BACKGROUND

The disclosure of interest by a director is a statutory duty arising out of distinctive position held by him. Such position does pose some ambiguity. It is very well possible that in the first instance even a director may not be able to give a clear reply about his legal position.

To understand this intricate subject one has to fall back upon the basics of the corporate existence, where and how the directors fit in, and a plethora of court judgements constituting precedent laws.

CLASSICAL MODEL OF COMPANY

A company under the companies’ jurisprudence is a legal and a juristic person, separate from its members. A company has independent corporate existence, limited liability, perpetual succession, common seal, capable of holding separate property in its own name, has transferable shares and capacity to sue and being sued. The most path breaking, prominent and well known case in this context is that of Solomon v Solomon & Co {1897} AC 22 {1895-9} ALL ER Rep 9 wherein it had been laid down that once a company is validly constituted under the provisions of the company law, it becomes a legal person separate from and capable of surviving beyond the lives of its members and it is immaterial whether any member has a large or small proportion of the shares and whether he holds those shares beneficially or as mere trustee. Manning, reviewing Livingstone’s “The American Stockholder” had stated that a company is an intricate, centralised, economic administrative structure run by professional managers who hire capital from the investor.

NEED FOR DIRECTORS

• Thus, a company is an artificial person, existing only in contemplation of law and has no physical existence and cannot act in its own person. It was held by court that a company has no mind or body of its own { Ref case : Lennard’s Carrying Co v. Asiatic Co, {1915} AC 705 at 713}, and therefore humans are required to run the company. They are the directors and collectively constitute the highest decision making body under the Companies Act known as Board of Directors.
• The word “director”, however in the wisdom of legislatures, has not been defined with any elaboration or clarity.
• In the new Companies Act 2013, a director has been defined in Section 2 {34} and means a director appointed to the Board of a company. In the erstwhile Companies Act 1956, the definition was also not comprehensively laid down, stating in section 2 {13} that a director includes any person occupying the position of director, by whatever name called.
• Thus it can be seen that the concept of director has undergone a change in the new Companies Act. As per the erstwhile Companies Act, a person would be a director if he is occupying the position of director by whatever name that position was called; usually he would be known as shadow director. Now, that has changed and his actual appointment to the Board is required to hold him as director.
• The directors are therefore appointed in terms of the company law who collectively work together as a Board through meetings, physically or through circulation or electronically. They do not have individual authority unless delegated by the Board through resolutions in terms of the company law. Or the director concerned is an executive director having powers through law and also by delegation.

POSITION OF DIRECTORS

There exist well established judicial precedents as well laws that the directors have fiduciary obligations and also duties to act reasonably and in the best interests of the companies where they hold such positions. Their duties emanate due to holding positions which may be synonymous to agents as well as trustees of their companies.

Directors as Agents

In view of the director occupying the position of an agent the general principles of agency would govern the relations of the director with the company and also govern the third parties who deal with the company through its directors. In Ferguson v. Wilson (1866) LR 2 Ch LR 77, the court had held that the company has no person, it can act only through directors and the case is, as regards those directors, merely the ordinary case of principal and agent.

Directors in Position of Trustees

In addition to the position of a director as an agent of his company, he is also considered as a trustee although not in the strict sense of the position. In Lands Allotment Co., Re, {1894} 1 Ch 616, 631, it was held that although the directors are not, properly speaking, trustees, yet they have always been considered and treated as trustees of money which comes to their hands or which are actually under their control and directors are held liable to make good monies which they have misapplied upon the same footing as if they were trustees. The Supreme Court had also recognised the fiduciary position of directors in the case of Chevalier I. I. Iyyappan v. Dharmodayan Co., Trichur , AIR 1966 SC 1017.

DUTIES OF DIRECTORS

• The Companies Act 2013 {new Act 2013} for the first time has laid down the duties of directors in unequivocal terms in section 166 in contrast to erstwhile Companies Act 1956.
• Section 166 states that subject to the provisions of Companies Act 2013, a director of a company shall act in accordance with the articles of the company; in good faith in order to promote the objects of the company for the benefit of its members as a whole, and in the best interests of the company, its employees, the shareholders, the community and for the protection of environment. He shall exercise his duties with due and reasonable care, skill and diligence and exercise independent judgment; shall not involve in a situation in which he may have a direct or indirect interest that conflicts, or possibly may conflict, with the interest of the company; 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. Lastly he shall not assign his office and any assignment so made shall be void.
• Before the enactment of section 166 aforesaid, there had already been judicial decisions pronounced over decades, laying down many fiduciary obligations and duties of directors as precedent laws. The Indian pronouncements had been under the erstwhile Companies Act/s.

