Position of directors : a legal perspective

As discussed above, directors are the key managerial personnel of a company. By far, it is
very clear that a company, be it private or public, is required to appoint a director. They are
entrusted with the entire management of the affairs of the company, and the same is done in
accordance with prevailing laws. The role played by the directors in the corporate governance
of a company is very significant and crucial.

The term ‘director’ has been defined under Section 2(34) of the 2013 Act; however, the
definition fails to provide clarity pertaining to the exact meaning of the term, duties,
responsibilities, functions, etc. the director is supposed to perform.

Defining and explaining the position that a director holds is a complex and herculean task.
The reasoning is that it varies according to the context and circumstances. There are no
precise words that can explain the position that directors hold in any corporate enterprise.
However, attempts have been made by various courts to explain the position that a director
holds. Let’s take a look at a few important case laws wherein this subject has been dealt with.

In the case of Imperial Hydropathic Hotel Co. Blackpool v. Hampson (1883), the Court of
Appeal opined that the position that a director holds in a corporate body is very versatile.
Depending upon the circumstances and context, a director can be regarded as a trustee, an
agent, or a managing partner. It is pertinent to note that these terms are entirely indicative of
the various legal capacities that a director may hold in relation to a company.

While explaining the legal position a director holds, Justice Jessel M. R. In Re Forest of Dean
Coal Mining Ltd. Co. (1872), opined that “it does not matter much what you call them, so
long as you understand what their true position is, which is that they are merely commercial
men, managing a trading concern for the benefit of themselves and all other shareholders in
it.”
In the case of Albert Judah Judah v. Rampada Gupta And Anr. (1958), it was observed that
the directors are the persons appointed to manage the affairs of the companies that are
incorporated under the Companies Act. These are the ones whose appointments are done in
accordance with the prevailing law. The role that a director plays may vary from that of an
agent to that of a managing partner, a trustee, etc. However, one must understand that these
expressions are not meant to define the powers, functions, and duties conferred upon them
exhaustively. It is restrictive for the purpose of suggesting useful perspectives from which
they may be examined.

Section 152(1) of the 2013 Act provides that, in default and as per the contents of the Articles
of the Association of a company, the ones who are the subscribers of the Memorandum of
Association (provided they are individuals and not an association, enterprise, etc.) shall be
termed as directors. However, this shall only be applicable until the directors are duly
appointed according to the prevalent provisions and procedures provided in the Companies
Act.

Thus, from the above discussion, it is clear that the directors may sometimes act as an agent
of a company, whereas sometimes they act as trustees or managing partners. But one clear
thing is that they are indispensable organs of the company, responsible for the management of
affairs of the company.

A brief explanation of the various legal positions that a director may hold is as under;

Director as an agent

Put simply, a company is an artificial person, and thus it cannot function and work on its own.
Thus, a company needs someone to work for it and manage its affairs. So in this sense, the
director acts as the agent of the company for which they work. Hence, pursuant to this
proposition, the relationship between the director and the company is governed by the
principles of the law of agency.
The fact that directors also act as the agents of the company was also recognised by the
Scottish Court of Session in the case of Ferguson v. Wilson (1904). The court acknowledged
the fact that a corporation or a company, being an artificial person, cannot act on its own, and
hence the directors act as the agents of the company and manage the affairs of the company.
While considering this duty that a director is entrusted with, the court opined that the
relationship between a director and company is akin to the relationship that exists between a
principal and agent.

It is pertinent to note that, just as a director does not act as the trustee of the shareholders but
that of a company, similarly, the directors are not the agents of individual members but of the
institution as a whole.

The High Court of Delhi, in the case of Indian Overseas Bank v. RM Marketing (2001), held
that if a director has not given surety for a loan taken by the company in his personal
capacity, he cannot be solely held liable merely because he holds the directorship.

Director as trustee

Criminal litigation

It is pertinent to note that the directors are the trustees of the money of the company, which
they are duty-bound to handle as they act as agents in the transactions that are carried out on
behalf of the company. As the directors are entirely in control of the company’s funds in the
official capacity, which they are obligated to utilise and administer for the benefit and profit
of the company, in this sense, they can be regarded as the trustees of the company.

