section_b_11_directors duty and corporate opportunity.pdf

8/20/2019 Section_B_11_Directors Duty and Corporate Opportunity.pdf

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Directors Duties and

Corporate OpportunityGroup Project – Legal Aspects of Management

GROUP 11

Avhijeet Kapoor PGP31077

Kapaganti Srinivas Guptha PGP31090

Rohan Tayal PGP31103

Tanmay Sah PGP31118


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Table of ContentsINDEX

Introduction .................................................................................................................................. 2

Status of the problem: - local, national and international .............................................................. 5

Rakesh Agarwal vs SEBI ............................................................................................................ 5

Hindustan Lever Limited (HLL) – Brooke Bond Lipton India Limited (BBLIL) ............................ 5

Rajat Gupta Insider Trading Case .............................................................................................. 6

Adequacy of legal provisions regarding director’s duties and corporate opportunities ................... 7

Effectiveness of Enforcement mechanism to deal with the problem/ implementation realities .... 9Strengthening provisions .......................................................................................................... 9

Weakening provisions ............................................................................................................... 9

Indemnities from Company ...................................................................................................... 11

D&O Insurance ......................................................................................................................... 12

Judicial Approaches to deal with problem with the help of High Courts and Supreme Court

Judgments ................................................................................................................................... 13

Role of Business/Industry Associations ........................................................................................ 16

Role of Legal Education and Awareness ....................................................................................... 18

Assessment of Performance ........................................................................................................ 21

Removal of Director ..................................................................................................................... 21

The Mechanism of Removal .................................................................................................... 22

Binding the powers of the directors......................................................................................... 22

Conclusion .................................................................................................................................. 24

References : - .............................................................................................................................. 26


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Introduction

Corporate executives are today possessed of immense power which must be

regulated not only for the public good, but also for the protection of those whoseinvestments are involved. Directorships will always be susceptible to abuse. Some

directors will always be faithless to their trust. There are numerous domestic and

international cases where Directors have capitalised their strategic position in the

company to serve their own interest. It is in this light that we study Directors Duties

and the Corporate Opportunities that are available to a Director and how the law tries

to keep Directors from misusing their power.

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

essentially from the common law as developed through the cases. But now company

legislation of some countries has made a departure from this tradition. The first and

the most obvious obligation of persons in fiduciary position is to act with honesty. It

requires that all the efforts of Directors must be aimed towards the benefit of the

Company. Thus, if a Director of a company is also a member of another company

and makes profits by supplying information of the company he is the Director of to

the other company, he shall be liable to account for such profits. Similarly, if aDirector is aware that a property of the company is worth more than it is being sold

for, it is considered a breach of fiduciary duty.

Similarly, a Director should not exploit to his own use the corporate opportunities.

The doctrine of corporate opportunity has been described as an act of a director or

controlling shareholder in diverting from the benefit of the corporation any enterprise

or transaction in which reasonable persons would agree that the corporation had

some expectancy or interest. While on one hand, rules so stringent that they

dissuade capable men from assuming such roles should not be established, on the

other hand, rules are needed so that these men remember that they are not at liberty

to sacrifice the interests of the company in favour of their own.

However, there are some cases when Directors may profit from their position without

incurring any liability to account for it. When a corporation is defunct, the Directors

are free to act for themselves. Similarly, when a venture is offered to and rejected by

the Directors, individuals are free to pursue their personal interests.


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Duties of Directors have been thus stated in Section 166:

(1) The directors have to act in accordance with the articles of the company

(2) A director of a company has to 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 protection of environment

(3) A director has to perform his duties with due and reasonable care, skill and

diligence and has to work with independent judgement

(4) A director is not to involve himself in a situation in which he may have direct or

indirect interest that conflicts or possibly may conflict with the interest of the

company

(5) A director is not to achieve or attempt to achieve any undue gain or

advantage either to himself or to his relatives, partners or associates. If he

does so, he will be liable to pay an amount equal to that gain to the company

(6) A director is not to assign his office. Any such assignment is void.

(7) If a director goes beyond the provisions of the section, he will be punishable

with a fine ranging from INR 1lakh to INR 5 lakh

Having summarized duties and corporate opportunities available to directors,

and subsequently listing the duties of a director, let us now explore two

specific duties of a Director, which if not carried out honestly, give rise to

corporate opportunity: - Duty of good faith and Duty not to make undue gain

Duty of good faith

Trading in corporate control state: - The Act provides that if the

directors receive any money on the sale of their controlling block of

shares which is over and above the money received by the other

selling shareholders, the extra money is in essence a price for the sale

of controlling power and the directors would hold it in trust for the

selling shareholders.


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Misuse of corporate information: - If a director makes any use of

unpublished and confidential information belonging to the company and

the company suffers a loss in consequence, it can ask the director to

make good the loss. Any knowledge or information generated by the

company is the company’s property which includes turnover of

business, profit margins, list of customers, future plans, and

manufacturing formulae and processes.