Honesty

• In York and North Midland Railway Co v Hudson (1853)61 Beav 485: 22 LJ Ch 529 it was held that directors have been selected to manage the affairs of the company for the benefit of the shareholders. It is an office of trust which if they undertake; it is their duty to perform fully and entirely. Since the directors hold a fiduciary position of trust, the first and most obvious obligation is to act with honesty.

Good Faith

• The good faith would require that all the endeavours of the directors must be directed to the benefit of the company. { Ref case: Bank of Poona Ltd v. Narayandas , AIR 1961 Bom 252 at 253}. It was held that a director should not exploit to his own use the corporate opportunities. { Ref. case: Cook v. Deeks {1916} 1 AC 554}.

Care

• The directors also have a duty of care which should be reasonable care. He has to attend with due diligence and caution the work assigned to him. The duty of care is uniform for all directors. {Ref case : Jorchester Finance Co Ltd v. Stebbing 1989 BCLC 498 Ch D.}. However, courts had extended relief where the directors had acted in good faith although liability had been incurred. Thus he cannot be held liable for mere errors of judgement.

Diligence

• The Supreme Court in the case of Official Liquidator v. P.A. Tendolkar {1973} 43 Com cases 382, held that a director could be held liable for dereliction of duties if his negligence is of such character as to enable frauds to be committed and losses thereby incurred by the company.

Attending Board meetings

• Various other duties of a director would include duty to attend board meetings although he is not bound to attend all board meetings. In case of genuine reasons he can seek leave of absence from the Board. However, if there is regular absence from attending the board meetings, it could be held to be an act of negligence on the part of the director. { Ref case: Charitable Corpn. v Sutton{1742} 26 ER 642}

Delegation

• Another duty is that the director is not to delegate his functions and he is bound by the maxim delegatus non potest delegare. The shareholders have appointed the director because of their faith in his skills, competence and integrity and may not have same faith in another person. But there are many exceptions to this as delegation is permitted in terms of the company law and the articles of association. Moreover certain duties may having regard to the exigencies of business be properly left to some other responsible officers. Subsequent to delegation, the ordinary directors are in absence of features arousing suspicions are entitled to presume that the affairs of the company are being properly conducted. {Ref case: Ganesan v. Brahamaya & Co {1946} Comp LJ 262 Mad}.

Disclosure of Interest

• The director’s other duties would include duty to disclose interest to the company and to ensure that his personal interest as an agent of the company and the interest of the company which is the principal, do not conflict. {Ref case : Walchandnagar Industries v Ratanchand, AIR 1953 Bom 285}

DUTY OF DISCLOSURE OF INTEREST BY DIRECTORS UNDER SECTION 184 OF THE COMPANIES ACT 2013

• The contour of position and duties of Directors being clearly laid down, the legal position of disclosure of interest by them is discussed hereinafter.
• It is of prime importance that for ensuring proper functioning, a director should be disinterested in the transactions of the company or otherwise it is natural that his personal interest is likely to prevail. {Ref. case: Jackson, The Wisdom of Supreme Court , 417 -18 {1962}.
• The first step in this regard is the disclosure of interest by the director. It was held in the case of Coltness Iron Co , Re, 1951, SC 476 {Scotland} that the interest to be disclosed is that which in business sense might be regarded as influencing judgement; the essence of the matter being that any kind of personal interest which is material in the sense of not be insignificant must be revealed.
• In the case of Public Prosecutor v. T P Khaitan AIR 1957 Mad 4 it was held that the arrangement hit by sections is one in which the director has a personal interest conflicting with his duties towards the company and does not cover any case where there is no personal interest involved.
• In another case it was also held that interestcould be other than personal interest and not necessarily confined to pecuniary interest. {Ref case; Fateh Chand Kad v. Hindsons {Patiala} Ltd {1957} 27 Com cases 340}.
• Interestingly in the case of Mukkattukara Catholic Company Ltd v. M V. Thomas {1995} 6 SCL 135 it was held in respect of sections 299 & 300 of the erstwhile Companies Act 1956 that the word “interest” means personal interest and not official or other interest. However it is also not limited to financial interest only and may arise out of fiduciary duties or closeness of relationship

DISCLOSURE & TIMING

The sub section {1} of section 184 deals with the disclosure of interest to be made by the director. It lays down that every director is under an obligation to make disclosure of his:- {a} concern, or

{b} interest,

in any of the following entities:-

1. company or companies or
2. bodies corporate, or
3. firms, or
4. other association of individuals.