In a strictly literal interpretation, the directors have not been deemed trustees per se; however,
they are regarded as trustees of the company’s properties, which have been entrusted to their
hands. A similar proposition was laid down by the High Court of Madras in the case of
Ramaswamy Iyer v. Brahamayya & Co. (1965). In the aforesaid case, the court held that
directors can be held liable as trustees if they misuse the power conferred upon them or if
they disregard the power of applying the company’s funds. The court further went on to say
that even after the death of the accused director, the cause of action remains with the legal
representatives of the director.

It is pertinent to note that the reason behind treating directors as trustees is often due to the
nature of their office and the responsibilities that come with it. From the discussion we had in
previous paragraphs, one thing that is crystal clear is that the directors are bestowed with the
duty to manage and control the affairs of the company. However, it is noteworthy that the
directors are the company’s paid officers. They work for the benefit of the shareholders of the
company; they are not trustees in a literal sense. For instance, a trustee of a will or marriage is
entirely different from the role that the director plays as a trustee.

The Court of Justice, England, in the case of Percival v. Wright (1902), made it very clear
that the directors are the trustees of the company and not of the shareholders. This principle
was reiterated in the case of Bruce Peskin and another v. John Anderson (2000) by the Court
of Appeal of England and Wales. The court clarified that the directors hold no fiduciary duty
to the shareholders. Thus, even though the ultimate profit that a company makes goes to the
shareholders, it cannot be said that the directors are the trustees of the shareholders. They owe
their duty as trustees to the company.

Director as a managing partner

As the terms suggest, managing partner in a literal sense connotes the person who is
responsible for or who manages the day-to-day running of a company, enterprise, etc. Further,
as we have discussed, a director, before everything else, is the person responsible for the
management of the affairs of the company. Thus, his role as a managing partner needs no
explanation.

Furthermore, the shareholders’ will and their needs are entirely taken care of by the directors
of the company. They act as the agents of the shareholders’ and pursue their objectives. Also,
one must note that a director possesses extensive powers and exercises many proprietary
functions. The Article of the Association as well as the Memorandum of Association bestow
on the board of directors the ultimate authority to formulate policies and decisions for the
welfare of the company in accordance with the law.

Directors as an organ of the company

The transformation and evolution of the roles and responsibilities of modern-day corporate
entities, with time, have led to the emergence of a new theory called the ‘organic theory of
corporate life’. In terms of this theory, certain officials of the company are treated as the
organs of the company. As per this theory, the company is held liable for the actions of these
organs in a manner similar to the one where a natural person is held accountable for the
actions of his limbs. Put simply, in the modern era, the directors are much more than just
agents or trustees; they are often regarded as the organs of the company. Almost the entire
work of the corporate entities and companies is conducted by the directors and their
managerial personnel. They are conferred with enormous powers through the regulations
embodied in the Articles of Association. The courts in various judgements have opined that
the directors function like the brain of the company, and it is through the directors that the
company acts. The same observation was laid down by the Hon’ble Apex Court in the case of
the State Trading Corporation of India Ltd. and ors v. Commercial Tax Officer,
Visakhapatnam and ors. (1963). Powers of directors

Generally, the powers conferred upon the directors are expressly or otherwise outlined in the
Articles of Association of the company. Once these powers mentioned in articles are
delegated and vested in the Board of Directors, only they can exercise them. It is pertinent to
note that the shareholders cannot order or direct the board as to how the powers are to be
exercised. Provided, the board exercises these powers within the prescribed scope.

General powers vested under Section 179

Section 179 of the 2013 Act provides that the Board of Directors will be entrusted with all the
powers conferred upon them by the company. The board is entitled to exercise all the powers
that the company has authorised. However, it is pertinent to note that these powers are subject
to certain restrictions.
The powers of directors are co-extensive with the powers of the company itself. The director,
once appointed, has almost total power over the operations of the company.

There are two limitations on the exercise of the power of directors, which are as follows:

The board of directors is not competent to do the acts that the shareholders are required to do
in general meetings.

The powers of directors are to be exercised in accordance with the memorandum and articles.