Duty not to make undue gain

Loans to Directors: - A company cannot, directly or indirectly advance

any loan, including any loan represented by a book debt, to any of its

directors or to any person in whom the director is interested.

Prohibition of Insider Trading of Securities: - No person including any

director or key managerial personnel of a company shall enter into

insider trading.

Restriction on Non-cash Transactions involving directors: - A company

is not to enter into any arrangement by which a director of the company

or its holding, subsidiary or associate company or a person connectedwith him is to acquire assets from the company for a consideration

other than cash.


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Status of the problem: Local, National and International

Problems arise when directors fail to perform their duties and take advantage of the

corporate opportunities that are presented to them. This problem happens at all

levels – local, national and international. Hence, laws have been established to try to

keep directors in check and regulatory agencies try to do their best to keep such

issues from occurring, but this is not an easy problem to solve. The Securities and

Exchange Board of India (SEBI) is the regulatory body for the securities market in

India while in the US the corresponding regulatory body is the Securities and

Exchange Commission (SEC). These agencies generally use wiretaps in their

investigations to establish charges against individuals. Let us look at some high

profile cases of corporate opportunity that have happened at local and international

levels to understand the status of the problem better.

Rakesh Agarwal vs SEBI

Rakesh Agarwal, the Managing Director of ABS Industries Ltd. was involved in

discussions regarding the takeover of ABS by Bayer. SEBI alleged that prior to the

announcement of the acquisition, Rakesh Agarwal with the help of his brother-in-law

bought shares of ABS in the open market and sold them after the announcement,

making a neat profit in the process. This is an example of corporate opportunity as

Agarwal was in a position to know the inside workings of ABS and utilized his

position to make a personal profit.

Hindustan Lever Limited (HLL) – Brooke Bond Lipton India Limited (BBLIL)

The controversy involved HLLs purchase of 8 Lakh shares of BBLIL two weeks

before the announcement of the merger of BBLIL and HLL. SEBI suspected insider

trading and served a notice upon the Executive Directors and the then Chairman of

HLL after conducting its investigation. The 5 Directors of HLL were insiders and had

access to unpublished price-sensitive information of BBLIL and as such this was a

case of corporate opportunity. In its defence HLL claimed that it purchased the

BBLIL shares so that Unilever, its holding company would have a 51% share in the

merged entity. The Securities Appellate Tribunal eventually overruled SEBI’s verdict

in this case.


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Rajat Gupta Insider Trading Case

Rajat Gupta is a prominent American of Indian origin who was the first foreign born

Managing Director of the management consultancy McKinsey & Company. He wasfound guilty of relaying confidential information about Goldman Sachs to hedge fund

manager Rajaratnam who was owner of the hedge fund Galleon. Rajat Gupta was

also caught via government placed wiretaps discussing a 5bn dollar investment by

Warren Buffet’s Berkshire Hathaway group and Goldman Sach’s first quarterly loss

with Rajaratnam who subsequently bought shares of Goldman Sachs at a profit.

Gupta faced 20 years for fraud charges, and 5 years for conspiracy charges but was

ultimately sentenced to 2 years prison.


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Adequacy of legal provisions regarding director’s duties and

corporate opportunitiesDirectors are fiduciaries of the company which exposes them to certain liabilities in

case of non-performance of the duties associated with their position.

The first type of liability is the civil liability where they may have to compensate by

making payments to the victims or the Government. Another type of liability is the

criminal liability resulting in fines and imprisonment.

The directors owe the company as people holding crucial positions. Hence, they are

also liable the company and the shareholders. So, companies can bring a claim and

the shareholders can also bring a derivative claim against the directors.

These have the combined effect of acting as a deterrents that prevent the directors

from going to the wrong path. But, there are certain inadequacies in the legal

provisions against the directors.

The inadequacies also arise due to inherent ambiguities regarding whether the

remedies should be propriety (claim in the property and personal assets of the

defendant) or personal (defendant must pay a sum of money).

English Court of Appeal explained the importance of the distinction between personal

and proprietary remedies thus:

“In some cases it matters because the fiduciary is insolvent; and the establishment of

a proprietary remedy may mean that the profit is unavailable for distribution among his

cred itors… In some cases it is said to matter because the secret profit has been

invested in an asset that has itself increased in value... Sometimes it matters because

the defaulting fiduciary no longer has the profit and the principal wishes to recover it

fr om a third party into whose hands it has come…”

Section 166(5) of the Companies Act says that:

“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…”


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This defines the remedy as personal, which is contrary to the Trusts Act (sec 88) and

appears regressive.

Also, this part does not define the way to calculate the ‘gain’.

Overall, section 166 of the Companies Act can be said to define how a director should

act while carrying out his role in the company. It does not specify but lays down the

broad guidelines in this regard.

Subsection (1) – says that a company should lay down the duties of its directors in its

articles.

Subsection (2) – on the outset says that the directors should ‘act in good faith’. Defining

good faith is a subjective matter. It is worth noting that the list of duties is very onerous

and extensive. This makes it hard to be objective and practical while observing

them. These duties can be interpreted differently in different situations.