Pertinently the concern or interest shall also include his shareholding.

The disclosure shall be made in such a manner as may be prescribed by the Central Government. {Already prescribed under Rule 9 of the Companies (Meetings of Board & its Powers) Rules 2014} The timing of the disclosure, however, has been stipulated in the sub section itself. Thus the disclosure shall be made:-

1. at the first meeting of the Board of Directors in which he participates as a director, and
2. thereafter at the first meeting of the Board held in every financial year, or
3. whenever there is any change in the disclosures already made, then at the first Board meeting held after such change.

The first and foremost requirement is that the director should have concern or interest in any one or more of the entities where-after he is to disclose only at the board meetings as have been laid down. The terms “concern” or “interest” have not been defined although the term “interested director” have been defined in Section 2 {49}.

Pertinently mere disclosure of interest is not sufficient but the nature of concern or interest has to be disclosed. This was held in Turnbull v. West Riding Athletics Club Leeds Ltd 1894 WN4. This will adequately bring to light where the director has a conflict of his personal interest with that of his fiduciary duty as a director and protection of the company against such conflict.

The interest of the director may be direct or indirect, as laid down in next sub section.

DIRECTOR’S DIRECT/INDIRECT CONCERN/ INTEREST

The next sub section {2} of section 184 provides that every director who is in any way whether {a} directly, or {b} indirectly concerned or interested in the following:-

1. a contract or arrangement, or
2. a proposed contract or arrangement

which are {a} entered into, or {b} to be entered into by his company with certain specified entities, shall disclose the nature of his concern or interest at the Board meeting/s.

The use of the terms “in any way” “directly or indirectly” in the sub section is in line with the section 299 of the erstwhile Companies Act 1956, and denotes very wide coverage in all aspects.

The terms “concerned” or “interested” similarly have wide import. {Ref case: Firestone Tyre & Rubber Co .Ltd., v. Synthetics & Chemicals Ltd., {1970} 2 Comp LJ 200}.

Moreover, it is clear that not only concluded contract or arrangement is covered but also the proposed ones.

The provisions of entering into contract / arrangement {transactions} with certain specified entities and disclosure requirements have been discussed hereinafter.

Transactions with Specified entities I

(A) Contract/ arrangement with {1} a body corporate in which that director or he in association with any other director holds more than two per cent {2%} shareholding of that body corporate, or {2} that director is a promoter, manager, Chief Executive Officer {CEO} of that body corporate.

Interpretations

• The term “contract” would be governed by the Indian Contract Act 1872. The term “arrangement” has not been defined. This however has been used in various places in the Companies Act 2013. It appears here along with “contract” and in Chapter XV of the Companies Act 2013 relating to compromises, arrangements and amalgamations wherein arrangement includes a reorganisation of the company’s share capital. But this does not help in interpretation in this provision. In any case “arrangement” should be read in a wider context comparable to “contract” the effect of which is to give rise to legal rights and liabilities.
• In the case of Seth Mohanlal v Grain Chambers Ltd, AIR 1959 All 276 it was held that the word contract or arrangement is intended to cover transactions in which a director acquires some right or incurs some liability “qua” director, as a result of it.
• The term “association” has not been defined and should be understood in common parlance to mean some controlling connections between the directors which could arise out of blood relations or otherwise. Interestingly if a relative of a director or such relative in association with any other director hold/s more than 2% shareholding, the said director will not be covered herein.
• The term “body corporate” has been used here instead of the term ‘company”. The body corporate has been defined in Section 2{11} of the Companies Act 2013 to include a company incorporated outside India, thereby widening the coverage of the disclosure requirements.
• The use of the term “shareholding” has widened the coverage to take into account equity or preference shares. The word “share” has been defined in Section 2{84} to mean a share in the share capital of the company and includes stock. Notably the term “securities” in terms of section 2{81} has not been used here otherwise very wide coverage would have happened as the definition of “securities” in section 2 {h} of the Securities Contracts {Regulation} Act 1956 would have been invoked.
• It may be significant to note here that if the concerned director of the company is a promoter , manager or CEO of the other body corporate , then there is no need for holding any shares in that body corporate to invoke these provisions .