The individual directors have powers only as prescribed by memorandum and articles.

The intervention of shareholders in exceptional cases

In the following exceptional situations, the general meeting is competent to act on matters
delegated to the board:

When directors have acted malafide.

When directors have due to some valid reason become incompetent to act.

The shareholders can intervene when directors are unwilling to act or there is a situation of
deadlock.

The general meetings of shareholders have the residuary powers of a company.

Powers to be exercised with general meeting approval

Section 180 of the 2013 Act mentions certain powers that can be exercised by the Board only
when they are approved in the general meeting:

To sell, lease, or otherwise dispose of the whole or any part of the company’s undertakings.

To invest otherwise in trust securities.

To borrow money for the purpose of the company

To give time or refrain the director from repayment of any debt.

When the director has breached the restrictions imposed under the sections, the title of lessee
or purchaser is affected unless he has acted in good faith along with due care and diligence.
This section does not apply to companies whose ordinary business involves the sale of
property or putting a property on lease.

Power to constitute an audit committee

Section 177 of the 2013 Act provides power to the board of directors to formulate an audit
committee. It is to be noted that the committee should be constituted of at least three
directors, including independent directors. Further, it is mandatory that the committee should
have independent directors in the majority. The chairperson and members of the audit
committee should be persons with the ability to read and understand the financial statements.

The audit committee is required to act in accordance with the terms of reference specified by
the board in writing.

Power to constitute nomination and remuneration committees and stakeholder relationship

committee

The Board of Directors can constitute the Nomination and Remuneration Committee and
Stakeholder Relationship Committee under Section 178 of the 2013 Act. The Nomination and
Remuneration Committee should consist of three or more non-executive directors out of
which one-half are required to be independent directors.

The Board can also constitute the Stakeholders Relationship Committee, where the board of
directors consists of more than one thousand shareholders, debenture holders, or any other
security holders. The grievances of the shareholders are required to be considered and
resolved by this committee.

Power to make a contribution to charitable or other funds

The Board of Directors of the company is empowered under Section 181 to contribute to
bona fide charitable and other funds. The prior permission of the company in a general
meeting is required when the aggregate amount of contribution, in any case, exceeds 5% of
the average net profit of the company for the immediately preceding financial years.

Power to make a political contribution

Under Section 182 of the 2013 Act, the companies can make a political contribution. The
company making a political contribution should not be other than a government company or a
company that has been in existence for less than three years.

Also, the amount of contribution should not exceed 7.5% of the company’s net profit in the
three immediately preceding financial years. The contribution needs to be sanctioned by a
resolution passed by the Board of Directors.

Power to contribute to the national defence fund

The Board of Directors is empowered to make contributions to the national defence Fund or
any other fund approved by the Central Government for the purpose of National Defence
under Section 183 of the 2013 Act. The amount of contribution can be the amount as much as
the company thinks fit. This total amount of contribution made is mandated to be revealed in
the profit and loss statement during the financial year to which it pertains.

Restrictions on powers under the statutory provision

The Companies Act 2013 also lays out the manner in which the powers of the company are to
be exercised. There are certain powers that can be exercised only when their resolution has
been passed at the board’s meetings. Those powers, such as the power:

To make calls.

To borrow money.
To issue funds for the company.

To grant loans or give guarantees.

To approve financial statements.

To diversify the business of the company.

To apply for amalgamation, merger, or reconstruction.

To take over a company or to acquire a controlling interest in another company.

The shareholders in a general meeting may impose restrictions on the exercise of these
powers.

General Duties of a director- Sec 166:

They owes their duties owing to the position and role that they have in the company

(1) Subject to the provisions of this Act, a director of a company shall act in accordance with
the MOA and articles of the company.

(2) A director of a company shall 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 the protection of environment.

(3) A director of a company shall exercise his duties with due and reasonable care, skill and
diligence and shall exercise independent judgment.

(4) A director of a company shall not involve in a situation in which s/he may have a direct or
indirect interest that conflicts, or possibly may conflict, with the interest of the company.