Subsection (3) – duties of skill, care and diligence can be subjective and

judgemental. Thus, it may vary from case to case basis.

Subsection (4) – requires directors to avoid conflict of interest.

Subsection (5) – here the terms “undue gain” or “advantage” have not been

defined. The terms “partner” and “associates” have not been clearly defined

also. Moreover, the inherent weakness/limitations in personal remedy for “undue gain”

weakens the deterrent against malpractices.

Subsection (6) – says that the director cannot assign his office but as held in the case

of Oriental Metal Pressing Works {P} Ltd., v Bhaskar Kashinath Thakoor {1961} 31

Com Cas 143 {SC} the word assign does not include “appoint” and thus the director

can appoint his successor.

Subsection (7) – contains the penalties and punishments when the director

contravenes this section. But, the penalty amounts hardly seem adequate as

deterrents.


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Effectiveness of Enforcement mechanism to deal with the problem/

implementation realities

Strengthening provisions due to the Companies Act 2013

There is now a provision for a class action mechanism that helps a group of

shareholders (having a minimum of 100 shareholders or a group having minimum 10%

share in the company) to file a lawsuit on behalf of all the victims/ affected persons,

which includes asking for compensation from directors for any fraud, illegal act or

wrong act or omission or conduct done by the directors.

Moreover, the 2013 Act contains a mechanism to bypass the usual court system by

enabling claims to be filed at the National Company Law Tribunal (NCLT) that is

expected to be faster, more productive and less costly.

Weakening provisions due to the Companies Act 2013

The impact of the liabilities is lessened by a great degree due to certain weakening

factors that act in favor of directors.

Safe Harbor Provisions

Firstly, there provisions that provide relief to the directors. For instance, a director

could claim relief on the ground that he acted “honestly and reasonably” in any

proceedings against him and that after considering all the scenarios of the case, such

director must be excused as it is fair. This provision available under the Companies

Act, 1956 (the 1956 Act) has is present in the 2013 Act as well.

The more recent legislation, moreover, contains a specific safe harbor provision for

independent directors. In order to compensate the vast amounts of the duties and

liabilities on the shoulders of independent directors, the 2013 Act seeks to decrease

their liability by limiting it only to issues directly linkable to them. An independent

director is liable “only in respect of such acts of omission or commission by a company

which had occurred with his knowledge, attributable through board processes, and

with his consent or connivance or where he had not acted diligently.” [Section 149(12)].


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This is to protect the independent directors against the potential liability for acts of the

company which are no fault of their own.

These provisions might be useful to streamline the functioning of the directors,

however, they can be interpreted by courts on the basis of certain circumstances and

from specific perspectives of the individual stakeholders in the cases.

In order to grasp the nature of these clauses, it would be useful to define correctly the

terminology used in this regard and its implied meanings: (i) “knowledge”, (ii)

“attributable through board processes”, (iii) “consent or connivance”, and (iv) “not

acted diligently”.

Knowledge – The question arises is that when does a director have an

act/matter within his/her “knowledge” while acting as an independent director?

Independent directors are not involved with the company’s executive decision

making on a regular and consistent basis. They are usually involved

intermittently in the company’s processes. The level of participation may range

from attending board meetings to consulting/advising management to

involvement regarding particular matters of strategic nature and contingencies

that may appear. Also, questions might be there concerning whether

“knowledge” in a particular case relates to real knowledge or constructive

knowledge. Answering this, it is possible to include both real and constructive

knowledge in the provision. Real knowledge would pertain to matters the

director in fact knew about. Constructive knowledge, in turn, would relate to

something the director “ought to know”, which would then create an obligation

of the director to conduct a thorough enquiry. Only including the clause of actual

knowledge would lead to unnecessary complications, as the director may be

better off in a position of not knowing, which would make the clause

unnecessary. It would push the directors to refrain from getting involved or

seeking any further information in a case where “red flags” have been raised.

Hence, we can conclude that such a broad interpretation would impose more

widespread and strict obligations on directors.

Attributable Through Board Processes - While the question of “knowledge” is

not very innovative and is present in various areas of corporate, contract, and

commercial law, the increase in the cover of “knowledge” to that “attributable


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through board processes” makes it more wholesome. This implies that a

director would be considered as having knowledge of all issues that would have

come into consideration/purview of the board level. For instance, “if board

papers are delivered to a director along with the agenda for a meeting, the

director may be imputed with knowledge regarding the contents of those

papers”. Similarly, the director is always considered to know about all the

meeting points of the board and the content that is discussed. In order to be

able to use the ‘safe harbour provision’, directors are required to have fulfilled

some prerequisites. For example, directors must make sure that any issues

pointed by them in a board meeting or any discontent that they express is

present in the minutes of the meeting such that it provides prima facie evidence

of the happenings before the board in a scenario where the role of the director

is questioned in a liability lawsuit.

