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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
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