universally recognised that the director of a company stands in a

fiduciary capacity with the company; the extent of his fiduciary duties is not codified by any

statute and is tested on the facts of each case.

CONCLUSION

The liability of a director arising under the above and any other laws can be mitigated

by delegating the responsibility to some other officer of the company, provided however the

director could be held liable if his knowledge, consent or attribution to the offence is

established. The company in respect of the negligence, default, breach of duty, misfeasance

or breach of trust may indemnify director, if he has acted honestly and reasonably in

discharge of his duties. In principle, the company is bound to indemnify the director against

the consequences of all lawful acts done by him in exercise of the authority conferred upon

him.

Accountability is an important element of Board effectiveness. There should be some

mechanism for evaluating the performance of the directors. The extent of liability of a

director would depend on the nature of his directorship.

Finally, I would like to make note that for prosecuting a person (whether a company or a

natural person) some nexus must exist between the offence committed and the person

charged / held responsible for the offence. As stated herein above, in some cases, the statute

itself clearly identifies the person who will be held responsible for the commission of an

offence, and in other cases much depends on the prosecution’s establishing a case against

such person. In the current Indian scenario, one is observing renewed force and attention

being given to norms of good corporate governance and a deprecation of corporate

misfeasance / malfeasance. Unfortunately, however, there is no codified law (other than

provisions of the Companies Act) that could define clearly the roles and responsibilities of a

Managing Director specifically in this context of corporate governance. However given the

fiduciary nature of a Director’s position, it is obligatory for a Director to act, at all times, in a

reasonable and responsible manner and in the interest of a company as well as its

shareholders.

21 | P a g e

BIBLIOGRAPHY

Books Referred-

MAJUMDAR, A.K., AND KAPOOR, DR. G.K., COMPANY LAW AND PRACTICE,

Taxmann Publications (P) Ltd., New Delhi, 13th ed, 2008

SINGH, Dr. AVTAR, PRINCIPLES OF MERCANTILE LAW, 818, Eastern book Company,

Lucknow, 7th ed., 2005

SINGH, Dr. AVTAR, COMPANY LAW, 15th edn, EBC.

Halsbury’s Laws of England, ‘Agency’, 4th edition, 2010.

Pollack & Mulla, Indian Contract and Specific Relief Acts, 13th edition, 2010.

A, Ramaiya, GUIDE TO THE COMPANIES ACT, PART 1 (16th ed. 2008)

Websites Referred-

www.readycompanies.com

www.narasappa.com

www.companydirectors.com

businesshelp.lloydstsbbusiness.com

22 | P a g e