Consent or Connivance – This is arguable easier to judge as it involves positive

role of the director including a higher mental state and a level of involvement

that us undoubtedly malicious.

Not acted diligently - This is related to the duty of skill, care and diligence which

requires the directors to comply with certain prerequisites. As in the case of

several other jurisdictions, the prerequisites are not well defined in the context

of India, as there is limited amount of related case law. However, it is probable

that all directors would be subject to at least some standard that must be

fulfilled. Therefore, directors cannot be ignorant to the developments in the firm,

not attend board meetings regularly or avoid to ask the appropriate questions.

All such issues would be under very strict investigation/observation which would

evaluate whether the directors have follow the due diligence on their part.

Indemnities from Company

Second, it may be possible for directors to be rescued by their employing firm i.e.

obtain indemnities. Under the 1956 Act, companies were prevented from giving such

indemnities, as they are prevented from indemnifying directors for default, negligence,

oversight of duty etc. There is however no such restriction in the 2013 Act. This may

give greater ability to the directors to seek indemnities from the company in case they

have to meet any liabilities, particularly if no fault can be attached to the directors’

conduct.


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D&O Insurance

Finally, linked to the latter, the usual practice of getting directors’ and officers’ (D&O)

insurance has become quite common in Indian firms, especially in the big ones, andis only likely to grow in the future considering the expansive liability provisions present

in the new law. Acknowledging this fact, the 2013 Act implicitly considers the ability of

the firm to pay a premium expense to get D&O insurance policies. While getting the

right level of D&O insurance policies would be wise action for firms and their board of

directors, thought must be given to the fact that such policies usually have particular

exceptions for wilful misconduct, fraud and other forms of intentional criminal conduct.


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Judicial Approaches to deal with problem with the help of High

Courts and Supreme Court JudgmentsIndian laws are majorly inspired by the laws and judgements of the

developed countries. The mannerism of the Indian courts can be extrapolated based

on the trends in UK and US courts. This the case even with the cases related to

directors’ fiduciary duties and corporate opportunity doctrine.

The discussion on directors’ duties and corporate opportunity is

incomplete without discussing this landmark case and decision pertaining to Regal

(Hastings) Vs Gulliver . This is a perfect example for violation of duty of loyalty.

Directors of Regal made a business transaction to benefit them and shareholders

wanted the profits made by them through the transaction be returned to the companyitself. The high court and court of appeal favored the directors but the House of Lords

held that the defendants have got their profit “by reason of the fact that they were

directors of Regal and in the course of the execution of that office”. The guiding

principle was clearly mentioned by Lord Russell of killowen.

“The rule of equity which insists on those who by use of a fiduciary position make a

profit, being liable to account for that profit in no way depends on fraud, or absence of

bonfires or upon questions or considerations as whether the property would or should

otherwise have gone to the plaintiff or whether he took a risk or acted as he did for the

benefit of the plaintiff has in fact been damaged or benefitted by his action. The liability

arises from the mere fact of a profit having in the stated circumstances been made.

“The same corporate opportunity doctrine has been further corroborated in cases like

Phipps Vs Boardman (1966) and Industrial Development Consultants Vs Cooley

(1972).Cooley was appointed as a Managing director of IDC group .Eastern Gas

Company had a lucrative project to design an establishment in Letchworth. Theywanted Cooley to take care of the project on his own rather than through IDC. Cooley

liked the proposal and resigned the company quoting that he is not well. But later the

company came to know about it and sued against him quoting he has misused his

powers and position. But it was clear that IDC had no scope of getting the project. But

the decision was made against Cooley. The lord quoting “I do not think it is necessary,

but it appears to me very important, that we should concur in laying down again and

again the general principle that in this court no agent in the course of his agency, inthe matter of his agency, can be allowed to make any profit without the knowledge and


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consent of his principal; that that rule is an inflexible rule, and must be applied

inexorably by this court, which is not entitled, in my judgment, to receive evidence, or

suggestion, or argument as to whether the principal did or did not suffer any injury in

fact by reason of the dealing of the agent; for the safety of mankind requires that no

agent shall be able to put his principal to the danger of such an inquiry as that.”

Professor Gower who is acclaimed worldwide says that an equitable law has been

stretched to inequitable ends.

American Courts and laws have watered down the corporate

opportunity doctrine to give some leeway to the directors. In the landmark Guth Vs

