V V Ranganathan: Directors on tenterhooks

The new UK law makes it easy for shareholders to sue directors for a much wider range of deeds than were possible earlier. The Indian law could well take inspiration from this.

Life for a company director is rapidly changing. The new sets of provisions in the latest UK Companies Act are bound to disrupt the life of directors. While the position in India is not as piquing, Indian courts are likely to be guided by the philosophies behind the new amendments in the UK in the absence of specific provisions under the Indian Companies Act 1956. Given the spate of M&A activities in the recent past, many directors from India who are on the board of companies in the UK have to be careful to understand the implications of the new amendments which have come in force from 1 October 2007.

The UK Companies Act has been thoroughly revamped and modernised. It took a good nine years to get the new law into shape. It is now the most comprehensive piece of legislation on companies and the single biggest statute in the UK's legal history. The new Companies Act has 1300 sections and 16 schedules, not to speak of the emerging regulations that are expected to follow soon. The new Act will become fully operational in 2008 while many sections dealing with Directors has become effective from 1 October 2007. Yes from this month onwards!

The new Companies Act has made several sweeping changes and is shareholder friendly. Some of the significant changes are to empower shareholders with new legal rights to proceed against directors, giving external auditors the option to negotiate with companies to limit their liabilities, doing away with restrictions on objects clause unless restricted by articles of association and companies are no more required to have an authorised share capital. But the most substantial changes are those relating to directors. For the first time the statute has set out the duties of directors as opposed to drawing inferences from case laws.

The seven statutory duties called General Duties of Directors enshrined in the UK Act (Sections 170 to 177) are

Duty to act within powers (Section 171)

Duty to promote the success of the company (Section 172)

Duty to exercise independent judgment (Section 173)

Duty to exercise reasonable care, skill, and diligence (Section 174)

Duty to avoid conflicts of interest (Section 175)

Duty not to accept benefits from third benefits (Section 176)

Duty to declare interest in proposed transaction or agreement (Section 177)

Section 170, while giving an introduction to the scope and nature of general duties of a director, categorically says "The general duties specified in sections 171 to 177 are owed by a director of a company to the company." It goes on to say "The general duties are based on certain common law rules and equitable principles as they apply in relation to directors and have effect in place of those rules and principles as regards the duties owed to a company by a director. The general duties shall be interpreted and applied in the same way as common law rules or equitable principles, and regard shall be had to the corresponding common law rules and equitable principles in interpreting and applying the general duties."

A quick glance at section 172, where the various duties to promote the success of the company are arrayed, duties such as having regard to the interests of the company's employees, the need to foster company's business relationships with suppliers, customers and others, the impact of the company's operations on the community and the environment, the desirability of the company maintaining a reputation for high standards of business conduct are conspicuous. These are not mission statements any more, but statutory responsibilities.

While these seven specific duties have brought clarity to the role and responsibilities of directors in the UK, what will be of great concern to them will be interpretations that courts are likely to make given the complexity and the dynamism of the interplay between these specific duties and common law principles. In India the duties of directors are under the various sections of the Indian Companies Act. But when you examine them, they are all mostly in the nature of activities that they are required to perform to comply with the law. Nothing like the seven duties listed above which are far-reaching in nature. In India the degree of due care and diligence by directors is to be inferred through section 212 of the Indian Contract Act that deals with skill and diligence required from an agent where as the new Section 174 says "skill and diligence that would be exercised by a reasonably diligent person with the general knowledge, skill and experience that the director has". This means that if a lawyer or an accountant sits on the board, then he or she is expected to function with the general knowledge, skill and experience that the director has.

In order to fortify the enforcement of law to ensure compliance of the new set of duties by directors, it has been made easy for shareholders in the UK to sue directors under section 260 on behalf of the company for a much wider range of deeds than are presently possible under common law. While shareholders have a "derivative claim" (meaning the right to proceed (a) in respect of a cause of action vested in the company, and (b) seeking relief on behalf of the company) the new procedure gives additional ammunition in their hands to sue directors in respect of an 'actual or proposed act or omission involving negligence, default, breach of duty or breach of trust by a director of the company' (S. 260(3)). It is immaterial if the cause of action arose before or after the person seeking to bring or continue the derivative claim became a member of the company. Also the shareholder need not establish that the director had benefited personally nor is it necessary that the said director controlled a majority stake in the company (fraud on minority).The new law however seeks to prevent the perils of frivolous claims by requiring courts to grant permissions to sue.

So is there a cause for worry for directors in India? If they are on the board of UK companies, then they better educate and equip themselves soon. Time is not far for enlightened companies in India to imbibe some of the better corporate governance cultures from the UK by voluntarily amending their articles of association to explain the duties of directors. After all, the Sarbanes Oxley in the US did not take much time to invade and pervade the globe. The Companies Act in India which is now just about half the size of the new UK Companies Act has been principally inspired by the old UK law. It is due for a thorough overall and the inspiration could still come from the new UK Act. After all they spent nine years to achieve this. Why reinvent the wheel?

To access previous articles written by the author on Directors please visit www.business-standard.com