Transactions with Specified entities II

(B) Contract/Arrangement with a firm or other entity in which, such director is a partner, owner or member, as the case may be.

The term “firm” mentioned here ostensibly denotes a partnership firm under the Partnership Act 1932, but the term “other entity” is meant to widen the coverage of this provision. Such entities could be a Society, Hindu Undivided family or a sole propriety concern.Here only the director is covered and not his relatives for invocation of these provisions.

Disclosure at the Board meeting/ voting/ quorum

• This sub section {2} further mandates that the director shall disclose the nature of his concern or interest at the meeting of the Board of Directors in which the contract or arrangement is discussed. He is however, not permitted to participate in such meeting. Consequently, he cannot vote which is to ensure that he will not be allowed to influence and swing the decision process at the board proceedings in his favour.
• It may be worth noting here that in case the transaction is with a related party he cannot be present at the Board meeting in terms of Rule 15{2} of the Companies {Meetings of Board and its Powers} Rules 2104. Since the transaction envisaged in this section will generally constitute with related party it appears irrational that where a director cannot be present in the meeting what is the further need to prohibit him to participate in that meeting. Moreover, in terms of section 174{3} of the Companies Act 2013 he shall be an interested director for which his presence shall not be counted for quorum. But then, where he cannot be present in the meeting in terms of said Rule 15{2} for his related party transaction, what is the further need to provide that he is not counted for quorum.

Subsequent concern/interest.

This sub section also stipulates by way of proviso that where any director who is not so concerned or interested at the time of entering into such contract or arrangement, but subsequently if he becomes concerned or interested after the contract or arrangement is entered into, he is required to disclose his concern or interest, forthwith, when he becomes concerned or interested, to the company. Alternatively, he needs to disclose at the first meeting of the Board held after he becomes so concerned or interested.

VOIDABLE AT OPTION OF COMPANY

The next sub section {3} provides for a situation where there is non compliance of subsection {2} with regard to disclosure by the interested director or where there is participation by the interested director in the contract or arrangement in which he is interested. It lays down that a contract or arrangement entered into by the company with such non compliance shall be voidable at the option of the company. In such a situation, the company has the option to either avoid the said contract or arrangement or confirm and validate it. { Ref case: Amritsar Rayon & Silk Mills Ltd v. Amirchand Saideh {1988} 64 Comp cases 762 { P & H}.

CONTRAVENTION

• This penultimate sub section {4} stipulates about contravention. If the director contravenes the provisions of sub-section (1) or subsection (2), he shall be punishable with imprisonment for a term which may extend to one year or with fine which shall not be less than fifty thousand rupees but which may extend to one lakh rupees, or with both. This sub section makes it clear that the onus of compliance is on the director and for any contravention he is liable. As far as the company is concerned there is no liability and it has the option to validate the offending contract or arrangement in terms of sub section {3}. In case it does not validate the same, the contract or arrangement, becoming invalid thereby, cannot be proceeded with.
• Noteworthy is the position that as per section 167{1}{c} of the new Act 2013 a contravention shall result in office of the concerned director becoming vacant.

EXEMPTIONS

As per clause {a} of last sub section {5} , no provision of this Section shall be taken to prejudice the operation of any rule of law restricting a director of a company from having any concern or interest in any contract or arrangement with the company. Hence a director cannot argue that by complying with this Section he can by-pass any other law which also restricts him in this regard.

This clause {b} states that nothing in this Section shall apply to any contract or arrangement entered into or to be entered into between two companies:-

1. where any of the directors of the one company or two or more of them together
2. hold/s not more than two per cent {2%} of the paid-up share capital in the other company.

This exemption is in line with section 299 {6} of the erstwhile Companies Act and is the touch stone as to whether this Section 184 applies or not.

But this is only limited to contract or arrangement between two companies only, and, shareholdings of the directors are merely taken into account and not shareholding of their relatives or other entities. This could be a loophole giving unintended exemptions where although the shareholdings of concerned directors are below the threshold limit but their relatives’/ entities’ shareholdings are beyond the said limit; still the exemption is available.

CONCLUSION

Disclosure of interest by directors can be termed as the most critical commencement of the process of carrying out of statutory duties by them and goes a long way in establishing corporate governance by avoiding conflict of interest. It should be followed by all directors at all times in letter and spirit.