Loft Inc. case this attitude of American Laws was very clear. Loft was a cola company

and Guth was appointed as a president of the company. Loft purchased syrup from

the coca cola but Guth felt that Loft could have got a better deal from Pepsi Co. But

by the time he has expressed his concern to the company management Pepsi Co

became bankrupt and is up for sale. Guth has purchased the Pepsi Co and later sold

the syrup to Luft. Luft has appealed against Goth that he has misused the corporate

opportunity. But the Highest court favored Guth. The court has quoted “Corporate

officers and directors are not permitted to use their position of trust and confidence to

further their private interests. While technically not trustees, they stand in a fiduciary

relation to the corporation and its stockholders. A public policy, existing through the

years, and derived from a profound knowledge of human characteristics and motives,

has established a rule that demands of a corporate officer or director, peremptorily

and inexorably, the most scrupulous observance of his duty, not only affirmatively to

protect the interest of the corporation committed to his charge, but also to refrain from

doing anything that would work injury to the corporation, or to deprive it of profit or

advantage which his skill and ability might properly bring to it, or to enable it to makein the reasonable and lawful exercise of its powers.” “On the other hand, it is equally

true that, if there is presented to a corporate officer or director a business opportunity

which the corporation if financially able to undertake, which is, from its nature, in the

line of the corporation’s business and is of practical advantage to it, is one in which

the corporation has an interest or a reasonable expectancy, and, by embracing the

opportunity, the self-interest of the officer or director will be brought into conflict with

that of his corporation, the law will not permit him to seize the opportunity for himself.”“The occasions for the determination of honesty, good faith and loyal conduct are


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many and varied, and no hard and fast rule can be formulated. The standard of loyalty

is measured by no fixed scale.”

So what exactly are Indian courts doing and what exactly are they going to do

in such cases?

It is difficult to say that Indian courts are following such strict guidelines as the UK

cour ts do. At the same time Indian courts don’t follow the lenient nature of the US

courts. They play in between. In the few cases of corporate opportunity the position

has not been clarified very clearly. Some cases where Regal was mentioned were:

1) Kishore Kundan Sippy Vs Samrat Shipping Company the company Law Board

took the position of American Law and supported more latitude to directors. On

appeal to Bombay High Court the Judge has expressed some reservations in

going with the American decisions. Going further, the division bench held the

American way on the point are “Definitely apposite”

2) In Sangram Sinh Gaekwad case the court has referred to the Regal case but

the judgement differed without the court offering an opinion on its correctness

3) In Dale & Carrington though, the stand taken in that of Regal case was

considered “well-settled”, but without having any further discussion on that

issue.

American Laws seems to have done a good job in dealing with

corporate opportunity cases but leaving the directors to make decide on which come

under exploiting corporate opportunity and which doesn’t come under corporate

opportunity is not advisable for sure. They should have certain directive clearly cut-out

for this purpose. We have to wait and watch as India progresses and becomes a more

developed nation, if it takes the stringent approach of UK or a bit laxed approach of

US to give some leeway to the directors.


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Role of Business/Industry Associations

SEBI’s role in directors’ duties comes in the form of its legislation to prevent

insider trading which is a violation of fiduciary duty of directors

With a great growth in the stock markets, the recent development

in the corporate opportunity is the insider trading where the directors and higher

officials who are close to the developments in the company exploit their knowledge to

take advantage in the stock market ahead of the retail investors. This is a clear

violation of duty of loyalty and fiduciary duties.

SEBI (Prohibition of Insider Trading) Regulations, 2015 has

come into force with effect from 15th May, 2015 after having been gazette on 15th

January,2015. This will replace the older regulation which were formed in 1992 and

later amended in 2002.The regulation was named at first as SEBI (Insider Trading) but

later the name was changed to SEBI(Provision for Insider Trading) in 2002. The new

regulation has the same name as that of the old one amended in 2002.

The earlier Company Law which was made 1956 did not have any

provisions to address the insider trading but the new company law that was made in2013 had provisions to address Insider Trading in section 195.It is quoted in the

section as follows :

No person including any director or key managerial personnel of a company shall enter

into insider trading. Provided that nothing contained in this sub-section shall apply to

any communication required in the ordinary course of business or profession or any

other law.

But the SEBI regulation had the provisions for Insider trading in both its 1992 and

2015.Ther are some definitions, rules and punishments that are different in both. For

example The Companies Act, 2013 states about `non-public price sensitive

information’ and the Regulation states about ̀ unpublished price sensitive information.’

Unlisted companies come under the ambit of Registrar of

companies while the listed companied come under the SEBI regulations. Having a law

and a regulation overlooking the same issue may lead to confusion in many a cases.


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It will lead to duplication of cases also. The authorities should ensure that these both

converge for efficient implementation.

India is now poised to become an economic power house. Many

of the corporate biggies are looking forward to India. The legal structure to support the

financial and business systems should be well framed. Having the laws for just sake

of having them and amending them later only when the need arises doesn’t project

the image of India in a pleasing way. The acts and laws framed should not be

conflicting and should be pragmatic and practical to the extent possible. At the same

time the laws should not be lax for the culprits to escape getting rid of the liabilities.

Directors, who act as a back bone to the corporations should be on their toes

continuously and the laws should ensure that they do so.


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Role of Legal Education and Awareness

Many a times, innocent executives get involved in violation of Directors Duties. They

do not intend to violate these laws, but due to lack of legal education and awareness,they end up breaking the law and committing a crime. There are many real life

examples where people ended up breaking the law unknowingly and paying the

price for their deeds. Accidental violation is law is quite prevalent in cases of Insider

Trading. There have been quite a few cases where investors unknowingly indulge in

insider trading due to various reasons. Also there have been cases where top

executives of a company mistakenly pass vital information about their company’s

operations to unrelated people and thus get involved in abuse of Directors duties.