(5) 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.
Role of an auditor

Powers and duties of auditors and auditing standards

Powers

Right to access :

Every auditor of a company shall have right to access at all time to book of accounts and
vouchers of the company. The Auditor shall be entitled to require from officers of the
company such information and explanation as he may consider necessary for performance of
his duties.

There is an inclusive list of matter for which auditor shall seek information and explanation.
This list helps auditor to take special care on serious issues. The list includes issues related to:

(a) Proper security for Loan and advances,

(b) Transaction by book entries

(c) Sale of assets in securities in loss

(d) Loan and advances made shown as deposits,

(e) Personal expenses charged to revenue account

(f) Case received for share allotted for cash

The auditor of holding company also has same rights.

Auditor to sign audit reports :

The auditor of the company shall sign the auditor’s report or sign or certify any other
document of the company and financial transactions or matters, which have any adverse
effect on the functioning of the company mentioned in the auditor’s report shall be read
before the company in general meeting and shall be open to inspection by any member of the
company.

Auditor in general meeting:

It is a prime requirement under section 146, that the company must send all notices and
communication to the auditor, relating to any general meeting, and he shall attend the
meeting either through himself or through his representative, who shall also be an auditor.
Such auditor must be given reasonable opportunity to speak at the meeting on any part of the
business which concerns him as the auditor.

As per section 101, notice of general meeting must be given before 21 days either in writing
or through electronic mode to the auditor in such manner as may be prescribed. Every notice
of a meeting shall specify the place, date, day and the hour of the meeting and shall contain a
statement of the business to be transacted at such meeting.

Right to remuneration

The remuneration of the auditor of a company shall be fixed in its general meeting or in such
manner as may be determined therein. It must include the expenses, if any, incurred by the
auditor in connection with the audit of the company and any facility extended to him but does
not include any remuneration paid to him for any other service rendered by him at the request
of the company.
Consent of auditor

As per section 26, the company must mention in their prospectus the name, address and
consent of the auditors of the company.

Duties

Make report

The auditor shall make a report to the members of the company on accounts examined by him
on every financial statements.

The auditor report shall also state:

(a) Whether he has sought and obtained all the necessary information and explanations,

(b) Whether proper books of account have been kept,

(c) Whether company’s balance sheet and profit and loss account are in agreement with
books of accounts and returns,

(Refer to section 143 for detailed list)

Audit report of Government Company :

The auditor of the government company will be appointed by the Comptroller and Auditor-
General of India and such auditor shall act according to the directions given by them. He
must submit a report to them which should include the action taken by him and impact on
accounts and financial statement of the company.
The Comptroller and Audit – General of India shall within sixty days of receipt of the report
have right to (a) conduct a supplementary audit and (b) comment upon or supplement such
audit report.

The Comptroller and Audit – General of India may cause test audit to be conducted of the
accounts of such company.

Liable to pay damages

As per section 245, the depository and members of the company have right to file an
application before the tribunal if they are of the opinion that the management or conduct of
the affairs of the company are being conducted in a manner prejudicial to the interests of the
company

They also have right to claim damages or compensation from the auditor including audit firm
of the company for any improper or misleading statement of particulars made in his audit
report or for any fraudulent, unlawful or wrongful act or conduct.

Branch Audit :

Where a company has a branch office, the accounts of that office shall be audited either by
the auditor appointed for the company, or by any other person qualified for appointment as an
auditor of the company. The branch auditor shall prepare a report on the accounts of the
branch examined by him and send it to the auditor of the company who shall deal with it in
his report in such manner as he considers necessary.

Auditing Standards :
Every auditor shall comply with the auditing standards. The Central Government shall notify
these standards in consultation with National Financial reporting Authority. The government
may also notify that auditors’ report shall include a statement on such matters as notified.

Fraud Reporting :

If an auditor of a company, in the course of the performance of his duties as auditor, has
reason to believe that an offence involving fraud is being or has been committed against the
company by officers or employees of the company, he shall immediately report the matter to
the Central Government within such time and in such manner as may be prescribed.

Winding up

As per section 305, at the time of voluntary winding up of a company it is a mandatory

requirement that auditor should attach the copy of the audits of the company prepared by him.