One such example was published in the New York Law Journal by Michael

Schachter, who is a partner in Willkie Farr & Gallagher's litigation department and

co-head of the firm's white-collar criminal defence practice group. In that case,

Robert Moffat, who was a top executive working for IBM, was accused of leaking

important information of his company to Danielle Chiesi, who was working at New

Castle Partners hedge fund. Danielle traded on the information he received rom

Moffat and made huge profits. Moffat eventually pleaded guilty and got a jailsentence of six-month. But before he pleaded guilty, his attorneys argued that he

was not liable for the incident because there was never any kind of personal benefit,

monetary or otherwise involved for him in the deal. The argument didn’t work out for

him and the court held Moffat liable for the whole incident.

On the other hand, Schachter also cites the Supreme Court's decision in Dirks v.

SEC. In this case the court decided that if a person by mistake discloses some

information of material, non-public information, it does not necessarily mean that he

has breached the insider’s fiduciary duties.

He also cites the case SEC v. Switzer. In this case, Barry Switzer, who was a former

football coach at the University of Oklahoma's, traded on information he heard from

George Platt, who served as the CEO of Texas International, when they met at a

track meet in high school. The court ruled that because Platt shared the information

with his wife without having an intention of being overheard, he did not breach his

fiduciary duties and this also made Switzer not liable for the whole event.


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Thus we see two different cases but both of them have a similar plot and in both the

cases the accused mistakenly divulges important company information to an

outsider. The ruling was different in both the cases but it shows that one can be held

liable for even accidently being involved in insider trading and the same goes for any

sort of violation of director duties.

Proper legal education can therefore help in curbing this menace and providing

adequate training and information to the employees about these duties. It can save

innocent people from involving themselves in illegal practices. The companies

should organize training programmes in which they can educate their employees

about director duties and corporate opportunity. These training programmes can

include workshops and lectures to enhance the legal awareness of the employees.

For example, if you want to train our senior executives about insider trading, you

don't always have to just train them on the window policy, or just on insider

TRADING; you can add training about regulation FD, which also relates to the

disclosure of non-public information. The training programme should tell them about

when not to talk to analysts before an earnings announcement. But the companies

need to have periodic training for effective implementation. Also they should be

made aware about the different legal aspects of insider trading and instance which

can lead to insider trading. The companies should educate their employees about

various ways in which they can save themselves from being involved in insider

trading. Some guidelines given by the company can be:-

1. Watch the questions they ask when they intend to receive information

related to a security - They need to be careful so that they don’t phrase their

questions in such a way that it proves as something provocative for a person

and he reveals insider information before they are about to trade. Also, it is

very important that they themselves should not give an impression that they

want that kind of information. Doing such kind of activity can get them in just

as much trouble as actually conducting an inside trade.

2. Check the sources they receive information from – If they are about to

conduct a trade on an information that is given to them by another person,

they must make sure that they are able to find the same information through

various public platforms and it is not something that is known only to that


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person. If you can’t f ind that information anywhere else, you may not want to

pursue the trade.

3. Report to the proper authorities when they receive information related to

their portfolio that they are not sure if it is public or not – Doing this will

certainly help prove that they have honest intentions and do not intend on

using any sort of insider information for trading purposes.

4. Identify when someone the person giving them the information is

violating a breach of duty. This is a red flag that you are hearing information

you shouldn’t be. Also, the implications for insider trading can be even worse,

if they have signed a confidentiality agreement with the information provider.

They must make sure that they are aware of the information that is being

passed to them by the information provider and whether or not that

information is passed in a way that is likely to violate insider trading statutes.

5. Make sure everyone they trade with is clear on insider trading policies –

People are sometimes held liable for the actions of some other person in their

team who are not sometimes clear on insider trading policies. Thus the

policies and agreements must be in place to ensure that no one tradesoutside the bounds of securities laws.

6. They must be careful in repaying favours – Some people may be in a

situation where they can access insider information on their employer or a

company in which they have worked before. There may be person who would

have done you some favour long time back, but everyone should be careful in

repaying such kind of favours. Many people end up divulging important

information to people who had done them a favour. So, one must not offer any

kind of sensitive information in any case. If done, not only the person to whom

you have given the information is guilty, but you are also the part of the crime.

Such type of information given in awareness programmes can help employees

understand better about the legal aspects of director duties and thus help in stopping

violation of law.


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Assessment of PerformanceThe assessment of the company’s board of directors is very essential for the

effective functioning of the company. In countries such as USA, it has become very

common to evaluate the performance of the directors against the results of the

company. When the majority of the shareholders are not convinced with the

performance of the company, the director is bound to be removed from his or her

post.

The Evaluation could be in-house or out-house. In-house means the company using

its own internal bodies to evaluate the performance, whereas out-house means that

the company hires a firm to evaluate the performance of its executives. In-House

process yields better and more accurate results but an out-house process is far moretransparent and honest and is thus always preferred over the in-house process. Also

this assessment of the board of directors should be done on an annual basis. This

helps to know what the skills are in which the directors lack and thus help in instilling

these required skills in the directors. Due to high costs of putting a new director in

place, it is always better to install the required skills in the existing directors. Thus

this assessment process should be viewed as the base of an action plan to ensure

that the board has the required set of skills to take the company forward andincrease its performance every year.

Removal of Director A director may be removed due to a number of reasons. Directors may be removed if

the company decide that he does not have the required skill set to manage the

company. Also if the director becomes interested in a contract with the company and

fails to declare that interest to the board then the director is bound to vacate his

position. There are numerous other reasons due to which the director’s position may

be vacant :-

a) He is no more or he himself resigns

b) In case of an ex officio director, ceases to hold office, title, designation or

similar status that entitled the person to be an ex officio director

c) If the court places him on probation.

d) If he is removed from the post by the decision of the shareholders or by the

order of a court


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e) If he becomes incapacitated and is no longer able to perform his duties

After his post is vacant, the director has the power to appoint the next director but he

will only serve as a temporary replacement until the shareholders elect a new

director.

The Mechanism of Removal

The director can be removed by a resolution passed at a shareholders meeting. But

the director must be given a fair opportunity to state his case. If a company consists

of two or more memebers in its board of directors, the board also has a power to

remove one of the directors in some cases, such as:-

a) If he becomes incapacitated and is no longer able to perform his duties

b) He neglects his duites as a director and does not perform his functions well

c) He has become ineligible in terms of the Act.

The director who is being removed is allowed to make representations to the

decision makers so as to stop the impending removal.

When the director has a valid contract with the company the director has to be

compensated in full, as it is a breach of the contract to remove the director from

his post. The exception arises when the director himself had breached the

contract in the first place.

Formalities when a Director Resigns:-

The director provides a letter of intention to the company when he resigns, which

is preferable if it is a written record. The ease with which the director is able to

resign will be a function of the existence of any contract between the director and

the company, and whether in addition the director acts as an employee of the

company.

Binding the powers of the directors

The board of directors of a company have all the powers and authority of a company

except when restricted by the Memorandum of Association of the company. It is

therefore important for the directors to follow the MoA of the company, especially

regarding those provisions that restrict the powers of the directors.


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The board also has powers to contract on behalf of the company unless delegated to

another person, for instance a managing director. The strategic powers are often

reserved by the board as they heavily influence the fate of the company.

Therefore decisions regarding the following cases must be handled by the board:

Decision regarding use of auditors, lawyers, consultants and other outside agencies.


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Conclusion

Directors’ role is far more than just being a figure head of the corporation. He is liable

for any document containing his signature. There is absolutely no distinction betweenexecutive and non-executive directors at least before law and regarding their duties

and liabilities. Accepting the position of director is accepting the responsibility of

applying their skills, judgment, reasoning, questioning skills, experience in the related

field for the benefit of the company come what may. It is very easy for the law to restrict

the powers of the directors to take decision there by restricting their powers to exploit

their position but this makes the position of directors meaning less .That is the reason

a lot of care has been taken while framing Companies Act, 1956 and the recently

framed Companies Act, 2013 include a lot of provisions for the directors to act freely

as risk taking is an integral of the business. The act requires that the directors should

act with sole motive of benefitting the company. Even if their decisions turn to be loss

making to the company the directors are not at liability if their sole motive was to benefit

the company and they have acted in discretion with their experience and skills. This is

very relevant in todays’ business arena where the markets are very vulnerable and

risk taking has become a requisite of doing business. Doing the business in a

conventional way without taking any risk at all has no future at all in today’s business.

Directors must be absolutely sure and aware that they are nor using theirs powers or

position to advantage of himself or people related to him.

Directors should also be aware that the laws and acts are

framed to check if they are acting against the interest of the company on whose board

they are in to benefit the companies in which the directors in question hold interest in.

Directors, executive or non-executive must act within their powers described both in

the act and also in the articles of association and at any cost should not cross the limits

set to their powers. If at all such an action happens and leads to loss the directors are

held completely personally responsible for the loss and is recovered from their

personal assets. The directors should not hold positions that come in conflict with the

interest of the company or they should not hold positions in the rival or competing

companies. This may lead to disqualification and punishable if kept secret. The courts

of the country perform a test called objective test in cases of directors having a conflict

of interest or exploiting their power and position. In this test the court assumes the


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position of a common man and looks at the director to see if he has acted solely to

benefit the company without any inclination to benefit him or his relations at the cost

of the company. Court will also take into account subjective elements while performing

this objective test. These subjective elements will include elements like experience,

judgement, skills etc. This is exactly what has happened in the Australian Centro case.

Every director according to the law is expected to have a

rudimentary knowledge of the business he is in. He need not know the ‘nitty gritties’ of

the business. He need not know the day to day activities of the business he is heading

but he is expected to have knowledge about the corporate affairs and mainly the

financial condition of the business. He is not expected to be an auditor but he is

thoroughly expected to have a questioning mind and view and should go through thereports and us his discretion before signing any document. He can rely on the advice

of professionals like engineers, auditors, accountants, lawyers but he cannot escape

the liability. He owns the responsibility for the information they provide. That is the

reason he should use his best judgement while choosing his advisors.

Directors are expected to avoid possible conflict of interest

to maximum extent .South African law states that when a director accepts a position

of responsibility on the board it is implicit that he places the company’s interest before

personal interest and this need not be stated separately. If there arises any conflict of

interest while taking any decision then he has no say in the decision regarding that

matter. Some personal interest state that before board and leave the meeting

immediately. Conflict of interest is to be taken by the directors very seriously and the

takeover regulation panel, company law and SEBI regulations are very strict regarding

these matters. Corporate opportunity as in directors using the opportunity personally

which otherwise would have been used by the company is very strictly handled by theregulations.


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References

1. Introduction to Company Law – Eleventh Edition by Avtar Singh

2. CONTRACT AND TRUST IN CORPORATE LAW: THE CASE OF CORPORATE

OPPORTUNITY' BY RICHARD A. EPSTEIN"

3. http://www.moneycontrol.com/news/market-edge/insider-trading-sebi-must-

knock-few-heads-to-drive-message_1233505.html

4. https://corporateinsiderstrading.wordpress.com/category/famous-cases/

5. International Journal of Business and Social Science Vol. 3 No. 2 [Special Issue –

January 2012] 21 Directors’ Duties and Liabilities – Where Are We Now and Where

Are We Going in the UK, Broader Commonwealth, and Internationally?

6. http://indiacorplaw.blogspot.sg/2013/09/remedies-against-directors-undue-

gains.html

7. http://indiacorplaw.blogspot.in/2014/06/director-liability-under-new-regime.html8. https://en.m.wikipedia.org/wiki/Unjust_enrichment

9. http://taxguru.in/company-law/directors-aware-duties-section-166-companies-act-

2013.html
http://www.moneycontrol.com/news/market-edge/insider-trading-sebi-must-knock-few-heads-to-drive-message_1233505.htmlhttp://www.moneycontrol.com/news/market-edge/insider-trading-sebi-must-knock-few-heads-to-drive-message_1233505.htmlhttp://www.moneycontrol.com/news/market-edge/insider-trading-sebi-must-knock-few-heads-to-drive-message_1233505.htmlhttp://www.moneycontrol.com/news/market-edge/insider-trading-sebi-must-knock-few-heads-to-drive-message_1233505.htmlhttps://corporateinsiderstrading.wordpress.com/category/famous-cases/https://corporateinsiderstrading.wordpress.com/category/famous-cases/http://indiacorplaw.blogspot.sg/2013/09/remedies-against-directors-undue-gains.htmlhttp://indiacorplaw.blogspot.sg/2013/09/remedies-against-directors-undue-gains.htmlhttp://indiacorplaw.blogspot.sg/2013/09/remedies-against-directors-undue-gains.htmlhttp://indiacorplaw.blogspot.sg/2013/09/remedies-against-directors-undue-gains.htmlhttp://indiacorplaw.blogspot.sg/2013/09/remedies-against-directors-undue-gains.htmlhttp://indiacorplaw.blogspot.in/2014/06/director-liability-under-new-regime.htmlhttps://en.m.wikipedia.org/wiki/Unjust_enrichmenthttps://en.m.wikipedia.org/wiki/Unjust_enrichmenthttp://taxguru.in/company-law/directors-aware-duties-section-166-companies-act-2013.htmlhttp://taxguru.in/company-law/directors-aware-duties-section-166-companies-act-2013.htmlhttp://taxguru.in/company-law/directors-aware-duties-section-166-companies-act-2013.htmlhttp://taxguru.in/company-law/directors-aware-duties-section-166-companies-act-2013.htmlhttp://taxguru.in/company-law/directors-aware-duties-section-166-companies-act-2013.htmlhttp://taxguru.in/company-law/directors-aware-duties-section-166-companies-act-2013.htmlhttp://taxguru.in/company-law/directors-aware-duties-section-166-companies-act-2013.htmlhttps://en.m.wikipedia.org/wiki/Unjust_enrichmenthttp://indiacorplaw.blogspot.in/2014/06/director-liability-under-new-regime.htmlhttp://indiacorplaw.blogspot.sg/2013/09/remedies-against-directors-undue-gains.htmlhttp://indiacorplaw.blogspot.sg/2013/09/remedies-against-directors-undue-gains.htmlhttps://corporateinsiderstrading.wordpress.com/category/famous-cases/http://www.moneycontrol.com/news/market-edge/insider-trading-sebi-must-knock-few-heads-to-drive-message_1233505.htmlhttp://www.moneycontrol.com/news/market-edge/insider-trading-sebi-must-knock-few-heads-to-drive-message_1233505.html

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